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

Okay. Awesome. Well, good afternoon, everybody. This is Noah Poponak here from Goldman Sachs Aerospace and Defense Equity Research. Very happy to have with us our next presenting company, [ from our hi-tech groups ] , Spirit Aerosystems. With us from the company is Tom Gentile, the CEO of the company. Tom, thanks so much for joining us today. We really appreciate it.

No, it's great to be here. And before we get started with Q&A, I do have a safe harbor statement. So just want to remind everybody that any projections or goals that we may discuss today could involve risks, which are detailed in our news releases and our SEC filings. And then just to maybe give a little bit of a prelude. Last year, obviously, was a very difficult one for Spirit. With the dual crisis of the MAX grounding and also the pandemic, we saw overall about 60% reduction in our deliveries. Our revenue went from $8 billion in 2019 to $3.4 billion in 2020. So we obviously had to take a lot of aggressive actions to address that, that situation. First thing is we had to keep our employees safe. We worked right through the pandemic, continuing to deliver aircraft to our commercial [ mid-size ] customers, and we were able to do that. We also had reduced cost at the lower levels of production. And we ended up taking out about 8,000 people out of our commercial aerospace workers, and that was about 45% of the total. We ended up taking about $1 billion of cost out on an annualized basis. We also stabilized liquidity. We raised $2.1 billion in new capital of the bond market. We canceled the acquisition of Asco. We reduced capital expenditures. We were able to get an advance from our largest customer. So we took a number of actions to stabilize liquidity. We did end up the year at $2 billion in cash on hand. So we were pleased with that. We continued to invest in productivity and innovation on our factory floor so that when rates do come back, we can be more productive. We also continued to diversify. And the pandemic showed us is we were too concentrated in certain sectors. So we did complete the acquisition of the Bombardier aerostructure assets. And that gave us more Airbus content, more aftermarket content, more defense content. So this year, in fact, our Boeing revenue, our Boeing share of our revenue was about 46%, Airbus is 27%, Defense is 18% and business jets and aftermarket are both about 8%. So those are the things we did last year. The good news is, this year, we are starting to see some recovery in narrow-body aircraft, which mostly serves domestic travel. We are seeing domestic travel recover. China has more or less recovered to pre-pandemic levels. In the U.S., we're seeing 1.6 million people pass through TSA checkpoints. So that's about 65% [ back ]. Europe is still lagging, but that's good. The MAX has -- had been recertified. And so this year, we're going to produce about 160 MAX units versus only 71 last year. By comparison, pre-pandemic in 2019, we produced 606. So we still have a ways before we get back, but we are starting to increase. In fact, we've even started to recall some of the workers that we laid off in Wichita. And our cash flow for this year in terms of our cash usage, we see it to be about $200 million to $300 million. And that's after the cash tax benefit, but much less than last year when we had a cash usage of $870 million. Now wide-body production is going to lag. International traffic with [ widebodies here ] is still more than 90% down to pre-pandemic levels. So it's going to take a while, probably 18 to 24 months at least for wide-body production to catch up. One thing that we are doing is we are repurposing some of our wide-body capacity to defense, and that will help us grow our defense business. So last year, defense grew for us 18%. This year, it will grow about 15%. We see it being $1 billion by the mid-2020s at normal defense margins. We're also growing our aftermarket business. The acquisition with Bombardier more than doubled our aftermarket assets, and we see it being a $500 million business by 2025 at accretive margins. And we did a couple of small deals. We added a company called Applied Aerodynamics , which does radome repairs. And then we also did a JV with EGAT in Taiwan. So we will have Airbus repairs, Boeing repairs and now radome repairs in Europe, in the U.S. and in Asia with that JV. So the aftermarket business is really set up for growth. And all these things will really put us on track for being cash flow positive in 2022. So that's just a quick introduction to where we are at Spirit AeroSystems. So Noah, we can go to Q&A.

Yes, that's great. Thanks for that, Tom. That helps level set us here. If anyone in the audience has questions, you could send that through the screen, instructions there, and I'll be happy to pass them on to Tom.

Tom, maybe circling back to the MAX, it's a tricky situation with the numbers where Boeing has a delivery number, which consists of what they're producing and then what they're unwinding out of their inventory of built but not delivered. Then Spirit is producing but also unwinding its own inventory of built but not delivered to Boeing. And so help us think through the progression for Spirit of how much you're going to build versus how much you're going to unwind from inventory as you progress through this year into next year and when you ultimately link up with Boeing.

