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

Good afternoon, everyone. I guess good afternoon bordering on good evening. Thanks for joining us on the aerospace defense track here at the JPMorgan Industrials Conference for 2021. And we are going to wrap up the aerospace defense track tonight with Spirit AeroSystems. And I'm very grateful to have Mark Suchinski here, CFO. And he's going to speak with us for a little while about the company. Mark, maybe I'll hand it over to you kind of for a brief introduction, and then we'll get into some Q&A.

Sounds great, Seth. And good afternoon to you, and good afternoon to everybody that's on the virtual call here. Let me first start with a quick safe harbor statement. I need to remind everyone that any projections or goals we may include today in our discussion are likely to involve risks, which are detailed in our news release and our SEC filings. Sorry, we had to take care of that business first. Just some opening comments. Obviously, 2020 was a really challenging year for commercial aerospace, for Spirit in particular with our heavy concentration on the 737 MAX dual challenges of the grounding of the MAX and COVID that hit earlier last year. We feel like we reacted fairly quickly. We first started with right-sizing the business to the lower levels of production. Production deliveries were down more than 50% in 2020. We also took quick actions to address liquidity. That was a really important factor as I stepped into this job to make sure that we had adequate liquidity to run the business during the lower levels of production. At that time, there was a lot of uncertainty as it related to the length of the downturn in the industry, and that still is a big question mark today. In addition to that, not only did we rightsize the business and address our cost structure by attacking our nonlabor base of about $1 billion. We focused on liquidity. But we also didn't forget investing in the business, investing in the future. So we spent a lot of time working on productivity initiatives, automation in the factory. We know that there will be a recovery. People will fly. It's not a matter of if. It's going to be when. And so we know single-aisle rates will recover over the next couple of years, and Spirit needs to be in a situation where we can take advantage of those higher levels of production. So we focused on really improving the business, the productivity, a lot of digitization, automation, to help improve our factory during future rate of recovery. We also focused on diversification in 2020. We were dealing with lower rates of production on the commercial side. But we did the FMI acquisition in January of 2020. It's a defense -- small defense company that focuses on hypersonics, in missiles, in space. We're really happy to have them part of the Spirit family. It's opened up quite a few doors on the defense side for Spirit. In addition to that, we closed on the Bombardier acquisition in October, Belfast site, Morocco and Dallas. With -- it was our biggest acquisition since we acquired Prestwick, Scotland in March of 2006, added to our Airbus content and added to aftermarket and to business jets. And so it really hit the mark on our strategic initiatives as it relates to diversification. As we look forward into 2021, there's still a lot of uncertainty. Airlines are starting to recover now. I would say I feel more confident about our production rates in 2021 than I did just 60 days ago. Traveling -- travelers, there's more travelers being accounted for through the TSA. We're hearing some airlines stating that potentially March could be a breakeven cash flow. And so first and foremost, for our business to recover, we need people to travel. We need people to be comfortable with travel. And that starts with vaccinating and lowering the COVID situation that we have in the marketplace. Once people get comfortable to travel, that will help the airlines. If the airlines are financially healthy to order more aircraft, Boeing and Airbus, that will help us. We think the recovery will first start with narrow bodies. It will start with domestic travel, regional travel. More than 80% of our backlog is single-aisle aircraft like 737, A320. And so I think that positions Spirit well as things recover. There are rays of sunshine here. We're seeing the virus really slow. We're not out of woods yet. We still have to stay vigilant on fighting the virus, get people vaccinated. But we see some good signs here. The Biden administration has done a good job of getting the vaccinations out. We're starting to see more people travel and get more comfortable. And so we're feeling more confident in the recovery in the back half of this year. We feel more confident that single-aisle production rates will start to increase as we move into 2022. We're also focused. Again, 2021 is diversification, delevering and driving improvements in our profitability. And so the acquisitions check the mark under diversification. We talked to on our fourth quarter earnings call around delevering. We started that with paying off our June $300 million floating rate notes. We paid those off. We've redeemed those in February of this year. And we see a line of sight to paying down roughly $1 billion of debt over the next 3 years, either with cash on our balance sheet and cash flow that we expect to start to generate in 2022. And that will move our leverage down. We'll get back to more like investment-grade credit metrics like we were in 2018 and 2019. And then we're going to continue to focus on how do we drive improvements in our business, execute productivity improvements, supply chain enhancements to drive to our targeted margins of 16.5%. And we think that when we get out in 2023 and we're at the low rates of production in the 40s on 737 and higher on A320, that we think that we're going to put ourselves in a good position to achieve those types of margins and get back to generating the type of earnings and cash flow that you saw from Spirit back in 2018 and 2019. Over to you, Seth.

