Spirit AeroSystems Holdings, Inc. (SPR) Earnings Call Transcript & Summary

Okay. I think we are live. So I'm just going to get started. It's Rob Spingarn at Crédit Suisse and I want to welcome Spirit AeroSystems. Today, we have Tom Gentile, Chief Executive Officer; and Mark Suchinski, Chief Financial Officer. Thank you both for joining us.

Thanks, Rob.

Great to have Spirit here. In a minute, I'm going to turn it over to Tom to get started. But I want to remind our audience that I will be asking questions, but I'm happy to ask your questions, too. So please e-mail me at my robert.spingarn@credit-suisse e-mail address. And I think that's displayed somewhere, hopefully. And I'll ask your questions anonymously. And so with that, it's great to have Spirit here, especially given the current environment and the demands on your time. I know investors are keen to hear the latest developments at Spirit, Tom. So I thought maybe we'd start with some opening remarks.

All right. Thanks, Rob, and good afternoon, everybody. Great to be here, even though it's virtual. Before we start, I would like to just readout safe harbor statement. I need to remind everybody that any projections or goals that we include in the discussion today are likely to involve risks, which are detailed in our news releases and our SEC filings. So with that, I thought I would give you an overview of our current situation. This has obviously been a very challenging year for Spirit. Now back in December 2019, after the second crash, we only had suspended deliveries of the MAX, but then in December, when it still had not been recertified, they actually suspended production. Now we have been building at a rate of 52 per month. And Boeing has been building at 42 per month, since the second crash. And that was obviously a big deal for Spirit. In 2019, we delivered 606 737 MAX units to Boeing. And we built 70% of the structure represented half of our revenue. So when it suspended production, it led to some significant consequences. We were downgraded. We immediately had to start taking actions to renegotiate our bank covenants, and we had to really adjust to a lower level of production. And we had that more or less stabilized. We had agreed to produce 216 units in 2020. But then when the pandemic hit in March, things deteriorated even more. It wasn't just the MAX. It was all of the Boeing programs and all the Airbus programs. So we saw our production levels drop by 45% in total in 2020. In Q3, our revenues were down 58%, and our cash flow went from $723 million in 2019, to this year, it will be a usage of $800,000 to $900,000. So a significant change. So we started taking actions to address that. First thing we did is we cut costs to align to the lower levels of production. We took 8,000 heads out of our commercial aerospace group, that represented about 44% of the total headcount. We also cut our executive salaries by 20% and we put our salaried employees on 4-day work weeks through the end of the year. We also started to close facilities, get out of leases. We cut our indirect costs. It took out about $1 billion of costs that represented 40% or so of our nonmaterial base. So we aligned our cost to lower levels of production. Second thing we did is we had to reserve liquidity. The good news is we came into the year with just over $2 billion of cash on our balance sheet, but we have a lot of obligations, a couple of acquisitions to close. So we started taking some pretty severe actions. We suspended our share repurchase. We cut our dividend to just 1% -- $0.01. We cut our capital expenditures in half to $125 million. We deferred advanced repayments to Boeing of $123 million. We were able to negotiate an advance from Boeing of $225 million. We're also able to raise $2.1 billion in new capital, bonds. The first set was at 7.5%. The second tranche was at 5.5%. The second tranche was 9x oversubscribed. So there was good acceptance. We used some of that money to pay off all of our bank loan and cancel our credit facility, our revolving credit facility. And what that did is it got us out of some restricted covenants to give us a lot more flexibility. So at the end of Q3, our Q3 pro forma cash balance was $2 billion. Our cash burn in Q3 was $71 million. So at this point, we have more than 20 quarters of cash on our balance sheet. We also have taken actions to continue to diversify our business. If anything, that the pandemic and the MAX crisis showed us was overconcentration was not good. So the acquisition of Bombardier, which we did go ahead and complete, but had a $225 million discount, really accelerated our transformation, gave us more Airbus content. We have the whole wing. It's a composite wing on the A220. We also have more business jet content, more aftermarket content, it more than doubles our aftermarket content. And we also can do more defense work. Our dependent business last year grew 20%. Next year, we expect it will grow 15%. We've got a lot of good programs that are getting into their production phase. We've also won a lot of new work with the open commercial capacity that we have. So next year, Boeing will represent 45% of our revenue, Airbus 25%, defense 15%; and business jets and aftermarket, 8% each. So we're a much more diversified company. We've also taken advantage of the slower period of production to drive productivity. We've invested a lot in digitization, automation, robotics on the factory floor. We've changed our factory flows. So we'll be more efficient coming out of this. We'll be able to produce at the same levels with fewer heads and at lower cost than we could before. And then finally, we're really working hard on our culture. This has been a dramatic period for Spirit. We've taken 45% of our workforce out. A lot of people are still working from home. So we're putting a lot of focus on safety and health and quality and also on diversity inclusion. With all the events in the country this year, it's something that we need to do, and we're working very closely with our entire team to be a more diverse and inclusive company. So although it's been a big challenge this year, we feel we're in a good position. Our backlog is still $40 billion for an 8-year of production. And with the pandemic, we're seeing domestic travel recover first. The China and Russia are already back to the same level they were in 2019. We'll see the same in Europe and North America. That's in a favor of narrow-body aircraft. 85% of our backlog units are narrow-body, the MAX, the A320 and now the A220. So that really positions us well. We've cut costs, as I've said, to align with the lower levels of production. We've stabilized our liquidity position. And with the more content we have on all the major programs Boeing and Airbus and defense primes, we feel that Spirit is very well positioned for the future. So Rob, we can go to questions now.