Right. Well, we've got 130 units of inventory ships that's come at Spirit. And that includes fuselages, slats and flaps, [indiscernible] and thrust reversers. Those are owned by Boeing. So that's Boeing's inventory, but we're storing it on their behalf here. But when we talk about 160 units or so to produce this year, that's what we're producing, that's new production. Boeing is going to deliver more than that this year because they have their own units that they're delivering. They built 450 during the grounding period, which they did not deliver. So they'll be delivering those. But our view is when we say 160, that's new production for Spirit. Now our plan is, and Boeing's plan, we'll lag there because they're going to be producing new units as well during this time. But we'll lag them by about 5 or so per month, and we'll burn down the inventory that's here in Wichita. And the plan right now is by the middle to the end of next year, that inventory -- it's about 130 units right now, that will be down to around 20 units, which will be about -- which will become a permanent buffer for the production system going forward. So that's how we see this unwinding over the next couple of years. And then once we get to that point, we will sync up with Boeing, so we'll both be producing new aircraft at the same rate.

So the 130 was the number at the end of 2020? So that -- you didn't -- none of that was unwound incrementally during the first quarter?

No. I mean, it's -- we build new ones and deliver them. And so we managed to keep it about steady. But it should start to unwind now. The plan with Boeing was going to go ahead of us in their production rate and start to burn down starting right about now through the summer.

Okay. So you'll lag Boeing, 160 divided by 12, low to mid-teens average per month through the year. So you'll lag Boeing as they get to 31. And then assuming they go higher, you'll lag for a few quarters while they go higher. And then, as you said, in the middle or back half of 2022, when you're down to your buffer stock of 20 chipsets, you would then link up to Boeing.

Right. That's kind of the current trajectory that we have in place.

And so that would imply that, if you're trailing Boeing to 31, if 42 is a break that's going to happen at some point or 52 is a break that's going to happen at some point, even if it takes 3, 4, 5 years to get there, which I know at some point Boeing had a plan to get there in the not terribly distant future, we know what the A320 numbers are, my point is -- or my question is, it implies that you would have pretty fast growth on the MAX beyond second half '22 once you've linked up to Boeing because they'll still be going higher and you'll kind of be down here with 30 to 40 to 50, especially if you're lagging them. It implies a pretty fast growth rate in sort of 2 years from today to 5 years from today.

That's correct. Yes. I mean it's -- if they keep on the trajectory that they've kind of indicated, that's absolutely the case is we'll see a very high growth rate on the MAX as we will on A320. Airbus wants to get that back up as well. Now the good news is, is we're much better prepared this time going up in rate than we were, say, from 2016, 2019. For one thing, we're not shifting models. Back in 2016, we were 100% NG, and we were still producing NGs all the way up to 2019. Right, at the beginning of 2019 is when we switched to 100% MAXes. But we're 100% MAXes now. All the capital is in place, all the infrastructure, all the tooling. We already had all the workers here and trained them, how they played off. We've played them off. We have to recall them, but they've already been trained once. So that will be a slightly easier process. And we've also made a lot of improvements to the factory since 2019. We did a tie to a lot of things. We've gotten a lot of automation. We've changed the flow. We've moved some things around. So we're in much better shape to go up in rate for the next 3 years than we were back in 2016.

Okay. That's interesting. So I'll ask a few more things on the production rates on the top line, and then I want to explore those -- I want to explore that preparation and the implication margins a little further. On the earnings call, you mentioned on the A350 some variability in the pull from Airbus relative to their stated production rate. The [ 787 ] obviously has had the volatility that it's had. What is -- what are you thinking on the widebody side? I mean is it -- does that mean it's just kind of worse than we all think because of the lack of cross-border travel? Or is this kind of just normal when you're moving the rate around to have this degree [ that you're going ]?

I mean, it's typical, let's say. It's not unusual for the OEMs to move the rate around, without changing the headline rate. They might say I'm producing it, bye, but then they might -- if they have a furlough or an extended lead, they end up producing fewer aircraft, and so they take numbers out of the system. And so we -- I think it was 8 or 9 units that came out of this year or next year. That was what we talked about on the call. And that's not atypical. But this -- I mean, but there is softness in the wide-body market right now just because international travel hasn't picked up, and there's some uncertainty around that. But we expect it will pick up, and then that will normalize. So that's where we are. But again, we do think that widebody's production rates are going to be lower for longer. And so we are using some of that capacity, which is open right now to lead the benchwork, and we've been successful with that. And so that will help us absorb some of the fixed costs that we have for A350 and 787. So even if they never go back to the same rates that they were in the past, we can still achieve some of the margin targets that we have because we'll be able to absorb some of that fixed cost with the benchwork.

That's interesting. You can flow the new work you're going after. That's full addition, new addition to the business. You can flow that into the capacity that was previously used for widebodies if they're at lower rates.

