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spk10: Good morning, ladies and gentlemen, and welcome to Spirit Aerial Systems Holding Incorporated second quarter 2022 earnings conference call. My name is Matt, and I'll be your coordinator today. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star one on your telephone keypad. I would now like to turn the presentation over to Aaron Hunt, Director of Investor Relations. Please proceed.
spk15: Thank you, Matt. And hello, everyone. Welcome to SPIRIT's second quarter 2022 results call. I'm Aaron Hunt, Director of Investor Relations. And with me today are SPIRIT's President and Chief Executive Officer Tom Gentile, SPIRIT's Senior Vice President and Chief Financial Officer Mark Szczesinski, and SPIRIT's Executive Vice President, Chief Operating Officer and President of Commercial Division Sam Marnick. After opening comments by Tom and Mark regarding our performance and outlook, we will take your questions. 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, in our SEC filings, in the forward looking statement at the end of this web presentation, and referenced in our call today. 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. And as a reminder, you can follow today's broadcast and slide presentation on our website at investor.spiritarrow.com. With that, I would like to turn the call over to our Chief Executive Officer, Tom Gentile. Tom.
spk13: Thank you, Aaron, and good morning, everyone. Welcome to Spirit's second quarter earnings call. We continue to navigate a dynamic environment driven by challenges in supply chain, staffing, and inflation. OAN schedule changes as they respond to this dynamic environment also disrupt operations and drive the need for rescheduling and replanning efforts. Despite these near-term pressures, the long-term outlook for air traffic and the global aviation industry remains strong. Domestic air traffic has recovered to close to 2019 levels, and over the July 4th holiday weekend, air traffic even exceeded 2019 levels. Aircraft backlogs remain healthy. Spirits backlog is $34 billion, of which 85% is narrow-body aircraft. Along with the rest of the industry, we were happy to be back at the Farnborough Air Show in July, which was the first major gathering of the entire global industry since the 2019 Paris Air Show. The return of the event was welcomed for us to reconnect with many of our customers, suppliers, and other stakeholders. At the air show, we saw continued narrow-bodied demand improvement with Boeing securing multiple 737 MAX orders, including 100 737 MAX-10s from Delta Airlines. Prior to the show in early July, Airbus also secured a large narrowbody order for nearly 300 A320s. Those orders reinforced the improved long-term outlook for narrowbody aircraft that support future production rate increases. While the long-term outlook remains favorable, this quarter we did experience economic pressures like the rest of the industry. As we ramped 737 MAX production to 31 airplanes per month in May, we saw additional challenges surface in our supply chain. These challenges at some suppliers resulted in part shortages in our factories. As a result, we are taking longer to stabilize at rate 31 aircraft per month on the max and have taken the opportunity to burn down the fuselage buffer we have in Wichita, which was reduced by 19 shipsets during the quarter and now sits at 66 shipsets. Overall, we now expect to deliver about 300 737 MAX units in 2022. We also saw a number of schedule changes this past quarter, particularly on the A350, 767, and 787 programs. These schedule changes contributed to the forward loss this quarter. The 787 program also required some additional engineering analysis to support Boeing's efforts to resume deliveries. We continue to respond to all of Boeing's questions on the 787 so they can complete their work with the FAA. In addition, we saw several supplier bankruptcies that created challenges this quarter. On the A220 program, one supplier bankruptcy drove a forward loss of $25 million related to schedule recovery efforts and transfer of work. Through the efforts of our supply chain team, we have been able to ensure supply continuity to our customers. Also, we are experiencing challenges with inflation on purchase services, logistics and transportation that have created some headwinds to our results. Finally, in light of the Russian invasion of Ukraine, our customers stopped shipping parts for an aircraft program. Due to the uncertainty of that program, we have taken a net charge of $28 million related to adjustments of certain assets and liabilities associated with U.S. sanctions on Russia. Our defense segment continues to show solid growth. Recently, we had three big wins in defense. First, Spirit was selected to provide the pylons and nacelles for the B-52 re-engine program. Second, Sierra Space also awarded Spirit the Shooting Star cargo module for their Dream Chaser program. Third, in mid-July, we joined Airbus Helicopters as a strategic partner to support the British-produced H-175M for the UK's new medium helicopter requirement. These wins demonstrate the momentum of our defense business in its core markets. Our defense and space growth strategy is moving us into new markets and expanding our relationship with the OEMs and primes. The aftermarket business also had a very good second quarter, growing revenue by 42% over the second quarter of last year and delivering 15% margins. Without losses on Russia-related programs, margins would have been about 20%. We also expect to see the business and aftermarket benefit from new opportunities like the recently announced deal with Boeing Global Services on the MAX and the Gamico partnership in China. I also want to highlight that we released our second annual sustainability report in July. We shed our progress toward our sustainability targets, including key accomplishments of transitioning to 100% wind power at both our Wichita and Tulsa facilities. In addition, we completed an agreement to install a large solar panel array on the roof of our Malaysia facility. We continue to leverage our research and technology investments to assist in the development of newer, more fuel-efficient aircraft. I'm now turning the call over to Mark to take you through a few more details on the financials of our second quarter results. Mark?
