Spirit AeroSystems : Q1 2024 Spirit AeroSystems Holdings, Inc. Earnings Conference Call Transcript

Corrected Transcript

07-May-2024

Spirit AeroSystems Holdings, Inc. (SPR)

Q1 2024 Earnings Call

CORPORATE PARTICIPANTS

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OTHER PARTICIPANTS

MANAGEMENT DISCUSSION SECTION

Operator: Good morning, ladies and gentlemen, and welcome to the Spirit AeroSystems Holdings, Inc. First Quarter 2024 Earnings Conference Call. My name is Candice and I will be your coordinator for today's call. All lines have been placed on mute during the presentation portion of the call with an opportunity for question-and- answer at the end. [Operator Instructions]

I would now like to turn this presentation over to Ryan Avey, Senior Director, Investor Relations and FP&A (sic) [Director, Investor Relations] (00:00:32). Please proceed.

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Ryan Avey

Director-Investor Relations, Spirit AeroSystems Holdings, Inc.

Thank you, and good morning, everyone. I'm Ryan Avey. And with me today are Spirit's, President and Chief Executive Officer, Pat Shanahan; and Senior Vice President and Chief Financial Officer, Mark Suchinski.

Before we begin, I need to remind you that any projections or goals we may include in our discussion today are likely to involve risks, including those detailed in our earnings release and our SEC filings and in the forward- looking statement at the end of this web presentation. In addition, we refer you to our earnings release and presentation for disclosures and reconciliation of non-GAAP measures we use when discussing our results.

With that, I would like to turn the call over to Pat.

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Patrick M. Shanahan

President, Chief Executive Officer & Director, Spirit AeroSystems Holdings, Inc.

Thank you, Ryan, and good morning, everyone. Let me say at the outset that I am so proud of the Spirit team and particularly proud of what we've accomplished through teamwork. I love this industry, our customers and the people that work in it. And we set out every day to make the industrial system better while ensuring safety, quality and compliance in the supply of our products and services.

For Spirit, the primary objectives of stabilizing operations, delivering on our customer commitments and strengthening our company financially have not changed. We are laser-focused and continue to make real progress towards these objectives.

Spirit AeroSystems is a critical component of a global network of engineers, manufacturers, customers and governments that comprise the aerospace industry. In that context, I'm going to frame our ongoing efforts.

Demand for commercial air travel remains robust and firm. Our collective responsibility at Spirit is to match capacity and capability, short- and long-term. It is a responsibility that defines the company and is at the core of our commitment to our customers. So as the industry prepares to ramp up production, we are diligently working across the industrial system to ensure we possess and demonstrate the capability to deliver on our commitments.

Before moving to other topics, I would like to address talks with the Boeing Company about a possible acquisition. At the beginning of March, we responded to media speculation by confirming that we are in discussions with Boeing. Those discussions continue. And as all of you understand, I am not at liberty to comment further. When and if we have something to disclose, we'll make an announcement.

At our last earnings call, I spoke about Spirit's rapid response in support of the FAA, NTSB, airlines and Boeing resulting from the Alaska Air accident. Those actions concentrated on mitigating human factors by improving mechanic proficiency, compliance, mistake proofing and observation. Those systemic changes continue to take root as our foundational relationship with safety and quality matures. Building on that foundation of improvement, we've expanded our actions to strengthen leadership, product conformity and governance.

In terms of leadership, Gregg Brown has joined our team as SVP for Global Quality. Gregg is an airline operator and airline safety and quality expert and authority in the management of the FAA's Safety Management System. He most recently was the Vice President of Technical Operations at JetBlue. Gregg possesses expertise for Airbus and Boeing products, having served in the industry and at Southwest Airlines for almost four decades.

Steps to strengthen product conformity have been significant. The decision was made to fundamentally change the inspection process. This change aligns Spirit and Boeing efforts into a joint inspection. Partnering with Boeing, this transformative undertaking was industrialized in 34 days. Today, working shoulder to shoulder with a standardized 26 zone product verification process, the teams verify product conformity on the 737. Each week, the process improves in tandem with quality results being fed back to the teams working in station.

Ultimately, our goal is not to streamline this operation, but to move it further upstream to where the work is performed. In the interim, utilizing end-to-end digital feedback and analytics, we are accelerating the quality improvements initiated in the first quarter.

