Spirit AeroSystems Holdings, Inc. (NYSE:SPR) Q2 2023 Earnings Call Transcript

Spirit AeroSystems Holdings, Inc. (NYSE:SPR) Q2 2023 Earnings Call Transcript August 2, 2023

Spirit AeroSystems Holdings, Inc. misses on earnings expectations. Reported EPS is $-1.21 EPS, expectations were $0.79.

Operator: Good morning ladies and gentlemen and welcome to Spirit AeroSystems Holdings, Inc. Second Quarter 2023 Earnings Conference Call. My name is Jordan and I’ll be your coordinator today. [Operator Instructions] I’d now like to turn the presentation over to Ryan Avey, Senior Director of Investor Relations and FP&A. Please proceed.

Ryan Avey: Thank you, Jordan and good morning everyone. I’m Ryan Avey and with me today are Spirit’s President and Chief Executive Officer, Tom Gentile; Senior Vice President and Chief Financial Officer, Mark Suchinski; and President of Commercial and Chief Operating Officer, Sam Marnick. Before we begin, I need to remind you that any projections or goals we may include in our discussion today are likely to involve risks, including those detailed in our earnings release and our SEC filings and in the forward-looking statement at the end of this web presentation. In addition, we refer you to our earnings release and presentation for disclosures and reconciliation of non-GAAP measures we use when discussing our results. With that, I’d like to turn the call over to our Chief Executive Officer, Tom Gentile.

Tom Gentile: Thank you, Ryan and good morning everyone. Welcome to Spirit’s second quarter results call. I’ll begin today by discussing the IAM contract and providing an update on the 737 vertical fin attached fitting progress. On the IAM contract, we are very pleased to have in place a four-year contract with our IAM represented employees, which reflects the gratitude we have for their contributions. While the first vote resulted in a work stoppage, we quickly went back to the table with our union partners and reached a resolution. Due to the work stoppage from the strike, we now expect to deliver between 370 and 390 737 fuselages this year. The front of our production line is starting to break to 42 airplanes per month in August, but we won’t be able to fully recover the lost manufacturing days from the work stoppage and the subsequent resumption of full production at our Wichita site.

Mark will walk you through some of the financial impacts related to the new contract and work stoppage in his comments. On the vertical fin attached fittings. First, all the rework on the available 737 fuselages in Wichita was completed during the second quarter, which was ahead of the time line we provided on our last call and within the financial estimates that we provided. We were quickly able to develop a repair process and prioritize the rework. I want to recognize our operations team for the incredible effort they made to develop the repair, implement it and maintain the schedule and budget. With regards to the units at Boeing, we have also recorded a provisional liability in the second quarter related to a potential claim for the repair work performed to date at Boeing.

Additionally, we do not expect a material financial impact associated with previously delivered airplanes in the fleet. Now, turning to our commercial business. Commercial air traffic demand continues to be strong and is approaching full recovery to pre-COVID levels. Based on May results, global air traffic is at 96% of 2019 levels, with domestic air traffic now exceeding 2019 levels by 5% and international approving to 91% of 2019 levels. This strong recovery in traffic, combined with robust airline demand for new airplanes with improved fuel efficiency and seating capacity has fueled the recent large orders booked from airlines. As a result of these orders, our backlog at Spirit grew from $37 billion to $41 billion in the second quarter, which includes work packages on all commercial platforms in the Airbus and Boeing backlog.

We are focused on executing the upcoming rate increases to meet the strong recovery in demand. While we are making progress, there continues to be challenges in the supply chain, which have destabilized our production lines. We still see examples of distressed suppliers, even smaller ones, which have significantly disrupted our operations because of shortages we’ve had to address. Over the last 18 months, we have incurred impacts approaching $200 million from individual distressed suppliers and other supply chain pressures, which have been reflected in our past earnings. These challenges in the supply chain also drove some of the forward losses recorded in the second quarter, primarily on the 787, the A350, and the A220 programs. Our priority for the second half of the year remains on execution within our factories and managing these supply chain challenges to meet production rate increases.

While we continue to expect supply chain challenges, we have put plans in place to help mitigate the impacts. We have Spirit employees in the field, working with suppliers regularly, addressing rate readiness, helping them buy material, extending contracts and offloading work to release some of the pressure. As we’ve mentioned previously, in our own factories, we are bringing in new employees earlier than we have in the past to help ensure a smoother transition on production rate breaks. Expectations for deliveries on our other programs for the year are as follows: 40 to 45 ship sets on 787, about 60 ship sets on the A350, 580 ship sets on the A320 and 75 to 80 ship sets on the A220. Now let’s move to an update of our defense and aftermarket businesses which both continue to perform well toward our 2025 targets.

