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

I'm just helping the clock run for Tom. So thank you everyone for joining. My name is Sheila Kahyaoglu with the Jefferies Aerospace and Defense Equity Research team, and we have the Spirit Aerospace Systems (sic) [Spirit AeroSystems Holdings] team with us. Thank you guys so much for supporting us.

Thank you, Sheila, for having us.

We have Tom Gentile here as well as who's President and CEO; and Mark Suchinski, who's SVP and CFO. Did I pronounce that correctly, Mark?

Yes, you did.

Okay, good, because we're going to have a contest later on.

Can I say a quick safe harbor statement first?

Sure.

Okay. So we'll get the legalese out of the way here.

Well, I'll just read it. 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 releases and SEC filings.

Perfect.

Perfect. Just to start off, what are next steps from Spirit as we think about how you guys are going to normalize production rates and continue to rise? And how do we think about both the short term and potentially the next 3 to 5 years?

Right. Well, as we get beyond the 2 recent quality issues, we look forward to the future where there's a lot of demand now for aircraft. Air traffic has recovered just this morning, I saw it's 95% of 2019 levels. And domestic traffic is actually above that, and that favors narrow bodies, which Spirit has a very strong position on narrow bodies. 85% of our backlog of $42 billion is narrow bodies. And on the 37, we actually have a huge work package with 70% of the structure. And on the A320, we have a very significant package with the leading edge, the trailing edge and the spoilers, which is about 60% of the structure on the wing. Both of those programs are going up in rate significantly. And ultimately, that's going to drive Spirit's economics. Next year, we will be cash flow positive and also in '25 as Boeing goes up above 50, the 37 and Airbus goes up above 75. But for us to really get the execution, we are making a lot of changes in our plant. Over the last 4 years, we've invested a lot in lean production flows. We've changed the layout of the plant to make it more efficient. We've moved some of the subcontracting parts out of the plants, so they come in and tack now for final integration. We've also invested a lot in digitization and automation. We have a new automated digital logistics center. We've digitized a lot of the workflows. We've created tools for scheduling. We've implemented a lot of quality tools like optical inspection as well as visual work instructions. So those are some of the things that we've done to the plant. We've also beefed up the organization. We've put some new operations leaders in place to give us better coverage on first shift as well as the off shifts. We've put in place line-side support teams with cross-functional support like engineering quality, HR as well as supply chain so that we can solve problems real time on the factory floor to give our managers more time to manage. And so those are some of the changes that will help us meet today's rates as well as the future rates that are coming up, not only in the narrow body programs but also the wide-body programs.

And that's super helpful laying out some of those changes. What are the biggest pinch points you're seeing in terms of ability to meet production rates? It was previously some supply chain, mostly labor as well?

It's really those 2 things. It's labor and supply chain. On labor, first of all, we were very happy we got our contract with the IEM concluded this past summer. It's an industry-leading contract and now that it's in place, we can focus on execution. Of course, we were disappointed we had the work stoppage, but we have a good relationship with the union, and they had endorsed the original deal, but after it was a negative vote, we got the feedback. We've got back together with them. There was some confusion around the health care plan. We quickly addressed that. We restructured the deal, took some of the signing bonus money, spread it out in terms of gross wages, and we also changed the overtime on the weekend. So we used to be able to designate mandatory overtime in the weekends, and we eliminated that. So that contract out in place and obviously the second vote passed, and it was a relatively short strike. But labor continues to be a challenge to find enough skilled workers. We've got the gross numbers now in place, but we're still seeing a fair amount of attrition, especially amongst newer employees. And it's also taking these new employees longer to get up to speed. We laid off 8,500 people in Wichita alone during the pandemic. A lot of those were older, more senior experienced workers who took voluntary retirement packages. And the new workers that are replacing them are taking a little bit longer to get up to speed. So we're hiring them 8 to 10 weeks in advance and training them. We're also putting in place workplace coaches to help them with on-the-job training and a new position that we agreed in the recent contract, master mechanics, again, to provide coaching and support to the new hires to get them up to speed faster. But that's one of the challenges in terms of the rates is labor. The other is supply chain. And while the air traffic is recovering, I would say the supply chain is still stressed. We see a lot of small suppliers who, because of the cash conversion cycle, have to hire labor, get material, long lead material in advance, and that puts them under some cash pressure. We also see shortages of raw material and even faster, some basic things, and that creates disruption across the supply chain. And when the suppliers are distressed, it creates part shortages for our factory, which is disruptive. But it also means sometimes we have to find cover and support and in the last 18 months, we've had $200 million of charges in supply chain that we've had to cover either by dual sourcing, in-sourcing or providing cover. So it's getting a little bit better, but it's still a pinch point as we go up in rates and it's putting pressure on the system. And so I would say right now, those are the 2 big issues that we're focused on is labor and supply chain.

