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

Thanks, everyone. We're coming in for our last aerospace and [defense] fireside chat of our 2023 Conference with Spirit AeroSystems. So we have Mark, Spirit's CFO here today. Pleased to have you here and turn it over to you for forward-looking statement disclaimers and whatever you'd like to kick it off with.

All right. Well, thank you, David, for having us here. Let me just quickly start off with just some business here, safe harbor statement. I just need to remind everyone that any projections or goals we have may -- included in today's discussions are likely to involve risks, which are detailed in our news release and our SEC filings. So with that, just a couple of quick comments I would make is we made still Spirit in our industry. Over the last several years, it's obviously been fairly challenging. We started off with the MAX grounding rolled into COVID in 2020, and that had obviously a significant impact on their travel and the impact on airlines and in our major customers. And then we roll into 2022, where things start to feel like they're firming up. We're getting on the backside of COVID, travel is starting to really start to come back. And then we see the Russian Ukraine conflict and the impact it had on energy costs and fuel. And then we see the macroeconomic environment with inflation, wage pressures hit in 2022. So obviously, for us, 2022 was not the year that we had expected coming into it. But I would just say, as we look forward here in 2023 as it relates to our business, Aerospace and defense, we feel good where we're at. There is a strong demand for travel we've seen China open up, which should have a positive impact on the twin aisle airplanes. Airlines, there is a huge demand for airplanes. They want the newer, more fuel-efficient, lower maintenance cost airplanes. And so we're entering a phase here of real positiveness over the next several years with very, very strong demand for airplanes. And so we're in a situation now where we collectively from the OEs all the way down to the supply chain, we've got to work on execution. It's an execution play right now to hit these production rates, and we've talked some more about some of the challenges that were on labor supply chain. But at the end of the day, we really feel good about the industry of where we're at today, and where we think the industry is going over the next several years.

Okay. Terrific. So you've identified the structural cost opportunity you have from -- you've laid out a couple of things, operations, supply chain infrastructure overhead. -- what is that opportunity? And how does that build upon the cost -- the structural cost takeouts you've already done over the last -- course of the last couple of years?

Well, over the last couple of years with the MAX grounding and then COVID, we were forced to rightsize the business. In 2019, our revenues were $8 billion. In 2020, due to the impacts of COVID, we dropped to $3.4 billion. It was a 60% drop in an industry that is very capital intensive. And so we had to take some very tough actions to protect the business from a long-term standpoint. And as you said, we reduced our workforce by over 8,000 employees. We cut back in a variety of areas to just get through the challenging time there. We had to hit the capital markets to make sure that we had the appropriate amount of liquidity. And so really, David, what's happened over the last couple of years, it's a little bit of a start and stop, right? So where we thought production would be in '21 and then even '22 from an OE standpoint, didn't end up being where we had expected. And so setting aside the factory, which we have to continue to invest and hire the people to meet the production rates, I think, to a certain degree, when we talked about overhead indirect people, we started to bring people in anticipation of those higher production rates in '21 and particularly 2022, which really hasn't come through, right? And so I think to a certain degree, the announcements that we had around the cost optimization program, we've established a specific team led by one of my finance leaders, which is evaluating all aspects of the business. And the one item that we did highlight on our earnings call in February is elimination of 1,000 overhead positions, and that's going to come through by eliminating open positions, attrition and some performance that we probably didn't address as we expect it to go up in rate. And so I think, these actions will all come to fruition between now and the end of the year when we think about the full year benefits for the elimination of -- this should be a permanent structural benefit that we have, that we maintain as we move into '24 and '25. Even as we go up in rates, it's a layer that will remove. Some of it is spans and layers. It's organizational changes, there's some consolidation focus that we have in our U.K. operations. And so we're attacking that in a manner that I would say is something we have to do based on our current financial performance and where our balance sheet is. So it's a bit of a challenge because we're also now focusing on production rate increases here in 2023 with the expectation production rates will continue to climb in '24 and '25. So I know some people, it's -- well, how can you cut and grow, I think we have to thread that needle. There are certain portions of our business. And the labor side we have to attack. It will -- the benefits will come on fairly quickly as it relates to that. But there are a variety of other projects, as you said, in those three buckets. We've got over 300 projects identified with owners. Some of them is eliminating facility redundancies, closing leases. We just entered into an agreement where when we think about our non-inventory purchasing, a plan to consolidate that across the globe to get buying power as opposed to each site going off and doing their own buy. So very focused on the cost side, the overhead indirect side while continuing to do the right things to improve productivity and efficiency in the factory. And so we have to do all of that while supporting our customers and meeting the production rates in front of us.