Our Defense & Space business once again produced strong revenue growth, up 30% this quarter compared to the second quarter of 2022. The new business pipeline also remains robust, and we continue to make good inroads with the defense primes, displaying our design build capabilities and commercial best practices. Year-to-date, we have won 20 different contracts worth more than $200 million in total. We continue to bid on large defense programs and are on track to reach our target of $1 billion in Defense and Space revenue by 2025. Our Aftermarket business also had another quarter of solid revenue growth, up 15% compared to the same quarter last year, driven by increased MRO and spares volume with strong operating margins of 26%, helped by some one-time items.

The aftermarket team also remains on plan to reach their 2025 revenue target of $500 million. I’ll now turn the call over to Mark to take you through some more of the financials for our results. Over to you, Mark.

Mark Suchinski: Thanks Tom and good morning everyone. I want to begin by discussing the two significant items that occurred during the second quarter, the 737 vertical fin attached fitting rework and the Wichita IAM negotiations. The teams worked diligently throughout the quarter on the 737 vertical fin attached fitting rework related to the quality issue that we explained in April. We’re pleased to have resolved the required rework on available units in Wichita within the $31 million cost estimate we discussed on the last earnings call. We recorded a contra-revenue charge of $23 million in the quarter to account for a potential claim from Boeing related to our estimate of the repair work to-date at their facility, which we believe represents about half of the units.

However, I want to emphasize that any potential claim we may receive from Boeing could be materially different from our estimate. Now, as it relates to the IAM. The IAM negotiations and strike disruption affected all of our programs at the Wichita, Kansas site, which the 737 program was mostly impacted. Financial impacts during the quarter included $28 million of charges in the estimates primarily related to higher employee benefits, including wages from the new AIM contract as well as strike disruption charges of $7 million and higher excess capacity costs. Additionally, as we look ahead over the life of the new union contract, we are forecasting labor costs to be approximately $80 million more on an annual basis. This will put pressure on margins going forward in addition to the broader inflationary pressures we are experiencing.

With the quality issue resolved in our factory and a new labor contract in place, our entire focus is directed towards executing on our customer commitments, including the upcoming production rate increases. Now, let me take you through the details of our second quarter financial results, so let’s move to slide two. Revenue for the quarter was $1.4 billion, up 8% from the second quarter of 2022. Second quarter 2023 revenue was impacted by disruption from the vertical fin attached fitting issue as well as the IAM work stoppage. The year-over-year improvement was primarily due to higher production on the 737 and 787 programs and increased Defense & Space revenue, partially offset by lower production on the A220 program. The Defense & Space segment had a strong quarter with top line growth of 30%, increasing revenue by about $45 million.

Also, aftermarket had a robust performance with 15% revenue growth and 26% margins. Overall, deliveries for the quarter increased 8% on a year-over-year basis. Now, let’s turn our attention to EPS. We reported earnings per share of negative $1.96 compared to negative $1.17 in the second quarter of 2022. Excluding certain items, adjusted EPS was negative $1.46 compared to negative $1.21 in the prior year. Operating margin decreased slightly to negative 9% compared to negative 8% in the same period of 2022, driven by higher changes in estimates as well as the potential customer claim that I discussed in my opening remarks, partially offset by the absence of losses related to the Russian sanctions recognized during the second quarter of 2022 and increased aftermarket earnings.

Second quarter forward losses totaled $105 million, and unfavorable cumulative catch-up adjustments were $22 million. This is compared to $64 million of forward losses and $8 million of unfavorable cumulative catch-up adjustments in the second quarter of 2022. The current quarter forward losses relate primarily to the 787, A350 and A220 programs. The 787 forward losses of $38 million resulted from the new IAM union contract as well as increased supply chain and other production-related costs. The A350 charges of $28 million were primarily due to increased costs related to production rate recovery efforts, including freight as well as unfavorable foreign currency movements, and the A220 loss of $27 million was driven by higher estimates of supply chain costs and unfavorable foreign currency fluctuations.