Just talking -- thinking about the MAX, we'll get to the recently disclosed issue. Where are you in terms of rate today? How do we think about gating factors to go up in rate the next rate breaks, whether it's 37 or 42 a month. And how do you think about the lead time relative to Boeing?

Right. Well, we right now are starting to cycle at 42 aircraft per month. We've got 2 production lines in our plant. We can go up to 3, but we have 2 right now. Each produces 21 per month, so 1 a day. So we call it 2 1-day lines. So we load 2 each day, and we try to deliver 2 each day. Right now, we're just getting into that and starting the cycle at 42 and there's always some start-up issues. For one thing, with no mandatory weekend over time, we have to find a different way of working. And so what we're doing is what we call alternative work weeks is we're putting different shift patterns in place so that we have weekend coverage full time. So that's one of the things that we're doing. In addition, on the 42 aircraft per month, we are now about aligned with Boeing in terms of production rate. And as we go into next year, we're going to finish this year at 42, we're going to go into next year at 42, So this year, our guidance was 370 to 390 aircraft on the MAX. We're probably going to be at the low end of that range given all the pressures and there's some pressure to that. But we're going to end this year at 42 aircraft per month. And we're going to be at 42 aircraft per month all of next year as will Boeing. And that's about 500 aircraft next year. And then in '25 and '26, Boeing has said they want to get up to 50 aircraft per month. And they've added a fourth line in Everett. So they're very serious about it, and they certainly have the backlog to support it. That would get us back up to 600 aircraft per month. So that's how we will align with them. We typically are about 6 months in advance of them. Because we're earlier in the production process. And so we start hiring even 10 to 12 weeks before that. So we got enough time to train our employees and also to get them on-the-job experience.

Talk to us about the recently disclosed aft pressure bulkhead issue on the MAX. In terms of deliveries, it doesn't seem to change your guidance for the full year. Any potential rework to profitability and free cash flow?

So let me just talk about quality in general. So quality, obviously, is very important for Spirit and for the whole industry. The safety of air traffic depends on it and we work on it all the time. We have a quality management system that actively and continuously seeks out quality issues so that we can fix them and make our products with better quality and safer in terms of outcome. Now we're disappointed that in these 2 issues, but escapes are not uncommon in our industry. A few slides, for example, has 80,000 different parts and 450,000 fasteners. So escapes happened, and they happen on all programs. They usually don't get this much attention. In this case, I would say there's greater scrutiny on quality in general, post the MAX grounding and post the pandemic and particularly on the MAX, for obvious reasons. And in this case, for an abundance of caution, Boeing decided to pause production or deliveries temporarily while we were doing bounding. Normally, that doesn't happen. We identify an escape. We bound it, do a safety of flight analysis. And in this case, Boeing and the FAA determined there was no immediate safety of flight issue, and so the fleet could continue flying. The other thing that was unusual about this particular issue is that normally, when we have an escape, you fix the units in our factory and then in Boeing's factory, and we're done. But of course, in this case, Boeing has 250 units that are stored, and we have about 60 that are stored in Wichita, Boeing-owned inventory, and some number of those have to be fixed. So in this case, with the aft pressure bulkhead there were 3 suppliers over time. The issue related to Spirit, we were using an automated drilling process, which, if not done perfectly, could create an oblong hole, okay? And this came up. But one of our quality processes actually found this. So our quality management system includes a process where we encourage employees to speak up if they see a manufacturing process that could be fixed or improved. And one employee came up and told us about this, we were already actively working on a fix when the escape was found. But we are in the process of bounding it. And for us, it looks like we have about 39 units to replace -- to inspect and repair. We've already inspected through X-ray 15 of those. What we have to do is about 1,000 holes in the aft pressure bulk head, 500 of them are machine-enabled, so it could be suspect. So we X-ray all of those, and then we look to see on the X-ray could they be suspect. And if they are, what we do is drill out the fastener, inspect the hole. If there's no issue with the hole and often there isn't, we just put in the same size fastener. If there is an oblong hole, what we do is we oversize it, drill it out again, so it's a little bit bigger and then put in a larger fastener. So we expect to be done with the repairs of the units in our factory by the end of November. Now for Boeing, it may take a little bit longer because they have, in many cases, completed aircraft. The 250, there's maybe 65% or 70% of those that could require inspection and repair. But for us, what they've agreed is we had 29 in WIP. We are going to complete the production on those 29. We set up essentially a separate factory across the street where we're going to have 8 repair lines and we'll do X-ray on 2 of those and then repair on 6. And so we will be able to flush through our 39 relatively quickly, and then we'll deliver those to Boeing. So we'll complete the production on the ones that are in our WIP. Boeing will pay us for those. We'll then repair them and ship them to Boeing. Boeing could have some delays as they're waiting for our units to come and their repairs could take longer because ours when we repair it, it's a fuselage only. For them, they may have -- if it's a finished aircraft, they already have the lab and the galley and the overhead bins and things like that and systems. So they have to work around that. So it could take them a little bit longer. But in this case, once we do the X-ray and we've assessed which holes we need to address, the repair itself for us is fairly straightforward to drill out the holes and replace the fasteners. But that's the work that's underway. As I said, we've already completed the X-ray on 15 of the 39, and we started the repair.