Right. Well, because if you think about composite production, you need an automated fiber placement machines, autoclaves, trim and drill, auto fastening, nondestructive inspection. Those are very expensive pieces of capital. We have all that available. And right now, it's open. And so we've been able to repurpose that for defense. And that's actually helped us win some defense business, and that will also help absorb some of the fixed costs in those production facilities for A350 and 787.

Interesting. Maybe spend a little bit more time on the drivers behind your goals in defense. How do you get there?

Well, first of all, we -- one program's in a number of areas, and those are starting to enter into their production basis. So if you think about -- first of all, on military, we got the military derivatives for Boeing commercial aircraft. So the P8 is a version of the 737 MAX -- NG. And the P8 is a surveillance reconnaissance aircraft for the Navy. Then the KC-46, the tanker, that's a version of the 767. So we have our normal work packages on those. In addition, we want to work on other programs. So for example, we're 1 of 7 suppliers that was named through the B-21 Raider bomber program. That's obviously a very significant program for the Air Force. That's right now in the development phase. So it will get into low rate initial production and then full rate production. We're also making the whole fuselage for the CH-53K heavy lift helicopter for the marines. That is right now in low rate of initial production, LRIP, and it's going to go into high rate full production in the next couple of years. So with the programs that we're on, just as they get into their production basis, we see that $0.5 billion to $1 billion by the mid-2020s, and then we've also won some additional work with classified programs that will also help us get to that number. So we have high level of confidence in achieving that $1 billion by the mid-20s just because of the programs that we're on. We also see an opportunity to expand. So as you may recall, we made an acquisition of FMI in the beginning of 2020, which makes us really the leader in 3D woven carbon-carbon, which is used for flight control surfaces and high-temperature applications like hypersonic missiles. So we see hypersonic missiles, space, attritable aircraft as natural defense plays and adjacencies for Spirit that we can enter based on our current capabilities.

So it sounds like the $1 billion is based off -- almost entirely on programs already won and secured and that you can just keep growing that from there with new wins, which you are looking at.

Yes, correct.

Interesting. Okay. And then maybe kind of similar discussion on your aftermarket aspirations, the $500 million target you have there. I mean is that really current platforms you're on, just capturing all the aftermarket you think you should and can on those programs? Or is it expanding the aperture into original equipment positions you do not have gaining the aftermarket related to [ us ]?

No, we can get there with the programs that we have. So as I was saying before, historically, we always did Boeing repairs on mostly on things like thrust reversers, nacelles, inlets, flight control surfaces. When we acquired Bombardier, we inherited a whole bunch of similar work but on Airbus programs. They do nacelles and thrust reversers and inlets and flight control surfaces but for Airbus, and they have big operations in Belfast. So what we did first is we've cross-pollinated. We put Boeing repairs in Belfast. We brought the Airbus repairs here. The next thing we did is we acquired this company called Applied Aerodynamics, which does radome repairs and landing gear doors. So we've been able to now put those repairs in the U.S. and in Europe. Then this joint venture that we just announced with EGAT in Taiwan gives us an Asian footprint. And we did put Airbus repairers, Boeing repairers and radome repairers now in Asia. So it's with that footprint in the 3 different geographies with the range of repairs that we do that can get us to the $500 million. That's just a straight trajectory of where we are. It's not a backlog per se, but it's doing those repairs in those locations gets us to that level of revenue.

Okay. So that's interesting with regard to the visibility behind those targets. Let's move over to your profit margins and cash flow. You've discussed this $1 billion annualized cost number. Can you help frame for us how much of that is structural versus cyclical or variable?

Well, a lot of it is, of course, variable because it's direct labor that went out. That will come back as rates go up. And then even some of the indirect labor is associated with rates, quality inspectors, the Asian engineers, support staff for the factory. So a lot of it is variable. But there's some fixed amount. So we -- as you know, or as you may recall we closed some of our facilities in San Antonio and McAlester, Oklahoma. So some fixed cost, I think about 3% to 5% is the fixed cost that came out. And that's part of what we've already incorporated into that target of 16.5% margins that we want to get back to. And we think we can get back there once the MAX, which is our biggest program -- once the MAX is at about 42 aircraft per month, which is where we were in 2016. We think that's a level we can get back to the 16.5% margins, including some of those fixed costs that we took out.

Sorry, what -- did you say 3% to 5%?

Well, 3% to 5% of the $1 billion is fixed costs that we've taken out that will come back.

3% to 5%.

Right.

So the vast majority of the $1 billion is variable costs?

Correct.

Okay. Got it. Will -- how should we think about where mix goes moving forward? Will you have things that are accretive to the margin or dilutive to the margin, growing the fastest for you over the next 3 to 5 years?