SPR - NYSE

Good morning, ladies and gentlemen and welcome to Spirit AeroSystems Holdings Inc.'s Fourth Quarter and Full Year 2022 Earnings Conference Call. My name is Glenn, and I will be your coordinator today. [Operator Instructions] I would now like to turn the presentation over to Aaron Hunt, Director of Investor Relations. Please proceed.

Thank you, Glenn, and good morning, everyone. Welcome to Spirit’s fourth quarter and full year 2022 results call. I am Aaron Hunt, Director of Investor Relations; and with me today are Spirit’s President and Chief Executive Officer, Tom Gentile; Senior Vice President and Chief Financial Officer, Mark Suchinski; Executive Vice President and President of Defense & Space Division, Duane Hawkins; and Spirit's Executive Vice President and Chief Operating Officer and President of Commercial Division, Sam Marnick. After opening comments by Tom, Duane, 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, and 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 spiritaero.com. With that, I’d like to turn the call over to our Chief Executive Officer, Tom Gentile.

Thank you, Aaron and good morning everyone. Welcome to Spirit’s fourth quarter and full year 2022 results call. Last year, we saw domestic travel continue to recover across the globe. The US was the best performing market, where air traffic was 2% below the 2019 level. And in China, we are encouraged to see some travel restrictions lifted in the 737 MAX return to service. Domestic air travel favors narrowbody aircraft like the A320 and the 737 MAX, both of which logged several significant new orders during the year. The orders and additional backlog provides support to Airbus and Boeing's plans to increase narrowbody production rates further. We are encouraged by the continued demand, which we expect will benefit Spirit since 85% of our backlog is tied to narrowbody aircraft. While demand remains robust, we experienced a number of challenges as we increased production rates during 2022. We had to hire a significant number of new employees who are taking time to reach the same level of proficiency as the workers we had prior to the pandemic. We also experienced higher levels of attrition with the new employees we hired. In addition, our suppliers encountered similar challenges, which resulted in higher levels of part shortages throughout the year. We also encountered higher levels of inflation. Despite these challenges, we managed to increase our production rates across several major programs by 27% overall. On the 737 program, we managed through the challenges as production increased from 162 units in 2021 to 281 units in 2022, a 73% increase. To support the recovery and the expected higher level of production in 2023, we began hiring additional headcount in the fourth quarter, which drove additional cost, but is an investment to get ready for the production rate increases in 2023. While we expect to see ongoing supply chain challenges and issues, as we stabilize production, our December 737 production was 40 units, demonstrating our capability to produce at higher rates. In 2023, we plan to produce about 420 737 shipsets which includes the units behind schedule from 2022. In January, we delivered 33 737 units. Turning to our wide-body programs, the 787 program navigated through challenges last year, and we delivered 20 units to our customer. Our 787 production resumed with a new build process to address the fit and finish requirements applicable to all the partners on the program. After completing a few units with the new process, we have found more labor per unit is needed than originally expected, which is one of the reasons driving an additional forward loss on future units this quarter. It is also taking us longer than we expected to rework the stored 787 units. We now believe we have incorporated what is needed for the 787 fit and finish requirements in the new-build process and rework. On our A350 program, we continue to see disruption, driving increased cost pressure. During the year, we saw continued disruptions from the supply chain. The transfer of parts and the ramp-up of production put the program behind schedule. We have initiated our recovery plan. However, recovery costs included expedited shipping of components to support our customers' production are resulting in additional forward loss. Mark will walk you through the details of the forward losses on these two programs in his section. We continue to support Airbus on their narrowbody programs. Our production was in line with demand from Airbus, and we expect to continue to produce to remain in sync with their production plans. In 2023, we plan to produce between 650 and 680 A320 units and about 80 A220 units. In looking at our wide-body programs for 2023, we will support our customers as they increase their production rates to support the international traffic recovery. On the 787 program, we expect to produce between 40 and 45 787 shipsets. On the A350 program, we plan to remain in sync with Boeing -- or excuse me, with Airbus production as they increase from five to six aircraft per month and plan to produce about 60 units on the A350. Now, let's turn to our Defense and Aftermarket businesses. On Defense & Space, our segment President, Duane Hawkins is retiring from his current role in just a few weeks and will hand off the segment to Mark Miklos. Duane and the team have done a great job in building Spirits' Defense & Space segment, and we wanted to give him an opportunity to take you through some of the many highlights from 2022. Duane?