With critical new building blocks, process changes and insight, we have further reexamined governance. Breakthrough performance in safety and quality will be realized and sustained if teams at the point of production own their operations. We are moving from the office to the factory floor. We're enabling integrated product teams composed of quality assurance, manufacturing engineering, factory operations, supplier management and the customer. This form of governance, which is not new to our industry provides the requisite authorities, resources, inspiration and motivation that unlocks discretionary effort. This change in governance is early stage but has the greatest potential.

Now, I will provide context on cash usage for the quarter. As Boeing mentioned on their call, they deliberately slowed 737 production below 38 per month to incorporate improvements to quality and safety management systems, including reducing traveled work and addressing supplier non-conformances. The inspection process changed by Boeing, in effect paused our ability to receive payment for completed fuselages.

The implementation of the product verification required that we inspect all the fuselages stored in ship-in-place utilizing the new conformity process. This represents a total of 54 ship-in-place units that needed to flow through the newly established process beginning March 1. In the quarter, we produced 89 units and delivered 44 units prior to implementing the new process. The result was an increase of 45 fuselages to our work in process.

To offset the lack of payment but recognizing the completion of fuselages, Boeing advanced Spirit $425 million to be repaid in the third quarter as the production system returns to equilibrium. We appreciate greatly Boeing's support operationally and financially as we strengthen the industrial system.

Boeing is also modifying 787 deliveries due to supply chain challenges. Mark will provide additional detail, however, with the 737 production rate currently at 31 airplanes per month and 787 deliveries approximately 25% below original plans, we will make near-term adjustments to our supply chain to ensure optimal levels of inventory and rate capability.

We are closely coordinating with our supplier partners to mitigate the short-term disruption. Our intent is to quickly resynchronize the industrial system, whilst still balancing the capacity and capability to snapback to future production rate increases. The Spirit team is focused on driving our safety and quality efforts, synchronizing supplier partner operations and aligning to meet our commitments to defense customers, Airbus and Boeing.

Turning to Airbus. As we've discussed on earning calls over the past year, we've been attempting to reach a commercial agreement in the best interest of both companies. These conversations have yet to result in an agreement. As a result of this impasse and the continued pressure on meeting the delivery targets demanded by the rapid rate in the Airbus A350 and A220 programs, we booked significant losses this quarter, including net incremental losses for anticipated performance obligations extending beyond 2026.

The strain on the supply chain being experienced by Spirit and other suppliers is both commercial and an operational risk. We have risen to the challenge thus far and we'll continue to work with Airbus to ensure that quality and safety remain the foremost considerations.

And to close. While it's not been the focus of my opening remarks today, I want to highlight the strong performance of the Defense and Aftermarket teams. They continued to execute day in and day out and are performing to their commitments operationally and financially.

With that, let me turn the call over to Mark, who will take you through the financials before we open up the call to Q&A. Mark?

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Mark J. Suchinski

Senior Vice President & Chief Financial Officer, Spirit AeroSystems Holdings, Inc.

Thank you, Pat, and good morning, everyone. As Pat covered in his opening remarks, there have been a number of events that have occurred since our last earnings call. I want to discuss the financial impacts of these items before getting into the first quarter results.

First, the implementation of Boeing's product verification process on the 737 program, including moving inspections and rework teams from Renton to Wichita, while no longer allowing travel work. This has been a collaborative effort to enhance quality and eliminate rework, but consequently has created delayed delivery acceptance in our factories, which has led to the build-up of undelivered units, higher levels of inventory, in contract assets and lower cash flow.

We are working with Boeing to mitigate the slowdown resulting from the process changes. And despite the slow start, we are seeing signs of improvement. And in the long-term, expect the benefit to be more synchronized with our customers inspection process. Over the next few quarters, we expect to have our production systems aligned and built up units delivered.

Additionally, we have incurred factory and supply chain costs that were incurred to align with the higher 737 production rate, which has now been delayed. Our current rate is approximately 31 aircraft per month and we now expect to remain at the lower than planned rate throughout the rest of the year.

Similarly, on the 787 program, we are now anticipating delivering approximately 55 units during 2024, down from our original plan of approximately 80. All of these items will have a negative impact on cash flow throughout the year, but I want you to know that we are strongly focused on liquidity and actions to improve our current position.

Now, let me take you through the details of our first quarter financial results. So, let's move to slide number 2. Revenue for the quarter was $1.7 billion, up 19% from the first quarter of 2023. The year-over-year improvement was primarily due to higher production on our commercial programs and increased Defense & Space revenues.

