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

Okay. And on the 737, there's been reports and Boeing sort of confirmed them that they did slow down the final assembly line during May. And it sort of sounds like it's a little bit of a different approach. It sounds like you don't want traveled work to exit the building, you want to slow the positions or slow the planes in position from manufacturing perspective. What I'm curious is, what do you see being upstream from that as a ripple effect if they're slowing the final assembly?

Right. So the good news is we have this buffer. Boeing owns it, but we store it in Wichita right now, eventually it will be up and written. And that can flex. So when they slow down, what happened is that buffer just grew a little bit. And then when they catch back up, it will plateau or go down. But that's how we were able to manage it. So they were able to slow their assembly line. It didn't have any impact on us. And so that enables us to maintain that stability and that consistency. And so that tool is something -- I wish we had it back in 2016. We didn't, but we have it now and it's going to be very helpful.

Okay. It's not an inexpensive tool for inventory?

No, it's -- but what I would say is it's like penny wise pound foolish, okay? Yes, it costs a little bit more in inventory, of course, Boeing is paying for that. But if you don't have that and you get a missed loads, say, up and written, the cost of that is catastrophic. So you'd rather to have a little bit of an investment in buffer inventory and not have the risk of a missed load down the line.

Okay. And then the 787, maybe 2 angles. One is on the 115 or so that are prebuilt and being stored or parked in inventory, is there work that Spirit has to do? What scope of work do you have to do on the rework as part of the compliance package?

So yes, what happened on the 787 is upon very careful analysis and review of the way the product was being built, as they discovered in some cases that too much pull-up force was being used to join structures and that instead of using pull-up force that they should put a shim to close any gap. So they started to do a very thorough review of the entire airplane, literally every single fastener to identify where those situations existed. And then what they're doing is validating going forward how to make the repairs and also what the new build process should be. And that's what's taken so long. But they've got the analysis done. They've turned it over to the FAA, and they're in the process now of resolving how they get back to delivery. But in the meantime, what happened is these nonconformances existed in terms of how the plane was compared to the engineering specifications. Now when I say a gap, we're talking about a gap that might be a fraction of the width of a human hair. So it's very, very small. But it's a nonconformance. It's not a safety of flight issue. So you'll notice that no aircraft have been grounded in the fleet. It's not a safety of flight issue, but because technically, it doesn't meet the engineering requirements that products that haven't been delivered yet need to be basically reworked to get them back to the engineering, and that's the 120 units. Now in the forward fuselage section, we call it, Section 41, there's 3 or 4 areas where we have to go and do some rework. We're about halfway done with that now as we've been working as this process has been going. But as we get access to those aircraft, we'll complete our rework. That was part of the forward loss that we announced in last year, the Q1 and Q2.

And is your estimate, I recall when you took the charge, that's taking the charge for future cash that will be expended to do this work that you're talking about, is that estimate of the total cost to do the work holding?

So far, so far. Now it could be that there may be some revisions to that going forward. But right now the estimates are basically in line with what that forward loss was.

Okay. And likewise, on the production side of the 787, in terms of getting turned on and your expectations as to how quickly you'll come back online, what's your current outlook for that?

Well, what we said is we think we'll deliver about 20 units this year. Now that's down from what we were originally anticipating, but that's where we are. But once they get the FAA okay, we can resume production. We know exactly what we need to do. However we expect production will stay at a fairly low rate for a while until they get some of that inventory cleared out and delivered and then we'll go back up grade. But one thing I would say about the wide-bodies is international travel is down, and it's taking longer to recover post-pandemic. And so that means that wide-body demand is still lower. And we probably won't go back to the same levels of wide-body production where we were before. So in other words, 787 was a 14 aircraft per month, A350 was at 10. Unlikely we'll go back to that. So we do have excess capacity on wide-body. And one of the things that we've been doing at Spirit is basically repurposing some of that capacity for defense work. And most of that capacity is composite fabrication, which is heavily used in defense. And that's actually been a great value proposition for us to go to the defense primes and offer it, and we've been able to win some work on some classified programs as a result.

And actually, I was going to go there next, both the aftermarket and the defense side and the growth outlooks you have embedded into them. So maybe start on the aftermarket, you're $300 million today going to $500 million in 2025. Margins, are they going to hold in this range as you have...