Thanks Tom. In 2022, the Defense & Space team did a really good job, executing on existing programs and winning some new ones. Across our five growth areas, hypersonics, UAS, next-generation effects, next-generation aircraft, and space, we expanded relationships with current customers and created some new ones. The Defense & Space segment revenues were up a little over 11% from 2022 to $650 million with approximately 11.2% margin. We had solid contributions from the P8 and KC-46 programs. On the CH-53K program, we began preparing for full rate production by developing our rate production tooling and manufacturing build plan, while also delivering LRIP units. And in December, we had the opportunity to attend the B-21 unveiling to celebrate the team's contributions to this important new defense platform. Spirit is one of the seven partners on the B-21 program. We have a strong pipeline of Defense & Space opportunities that we continue to pursue. In 2022, the team won multiple classified and unclassified programs that could eventually result in significant revenue for Spirit. One of the first in the year was a win for the B-52 commercial engine replacement program, where Spirit will build the struts and nacelles for approximately 78 aircraft that are in service. We were also selected to support the KC-135 horizontal stabilizer program, which will help extend the life of an aircraft we often see racing the skies here in Wichita. Another win in the year was the strategic partnership agreement for the Sierra Space Shooting Star Cargo module. In addition to the Shooting Stars, Sierra Space and Spirit will work together to advance a family of cargo modules and service modules. And finally, we are closely monitoring the protest of the Army FLRAA award to our partner, Bell Helicopter and look forward to supporting them on this exciting new program. Spirit is proud to be a member of Team Valor. The Spirit National Defense Prototype Center, NDPC, continues to support development, prototyping, and industrialization capabilities to support our growth strategy. In addition to the NDPC, we have continued to repurpose some of our excess wide-body capacity to defense applications. So far, approximately 1.2 million square feet in Wichita has been transitioned to our Defense &Space business. This includes the establishment of our defense manufacturing center, which we'll provide significant classified machining capability with full-size determinate assembly accuracy. The ability of our team to be involved from the initial concept design to production is critical to optimizing how we can support customers on future programs. We closed out the year with the acquisition of [Indiscernible], a small company in Rhode Island that has a great set of technologies that complements our capabilities. The 100,000 square foot facility and the 35 talented individuals brings some unique 3D composite weaving technology and equipment to enhance our portfolio that will support hypersonic weapon development as well as other new product development opportunities. I'm proud of the Defense & Space business that we've been building at Spirit. It's on track to our target of $1 billion in Defense & Space revenue by 2025 with 12% to 14% segment margins. And I look forward to working with our new Spirit Defense & Space leader, Mark Miklos as he takes over on April 1. Back to you, Tom.

Thanks Duane. Our Aftermarket business also had a strong year with revenue growth of 30% at 19% margins. The aftermarket team continued to build out our strategy to expand our MRO capabilities in key geographic regions. In Asia, we established multiple ways to support customers in that region. In April, we signed an agreement with GAMECO to be the Spirit authorized repair center in China. Then in September, we formed a joint venture with Evergreen Technologies Corporation in Taiwan and signed an MOU with Malaysia Airlines Berhad to establish repair services for nacelles and flight control surfaces. We also signed a partnership with Boeing to provide repair services for the MAX on flight control surfaces, nacelles, and thrust reversers. We closed out the year with an MOU with Joramco, the engineering arm of Dubai Aerospace Enterprise to explore how to bring a range of composite and metallic aerostructure repairs and services to customers in the Mideast region. We continue to target $500 million of revenue for our Aftermarket business with margins in excess of 20% by2025. I'll now turn it over to Mark to take you through more details on our results. Mark?