spk09: Thank you, Tom. And good morning, everyone. We feel optimistic about the strength of the post-pandemic aerospace recovery as we continue to see narrow body production rates increase. That said, we experienced some near-term pressures this quarter. We received scheduled changes from our customers and faced a constrained supply chain, labor shortages, and rising costs. These challenges are not unique to Spirit, and I'm confident in our ability to manage through the uncertainties over time. Now let me take you through our second quarter financial results. Let's start with revenue on slide three. Revenue for the quarter was $1.3 billion, up 26% from the same quarter of last year. This improvement was primarily due to higher production on the 737 and increased aftermarket revenue, partially offset by lower production on the 787 program. Turning to deliveries, the narrow body programs in the second quarter of 2022 were 60% higher compared to 2021, with 234 deliveries in the second quarter of 22 compared to 146 in the same quarter last year. The 737 and A320 programs each had increased deliveries. The second quarter 737 MAX deliveries were 71 units compared to 35 in the second quarter of last year, while we delivered 147 A320s compared to 96 in the prior year. Wide-body program deliveries were down 19 percent to 35 units compared to 43 in the second quarter of 2021, driven mainly by the 787 program. Overall, deliveries increased to 318 units compared to 235 in the same period of last year. Now let's turn to earnings per share on slide four. We've got a lot going on from an EPS standpoint this quarter. So I plan on walking you through the key drivers that impacted earnings. We reported earnings per share of negative $1.17 compared to negative $1.30 per share in the second quarter of 2021. Adjusted EPS was negative $1.21 compared to negative $0.31 in the same period last year. 2022 adjusted EPS excludes the deferred tax asset valuation allowance gain related to the settlement of the repayable investment agreement, and losses related to the sanctions, while 2021 adjusted EPS excludes restructuring costs and the deferred tax asset valuation allowance. We continue to see supply chain challenges with many of our suppliers experiencing staffing pressures resulting from a tight labor market and less experienced new employees as they have increased production rates. In turn, This has led to part shortages and disruptions in our factories during the quarter. We also experienced further increased inflationary pressures in logistics, energy, consumables, and other indirect areas. Operating margin was negative 8% compared to 10% in the second quarter of 2021. The margin increase reflects increased production rates partially offset by higher unfavorable changes in estimates and losses related to Russian sanctions. Operating margins in the quarter were negatively impacted by significant events, including supplier bankruptcies, losses related to Russian sanctions, and production rate changes. This quarter's net forward losses were 64 million, and we had unfavorable cumulative catch-up adjustments of 8 million. This compared to 52 million of forward losses and 10 million of favorable cumulative catch-up adjustments in the second quarter of 2021. The current quarter four losses were primarily driven by the 787 and A220 programs. The 787 charge were a result of production rate decreases and increased supply chain and engineering costs, while the A220 charges were the result of increased costs associated with the supplier bankruptcy and cost to relocate that work. The unfavorable cumulative catch-up adjustments during the quarter were driven by schedule changes, part shortages, and increased estimates for supply chain, freight, and other costs, mainly on the 737 and A320 programs. In relation to the sanctioned Russian business activities, we recorded losses of $42 million and the reversal of a previously booked forward loss of $14 million for a net charge of $28 million. These charges resulted from impairments on inventory and capital as well as reserve adjustments. Second quarter 2022 earnings also included $45 million of excess capacity costs, a decrease of $3 million over the same period of 2021. The quarter did not include any restructuring or abnormal COVID-19 costs compared to $8 million of these combined expenses during the second quarter of 2021. Other income for the second quarter of 22 was $35 million. $4 million higher than the same period last year, and reflects several offsetting items, including a gain of $21 million related to the settlement of the repayable investment agreement and higher foreign currency gains, partially offset by lower pension income, higher excise taxes, and losses on foreign currency forward contracts. Now turning to free cash flow on slide five. Free cash flow usage for the quarter was $62 million. Cash usage was higher this quarter compared to the same period of 2021, driven by higher working capital due to increased production activities, the quarterly cash repayment of $31 million related to the Boeing 737 Advance received in 2019, and the interest associated with the settlement of the repayable investment agreement. Additionally, during the second quarter of this year, Spirit received the remaining $25 million of the AMJP program grant award, which was awarded in 2021, and $27 million of pension-related cash benefits net of excise tax. Looking ahead, due to lower 737 deliveries than previously expected, ongoing supply chain disruptions, and continued inflationary pressures, we are now targeting full year 2022 free cash flow usage between $250 million to $300 million, inclusive of the $123 million Boeing advance repayment. This reflects estimated capital expenditures of $125 to $150 million. Higher 737 deliveries, our effective management of working capital, and burndown of inventory are important to achieving this year's free cash flow improvement in the back half of the year. In addition, Further inflation, schedule changes, and supplier disruptions could have an adverse impact on full-year cash flow expectations. With that, let's now turn to our cash and debt balances on slide six. We ended the quarter with a healthy cash balance of $770 million and $3.8 billion of debt. The cash balance reflects the payment of $293 million made during the quarter to the UK's Department of Business, Energy, and Industrial Strategy to settle the repayable investment agreement, which we acquired as part of the Bombardier acquisition in 2020. We remain committed to reducing debt levels through cash flow generation as narrow body production rates improve over time. Now let's discuss our segment performance, first beginning with commercial