Overall deliveries in the quarter decreased 11% year-over-year as a result of fewer deliveries recorded on the 737 program, due to the reasons I described in my opening remarks. The in-process and completed 737 fuselages that have not been through the new source inspection process are recorded as contract assets and not counted towards our shipset deliveries until accepted. The overtime accounting revenue recognition on these units has been reflected in our quarterly financial results.

Now, let's turn our attention to EPS. We reported earnings per share of a negative $5.31, compared to negative $2.68 in the first quarter of 2023. Excluding certain items, adjusted EPS was negative $3.93, compared to negative $1.69 in the prior year.

Operating margin was lower compared to the same period of 2023, largely driven by higher unfavorable changes in estimates during the first quarter of 2024. First quarter, net forward losses were $495 million and unfavorable cumulative catch-up adjustments were $39 million. This is compared to $110 million of forward losses and $12 million on unfavorable cumulative catch-up adjustment in the first quarter of 2023.

The current quarter forward losses were primarily driven by A350 and A220 programs of $281 million and $167 million respectively. I know these are large losses, but are really due to the inability to reach a conclusion to commercial negotiations with Airbus and as a result, we were required to adjust our assumptions and record forward losses on the A220 and A350 programs, which drove $373 million of total losses. This includes forward losses through 2025, our current accounting contract, as well as losses for anticipated performance obligations beyond 2026. The remainder of the forward losses were result of production cost growth and additional firm orders.

Additionally, the 787 program drove $34 million of forward losses due to supply chain and labor cost growth to support future higher production rates. The unfavorable cumulative catch-up adjustments primarily related to increased 737 costs, associated with the product verification process changes, which caused delayed delivery acceptances and a significant build-up of undelivered units in Wichita.

Now turning to free cash flow. Free cash flow usage for the quarter was $444 million, compared to free cash flow usage of $69 million in the first quarter of 2023. Primarily caused by disruption to the 737 production and delivery delay experienced in the period.

Having a large number of unbilled 737 units built during the first quarter, had a significant negative impact on our first quarter free cash flow. Once these units can be fully inspected under the new product verification process, they will be considered delivered and we can collect the cash earned on those units. The prior year, free cash flow reflects $180 million surplus cash payment received related to the termination of the Pension Value Plan A.

Now with that, let's turn to our cash and debt balances on slide 3. We ended the quarter with $352 million of cash, which reflects the unfavorable impacts of the disruption experienced on the 737 production and delivery process.

We ended the quarter with $4.1 billion of debt. In April, we entered into an MOA with Boeing to provide cash advances totaling $425 million. These funds were used to address Spirit's high levels of inventory and contract assets, lower operational cash flows, decreased deliveries, and higher factory costs, attributed to the change in the product verification process, and the FAA's imposition of limitations on the Boeing increased production rates.

This advance will be reflected in the second quarter financial results and will be treated as financing activity on the statement of cash flows. As I mentioned in my remarks, we are strongly focused on liquidity and are working plans to improve our current position.

Next, let's discuss our quarterly segment performance along with the Commercial segment on slide 4. Even with the 737 disruption impacts, commercial revenue increased compared to the same period of 2023, primarily due to higher production across most of our programs.

Quarterly operating margin decreased, compared to the first quarter of 2023, primarily driven by higher changes in estimates recorded in the current period. These changes in estimates included net forward losses of $494 million, which were largely driven by the change in assumptions on our conversations with Airbus and unfavorable accumulative catch-up adjustments of $39 million. In comparison, during the first quarter of 2023, the segment recorded charges of $110 million of forward losses and $11 million of unfavorable cumulative catch-up adjustments.

Next, let's turn to Defense & Space segment on slide 5. We are especially pleased with the performance by the Defense & Space teams this quarter. Revenue grew to $251 million due to higher activity on development and classified programs, as well as the Sikorsky CH-53K and FLRAA programs.

Operating margin of 13% in the first quarter increased compared to the same period of 2023, primarily due to higher classified program activities and strong execution by the team.

For Aftermarket segment results, let's now turn to slide 6. Aftermarket had another solid quarter with revenue of $96 million up slightly over the prior year, primarily due to higher spare parts sales. Operating margin in the first quarter of 2024 decreased compared to the first quarter of 2023, primarily due to lower MRO activity during the current period.

With that, we will be happy to take your questions.