Thank you, Tom and good morning everyone. We experienced significant pressure in 2022 due to production schedule volatility of constrained supply chain, ongoing inflation, and labor pressures, including shortages, high levels of attrition and increased training for our new hires. These challenges have resulted in higher than anticipated costs and disruptions in our factories. We expect some of these pressures to continue into 2023, particularly those related to the supply chain and training new employees. We enter 2023 strongly focused on execution and getting our factories and people in place to stabilize and support higher production rates. Now, let me take you through the details of our 2022 financial results. Let's start with revenue on slide two. Revenue for the year was $5 billion, up 27% from 2021. This improvement was primarily due to higher production on the 737, A320, and A220 programs, as well as increased Aftermarket and Defense & Space revenue, partially offset by lower production on the 747 and 787programs. The Defense & Space segment had a strong year with topline growth of 11%, increasing revenue by about $65 million. Aftermarket also displayed strong execution with revenue growth of 30% over 2021 levels. Turning to deliveries. Overall, narrowbody deliveries in 2022 were 37% higher than 2021. We delivered 119 more 737units and 124 more A320 units compared to 2021. Alternatively, wide-body program deliveries were down 6% compared to 2021, mainly driven by 17 less 787 units in 2022. Overall, 2022 deliveries increased 27% year-over-year. Now, let's turn to earnings per share on slide three. We reported earnings per share of negative $5.21 compared to negative $5.19 in 2021. Excluding certain items, adjusted EPS was negative $2.81 compared to negative $3.46 in the prior year. Operating margin was negative 6% compared to negative 12% in 2021. The improvement over 2021 is due to higher production rates, specifically on the 737 program, partially offset by continued disruption in our factories, resulting from part shortages and labor challenges, which led to out-of-sequence work and operational instability. Full year forward losses totaled $250 million and unfavorable cumulative catch-up adjustments were $28 million. This compared to $242 million of forward losses and $5 million of unfavorable cumulative catch-up adjustments in 2021. Specifically related to the fourth quarter of 2022, we incurred $114 million of forward losses, which were primarily driven by the 787 and A350 programs. The 787 forward loss of $38 million recorded in the fourth quarter was largely driven by higher cost estimates related to restarting the factory in ramping production as well as new build requirements on each unit resulting from the fit and finish issues. We forecast the cash impact from this loss to occur over the next four years. The A350 charge of $67 million in the fourth quarter of 2022 was a result of additional costs related to labor and part shortages, manufacturing quality issues, and additional freight to support our customer deliveries. In addition, during the fourth quarter, we experienced disruption resulting from transferring the production of parts from a supplier into our Kinston facility. This resulted in additional disruptions to our factory and we have now initiated a recovery plan, which will result in additional costs. Approximately $40 million of that forward loss will have an impact to cash in 2023. Additionally, in the fourth quarter of 2022, we recognized unfavorable cumulative catch-up adjustments of $59 million, primarily driven by the 737 and A320 programs. On the 737 program, we experienced disruptions due to labor inefficiencies and continued part shortages, which exacerbated the behind schedule hours and our out-of-sequence work. To catch up and prepare for the next rate break, we've made the decision to accelerate the hiring and training of employees to support a rate of 42 aircraft per month. This investment has a near-term impact on the program's profitability and cash flow, but we believe it is important to improve Spirit's production efficiencies as well as prepare for higher production rates in the future. The A320 program's unfavorable adjustment was driven by operational and supply chain disruptions and increased costs related to material, freight, and labor. 2022 earnings also included $157 million of excess capacity costs, a decrease of $60 million over 2021. Other expense was $14 million compared to other income of $147 million in 2021. This variance was primarily due to pension plan termination activities that were undertaken separately in each of the years. 2021 included a curtailment gain of $61 million resulting from the closure of the defined benefit plans acquired as part of the Bombardier acquisition. And in 2022, we terminated the frozen US Pension Value Plan A, which resulted in non-cash charges of $108 million. We anticipate additional pretax noncash charge in the first quarter of 2023 for the final settlement accounting as well as tax-related charges for the income and excise taxes, which we expect to conclude no later than the second quarter. Now, turning to free cash flow on slide four. Free cash flow usage for the year was $516 million, in line with the range we communicated on our third quarter call. Free cash flow in both years were impacted by several large one-time cash items, including a $300 million tax refund received in 2021, a payment of $154 million to the Belfast pension plan in 2021, as well as the repayment in 2022 of $123 million Boeing 737 advance that we received in 2019. In addition, 2022 free cash flow was negatively impacted by production schedule changes; the Ukraine, Russian conflict; headwinds from forward losses; labor constraints; supply chain part shortages, and inflationary pressures. There were also several other cash items in 2022 that will not recur going forward, including $38 million of a grant received from the AMJP program and $27 million of net pension-related benefits from the termination of the Pension Value Plan B. Looking to 2023, we plan to deliver approximately 420 737 units and 650 to 680 A320s during the year, which will be the largest driver of cash flow improvement. Additionally, 2023 will be positively impacted by $120 million to $140 million of surplus cash from the termination of the Pension Value Plan A, partially offset by higher interest payments and a previously reserved litigation payment, which has been appealed. Incorporating all items, including the pension surplus cash, we are targeting 2023 free cash flow to be better than breakeven, reflected estimated capital expenditures in the range of $125 million to $150 million. We anticipate the first quarter free cash flow to be the weakest and cash flow improving throughout the last three quarters of the year, partially due to normal seasonality of our cash flows. With that, let's now turn to our cash and debt balances on slide five. We ended the year with $659 million of cash and $3.9 billion of debt. These balances reflect items I previously listed as drivers to free cash flow in addition to the $319 million payment to settle the repayable investment agreement in the first half of 2022 and the refinancing activity we completed during the fourth quarter of 2022, including refinancing and extending maturities on $800 million of existing debt and upsizing by $100 million. Now let's discuss our segment performance, starting with the Commercial segment on slide six. In 2022, Commercial revenue was $4.1 billion, an increase of 30% compared to 2021, primarily due to higher production volumes on the 737, A220, and A320 programs, partially offset by lower production on the 747 and 787 programs. Operating margin was negative 2% compared to negative 7% in 2021, driven by higher volumes on the 737. As I previously mentioned, the changes in estimates during the year included forward losses of $244 million and unfavorable cumulative catch-up adjustments of $30 million. In comparison, during 2021, the segment recorded $227 million of forward losses and $6 million of unfavorable cumulative catch-ups. The segment had excess cost of $150 million compared to $207 million in 2021. Additionally, the segment recognized $38million of charges related to the Russian sanctions, which had an impact during 2022. Now, let's turn to the Defense & Space segment on slide seven. Defense & Space revenue grew to $650 million or 11% higher than 2021 due to higher development program activity and increased P-8 production. Operating margin for the year increased to 11% compared to 8% in 2021. The improvement was due to higher classified program profit and the absence of non-recurring charges taken into 2021. In 2022, the segment recorded forward losses of $6 million and excess capacity cost of $8 million compared to forward losses of $14 million and excess capacity cost of $11 million in 2021. For our Aftermarket segment results, let's turn to slide eight. Aftermarket revenues were $311 million, up 30%compared to 2021, primarily due to higher spare part sales as well as higher maintenance, repair, and overall activity. Operating margin for the year increased to 19% compared to 21% in 2021 due to one-time inventory adjustment charges as well as losses of $4.2 million related to the Russian sanction. 2022 was a more challenging year than we expected, production schedule volatility, a disrupted supply chain, labor constraints, and ongoing inflation resulted in increased costs, forward loss charges, and instability in our factories. Despite the many challenges during the year, there were several things that went right. Many of our financial metrics have reflected continued improvement over the last two years, and I expect the recovery to continue going forward. We have announced wins in our Defense & Space and aftermarket segments, and we have restructured our debt, including executing on refinancing activity, which has extended our maturities and settled a repayable investment agreement. As we enter 2023, we are working with our suppliers and our internal teams to stabilize production and position ourselves for higher production rates. The focus on operational execution as well as optimizing our costs should enable us to improve profitability and cash flow as we move throughout2023. Now, let me turn it back over to Tom for some closing comments.

