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

Are you planning to do a little more remark or just pass it off to you?

No. I think just open it up and we'll just jump right into Q&A.

Okay, wonderful.

Well, what we'll do probably right before that, though, let me just make the safe harbor comment.

Yes. I'll have to also do disclaimer. So I'll start to do disclaimer. Thanks, everybody, for joining us for our next session. We've got Mark Suchinski from Spirit Aerospace (sic) [ AeroSystems ]. He is the CFO. So before we get started, I have to read our disclosure. So for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. And I think, Mark, you've also got your disclosures to read.

Yes. Let me make a quick safe harbor statement. I need to remind everyone that any projections or goals we may include today in our discussions are likely to involve risks, which are detailed in our news releases and our SEC filings.

Well, great. Now that we're done with disclosures, let's chat our recovery, Mark. So maybe we could start -- I mean, I was in Wichita during Investor Day in March. We saw updates that were made to the production floor. And you talked about how these changes could make the company more efficient for the 737 MAX as the program recovers. So since then, we've seen the MAX production rates go from 26 per month for you to closer to 31 per month. How have the efficiency gains that you expected you would realize compared to what you're actually realizing today? And are there anything on the positive or negative that you want to call out?

Well, you're right. Over the course of the last couple of years, we've really made some investments in the production system. We've digitized our factories, in particular, the 737 line and we've added some automation. And all of that is in tune with us driving productivity to help improve our overall margins. And so we have to remember just 2 years ago from a production rate standpoint, the MAX was 0. And over the course of the last 2 years, we've increased to 31 airplanes per month. And so we've been really starting to see the overall benefits from the automation. I would say that we're not quite all the way there as it relates to those investments and pushing all the way through. We've seen some lumpiness from a production rate standpoint because some supplier disruptions, as we've gone from 21 aircraft per month to 31. But we're really, really optimistic about those benefits and we think that they will definitely yield some improvements as it relates to our ability to go up in rate more effectively and also improve our productivity and realization in our factories.

Great. Focusing on the 737 MAX, right, your target has been 16% segment margins, and you've said that that would be when the 737 MAX is in the mid-40s per month. So when you look at the other programs in your portfolio, like the 787, A350, A220, all at forward losses, so there's 0 margin. I mean, to get to a full company segment margin of 16%, it's implying that the 737 MAX really needs to get to a fairly high margin above that 16%, right, to get to an average of 16%. So can you provide color on where we are today on MAX profitability? And give us a better bridge in terms of how you get to that higher -- it's probably in the 20s of profit for the program?

Yes. I think what we've done is we've stated that at our sustained production rate on the 737 at 42 a month, where we can drive some stability in the factory and achieve the benefits that we just talked about as it relates to the automation and the digitization, that we can achieve in the ballpark of 16%, 16.5% margins. And really, we go back to our history, right? And really, you go back and look at your history to say what have we done in the past and where could we go in the future? And so when we look at the 737 program in 2016, where we were producing at 42 aircrafts per month, we were at around 12 airplanes per month on the 787 close to 7 to 8, between 7 and 9 on the A350. And we were able to generate somewhere near the 16% margins. We talked about some of the improvements that we've done from a business standpoint. So if you spin that forward, structurally, profitability-wise, the 737 is on the same level as we were back in 2016. We have the added benefits of lower production volumes on the low-margin programs like 87 and A350. But we also have the benefits of much higher revenues on both defense and aftermarket. And aftermarket has nice accretive margins in excess of 20%. And our defense business is growing. And although slightly dilutive to the 16% margins, but strong in the 12% to 14% range and that -- those additional revenues on defense and aftermarket help offset some of the dilution from the 0 margin programs.

That's really helpful color. And on the 737 MAX, talking about of your 2016 margin versus where you would be at 42 per month, the differences of inflation. Can you talk about how that would affect that production rate? And also what happens -- would you still get to the 16% if we're seeing production rates change more? Because when you look at where Airbus is, they're at 65 per month, whether they want to be 65 per month, maybe 75 per month for the A320. And for Boeing, if you look at the backlog, there's enough orders to produce higher than 42 per month.

Right.

So if we start seeing the production rates come in, increasing more frequently, does that change your 16% target?

Well, I think we like to say we have to run real fast to stand still. And so you talked about some of the inflationary pressures. We're seeing it today in energy and fuel costs is putting a lot of pressure on our cost structure and have had a negative impact on cash. And we know that the labor markets are tight and that there's going to be pressure from a labor wage growth standpoint over the next couple of years. We've got a union contract next year. And so at the end of the day that -- those costs are going to be in front of us. We're going to have to deal with those. We're going to have to continue to drive really, really hard from an automation and from a supply chain optimization standpoint to offset some of those headwinds. I think the benefits are that our touch labors are a fairly small percent of our overall costs. So it gives us an opportunity to get through some of the wage growth that we're going to see over the next couple of years. But we're really excited about getting the 42 a month, getting there over the next couple of years and generating better revenue and earnings and driving the free cash flow that you guys all saw back in 2017, '18 and '19, right? And structurally as a company, we're really no different than we were pre-pandemic. We're a stronger company, better defense, better aftermarket and more Airbus content. And so it's all about the production rates, it's about the single-aisle recovery over the next couple of years. A320 is a really good program for us. And so we're excited about where Airbus is going with that. They've been much more transparent about where they're going. I think driving some stability at 31 a month before we go up in rate, 737 is a good thing that's going to have a positive impact on the whole production system.