Yes, we -- the last quarter, I think we're at about 22%, and that's where we see the margins is north of 20% on the aftermarket. So it's a good business. It includes both spare parts sales, mostly to Boeing, but also a lot of MRO, and we inherited that from the Bombardier acquisition. The other thing I would say about the aftermarket business is we're at 240 was last year, maybe it'll get up to the 300 is kind of the target for this year. But 500 seems like a big stretch between now and 2025. But if you just look at the pro forma business, what we had and what Bombardier had back in, say, 2018, it was already at $380 million. So it compressed during the pandemic. And so some of that is just getting back to where we were and then some growth. And the way I would describe the growth is Bombardier did a lot of Airbus work on things like air foils, the cells, thrust reversers in Europe. We did similar work for Boeing in the U.S. Once we acquired Bombardier, we were able to cross-pollinate that, put Boeing repairs in Europe, put Airbus repairs in the U.S. Then we bought a business, a small business in Dallas that did rate on repairs, and we were able to add that to the U.S. and to Europe. Then we signed a joint venture with EGAT in Taiwan, so we could take all of that work and now geographically expand to Asia. And then just recently at the MRO conference in Dallas, we announced that we signed a new joint venture with GAMECO, Mainland China. So now we've expanded geographically to there -- we'll continue to look to expand geographically, probably to Central America and the Middle East next and expand our customer base, but that's how we'll drive the growth in aftermarket.

Is it mostly through JVs and partnerships? Or do you think M&A at some point?

It could be M&A. I mean we did buy that Applied Aerodynamics and that was a bolt-on to fit right in. So we'll continue to look for those opportunities. But the partnerships enable us to move very quickly with a concept we call Spirit inside. So we find an MRO provider like GAMECO in China, and we say, we'll do all of the repairs on these programs for things like inlets, tank cowlings, thrust reversers and flight control surfaces as well as radomes. So we become an internal provider within their overall MRO capability.

Got it. Okay. Another area of opportunity, I guess, is in the emerging eVTOL space or space within the defense pocket as well. How much capital are you willing to put to work in those areas, given they're still speculative?

Right. Well, we look at it. Our balance sheet is pretty stressed, as you know. We took on a lot of debt during the pandemic. And our goal in part is to delever, pay off that debt, get back to investment grade. So in the meantime, we're really not in a position to make big cash investments in new technologies, but we want to play. eVTOL is going to be a big market in the future, and we want to put some markers in place. So we have been working with several of the major players in that space. And what we can do is provide in-kind investment, engineering support to help develop the designs and the manufacturing capabilities and the prototypes. And that seems to be a winning solution right now. We can provide that in-kind support, help these companies design and develop their manufacturing strategy for the technologies and in that way, stay involved. But that's definitely a market that we think we can add value to. It's going to be large in the future, and we'd like to be a part of it.

And you mentioned the stress balance sheet, can you paint picture as to how we get from where we are today to where you want to get to investment grade over the next several years?

Yes. So during the pandemic, I mean, the first thing we did, and this goes back to December of 2019 when Boeing cut production as we pulled our revolver. So that added $800 million of debt. Now then in basically April of 2020, the bond market opened up, we were able to go out and raise $1.2 billion at 7.5%. And then in October, we raised another $900 million at 5.5%. So our debt climbed pretty quickly to $3.8 billion. And with obviously no EBITDA in 2020, our debt-to-EBITDA ratio is quite high. So we've been working it down. What we've committed is we want to pay off $1 billion. We paid off $300 million last year. We have another $300 million note next year to pay off, and we'd like to pay off about $400 million of our term loan B. So that would start to get us down to the $3 billion range, $2.5 billion to $3 billion range. And at that point, as our EBITDA starts to grow and we get into the net 2 to 2.5x debt to EBITDA, that is where we feel we can get back to investment grade. And the reason we're interested in that is last year, 2021, our interest expense because of all the debt and the higher interest rate was $250 million. We'd like to cut that in half. We also have a stack up, if you will, of debt that's all due in 2025, and we'd like to spread that out. But we'd like to wait until we're back to investment grade. So as rates pick up and we continue to generate cash, we'll pay down the debt, get back to investment grade, get a better interest rate, spread out the debt and reduce our interest expense.

Okay. And the target in your mind as to when that investment grade to 2 or 2.5...

It really depends on the rate increases. But if the rate increases go into next year, I think by the end of '23 could be a reasonable time frame. But again, it really depends on what the rate increases are, particularly on the MAX.

Sure. Okay. In terms of the defense piece of the business, you have been able to sort of get in there, offer your excess capacity to some of the OEMs. Where is it coming from? Is it coming away from their internal capability? Is it coming from other suppliers they would normally seek? Is it new programs, so therefore, no one loses? How do you describe it?