That's great. Thank you so much, Tom, for that overview. Again, anybody wants to send a question to me, please do. I'm going to start kind of high level, if that's okay, Tom. And just touch on the pandemic and some -- build on some of what you just said. If we were to think about this in a baseball analogy, with any one being last February, March, when this whole thing started at least on a global basis, and with full recovery being inning 9. So -- where do you feel that we are at this point in recovery curve? I'm not talking chronologically. I'm talking about the...

It would put us -- and I would be a little bit bold here, but I'm going to put us in the fourth inning. And the reason is really because the MAX has been recertified by the FAA. Brazil has recertify it. The ASTRA has said they're going to recertify it probably in January and Transport Canada, looks like they're close. China, we still don't know yet. But the fact that the MAX is recertified by the FAA, I think it's a very big event for the industry, the whole industry. Because there was a huge disruption before the pandemic. Now we know for sure that it's safe to fly. And it's going to start coming back. We'll start to see deliveries probably before the end of the year. Now there's still a great deal of uncertainty because of the pandemic. But again, some good news even this morning, with the Pfizer vaccine approved in the U.K., truly on the verge of approval in the U.S. The Moderna vaccine is approved, there's the Oxford vaccine, [indiscernible]. So what was really very speculative before, it now looks like those vaccines are going to be here even sooner than we thought, which is good as it will help restore confidence in travel, and we should see domestic travel recover, the narrow-body production and then eventually, international travel and wide-body production. So I would say the fourth inning. We're through the top, early innings. We're not quite the halfway point yet because the vaccines are approved, and we don't see travel yet, but the big uncertainty is behind us. And I think that's a good thing.

And then just while we're on this baseball thing, and maybe this is for you, Tom or for Mark, do we get to -- where in all of that, would we be cash flow positive?

Well, we said we'd be cash flow positive in 2022. So as I mentioned, our cash burn in Q1 this year was $560 million. In Q2, it was $260 million, in Q3 was $71 million. Next year, we've said that it should be a little bit better. We don't have the working capital drain that we had early in this year, because production stopped so quickly. A lot of our purchases just kept flowing in. So we've built up working capital. We'll start to burn that off next year. So instead of being a headwind, working capital next year is a tailwind. And then we also expect the MAX production and the A320 production to go up next year. And so that will help. We had a little bit of headwind from the twin aisles, particularly the 787, the A350 and 777, but that should be offset by the 737. So next year, even if the cap turns a little bit more than $70 million a quarter, it's going to be between $300 million and $400 million. We have $130 million pension payment to make next year. But on top of that, we're going to have a cash tax benefit. From the CARES Act, we're able to take our operating loss from this year and carry it back 5 years at the, then, prevailing tax rates of 35% and recover that. So we think that will be about $300 million. So cash next year should be pretty good. By the fourth quarter, we hope to be cash flow positive and net cash flow positive in 2022. By the point -- by the time we get there, I'd say we're in the 6th or 7th inning. Because production rates should be starting to creep back up on the narrow-bodies. Revenues should be flowing in. We think we'll be back to our target margin levels of 16% to 16.5% by the time we get to the MAX at a rate of the 40 aircraft per month.

Let's just talk a little bit about rate visibility. You touched -- you alluded to this earlier, but where -- on MAX, where you are at present? What kind of slope you're thinking about now? And also with the other programs, especially given the fact that 87, at least right now, is going down.