Excellent. Thanks, Mark. And I think you kind of addressed a few of my questions in those remarks there. But maybe I'll ask some of them anyway in a little bit more abbreviated way just to kind of dig in further and emphasize the points, I guess, on 737, which is probably first and foremost on people's minds. And you mentioned on the earnings call that the company is producing at about 10 a month and, I think, expressed an intention to be building at a higher rate before the end of the year. And so I wonder if you could -- it sounds like it's increasing, but if you could characterize your level of confidence that, that 737 production rate for Spirit is going to be beyond 10 a month by the end of the year. And is -- that confidence level, has it changed year-to-date? Is it -- basically has it risen year-to-date, if it is indeed there?

As we mentioned in our 10-K, we expect 737 deliveries to be about double from 2020. And in 2020, we delivered 79 737s. So we expect to double that this year. It's -- our production plan is synced up with Boeing. I would say starting the year, there was still quite a bit of uncertainty as we saw the market unfolding. Boeing is working hard to deliver out of their inventory and stock. And that's their primary focus. But we know that there's a demand out there, and they'll continue to produce new aircraft. So I would say we're getting close to the end of the first quarter. We're mid-March. Our production plans are on track. We started the year at 10 aircraft per month. We're staying on track. I'm more confident than ever that our production plans of delivering roughly twice as many 737s in 2021 is going to occur. We've seen travel recover. We've seen Boeing achieve some nice orders on 737 MAX over the last several weeks. Boeing continued to reiterate on their fourth quarter earnings call, they expect to go to 31 aircraft per month on the 37 in the early part of 2022. And so I think our production system is synced up with theirs. And I'm gaining more confidence on production rates in 2021. It's a long-cycle business for us to adjust our rates. It's about a 4 to 6-month time frame from a lead time standpoint. And so we've got a good line of sight to the next rate increase in the middle of the year and then one towards later this year that will allow us to achieve the deliveries of roughly 160 this year. And based on what we're seeing and what we've delivered so far, I think we're in good shape to hit those deliveries in 2021.

Excellent. That's good color and that's helpful. When we think about -- I know it's been a difficult, difficult year in terms of workforce. And when you think about having some of the work come back and having some of the workforce come back, what's the production level where you need to start bringing more people on? And how are you preparing for -- it's probably -- it's different than going to a new high rate that you've never gone to before, but these are still significant percentage increases in production. And so how do you prepare for that to make sure that you're ready for those increases?