Well, it's a little bit of all of the above. I would say, for example, we've got 5 areas of focus. One of them is next-generation aircraft, that's rotorcraft and fixed leading. And so things like the CH-53K, which is the heavy lift helicopter, Sikorsky, Lockheed. In that case, we bring a lot of composite fabrication capability that is perfectly suited to that, which they don't necessarily have. And we can not only help design it and develop it, but we can also industrialize it and get to rate. The next program is we're 1 of 7 suppliers that some that have been named to the B-21, the new bomber program. That's with Northrop. And there, again, it's composite capability, it's systems integration. It's a lot of different skill sets that we can bring to bear. And that is something that I think we bring some unique capabilities. And in particular, I think one of the things that we've demonstrated is -- and composite production and other production, there's something called determinant assembly, okay? And what that means is that instead of using big tooling fixtures to put products on and then drill them so that you can connect them, is we can drill the holes in advance. You have 3D digital designs and you can actually put the holes where they belong before you even bring those parts together. So you can basically assemble it like you would assemble a cabinet from IKEA. And that is a very valuable thing that the defense primes value and want, and we're able to deliver it. So for example, with Lockheed, we did a project with them called Polaris. This was publicly --they announced it at Skunk Works. We were able to build a demonstrator for them using this advanced determinant assembly with full-size holes to easily assemble products. So these are the types of value that we can bring to the defense primes. But then I would also say in the missile area, the value that we bring is a little bit different. We bought a -- well, it's something that we have, and it's not really patented per se. It's process know-how. So in a sense, it's a trade secret, but it's a capability that we have. I'd say we're world-class on it. Boeing is also very good at it, but we're equally as good. And because we probably do more manufacturing than they do, I would argue we're better. So I think this is something that is extremely important. And in terms of the next-generation aircraft, whether it's military or eVTOL or commercial, having this capability, I think, really positions Spirit very well to be a vital partner on any future program. And by the way, I would also say one thing. I think Boeing did say that they're going to probably delay the introduction of a new aircraft at least for a few years until the technology matures. And ultimately, I think that's pretty good for Spirit because it means we'll just be producing the MAX for longer. And that's a great program for us and a great program for the airlines, but that's, I think, a good thing for Spirit.

And on that, is there any opportunity on the Airbus side from incremental content as they want to go to higher rates and maybe other suppliers don't have the capability or the desire to...

We're with the A220 wing, now which is a fully integrated composite wing with all the systems, we've become one of the top 10 Airbus suppliers and their leading external structure supplier. And we do win incremental work packages with Airbus. So recently, we won the inboard flap on the A321XLR. So that's an incremental work package. We'd certainly be open to taking on more. But the focus with Airbus obviously is going up in rate. They're planning very significant rate increases, and we want to make sure we can meet the requirements of those and also thinking about their next generation. So one of the projects that Airbus has been working on is called Wing of Tomorrow, and they're developing a composite wing if they ever want to put a new wing on the A320 or the A321. And we've been a major partner with them. One of the things that we developed and have announced publicly is the development of a 17 meters, so 51 feet long composite wing skin that was developed completely out of autoclave. So we used advanced fiber placement to lay it up with dry carbon fiber. And then we infuse the resin and we use heating tools to cure it not an autoclave. So it sounds a little bit technical, but it's a much cheaper, more efficient way to develop an advanced architecture. And I'd say we're one of the leaders in that area. And that's one of the things that we're working on with Airbus with regard to Wing of tomorrow.

And is that coming out of your Bombardier acquisition? Or is that coming out of heritage Spirit?

Heritage Spirit. It's in Prestwick, we built a new R&D facility in Prestwick called the Aviation Innovation Center, AIC. And it was in conjunction with Scottish Enterprise. So it's about a $35 million investment, but it's a state-of-the-art R&D facility on our Prestwick campus, and that's where we're doing the Wing of Tomorrow research.

Okay. When do you think is the earliest that the Wing of Tomorrow would actually be on a wing of tomorrow's plane?

Right. It depends on how the whole product development cycle goes. They'll be ready in a couple of years. When they decide to pull the trigger, we'll have to just see.

All right. Are there any other questions from the audience, please put them into the chat. I don't know, Tom, you -- anything else you'd want to close with in terms of questions that you're getting or misinterpretations or interpretations you want to amplify.

Right. Well, I did want to clarify the issue on the cash flow. And it was really based on the fact that we were assuming 350 units for this year, and we're going to end up at 315 of the MAX. So that was the clarification. The other thing I would say is the Bombardier acquisition really gave us a foundation for our diversification strategy, and it gave us enough critical mass in defense and aftermarket where we could really change the trajectory of the company. So we used to report to Wall Street and to all of you in terms of fuselage, wing and propulsion. We switched that and it's now commercial defense and space and aftermarket. We think that's a much clearer, more relevant way to report. We've also aligned our whole organization to that. We have leaders for each of those things now and that's how we run the business. And I think that will help improve our valuation in the future. We've always traded at a discount because we were structured and because we were so concentrated. As we diversify, we think that that discount should go away, if not turn into a premium.

Great. All right. Well, with that, thanks so much, Tom. Really appreciate it.

Thank you, Myles. We appreciate the opportunity.