on slide seven. In the second quarter of 2022, commercial revenue increased 28% compared to 2021, primarily due to higher production volumes on the 737, 777, and A220 programs, partially offset by lower production on 787 and 747 programs. Operating margin for the quarter improved to negative 4% compared to negative 6% in the same quarter of 2021. The slight improvement was due to higher volumes on the 737 and lower costs related to excess capacity and restructuring, partially offset by higher changes in estimates and losses related to Russian sanctions. The segment had combined excess capacity and restructuring costs of $43 million compared to $50 million in the same period last year. Net forward losses were $59 million, and unfavorable cumulative catch-up adjustments were $8 million during the second quarter of 2022. In comparison, during the same period of 2021, the segment recorded 51 million of forward losses and 11 million of favorable cumulative catch-up adjustments. In relation to the sanctioned Russian business activities, the segment recorded losses of 38 million as well as the reversal of a previously booked forward loss reserve of 14 million. Next, let's turn to defense and space on slide eight. Defense and space revenue improved 3% compared to the second quarter of 2021, due to increased PA production and development program activity. Defense and space revenues did see some pressure in the quarter from changes in timing as well as a shift between development and production on classified programs. Operating margin for the quarter was flat compared to the same quarter of 2021. The segment recorded excess capacity costs of $2 million and forward losses of $4 million compared to excess capacity costs of $2 million and forward losses of $1 million in the second quarter of 2021. For our aftermarket segment results, let's now turn to slide nine. Aftermarket revenues were up 42% compared to the same period of 2021, primarily due to higher spare parts sales, as well as higher maintenance, repair, and overall activity. Operating margin for the quarter decreased to 15% compared to 26% in 2021 due to losses of $4 million related to sanctioned Russian business activities. In closing, we're feeling the impacts of the strained supply chain, a tight labor market, and increased costs, and the associated impacts of these pressures to our customer production rates. While our recovery depends on some factors beyond our control, we remain focused on execution and delivering on our commitments to our customers. Now, let me turn it back over to Tom for some closing comments.
spk13: Thanks, Mark. The long-term outlook for the global aerospace industry continues to remain strong and supports increased narrow-body production rates. We believe Spirit is well-positioned to benefit from the recovery of domestic air traffic and the increasing narrow-body production rates since 85% of our backlog is narrow-body aircraft. Our current focus is on managing challenges in the supply chain and near-term pressures caused by inflation and other global events. As we see our 737 MAX production rates stabilize, we expect to see steady improvements over the remainder of this year. Our diversification efforts are progressing well, with the defense and space teams securing additional work statement in this quarter. We also have a healthy pipeline of emerging opportunities that the team continues to pursue that could provide additional future revenue. The aftermarket team has diligently worked to build a strong foundation, and we expect the segment's revenue growth to continue as aircraft utilization recovers. With that, we'll be happy to take your questions.
spk10: Certainly. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, press star one. As a reminder, if you're using a speakerphone, please remember to pick up your handset before asking your question. We ask that you please limit yourself to one question. We will pause here briefly as questions are registered. The first question is from the line of Doug Harnett with Bernstein. Your line is now open.
spk04: Yes, thanks. Good morning. Good morning, Doug. Tom, you talked about the 787, and my understanding was that in the work with the FAA, there was one outstanding issue that related to Section 41. But my understanding was that that The resolution of that was pretty much in hand now. Can you comment on where that stands and what work needs to be done? I'm thinking about this both in terms of getting delivery restart, but also what the impact would be on you of the timing of getting that 787 production back up.
spk13: Right. Well, a couple things. We've worked closely with Boeing on... responding to all of their questions related to the work statement we have on the 787. And we've submitted all of the engineering analysis that they've requested. Now, there was some additional engineering analysis this quarter, which Mark mentioned. That was part of our forward loss. But all of that work is complete that they have requested, and we've submitted it. And so we're working with them closely so that they can complete any outstanding items with the FAA and resume deliveries. Now, we did see the press reports last week that There were some encouraging signs on that. And so we'll continue to support Boeing. But as far as we're aware, there's no outstanding engineering analysis that they need from us for our work packages on the 787.
spk04: And then if I can, just one more thing. This quarter, we were surprised by the UK cash payment. We didn't know about that. Can you just help us understand if there are any other puts and takes we should be looking for in the next two quarters with respect to cash, other one-offs, either positive or negative?
spk13: Right. Well, the UK item is something we actually mentioned last quarter as a subsequent event. So we did try to give everybody a heads up that it was coming. And as we described it, it was really to pay off some liabilities and just clean up the balance sheet to reduce future interest expense. Over the next couple of quarters, really, from a cash standpoint, the items that are still out there that we've mentioned before is the repayment of that bowling advance that we got in 2019. It was $123 million, so it's about $31 million a quarter that we're paying off. So in the next two quarters, we have about $62 million of that left to pay. So anyway, that's what's kind of the outlook for cash in terms of one-offs. On 787, I just want to go back because you did ask about production rates, and we're at the same rate Boeing is at, which is about two aircraft per month. We expect to deliver roughly 20 units this year. We've delivered seven, so we've got about 13 or 14 more to go for the year.