Thanks Mark. Demand remains strong in the global aerospace industry. However, it was a challenging year to navigate the supply chain and other challenges we faced. We worked hard to make progress to stabilize at higher production rates, and we were pleased to close the year with some positive results, which will provide strong foundation for 2023. As we enter 2023, we expect free cash flow to be positive as we benefit from increased narrowbody production rates and continue to work on improving our labor productivity and stabilizing our supply chain. We have seen some improvements from the depths of the pandemic but expect that there will still be some volatility as the recovery continues. After 4 challenging years since the first MAX crash in 2018, we see some positive trends in the market that will benefit Spirit. Domestic traffic has recovered to 98% of what it was compared to 2019 levels, which will benefit narrowbody aircraft production. And 85% of Spirit's backlog is narrowbody aircraft. Boeing has said that they do not want to develop a new aircraft until 2035, which is good news for Spirit since the MAX and all of our other Boeing programs will continue for many years to come. China has started to fly the MAX again. Both China Southern and Hainan have both made flights, which is very good news for that program and offers upside as China brings the stored MAX aircraft out of storage starts taking deliveries again and then eventually places new orders. Boeing just announced that they're starting a fourth 737 MAX production line in Everett, which highlights their commitment to increasing rates on the MAX and that Spirit's biggest and most profitable program. And organic diversification in our Defense & Space segments and Aftermarket is progressing well. We also have some good growth opportunities in commercial including freighters for Airbus and Boeing eVTOL opportunities and other machining opportunities. For 2023, our three primary objectives will be what we are calling the three Rs. First, we must realize the production rate increases across all of our programs, while maintaining a safe workplace and improving quality. Second, we have to reduce structural costs to position Spirit to be profitable and cash flow positive even if production rates do not go up as fast as currently projected. We have assigned a senior executive and team of leaders to our cost optimization project focused in three areas; operations, infrastructure, and supply chain. In the infrastructure area, our target is to reduce 1,000 indirect positions from our 2023 headcount plan through a combination of reductions, attrition, and closing open hiring requisitions. Third, we want to reenergize our workforce so that we are ready to meet the challenges ahead as fast as we can as we face the fastest growing rates in the history of the aviation industry. With that, we will be happy to take your questions.