That's really helpful color, Mark. And then switching gears to the 787, I mean, now that you got the regulatory approval to restart deliveries, and we finally saw some orders, new orders at Farnborough, 2 for the 77. Should this program get towards back to an 8 per month or 10 per month production rate at some point? What do you have to do to support that rate ramp? And the second question to that would be, is there an opportunity for the 787 to be unit cash positive by 2025?

Well, it's a great airplane. The airlines really have a huge desire for the 787. It's great. FA has approved it. We're back delivering the airplanes. We're obviously at a low rate of production right now with Boeing targeting growing slowly to 5 a month. They're going to have to burn off the stored aircraft that they have, which is 100, which I think they've indicated it's going to take a couple of years to go do that. And so really, we're looking forward to the higher rates on the 87. We've got to -- we're facilitized. We're capitalized on the program. It's a highly automated factory for us. We do a great job with that program as it relates to manufacturing, quality and delivery. And so for us, on that program, higher production rates from an overhead absorption standpoint are critical as we move forward and we think about how do we improve the overall profitability of that program? We've talked before that at line unit 1406, there's a price adjustment, a positive price adjustment for Spirit, right, which will definitely help on that program. So the keys are getting the production rate back up, that helps from an overhead absorption standpoint. We've got the pricing opportunity at line unit 1406. And then with the slower production rates, that gives us more time to continue to work on the overall cost structure and drive profitability into that program. And so we're looking at some major structural changes where we buy product, where we build product and those are the heavy lifting that we're going to have to do. And so we're still, I would say, optimistic and continue with our focus on getting the cash flow breakeven at line unit 1406 and even with the low production rates today and getting to the 7, 8, 10 range. I think we're going to put ourselves in a good position over the next couple of years to go do that.

And switching gears to supply chain. Aerospace has been facing some supply chain headwinds. Can you talk about what you're seeing in your supply chain? And what mitigating actions you've taken to address issues that you faced?

Well, it's been pretty challenging. I think you'll hear probably a lot from this conference from A&D folks around the supply chain disruption. I think we talked about it in our second quarter earnings call and many others have. It's been challenging. And I think really, when you look at the supply chain, as I said before, we've gone from 0 to 31 on the 737 program. We did it fairly methodically. We went from 0 to 7 to 14 to 21. And those are the types of rate breaks that we've been able to demonstrate historically somewhere in the ballpark of 3 a month, a break of 3, 5 or 7. Where we really saw some challenges occur here is in the second quarter where we went from 21 to 31. It was -- it's the largest rate break that we've ever seen at Spirit since the divestiture from Boeing. And so we've gone from 21 to 31 and that's put some stress in the system. And I think when you think about the smaller suppliers, tight labor market, wage inflation, higher energy and fuel costs and that's pinching them from a financial standpoint, right? And also, it's what you call the cash conversion cycle from the time that they have to place raw material orders to hiring their employees to the time they produce the product and deliver to us, it's a fairly long time. And so what we've seen is we've seen more supplier bankruptcies in the last 6 months than we saw in 2020 and 2021. And some of -- many of our suppliers benefited from the government...

The [ PPU ]?

Exactly. And so that's helped them power through. But now those benefits from a government standpoint have gone away, and that's put some pressure on the system. Now we saw key supplier go bankrupt on our A220 program in the second quarter. I would tell you that the supply chain health isn't going to just correct itself in a quarter. I think there's several quarters ahead of us that we're going to still have to manage that. We continue to see part shortages having an impact on our line. But what we're doing here is we're -- we do outsourcing unloading work. We're tapping previous suppliers. And in some instances what we're doing is we're buying raw material for our suppliers, in some instances, take an additional buffer from them to help them get through the challenging times here. And over the next couple of quarters, we expect to see our supply chain start to stabilize more, right? But there's going to be still some bumps in the road as we move through and stabilize it at a rate of 31 aircrafts per month. And if we can go do that, we can get the entire supply chain back in alignment. We can get our factories back on schedule, drive that stability. That will be the perfect opportunity at that time to then go up in rate. And I think going up in rate when there's a lot of disruption that we're seeing, I really applaud Boeing's patience on let's get stable at 31. We obviously want to go up in rate because it's more revenue, it's more earnings, it's more cash. But let's think about this from the long-term standpoint. This isn't the quarter-to-quarter industry. It's the long cycle. Over the next couple of years, production rates are going to be higher on the single-aisle programs. The demand is there, the backlog is there. And so in my mind, let's get this thing stabilized at 31 a month. Let's get all on the same page from the OEM all the way down to the Tier 2s and 3s, drive some stability and then make the next move up and we'll be able to do that much more effectively and more profitably. And that's really what we're doing from an internal standpoint and working with our suppliers to drive that stability through the system.