Additionally, the unfavorable cumulative catch-up adjustments relate primarily to the 737 program, reflecting increased labor costs from the IAM Union negotiations as well as higher supply chain costs. Other expense in the second quarter of this year was $10 million compared to other income of $35 million in the prior year. This variance was due to gain recorded in the second quarter of 2022 of $21 million related to the settlement of the repayable investment agreement with the UK Department of Business, Energy and Industrial Strategy as well as lower pension income and higher foreign currency losses recognized in the quarter. Now, let’s turn to free cash flow. Free cash flow usage for the quarter was $211 million. Cash usage increased compared to the same period of 2022, largely driven by the negative impacts to working capital resulting from the rework and disruption related to the quality issue and the IAM work stoppage as well as preparation for the third quarter 737 production rate increase.

Second quarter 2023 cash from operations was also included customer advances of $50 million as well as an excise tax payment of $36 million related to the termination of the pension value Plan A. Looking ahead, the new union contract was in line with our 2023 free cash flow expectations. However, the work stoppage resulting from the IAM work stoppage led to fewer 737 deliveries that will not be able to be made up in the back half of the year. We now expect full year 737 deliveries to be in the range of 370 to 390 units. Additionally, during these periods of disruption, we continue to receive materials and inventory to support our own supply chain, which caused additional pressure to free cash flows. These items, in combination with additional forward losses taken during the quarter will negatively impact full year cash flows.

Given these headwinds, we are now expecting our free — full year free cash flow to be in the range of negative $200 million to $250 million. This updated range includes the benefit of $100 million of customer advances, which I will explain in more detail on the next slide. With that, let’s now turn to our cash and debt balances on slide three. We ended the quarter with $526 million of cash and $3.9 billion of debt. As I discussed on the last earnings call, as part of our subsequent event discussion, we entered into agreements during the second quarter with our customers to provide cash advances. As a result, we will receive $280 million this year, of which $230 million was received in the second quarter and $50 million will be received in the fourth quarter.

We plan to repay these advances with payments of $90 million in 2024 and $190 million in 2025. $180 million of these advances were received from Boeing and are categorized as other liabilities on the balance sheet and reflected as cash from financing on the statement of cash flows. The remaining $100 million is categorized as advances on the balance sheet and reflected as cash from operations and therefore, included in free cash flow. Receiving these advances will help provide additional cushion as we incur the near-term financial impacts from the lower 737 deliveries and the buildup of inventory for production rate increases. We continue to have access to public financing markets, and we’ll be looking at all available financing options to address our 2025 debt maturities as well as our overall liquidity.

Next, let’s discuss our segment performance, starting with Commercial segment on slide four. In the second quarter of 2023, Commercial revenue increased 5% over the same period of 2022, due to higher production volumes on the 737 and 787 programs, partially offset by lower A220 production. Commercial revenue was negatively impacted by disruptions from the vertical fin attached fitting issue and the IAM work stoppage. Quarterly, operating margin decreased to negative 7% compared to negative 4% in the prior year, driven by higher unfavorable changes in estimates in the current period and the potential customer claim offset by the absence of losses related to the Russian sanctions recognized during the second quarter of 2022. The changes in estimates during the second quarter, which I previously discussed, included forward losses of $102 million and unfavorable cumulative catch-up adjustments of $16 million.

In comparison to the second quarter of 2022, the segment recorded charges of $59 million of forward losses and $8 million of unfavorable cumulative catch-up adjustments. Additionally, in the second quarter of 2022, in relation to the sanctioned Russian business activities, the segment recognized net losses of $24 million. Now, let’s turn to Defense & Space segment on slide five. Defense & Space revenue grew to $190 million or 30% higher than the second quarter of last year due to higher development program activity and increased P-8 production. Operating margin for the quarter decreased to 6% compared to 9% in 2022, primarily due to increased costs on the PA and the KC-46 tanker, resulting from the IAM union negotiations and higher supply chain costs as well as onetime charges on the Sikorsky CH-53K program.

The segment recorded forward losses of $3 million, unfavorable cumulative catch-up adjustments of $6 million and excess capacity cost of $1 million compared to forward losses of $4 million and excess capacity cost of $2 million in the second quarter of 2022. For our Aftermarket segment results, let’s turn to slide six. Aftermarket revenues were $92 million, up 15% compared to the second quarter of 2022, primarily due to higher spare part sales and MRO activity. Aftermarket growth continues to be supported by the global recovery in air travel and is on track to meet the plan for the year. Operating margin was very strong for the quarter at 26%. However, don’t expect it to continue at this level going forward. The increase compared to the same period of 2022 was primarily due to higher margins on increased activity, the absence of Russian sanction losses recognized during the second quarter of 2022 and a onetime benefit that will not repeat of $2 million.