Okay. So I wanted to move to MAX, not surprisingly. So can you just help us square the 420 relative to where I won't say peers, but most of the industries come out, you seem like an optimistic outlier. I guess, what is your 420 base, I mean is that Boeing skyline? Is that your best guess? And is the 420 just simply 31 a month for first 6 to 8 months of the year, then 38 a month or a couple of months plus the 20 that you built that didn't deliver. So if you just lot there, but I think that's #1 issue everyone is struggling with.

No, completely understand. It's the #1 question that we get the biggest topic of conversation. What I will tell you is this, we're almost in the March and you think about our business, it's capital-intensive long lead, okay? So to prepare for production rates, you have to hire your workers, you have to order your raw material to support those rates. And from a contractual standpoint between us and Boeing, it's about a 6- to 7-month lead time, where they tell us we need you to go to higher rates, and that gives us enough time to bring in the pipeline of people. We train them, we get them certified. We place our raw material orders. And so as it relates to what we've said is, we've taken the position to be fairly transparent with you all, our investors, about the fact that we have purchase orders in place, we have -- the demand is being driven by our customer. That's what they want is what we consider to be our cash deliveries before 20, as you said. It's roughly 31 a month for the first half of the year, 38 for the last half, which averages out to around 35 cash deliveries per month in 2023 with roughly 20 units that we didn't deliver in '22 that will spill over into 2023. The other thing I would say, it's a complicated -- it's a bit complicated, right? And I think pre-COVID, it wasn't. We produced, it rolled off our line. We shipped directly to Boeing's production line, Boeing produced and delivered. Today, we produce and we get paid based on what Boeing wants us to do. Boeing has 250 airplanes that are stored, so they're delivering out of storage, they're delivering out of their new production. And the units that we produce, they go into -- at our site and to ship in place. So we build to a contractual build plan, it ship in place, it goes across the street. That's one mode of communication between us and Boeing. Boeing has a second mode of communication that says, hey, set aside those ship in places, I want to pull these units. These two are completely disconnected. So they pull those units to feed their production line. And then those are new builds that they build and deliver to customers like they do with the stored aircraft. So it's not a direct streamlined 1 plus 1 plus 1 equal 3, right? There's many moving parts here that go into this situation, and I really can't talk about our peers and where they are. But I can tell you that we've now spurred put ourselves out there that if we don't deliver 420, it's not because of Boeing, it's because we didn't execute.

So just to be clear, you have a -- I mean, in normal times, you have a skyline schedule from Boeing, you build to that schedule. We're now back to the point where you -- I don't feel like, you've had much of a schedule for a while. It's kind of been like what we think we need this. But now you have a skyline schedule, what your community to us is what the skyline schedule shows that you're contractually obligated to deliver.

That's right.

So there's no like we think it will be this -- this is you -- this is what the skyline chose. That's what you're contractually obligated to deliver.

And Boeing is very, very focused on us hitting our delivery points.

Hopefully, that clears it up for everyone. So on 787, I got a bunch more on MAX, but more kind of, I guess before, what is the biggest -- what do you see as the biggest risk in terms of your break from 31 to 38 in hitting that?