spk04: Okay, great. Thank you. Thanks.
spk10: Thank you for your question. The next question is from the line of Seth Seathmill with J.P. Morgan. Your line is now open.
spk14: Thanks very much, and good morning. I was wondering, you know, given the new starting point for cash flow in 2022, how we should think about the possibility to generate cash in 2023 and what the big building blocks are. And then, you know, Mark, I guess if the company is to end the year with, let's say, $850 million of cash on the balance sheet and, you know, First half is often a use of cash, and I think there's $300 million of debt coming due by the end of the first half of 23. How do we think about your approach to all of that?
spk09: Well, let me answer the back half of the question, and Tom could chime in on the first part. When you think about the adjustment to our cash flow this year, Some of that is just really working capital timing, right? We're going to deliver less units. With some of the supply chain challenges, we're going to have to build up some more strategic buffer from an inventory standpoint. So some of it isn't lost cash. It's going to be made up over time. So I just wanted to make sure that you understood that. But secondly, as it relates to your comment about the debt requirements next year and having roughly $850 million of cash at the end of the year, And you're right, first quarter, from a seasonality standpoint, is always our toughest quarter from a free cash flow standpoint. We expect that we'll use cash off our balance sheet to pay down that debt. At this point in time, we don't believe that there's any need for us to refinance it, and we expect to pay down that debt via the cash on our books and expected cash flow. That should come with higher production rates as we move forward into 2023.
spk13: Right, and Seth, on the building blocks for next year, obviously the most important are production rates, particularly for the 737 MAX. Since we're at 31 now, we expect that we would be at at least 31 aircraft per month for the whole of 2023. And as we said, in the high 20s, low 30s, in terms of MAX production rates, Spirit is at break-even. And so that is obviously going to be a key building block. The other thing we expect is 787 deliveries to recover some more, which will help burn down some working capital that we have in terms of WIP. And then a third building block would be our continued focus on working capital and streamlining our inventory as those production rates go up. And then, of course, very prudent capital expenditure management. So those would be the major building blocks for next year. And we do expect given the current outlook that we would be cash flow positive next year in 2023.
spk14: Okay, great. Thanks very much. Thanks, Seth.
spk10: Thank you for your question. The next question is from the line of Rob Spingar with Milius. Your line is now open.
spk02: Hi, good morning. Tom, at a recent conference, you'd mentioned that you'd exhausted your recall list and that incremental labor would need to come from external hires. So I wanted to ask you to talk about that process, how that's gone. Because I think earlier one of you mentioned that your supplier is having trouble with labor, but I want to see how you're doing with that. And then how's the learning curve on getting the newer people up to speed, and does it affect the relationship between a 42 rate on the max and a 16 and a half percent margin.
spk13: Right. So, uh, you're, you're right. We, we have more or less, uh, exhausted our recall list. And so we have started to tap into the market for new employees, but we did have a job fair last month. We had over 1200 people. We extended, uh, almost 700 offers. So we, we are seeing, uh, you know, good take up in terms of employment in the, in the Wichita area. In Tulsa, for example, we're actually slightly over our staffing number right now, so very solid there. And same in Kinston. And our overseas areas, Presswick, Belfast, Morocco, Malaysia, St. Nazaire, and France are all basically at their staffing numbers. So I would say our current staffing is solid. We do have to hire a few more people in Wichita, but one thing we've been able to do is shift around resources from some of the other programs. So for example, 787 production rates are down. We have shifted a lot of 787 staff to the 737 program. So I'd say we're fairly stable and the fact that production rates are gonna remain at 31 per month for the rest of the year gives us time to absorb that and to do the training that we need. The learning curve on new employees, we generally look at, we need about 90 days to get staff hired, get them through the basic training, get them through their specific training, and then get them on the job training. So it's those kind of three phases. And we try to leave 90 days to do that. And just being on the floor yesterday in our training center, we've got a lot of retirees that we've brought back, for example, and they are helping with that training. And so I would say it's basically on track to what we normally expect.
spk02: So you're still the same margin target at rate 42?
spk13: Yes, yes. Obviously, there'll be challenges, but once we get to rate 42, and that's obviously been pushed a little bit to the right, but once we stabilize there, our target is 16.5%, and all of our plans are built around that, absolutely. Great, thanks.
spk10: Thank you for your question. The next question is from the line of Kai Von Remore with Cowan. Your line is now open.
spk01: Yes, Tom, so I was surprised that you said you had 66 units stored at the end of the quarter. I assume that's down about 30 during the quarter, which would have said you were nowhere near close to 31 per month in terms of a run rate. Maybe explain to us why. And then going forward, when you talk of 31 per month, I mean, Boeing talks of 31 per month, but they're not there because they have to pause the rate to avoid traveled work. So what is the effective actually produced number in that 31, and what is your Boeing scheduled deliveries for this year for the total of the 737?