Right. So on the MAX, we're right now at about 7 per month. We're -- this year, we're going to deliver 72 units to Boeing, and we've got about 20 more to go for the quarter. So that's where we are right now, 7 aircraft per month. We're going up to 10 in January. Now what Boeing has said is they're going to be at 31 by the beginning of 2022. What we have said is we're going to lag that by about 5 a month to burn off the inventory we have here in Wichita. We've got about 130 units here at our store. Boeing has already paid us for those. So it's on their balance sheet, but we need to burn that off. And we'll burn that off at about 5 per month, and we expect by the middle to the end of 2022, we'll have that down to about 20 or 25 units. We'll keep that as a permanent buffer to cushion the production system. So that's really the situation on the 737. On the A320, the Airbus narrow-body, we're at 40 per month right now. And Airbus has asked us to protect 47 in the back half of the year. And they think they'll go up to 47, probably in the October time frame, and we're ready for that. And the good thing is we've got all the tooling, the capital and the infrastructure is already in place for the MAX for 57 a month, because that's where we were back in March of 2019. And for the A320, we're already just capitalized up to 63 a month. So that's good. And on the MAX, when we were going up in rate for 2016, we were still converting from the NG. We had increased our first MAX unit until June of 2017. And we were 100% MAXs by January of 2019. So we were making a big conversion while we were going up a grade. And while we were putting in place capital and tooling and infrastructure. Now all of those things are done. We're 100% MAXs. Got all the infrastructure, the capital and the tooling. So it should be easy. We need to recall the people. We need to get them retrained. We need to make sure the material orders and the supply chain are functioning. But this time, it should be easier to go up a grade. Now on the 787, we were at 14 per month, then that dropped to 12, we are at 10 right now, that's going to 6. So that's going to be some headwind for next year. The 777 if you go back to 2016, we were at 8.3 units per month. And then we were at 5 -- really, the last year, we were kind of between 3 and 5. Right now, we're at 2. And we expect that's going to continue into 2022 or 2023. And then the A350, we were at 10, and that's dropped now to about 6, may perhaps a little bit less when you take into account their holidays and furloughs. So the twin aisles next year are going to be a bit of headwind. The single aisles should be a positive if they hold to the schedules that they're currently at.

Just on the 777, if the 777X gets pushed sufficiently to the right, between COVID and demand and certification. And they -- and you produce through the remaining backlog on the classic, which, I guess, right now is freighters. That 2 per month, I guess, there -- if you have downside there at 2 per month, how significant is that to the company?

Well, we've already taken that into account, and we can offset it. So when we say we'll be at 15.5% margins when we get into the 40s on the MAX, it's taking into account that the 777 is at 2, which is much lower than it was back in 2016. And you're right, there's a lot of demand for freighters right now with all this -- the online ordering people are doing, plus the delivery of the vaccines, there's a shortage of freighters. And if anything, we could see some additional orders of the 777 and 767 freighter. And on Airbus, they've got their own freighters with the A330. So that's one positive part of the industry. We haven't seen the orders come through yet, but that's certainly a possibility and something Boeing has alerted us to be ready for.

Okay. Just quickly on the MAX, and then I am getting some questions in from the e-mail. So I'm going to go to those. But in terms of the production on Max, how have things -- how have you been able to change things for the positive during this time you've had over the past year to look for efficiencies and improvements I mean we know that you've improved the cost structure, but is there any way you can color that a little bit for us or elaborate what that -- what the factory is going to look like when you're producing again going forward?

Right. Well, as I said, we've got a lot of digitization and automation and process flow improvement. Let me give you a few examples. One is our warehousing. So right now, we had 500,000 square feet of warehousing across our campus in Wichita in 5 or 6 different buildings. We've consolidated all of that through what we call a global digital logistics center. So it's 1 building, 150,000 square feet, 7 stories high, and we have a fully automated warehousing system. It's called the Dematic system. It's the same one that Amazon uses as their big warehouses. Fully automated and digitized, and we can pick and store all automated, so much more productive, and then we can distribute it to our factory floor. We've installed a lot of workflow tools, digitization tools. We've been put in place new MES systems to the factory floor. We've also put in more processes, we call it, Floorsight, which digitizes all of the factory flows across the floor. And all of our management operating system status boards are all now digital on the factory floor. In addition, we're automating some of our simple assemblies, like floor being production. This is always very manual. We've got now a complete digitized, automated system for that. We work with actually an automotive company that is used to high-grade digitization and automation. And we put that in place. That comes online really just by the end of this month in November. So we're very excited about that. Another thing we've done is we're streamlining the flow in our main factory for the 737 MAX. So some of the sub assemblies like the wing box, or the 4 peak slots in the cap were all done in that main factory. What we're doing is we're taking those out of the main factory and putting them in other facilities on our campus in a more lean flow, so that we can streamline the production process in the main plant. So those are a few of the examples of things that we're doing that are going to really dramatically improve the productivity of the production process. And so when we come back in rate, we won't need as many people, there'll be more automation, and they'll be better quality.

And if you ever get back to 52 or 57, I imagine, with that kind of flow with the things you've done, you'd be at higher margins than before.

We could be -- and I always say you have to run fast to stand still in this industry because there's pressures on material and labor and Boeing and Airbus are always very demanding, let's say. But [indiscernible] on our program like the 737 is we've got our pricing lined up all the way to 2033 with Boeing and it's indexed to rate from 0, all the way to 70 aircraft per month. So right now, when the rates are low, we get a higher price. When the rates go back up in the future, the price will come down. But it's all indexed from 0 to 70 and it's set out to 2033. So it's a very solid contractual relationship with Boeing. We're pleased with that.

And then just briefly, on the 87 (sic) [ 787 ], given how automated it is, is it fair to characterize that as having smaller decrementals as volumes drop again? I understand the sliding pricing. But just again, I've been in the facility, very, very automated. Are the margins less volatile there as rate moves both down and then back up?

Yes. Well, I'll let Mark explain that because the 787 is a little bit more complicated situation because it's in a forward loss position. So Mark, could you explain that part a bit?