I think the -- we've worked -- we said this on our earnings call. Our new workforce is not as proficient as it was pre-COVID. We had very experienced mechanics, long-term employees. And when COVID hit, we were also upon a lot of the baby boomers moving out of our workforce, and we lost a lot of, what I would call, skilled mechanics in 2020 and 2021. Some of it was voluntary retirements, et cetera. And so really, the challenge that we had is the aggressive rate ramp from 21 to 31 in the middle of 2022. I would say that some of this is on us, we probably fell a little bit behind from a hiring standpoint. We've also learned that the new workforce is definitely less proficient than the old workforce. It's going to take a longer period of time to get them down the learning curve. And then we got hit with a lot of part shortages. So you're dealing with in the middle of the year, more part shortage than expected, a less seasoned workforce. And that put us in a position of being really not stable in our workforce, which drove us then to fall behind schedule and then add more people in the back half of 2022. And we talk about having 42 a month rate heads to only produce and deliver 31. And really, what we're trying to do here is to hire ahead knowing that our workforce is less proficient as they were before, getting more time on their bar lines, earning their hours in anticipation of the rates that are in front of us and also dealing with the levels of attrition that we haven't seen in the past. So really, those workers that we brought in the fourth quarter, we complemented that with contractors and hire over time. Those people are getting more proficient now, right? We just had a big job fair, which saw 2 weeks ago. 1,000 people showed up. We made 700 offers. So we're continuing to build that pipeline to better prepare us. So it's taking longer to hire them. It's taking longer to train them, and we have to build that into the equation. So we're making a bit of an investment right now, and it had a negative impact on cost and cash, right? But when we think about our performance on the financial side and the challenges that were a result of us not being staffed correctly, when we went from 21 to 31, we think this is the smart investment and it will help drive stability in our factory at 31 and will give us a much better chance to hit 38 a month. I'm feeling a lot more comfortable as it relates to our labor and the pipeline that we have. And so when we talk about what are going to be the biggest challenges? I won't say labor is not. I would say that it's a lower risk than before. We feel pretty comfortable about where our workforce is right now. It's less about being able to hire people. It's more about just getting them more proficient doing the jobs. The challenge we have will continue to be the choppiness from a supply chain standpoint. And I would say that it's not a broad problem across the supply chain, but what we're seeing is these one-off situations where that one supplier can really have a huge negative impact on the production system. And so we've invested a lot of time and effort over the last 6 months from a visibility and a metric standpoint of color coding and tracking our red, yellow and green suppliers having supplier development out in the factory, working on dual sourcing a backstop in our factory. But I would just say that the #1 challenge continues to be around the supply chain, a lot less about labor less about the raw material. But at the end of the day, I think the supply chain is getting better. We're today, it's better than it was a quarter ago. It's better than 2 quarters ago. I think there'll continue to be some level of choppiness over the next couple of quarters, but they're starting to heal up and get more stable just like we are in Boeing and Airbus. And so that's the challenge we have in front of us here, and we obviously have more inventory than we would like at this point in time, but we're tuning those suppliers up to bring the parts in to try to get ahead of things. We're building some strategic buffers to make sure that we protect on critical components, high-impact parts in the factory to better prepare for the 38, but it's a complicated business. I mean we built fuselages. They have 25,000 parts. It takes 4 months to build one and one part could shut you down. But we're doing all the things that are necessary to be as proactive as we can to prepare for that next rate break. And the truth is our whole industry was at a higher rate at one point in time. And I think to a certain degree, you get a [indiscernible] a little bit. Well, we were at 52, 31 is easy. Our business isn't easy. It's complicated. I think the workforce has changed a lot pre-COVID to where we are now. And so I think there's a lot more effort and planning that takes place as it relates to the production rate increases, and I can tell you that Boeing and Airbus are spending a lot of time with their suppliers making sure. And they're willing to take on more inventory, carry more working capital because their focus is, we've got to run everybody hard the weakest link could shut us down. So we've got to try to get the entire supply chain from top to bottom prepared for these rate increases because the demand is there.

So on 787, are you producing new barrels delivering to Boeing today, seems to be some sort of -- I mean based on what we know, Boeing is not delivering new off the line in Charleston right now. They seem to say it's your issue, not their issue. So are you delivering new barrels? And kind of what is the challenge on 787, I guess on the new side without thinking about what you have to fix, what's been produced that needs to be fixed?

I would just say this, David, we communicated to our customer, our delivery plan last year. It was 20. We had updated our investors through our earnings calls and said it was 20, we delivered 20. We've told everybody that we expect to deliver between 40 and 45 787s this year. What I would tell you is our factory is producing, and we expect to deliver 8 units in the first quarter, and we're on track to deliver 8 units, the second, third and fourth quarter, the rates will go higher, ultimately getting to 5 a month, so that we can meet the 40 to 45, And I think if you think about the situation, and we're going to deliver off our production line 8 units, and slightly higher in the second, third and fourth quarter, we're on track to meet the 40 to 45 deliveries.

So is there -- was there a new discovery on the 787 that you've had to modify the production process? Or was there not?