spk13: Right. Okay, so let me explain the buffer. I believe at the last call we mentioned that we were at 85, so we're now at 66, so that's a reduction of 19. To be clear, these are Boeing-owned buffer units that are stored in Wichita. These are fuselages. And I want to also be clear that it's not all a result of us lagging Boeing. Some of it, as I've said in the past, is we plan to have a buffer of about 20 units, which will maintain as a permanent buffer to cushion the production system. And in fact, we've already started to reposition some of those buffer units from Wichita up to the Seattle area to so that they're closer to the Renton site. That's where they'll be stored for the long term. So that process has already begun. And that's why the number dropped as much as it did this quarter. It wasn't just as a result of lagging Boeing. In terms of production rate for the year, for the remainder of the year, we are at 31. We did drop a little bit to allow the supply chain to catch up in June, May and June, but we are back to 31. And the effective rate that we're producing is 31 so that's the number that will be coming off of our line what we expect this year is that we will produce about 300 max units so last quarter we said 315 we've taken some out of the schedule this year to allow the supply chain to recover and burn down some of that buffer inventory so we're now expecting 300 total units for the year and I believe for the year we have already delivered about 131 So we've got 170 units or so to go.
spk01: But so if you have 66 that are on your premises, but some of them have been shipped to Boeing, Boeing has more excess fuselages, right? Because they're basically have not been hitting their 31 per month rate. So that really the buffer in terms of the D stock you have to go through is a little bit bigger. Is that the right way to think of it?
spk13: It's not bigger than it was in Q2, but I'd say the buffer is, I would say, basically flat to where it was because we've been more or less at the same rate as Boeing. And the goal, though, is to position about 20 units permanently up in the Seattle area to cushion the production system and then to burn down the rest of what's in Wichita. So I'm just trying to give you some transparency of what's left in Wichita, and what's here in Wichita is 66 units.
spk01: Got it. Thank you.
spk10: Okay. You're welcome. Thank you for your question. The next question is from the line of Sheila Kayoglu with Jefferies. Your line is now open.
spk07: Hi. Good morning, guys. Thank you for the time. I wanted to walk through and understand cash in the first half a little bit more and how that translates into what happens in the second half and eventually 2023. When we think about free cash flow outflow of 375 million in the first half, if we neutralize working capital, which I think is tough anyway, that's 200 million going away, and then take away 100 million of one-time items that you guys had in the quarter, we still get to about a 60 million free cash flow outflow in the first half. So I guess what changes and what gets better as maybe the max goes up in rate, but you did mention inefficiencies there. and the 787 increases. So if you guys wouldn't mind walking me through that.
spk13: Right. Well, Sheila, I'll give you a high-level overview, and then Mark will jump into the details. But I would say for the second half of the year, there are five levers that will help cash. So the first is 737 rates. We'll be at 31 per month for the entire six months of the back half, and so that is going to be a big driver of cash in the second half. The second is what I mentioned earlier, is the 787 deliveries. We only delivered seven in the first half, but we're planning to deliver 20 for the year, so we still have 13 to go. So it pretty much doubles the deliveries of 787 in the back half. The next main driver is working capital burndown. We do have a lot of inventory, and as the production rates go up, it will give us the opportunity to burn that inventory off. We'll also continue to manage capital expenditures very prudently. And some of these supplier bankruptcies have created losses for us, and we do have supplier recoveries that we can target, and we'll be working on that in the second half. So those are the five building blocks for what will drive cash performance in the second half. Mark, maybe you can add some additional to that.
spk09: Yeah, I think you captured it well, Tom. But, you know, Sheila, as Tom indicated, you know, we're going to deliver 100% 70, 737s in the back half of the year. And that helps from a cash flow in multiple ways. One is it's our most profitable program. And so that will help improve, you know, profit and cash to the bottom line. But also as we stabilize at 31 a month, you know, we were going up in rate in the first half of the year. We brought on a lot of inventory. If you look at our inventory, it's pretty much flat in the first half of the year. So as we stabilize the 737 production rate, we'll be able to burn some of that inventory that we've built up and created buffer to protect the production system. So 37 will be higher cash flow generation in the back half of the year. We won't be stocking up the inventory. We won't be building the whip to get the production line ready for the higher delivery rates. And we're going to see stable deliveries in the back half of the year. As Tom said, we'll see some modest improvements from a working capital by doubling our 787 deliveries. We've got a lot of WIP built up due to the fact that there hasn't been any deliveries in more than a year. That will help out. And then, you know, I expect us to do a much better job of burning down inventory in the back half of the year. If you look at our What we did from an inventory standpoint in 2021, we were close to an improvement of over $100 million. And so we expect to pick up the pace of getting our inventories in a line with production rates in the back half of the year. So I think those are some big, big drivers to it. You know, there's a lot of challenges in the marketplace, but based on those factors and where we see ourselves going between now and the end of the year with really driving production stability and not needing to add strategic buffers because of some supplier challenges in the first half of the year. We think we're in a position. We expect to go get there, but it's going to take a lot of hard work.
spk07: Can I just follow up on the 787? Because I thought that was a cash loser for you guys, given the advances of 400 per ship set and maybe a 10% margin hit there. So I thought you were losing a million per unit. How's that cash accreted in the second half?