Thank you. [Operator Instructions] Our first question comes from David Strauss from Barclays. David, your line is now open.

Great. Thanks. Good morning.

Good morning.

Free cash flow, so I guess prior to today, you were seeing better than breakeven without the pension cash gain, now you're seeing kind of better than breakeven, but including that, I guess what changed in terms of your forecast? Because it looks like now 420 on the MAX would be better than what you were talking about before, which I think was 31 a month. So, if you can just help us reconcile what changed now versus your prior free cash flow guidance? Thanks.

Yes. So -- thanks David. A lot of things have changed really since we made some of those forecasts. We have seen higher costs across the board in things like freight, utilities, and logistics, as well as labor. In addition, as we are looking at the -- just the overall cost for production, those are going up. So, we mentioned that we've, for example, hired now up to 42 aircraft per month on the MAX program. That's in advance of any rate increases to that level. And the reason we did that was to prepare ourselves for higher rates in the future. That means it's a higher investment now. And so those are the types of pressures and headwinds that make us to conservatively estimate that we'll be breakeven now, including the pension benefit of $120 million to $150 million. Mark, anything else to add?

David, I think Tom summarized it right, we continue to see instability in our factories. We're bringing in much higher headcount to support our 737 production, and that is going to have a negative impact on 2023 cost and cash flow. And so that is the first headwind and investment we need to make to drive stability in the factory and meet our delivery commitments to our customer. Secondly, I had mentioned some challenges in our Kinston facility, and we took an additional $60 plus million forward loss. And I had mentioned that that recovery is going to require us to hire more people, expedite shipments, and incur some additional costs to support our customer requirements and indicated that that cash impact will be $40 million, which was not incorporated in our last overall discussion. And then I'll also tell you, as we think about the supply chain that we have here, I think it's going to put a little bit of pressure on our working capital. We're needing to bring in additional inventory, provide some buffers ahead of the rate breaks, probably more so than we anticipated as the stability continues here. So, at this point in time, it's early in the year. We've just started. We want to make sure that we're providing you with some information that we can meet and we'll continue to update you as we progress throughout the year.

Thank you.

Thank you, David. Our next question from Cai von Rumohr from Cowen. Cai, your line is now open.

Yes. Thanks so much. So, the pattern of cash flow throughout the year, maybe give us some color there. Is it all three quarters of red ink and then one quarter of black ink, if you just breakeven? And then related to that, you delivered 33 737s in January. Is that a sustainable rate? Or is that just -- they were sort of pretty much done in the fourth quarter? And -- because the inventory bulge and now they're just getting out the door. So, that's kind of tough to build so that we're not going to get a huge benefit from delivering planes in the first quarter. Thank you.