Despite the recent challenges, we believe we are moving in the right direction. Going forward, we are focused on the long-term trajectory of our business. Our top priority is on the execution and stability in our factories with rate increases in the back half of this year as well as in 2024 and 2025. Supply chain remains very challenged, but we will continue our efforts to mitigate the impact and improve predictability as the industry continues to recover. There is work to do, but demand is strong, and we are working hard to restore our operational and financial strength. Now, let me turn it back over to Tom for some closing comments.

Tom Gentile: Thanks Mark. In summary, commercial aerospace demand is strong, and we are on the best platforms to take advantage of this demand. We worked through two recent challenging issues in the second quarter with the IAM contract and the vertical fin attached rework in Wichita. We expect that there will be continued challenges associated with the supply chain and stabilizing our factories going forward. We are making prudent investments and applying resources in the right places to help mitigate these challenges. Our focus in the back half of the year is on executing our production rate increases across all programs. We expect these actions will help enable us to drive sustained improvement in cash flows going forward. With that, we’ll be happy to take your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Myles Walton of Wolfe Research. Myles, the line is yours.

Myles Walton: Thanks. Good morning. Mark, maybe you can start with the free cash flow. I think when I adjust for the advance, you’ve lowered it by about $200 million. And certainly have some discrete items. I guess I was thinking might add up to $100 million as opposed to the $200 million. So, maybe you can just walk us through the — maybe a little bit more discretely the elements of that $200 million revision?

Mark Suchinski: Sure Myles. Hey, good morning, good to hear from you. Yes, I think the big impacts really — I’ve tried to cover it, first and foremost, with the work stoppage in Wichita, it’s had an impact on deliveries and obviously, 737 is the most significant program we have but there are a few deliveries that will fall out of the year on our other programs as well, the work stoppage happened on — essentially June 20th. And so there’s going to be some of the deliveries that we won’t be able to make up. There’s the cost of that disruption. We’re taking on more inventory to support the rate increase in the back half of the year, and we continue to bring on more inventory as a mitigator for some of the challenges that we’ve seen in our supply chain.

I would also tell you that if you look at our forward loss, additional forward loss charges that we booked both in the first and second quarter, that’s going to put pressure on cash in the back half of the year. So, really, I think to summarize it, lower Boeing deliveries led by 737, us taking on more inventory to protect the production system and then higher forward loss charges that we book that will end up having a negative impact on cash. And I think those will put us within the new guide that we have here and the goal really is to set this guidance for you, deliver on this and make sure that we meet the cash flow targets that we’ve provided to you.

Tom Gentile: And Myles, I’d just add one other way to look at it which is where we are right now in the year. In Q1, we had a negative $69 million. In Q2, it was negative $211 million. So, that put us at negative $280 million. And our goal is to be essentially breakeven in Q3 and Q4. And as Mark said, the next $50 million from the customer advance is going to be treated as cash flow. So, that would put us at $230 million, which is right in the middle of our range of negative $200 million to $250 million.

Operator: Our next question comes from Ken Herbert of RBC Capital Markets. Ken, please go ahead.

Steve Strackhouse: Tom and Mark, this is Steve Strackhouse on for Ken Herbert. Last call, we had discussed about 75% of the 250 aircraft in Boeing’s inventory. Potentially another 500 in the field. The Boeing has completed the rework on about half of those and the contract revenue amount is for $23 million. This implies a cost of about $67,000 per aircraft, which is about half of what you guys had said it was last quarter for yourselves. Is this a fair way to — is it fair for us to think that the 2023 should effectively double? Or can you give us a little bit more color on the number of aircraft that Boeing has identified or the cost to them?

Tom Gentile: Yes. No, that’s — Ken, so there’s a few things that — let me highlight and go through it. We think that they’ve repaired about half the units that they need to repair so call it, 73% or 74%. So, that is a little bit less than the 75% of the $250 million. So, it’s really the 73% that they’ve repaired, the $23 million repair estimate aligns to that. And so we’ve tried to make some conservative estimates. And it’s just based on the units that are at Boeing, nothing in the fleet. So, our view is that as our understanding of the current disposition in the fleet is we don’t expect any material impact for units in the fleet. So, the $23 million only represents the units that are at Boeing and yes, it represents half of what we think is going to need to be done eventually. But that was the best estimate we could make. And so we took the charge based on the low end of that estimate.

Mark Suchinski: Yes. So, I think if you do the math on that, you get a significantly different number than you quoted on the repair cost per unit.