spk09: So really, Sheila, the way that works is you're right. Those comments are exactly right. But we started the year from a work in process of a significant number of units. We were coming off a production rate that went from 14 to 12 to 10 down to five. The number of units at the beginning of the year that's in the production system, a lot of them almost completely built. The number of units that will be in the production system will be dramatically lower at the end of this year compared to end of 21 because the production rates are so much lower. So although we lose money on that, we'll be carrying at an absolute basis less WIP units in the production system at the end of this year than we had last year, and that creates some working capital benefit.
spk07: Okay, thank you so much.
spk09: Thanks, Sheila.
spk10: Thank you for your question. The next question is from the line of Christine LeWag with Morgan Stanley. Your line is now open.
spk08: Hey, good morning, guys.
spk04: Good morning. Hey, Christine, how are you?
spk08: In terms of cash, you know, you look at your net debt, it picked up from $2.6 billion last quarter to $3 billion at the end of this quarter. And with the lower free cash flow outlook for the full year at 22, I mean, cash balance kind of still gets under pressure. Can you discuss your debt covenants that you're monitoring and actions you could take to avoid potentially breaching terms?
spk09: Yeah, so, Christine, when you look at our capital structure today. We don't have any traditional banking relationships, not a revolver. So when you look at the debt that we have on our books today, it's a combination of bonds, right, in the capital market, debt holders, as well as term loan B, which is with debt holders, public debt holders. So based on the structure of those debt arrangements, There are no, what I would say, no quantitative covenant requirements from a call it a cash balance standpoint or from a leverage standpoint. So no real challenges as it relates to any type of potential covenant issues on those debt agreements. So that is not anything that we have to worry about from a near-term perspective. We obviously want to, I'm very focused on cash maintaining an appropriate level of cash balance and also very focused on paying down debt, you know, as we return to cash flow positive. So no near-term challenges as it relates to covenants. We talked a little bit about, you know, kind of the plans on how we'll deal with our bonds that come due in the middle of 2023, but I think we're okay here in the near term.
spk08: That's really helpful, Culler. And if I could do a follow-on on defense, um, You took a $2 million forward loss last quarter, $4 million this quarter. Are these forward losses related to the same program? And if so, can you provide some context around the size of the contract and potential risks going forward?
spk09: Yes, sure, Christine. It's pretty straightforward. About $1 million was associated with the V280 program that we're supporting. And so we have kind of a a cost-sharing arrangement with our customer there until that contract gets awarded. So that was a small modest for-loss due to kind of just a little bit of a delay in the government awarding that contract. We've got our fingers crossed that we're going to be on the winning team. And then the tanker on the defense side, our tanker on that along with our commercial 767 share the same production line. And we had a forward loss on the 767 program. A lot of that had to do with some pauses on the commercial production system. And so that program shares in that cost structure. And that resulted in a couple of million dollar charge being allocated to defense. But there's no systemic challenges around our defense programs that we see at this point in time. Great.
spk13: And I would say that if you look at the defense revenues, the growth did look modest at 3%. But overall, we're expecting about a 15% annual increase this year as we get past some of these transition issues in terms of moving from development to production on a couple of the bigger programs. But we have a lot of confidence in the defense business. We've had these wins. It's on track for a very solid year. And You know, Mark just highlighted some of the issues that were impacting the forward loss, but they're relatively small and not systematic.
spk08: Great. Thank you for the color.
spk10: Thank you for your question. The next question is from the line of David Strauss with Barclays. Your line is now open.
spk12: Thank you. Tom, could you maybe just clarify on the max buffer? I think, you know, we were at 100 originally. We were going to get down to 20 this year. Then I think you had said we weren't going to come down really at all, and now we're down 19. I mean, how does that – how do we get to 20 from, you know, 66 today? How does that progress? Right.
spk13: Well, it really – is what we've always said is in order to burn the duff buffer down we have to lag boeing in terms of production rates at some point so again the reason we originally said it was going to go from 100 to 20 over the course of this year is we expected boeing to be going up in rate uh and then we would lag them but they didn't go up in rate and we're now basically at the same rate of 31 and so we expect it to to level out now the reason we're down to 66 in Wichita is what I was saying to Kai, is that we started to reposition some units to the northwest so that they are a permanent buffer for the production system. Before, we used to deliver a unit out of Wichita and there was 14 days to the load point in Renton in Seattle and the train would take six to eight days. It left very little time if there was any sort of disruption, any sort of delay or or something that could impact production. So we decided with Boeing that we would keep that buffer of 20 units, and that's the plan. So we started to reposition the units. Right now, the buffer is not burning down in total because we're at the same rate as Boeing. But as they go up in the future, we will continue to lag them to burn this down. And I don't have an exact time yet right now in terms of when that buffer will get down to the 20 units overall. but it will be at some point when Boeing has increased their rates and will lag them.
spk12: Okay, I got it now. You guys mentioned you still think you can get to free cash flow positive for next year. Just wanted to ask you, the consensus for next year, I think, is 200, 225 million positive free cash flow. Is that realistic, or are you thinking closer to you know, slightly above breakeven for free cash flow next year?