Well, I think there's -- one thing to remember, we are tooled up and capitalized to 57 aircraft per month on the 737, 60 a month on A320. So one difference from now to where we were before was we are tooled and capitalized and ready to produce at higher rates. The other advantage that we have as we think about increasing production rate is today, we're going to be delivering essentially all 737 MAXs, whereas in 2017 and '18, we were delivering a combination of NGs and MAXs. So it's one model running down the production line. We're also benefiting from the fact that we'll be able to recall workers that previously worked on the 737 production line as we go back up in rate. They have familiarity with aerospace work and production work on the line. We'll have to have them trained. We're going to bring people in 60 to 90 days ahead of time to get them trained up and recertified. So we have one lever we can pull from our workforce that has been laid off as part of our workforce reductions. But we're also taking advantage of moving some workers from -- as 787 is going -- went from 10 a month down to 5 a month, we have some ability to move some workers from one program to another, right, to keep our folks employed, to keep production stable and to have some level of consistency as it relates to production rates. So we're taking advantage of moving some folks around from the twin-aisle programs that are going down in rate over to 737 as we need to ramp up in rate. And so right now, we're starting to move people from 87 over to 37. We're starting the hiring process on 37, the recall process where we have some folks that are in training to get ready for the next rate ramp. And so we're confident enough at the next rate break that we're bringing our folks back and getting them trained up and ready for the next rate break. In addition to those internal efforts, we're spending a lot of time with our supply base, rate readiness reviews. We're reviewing our critical suppliers to make sure that they're ready as the market starts to recover. They've been challenged just like we have on reducing their workforce. Many of them have inventory and stock. They've been overstocked. And so we're spending quite a bit of time of valuing our critical suppliers, making sure that, in some instances, we have dual sourcing in place, making sure that our internal fabrication organization could step in, in case a supplier went down. I think it's really important that as we go back up in rate, that we do it -- execute flawlessly. [ Low levels ] of overtime. We've been there before. We bring back the folks. We train them. We stay in sync with the supply chain -- our supply chain, making sure that raw material is ordered, our suppliers are bringing their employees back. And so we're spending a lot of time not only on our factory to make sure we're ready for the rate ramp but also making sure that our suppliers are prepared to deal with the production rate increases that we expect to occur later this year and into 2022.

Right. Okay. And then when we think about the inventory of fuselages in Wichita but owned by Boeing, there's probably -- I guess there's probably about 100 excess versus the -- versus what you would want to have there. How do we think about that inventory coming down? Is that something that happens, let's say, over the course of 2021 and maybe through the first half of 2022 and then you feel like you'll be set in that regard?

Yes. I mean what we've said previously is that we expect to burn that -- those additional units down by about the middle of next year, give or take. And so really, as the rate ramp starts to occur, our production system will lag volumes by about 5 aircraft per month until we sync up with them around the middle of next year. And so the middle of next year, we'll be synced up with Boeing's production, and then our suppliers will be synced up with us. And so it's going to take about 18 months or so for us to get the 2 production systems in alignment. But we're sitting at around 130. That's what we said in our earnings release. We're probably going need 20 or 25 in buffer. So we have about, as you said, about 100 that need to burn off. As our production increases, we should lag only just a little bit. So when Boeing hits 31 aircraft per month in the early part of '22, which is what they've indicated in the earnings call, the fourth quarter earnings call, we'll be probably in the 26 to 28 range, lagging them just a little bit. And so we expect that our production system and theirs to kind of sync up in the middle half of 2022.

Right. Okay. Okay. And then will we start to see those -- so I guess should we expect by sort of the next -- the next reporting period, we'll start to see those excess inventory sort of burn down and see that happen during -- all kind of consistently throughout 2021 here? Or is it something that happens more later on?

It will start to occur in the latter half of the second quarter, and you'll really start to see it come home in the third and fourth quarter of this year.

Okay. Cool. Okay. I guess you guys highlighted the $1 billion of cost takeout that you've done over the past year or so. And I wonder, how much of that would you classify as kind of variable cost versus how much is fixed cost?