No, there was no new discoveries. I would tell you that in August when the FAA approved going to restart deliveries. We had -- we knew what the production changes were to meet the quality/engineering requirements and that hasn't changed since August. What has changed for us is the -- when you change the build process around the cargo door in the front, you make estimates before you actually -- and so we had to put the engineering changes in place. We had to put the build process changes, the MEs were involved in it. And so we started building new barrels post August, and we produced 4 or 5 in the back half of 2022. You make estimates around the number of hours it's going to take, the process changes that you put in place and part of our forward loss that we took in the fourth quarter as we started to build these units, right? The time it's taking us from a mechanic -- from a build process is taking us longer than we previously had estimated. And it's almost no different than developing a new airplane. You do a new airplane, you build the production process. And so right now, the number of hours per unit to build those units are higher than we expected, right? As we incorporated the changes in the mill process, but in the back half of last year and right now, there are no new changes or no new fixes that are requiring us to change the bill process or add more labor to go do that. All the fixes were in place. We identified all the issues. We were ready for those issues. And once Boeing said, "Hey, we're going to the FAA approved the deliveries, you go restart production, and this is what you -- what we need you guys to deliver. That's what we delivered on. And again, I don't -- I'm not in the business of having a public spat with our customer. I mean, Boeing is a very important customer to us. Airbus is a very important customer to us. We are going to be very, very focused on building what they need and building them to the best quality, and that's what our goals are here in 2023.

Thank you. your contracts on MAX and 787, I mean, you've talked about inflationary pressures. I mean, there's -- you don't have any sort of escalation that you can pass any of this on to your coming, Boeing has escalation clauses with its customers and passing inflationary that you do not have in your 787 contract, I mean, obviously, you have the break on 787 where you can get better pricing. But I mean, you don't have escalation clauses to cover you for inflation on [ 787 ] or MAX specifically.

What I would tell you is there are provisions in all of our customer agreements that have some level of inflationary protection. Our smaller customers, the provisions are more favorable to Spirit. Our bigger customers tend to be more favored towards them. But there are provisions and protections in there that have terms in there that talk about inflation at certain rates, what portion Spirit would have to absorb versus what can be passed on to the customers. And we haven't gotten very specific about what those benefits are. We haven't quantified them. But I can tell you that in our current contracts today based on where inflation was in 2022, there has been some things that have been triggered with some of our customers. And we're over the course of 2023, incorporating those over time. Some of them started at the middle of the year, some start -- may start at the middle of the year. But it's not going to save the day for us, obviously. There is some benefits. But our real focus at this point in time is to execute and meet our cost commitments. When we have those types of conditions and we could take advantage of them, we do. But you're right, it's a challenging environment really for everybody below Boeing and Airbus, they do get inflation protection from the airlines. This industry, historically, suppliers are locked into firm fixed price contracts for some period of time or participate in some kind of cost challenge situation because production rates are going up. But I do think when we think about 2022, the macroeconomic environment where we're at, I think there's a certain degree of the supply base really looking at this and saying, hey, we need to be healthy, too. If there's inflationary protection that you're getting from the airlines in the inflation situation we're in with higher labor costs and energy costs, I think I've talked to a lot of folks in our industry, and I think we're all concerned about that. And so I think it's a dialogue that has to take place with the big OEMs on where they're at from a financial health standpoint, But I'd leave it at that.

Okay. So your forward loss balance on 787, 350, 220, it's around $700 million. It actually burned down a lot last year. You obviously took additional forward losses. But how does that burn off over the next -- without additional forward loss provisions? I mean is this kind of a couple of hundred million obviously depends on rates, all this, but I mean is it a couple of hundred million dollar drag a year for the next several years as you burn that balance down?

Well, specifically on 787, that accounting contract ends in, call it, the second quarter of 2026. So the forward losses will burn down on 787 between now and, call it, May of 2026. On the A220 program, those forward losses will be burned off by the end of 2025. So you've got that another 3 years. And then on A350, that also will burn off between now and 2025. But on A350, it's more weighted towards '23 and '24 and less so in 2025. So we've got a few more years, 2 or 3 more years. And so it's not like the forward loss balance will be 100% of that will be a cash consumer in 2023. It will be spread out over the next, call it, 2.5, 3 years. And obviously, a forward loss program, we've been dealing with 787 for quite some time. It's been reflected in our historical cash flows. And that will obviously be a headwind to our cash flow in '23, '24 and '25.