spk13: You know, I would just say it really depends on what the production rates are, particularly for the max. You know, that's still a big driver for us. And if those rates do go up, obviously above 31 for us, for Spirit, then that will create better cash flow opportunities. At this point, it's a little bit too early to call what the production rates will be on the 320 program, the 787 program, the 350 program, and the MAX program. So I don't want to comment on a specific cash flow outlook for next year, but it's just going to be dependent on rate. And as I said, in the high 20s, low 30s for the MAX, that's break-even for Spirit. So if the rates are above that, that will drive positive cash flow for us next year. Okay. Thanks very much.
spk10: You're welcome. Thank you for your question. The next question is from the line of George Shapiro with Shapiro Research. Your line is now open.
spk11: Yes. Mark, I want to go back to the cash flow comment you had made because, like you said, inventories and contract assets, if I look at them in total, are about flat year to date, but your payables have actually gone up by $90 million, so effectively you've got a benefit to working capital this year. So you were saying something about 100 million liquidation of inventory, I thought. What happens to payables in that context? Because I would think they've got to go down some from where they were in Q2.
spk09: Yeah, George, I think, you know, if you look at our balance sheet, you're absolutely right. We've seen our payable balance go up, which is a benefit on the working capital. But I think if you look at accounts receivable, that's up over 120 million. So that's an offset consumer of cash. So really, I think receivables growth is higher than payable growth. That neutralizes each other. As you said, we haven't seen from an inventory of contract assets, it's flat, so it hasn't generated or hurt us year to date. In the environment that we're in, when we're going up in rate, we should start to burn down the inventory and improve our turns. As we progress through the year, with higher production rates, that should result in payable balances staying where it is or slightly going higher. With higher production rates, we should see AR tick up a bit. But as we drive the stability and we dealt with some of the supply chain challenges where we had to add strategic inventory buffer in the first half of the year, we had to bring in extra inventory because of titanium and the Russian sanctions. As we move into the back half of the year, We should, you know, the contract assets, which was building WIP in the line to support the 31 a month 737, all of that stabilizes. And once we get stable and we get a steady drumbeat in the factory, we'll be able to liquidate some of the higher inventories that we have. We'll be able to align our min-maxes better with the current production rates. And so in the back half of the years, I think AR, AP kind of offset themselves. And I think if we do a good job of managing our inventory and we can drive the stability in the production system, we'll see inventories come down in the back half of the year. We won't have to replenish the inventories, and that will help improve the cash flow.
spk11: Okay. And then if you could just go through, excess capacity costs were somewhat higher this quarter. I think you've been saying they'd be down 40% to 50%. For the year, is that still the thinking, or now it's more 50-plus?
spk09: No, I think it's going to be down around 30% to 40%. I think last quarter I told you about 40%. It's probably a tick down from there. A lot of that has to do with, as Tom said, we slightly paused the factory in July on 737 to give some of our suppliers the time to catch up. We slowed down a bit. We kept our suppliers hot at 31 a month. to make sure that we had the parts at the right time. And so a little bit of that slowdown as we moved in from the second quarter, a little bit of impact on A220 with some part shortages on that program. That kind of stuff bled a little bit into our excess costs. So I would say it's not a material change from what we talked about in the first quarter. You know, we still, you know, we had 218 million of excess costs in 2021. and I still expect it to be 30% or 40% lower, so probably somewhere between $140 million and $150 million this year.
spk11: And how much more does that come down next year?
spk09: I would say that we're probably looking at another 40% to 50% reduction year over year.
spk13: But obviously, George, it depends on production rates. The excess cost is based on a max production rate of 52 aircraft per month, so it'll disappear when we get back to 52, but... It just depends on where the rate is in terms of how much we incur next year and potentially into 2024.
spk09: And the 31 a month helps us reduce the excess inventory or excess costs, and we expect that to happen.
spk11: Okay. Thanks a lot.
spk10: Sure thing. Thank you for your question. The next question is from the line of Michael Shiramoli with Truist. Your line is now open.
spk06: Hey, good morning, guys. Thanks for taking the questions. Just to stay on George's line of questioning there, I mean, the excess capacity costs, I mean, if you guys are going to hold 31 a month, presumably, you know, even if Boeing increases, you're going to stay at that 31 to burn down the buffer. So, I mean, I guess how far or how long do you envision staying at 31 a month into 23? And what rate do you really need to see Boeing go to? so you can move up in lockstep, you know, given the buffer that you have.
spk13: Right. Well, you know, just in terms of the outlook for next year, again, Boeing has not really committed to any change from the 31. If you listen to their earnings call, they said they're going to wait to see how the overall production system, including engines and systems and electronics, how all that plays out before they commit to what their production rate will be. So we'll have to wait to take their lead on that. But you're right, we're at 31 aircraft per month, and the excess costs are really based on returning to 52 aircraft per month. So there will be additional excess costs next year as we remain below 52. Now, in terms of the lag to Boeing, again, we've always said that we'll seek to lag them about five per month as they go up until we burn down the excess buffer. And, you know, that'll vary depending on how fast they go up. But that's basically the equation that we've laid out in the past, and that's what we'll stick to to burn down the buffer.
spk09: And just, you know, Michael, for clarity, if we stay at 31 a month, I know how much excess costs we'll have, and it will be lower next year than this year, even if we stay at 31 for the full year.