So just to follow up on that point. As we think about your current production rate, you're still going to go at 42 as you repair the other ones? And how do we think about the delivery free cash flow impact for '23?

Right. Well, this particular issue, because we're going to get all the repairs done by the end of November and ship those units, this by itself won't have a material impact on our range. We said the range was 370 to 390. What we're seeing is some additional pressures on supply chain and labor. So we think we'll be at the lower end of that range, possibly some pressure to that. But the good news is the team is cycling at 42, and we're working a number of different initiatives to offset any impact. Our goal is still to focus on breakeven cash flow in the back half of the year. We said we were about negative $200 to $250 million. But we, of course, had $100 million of customer advance in that. From one of our customers, the way their advance came through it counts as free cash flow. So that is what the outlook is. We're going to continue to try to hold to that. We are going to get the additional $50 million from the one customer that was supposed to come in November. It's actually -- they've already delivered it to us. So our cash balance is pretty solid. And what we're focusing on now is stabilizing at 42 a month with the 737, getting the workforce trained and so that we can finish the year off strong and hit next year at a solid 42 per month.

Switching gears to the 220 program. Where are you on that program today? And how are you thinking about the rate ramp there?

So the 220 program ultimately is going to be a great program, but it's been disappointing that the rates have been much lower than we expected. So for example, even this year, the original projection was we thought we would do 100 units then it went down to 82 then 78. We're probably in the 65 to 70 range right now. So it's come way down. That's put more pressure on the program. And so our economics on the program from what we originally thought when we concluded that deal in 2020, and we took a charge through 2025, there's pressure on that. And so this is, I think, true with 3 of our programs right now, the 220, the 350 and the 787 those are all composite programs, at least the work packages that we have. And it's -- we've never really achieved the learning curve to come down in terms of cost historically. And so those programs have always been under pressure. And now there's even more pressure because of wage inflation, other inflation, like logistics and utilities, parts shortages and also with the greater scrutiny on quality, some new work processes that add hours. And so all of those programs are under pressure and it really is not sustainable for Spirit. So we are having discussions with our customers, with Boeing and Airbus, about these pressures that we're facing and how we address them. I mean it's great that we have a lot of demand and rates are going up. But to achieve those rates, the supply chain has to be stable and healthy and spirit needs to be stable and healthy. And I think both of our customers realize that, and we're engaged in discussions.

So on the 220, is there a certain rate that makes sense in terms of reaching profitability levels that makes sense?

Well, we had originally said in 2025, when they reached 14 aircraft per month that we would be breakeven and better. It looks like that 14 aircraft per month by 2025 could be a challenge based on where we currently are. Because as I said, we've reduced rates from the original projections. This year, we're now in the 65% to 70% range. So I think by the time we get to 14 aircraft per month, we could be profitable or -- breakeven and toward profitability. But what we're seeing is that is being pushed to the right and we need to have that discussion with Airbus.

Makes sense. Switching gears to the 787, how do we think about your production rate today? And how do you think about the alignment and lead time with Boeing and your losses on that program?