Well, production rates dropped dramatically last year, right? And so we saw well over a 50% reduction in production rates between 2020 and 2019. So the first area that we attacked was variable costs. Obviously, we talked to labor folks. We had to reduce our workforce to the lower levels of production. And then all of the nonlabor costs that were variable in conjunction with that. But we really didn't stop there. We looked at holistically our fixed cost structure. We looked at -- we're closing 2 sites, one in San Antonio and one in McAlester, Oklahoma. It's about 500 employees. That work will be transferred to Wichita and to Oklahoma. And so we'll be able to absorb that work in our current infrastructure. So we'll be able to remove the utilities, property taxes, insurance, all the fixed costs that come with managing a site. And so those are some permanent fixed costs that we're going to maintain as we move forward to higher levels of production. But we also attacked -- did some reorganization. We combined our supply chain organization and our fabrication organization, renamed it make-buy. There's a lot of synergies by going to do that. We've looked at back-office functions. We've looked at our management spans and layers and really trying to optimize our cost structure. And so we're going to have to be very disciplined, fiduciary disciplined. As production rates go back up, you have the tendency to add. And so we need to continue with our vigilance on maintaining our low-cost structure. We have to add back to support production, but the areas that we've taken advantage of, we have to maintain those benefits in the higher levels of production. That is one lever that's going to help us get to the 16.5% margins. And our internal targets are to get greater than that, right? Our team is challenged to achieve margins in the 2023 time frame in excess of 16.5%. And so the factory improvements, the automation, the digitization, the leaning of the factory, the fixed cost takeout that we have, all -- we all believe that all of those things that we've done here and we'll continue to do in 2021 will allow us to get back to 16.5% margins at lower rates of production that maybe we could have historically.

Right. Okay. Excellent. Well, let's move on to the other platforms looking beyond the 737. And so for A350, where should we think about the production rate where Spirit can be cash flow positive on A350?

Well, we were just starting to turn the corner on A350, both from a Section 15 and a fixed leading edge at 10 a month. We were moving into the zone of profitability, cash flow generation on that program. Our Kinston site is facilitized up to 13 aircraft per month. And so there's a -- it's a heavily automated factory. And so there's a lot of fixed costs that are in the Kinston site. Airbus has indicated 4 to 5 aircraft per month on the A350 this year. We know that the twin aisle airplane programs are going to lag. Narrow body is on the recovery. I would say we don't need to see a lot of lift on the A350 production rate to get back to cash flow positive if we exclude kind of the noncash depreciation. So if we see a little bit of lift over the next couple of years, in the 6 to 7 range, we've got a good shot at being cash flow positive. But we're also taking a look at that factory. Is there some additional work that we can put into Kinston to help absorb some of that overhead and share the fixed cost structure? And so some opportunities to put some good work in there to take advantage of the factory and the automation that's there. That should also help us, I think, accelerate our ability to get back to cash flow positive on the A350 program. And so we're looking at how do we fill up the factory, knowing that it's going to take some time for A350 to recover from a production rate standpoint.

Yes. Okay. That makes sense. And I guess if we move on to 777. And we think about that rate coming down to something in the 2 a month range, but it's a place where the company has had good profitable content historically. And so is that a place where you can still be profitable and earn a decent margin even at that low rate?

777 has always been a very good, mature, strong program for us margin-wise. I think if you go back to 2015, 2016, we were at 8 aircraft per month. It was a really good revenue and earnings contributor. I would say at 2 aircraft per month based on the maturity, it's still a good program for us. Obviously, there's a lot less revenue that comes associated with that, but it's still margin -- double-digit plus margins. It's cash flow positive. And so we're excited to support Boeing as they certify the 777X program. And I think we're going to be fine with the 777 program at 2 or 3 aircraft per month. And we're supporting Boeing. We got our fingers crossed on the certification in 2023. And if we see the twin-aisle rates recover in '24 and '25, that will be a good contributor to our diversified plan when we get to the middle of the decade.

Yes. Excellent. Let's -- maybe let's move on. We can talk about the Bombardier structures acquisition. So I think that's pretty interesting. I guess first of all, if we think about what's contributing there, is it fair to think that of the $700 million of sales that you guys have talked about for that acquisition this year, maybe a little more than half of that is from the A220 and maybe a little less than half is from everything else? Is that a rough -- a good rough estimate?

I would say in 2021, probably around 40% is A220, maybe a little more. 60% is aftermarket and business jets.