spk06: Okay. Okay. Okay, but to get a 40% to 50% reduction, I mean, even if you go to 42, right, I mean, there's still 20% capacity there. So, I mean, this capacity is always going to be lingering to an extent, correct?
spk09: Yeah, really, you know, we'll see the lingering impacts of the excess cost until we hit 52 a month. But as we move into 23 and we get to 42 and 47, that becomes a fairly small number. Not to say it's zero, but it's a lot more manageable than what we saw in 2021, which was $218 million.
spk06: Got it. Got it. Okay. Perfect. Thanks, guys.
spk09: Sure thing.
spk10: Thank you for your question. The next question is from the line of Ron Epstein with Bank of America. Your line is now open. Good morning, guys.
spk05: So how much of the forward loss was distributed between 787 and A220? Yeah, so on the forward loss, 87 was around $31 million, and A220 was $25 million.
spk09: And the A220, 100% of that $25 million was associated with a fairly important supplier of ours that filed bankruptcy in the quarter And so we've been onsite, on presence, working with them to recover schedule, which is driving cost to us. And then we have a plan to unload that work. But once you unload it, you have to go through, you know, first part quals, FAIs. And so it's a sizable impact. And so we'll see that cash be consumed between now and the end of the year and into next year. So that's the 8-2-20. And then on 7-8-7, About half of that is tied to schedule. Once we got the official schedule, we're seeing we've trued up to the lower deliveries next year. A little bit of schedule impact this year. And then, as Tom talked about, we had some engineering costs to help them support getting the airplanes delivered to the customers. And then we saw some additional supply chain pressure on 787. We've got a big supplier on the West Coast. that has gone through financial challenges, and we're going to move that work from that supplier to another supplier. And in the meantime, that is going to cause us to have to incur some higher prices on the components that we were purchasing from them. So those two combined are about $66 million of the forward loss.
spk05: Gotcha. And then if I kind of go through the programs, it's 7.8% in forward loss, 3.3% in forward loss. I think I can infer Tanger isn't a forward loss and A220 isn't a forward loss. And some of this was supposed to fade in kind of that 2025 timeframe. How has that changed now? I mean, when do you expect, for example, A220 or Belfast to actually have a positive return on the investment? And when can we expect some of these other programs to actually make a positive return?
spk13: Well, I would say the A220 program continues to track very well to our original purchase accounting, absent this one issue on the bankruptcy from the supplier. So in 2025, the rates are supposed to go to 14, and that's when the forward loss ends and it becomes a profitable program for us. So that's right on track. The integration has gone well. We've transitioned off of the service agreement with Bombardier on information technology. We've uh ended up closing the pension program we've renegotiated the union agreement uh in addition we've paid off that refundable loan incentive to the uk government so a lot of very positive things are on track and the forward loss is proceeding exactly on plan absent this uh supplier bankruptcy this quarter and we are on track to be profitable uh once that program reaches rate 14 in 2025. and then on uh on 787 as we've talked historically um
spk09: You know, we get a price adjustment at line unit 1406. We continue to focus on getting the cash flow positive at that line unit. And so I think that's about the same time frame, 2025-ish, 2026, where we see us getting to, you know, break even cash flow, positive cash flow on the 787. And so those are, you know, two big programs that we're really focused on from an execution standpoint. Um, you know, the delay on the eight, seven, the lower production rates and the pause there is kind of put that plan, move that plan a little bit to the right. But, you know, I think Tom talked about the two 20, what our plans are and, and, you know, I'm just reiterating what we've told, told the market on seven, eight, seven. Gotcha.
spk05: Okay.
spk09: Thank you. Thanks Ron.
spk10: Thank you for your question. The next question is from the line of Peter Arment with Baird. Your line is now open.
spk03: Yeah, good morning, Tom and Mark. Tom, a lot of questions have been asked on production rates, but just a bigger picture, just given what's going on in the supply chain, maybe you could just – is Boeing going to have to give more of an advanced lead time just if they decide to take rates up? So instead of giving the typical, say, four to six months or whatever it may be when they're thinking about a higher rate on the max, Just given your insight of what you're seeing in the supply chain, are they going to have to let the supply chain know earlier? This is obviously thinking longer term. Thanks.
spk13: Right. Well, the normal lead time for production rate increases or any production rate changes is six months, roughly. That's normal. Obviously, we don't live in normal times right now, so we have to be a little bit adaptable and flexible. Boeing does have production rate scenarios that they talk about with the supply chain on a regular basis. And we use that to inform us and to, to get ready. And, and they, they, they use that with other suppliers. So, so we have various scenarios and we prepare for those. Uh, but the, the, the normal lead time is six months, but we've been very flexible and working with Boeing because we know that their environment is extremely dynamic with the airlines. And so we've been trying to accommodate that as much as possible. But we do have production rate scenarios that go out the next 18 months, and we are working to those so that we're prepared for a variety of different contingencies.
spk03: Appreciate that. Thanks, Tom.
spk13: Thanks.
spk10: Thank you for your question. There are no additional questions waiting at this time. That concludes the conference call. Thank you for your participation. You may now disconnect your lines.
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