So, Cai, as we said a little bit earlier, cash flow in Q1 is going to be our toughest quarter. And then the cashflow in Q2, Q3, and Q4 should be positive. That's the pattern that we are anticipating. Normally, the Q1 is our hardest because of several one-time cash payments that happen just in the first quarter from a seasonality standpoint. In terms of the production level for January, 33% is a run rate projection. As we said, we're going to produce about 420 MAX units for 2023. The plan for Q1 is about 105. So, it's just basically right on schedule throughout the year. We do expect some rate breaks in the back half of the year. But the total, again, is 420 units with 105 in Q1, and we started off the year with 33 in January.

If you mentioned the one-timers in the first quarter, could you give us some color on what those are because interest basically is -- gets hit in the second and fourth quarter. Thank you.

Yes. Sure Cai. I mean the first quarter always is typically from a seasonality standpoint, our worst cash flow. A lot of that has to do with shutting down production at the end of the year. And so what happens is, we start off the year, we pay bills but we go the first week or two without any cash receipts from all of our customers. And so I would say that is the biggest negative as it relates to our seasonality in the first quarter. Last seven to 10 days of the year, we don't make any deliveries. And therefore, it takes a couple of weeks for us to start delivering units and starting to get paid. And so cash receipts are always the lowest in the first quarter, but you still have 13 payment cycles in the first quarter, and therefore, that's what puts overall pressure on our cash flow. There's some incentive-related type compensated related things that get paid out in the first quarter that don't repeat. But you're correct. As it relates to the big headwinds on cash as it relates to interest is going to occur in the second and fourth quarters.

Thank you so much.

Thank you, Cai. Our next question comes from Sheila Kahyaoglu from Jefferies. Sheila, your line is now open.

Hi, thank you. So, I just wanted to ask us -- thanks guys. How are you thinking about the cash burn on the 787 just given the forward losses and what the contribution is in 2023, given the target to deliver between 40 and 45 shipsets. Can you hear me?

Yes. So, as we've said -- yes, 787 cash burn. 787 right now still continues to burn cash on a per unit basis. Part of it is related to Boeing advance from several years ago that we send with each shipset. So, it's about $450,000 per unit. And then on top of that, as I mentioned, with this new fit and finish, the set of requirements in the build process, is resulting in some more hours, which is creating some further drag in terms of the overall 787 program. We've reflected that in the forward loss that we announced in this quarter. But the 787 does continue to be a challenging program. We do have a price step-up at line unit 1405, where we go up to a higher price with Boeing. But until then, the program is going to continue to be negative as we continue to work our cost reduction programs.

Sheila, I would just add, I think you're going here. If you think about -- as Tom said, we're in a forward loss. So, everybody understands that our costs are higher than the price and 787 consumes cash. So, when you think about 2022, for most of the year, for a big portion of the year, production was stopped. And so we were incurring costs at the end of the day, you couldn't completely shut down the place, you still had to pay bills and some of the employees. So, our cost per unit at the lower production in 2022 was significantly higher. As we move into 2023, we are going to double production, which will help from a fixed cost standpoint and help reduce our cost per unit. And so when we think about cash flow, the consumption that we had in 2022 versus 2023, typically, as you build more units, that would put more pressure on your cash flow year-over-year. But with the doubling of production, when we think about the cash consumption in 2022 on 787, how much cash we consumed at delivering 20 units versus how much cash we're going to consume at 45 units, I would say there's a little bit of pressure on cash flow in 2023 compared to 2022, but that's how things shape up. We're going to bring the cost per unit down. Production starts back up. We're still losing money on it. Just a little less than what we lost in 2022. If that helps provide a little bit more clarity.

Yes. Thank you.

Thank you, Sheila. Our next question comes from Ken Herbert from RBC. Ken, your line is now open.

Mark or Tom, I just wanted to see if you could clarify. It sounds like on a per unit basis on the 737, you talked in the past about breakeven at 31 a month, looks like that number is just creeping up with obviously the incremental cost around staffing and supply chain disruptions. Can you level set us now on how we should think about that for the 737, maybe sort of where we are today and where you expect it to be at the end of the year?

Great. Well, can I think -- it is true that we are seeing higher levels of cost on the 737 program right now, in particular, because we've overstaffed it to get ready for higher rate breaks. And we've also seen some increases in cost in things like utilities and logistics and even some labor costs as well as supply chain. So, we said that in the past that once we got to 31 aircraft per month, that would be breakeven. This year, we're going to -- basically, we started the year off at 31%, and we're going to continue. We have a couple of rate breaks later in the year, and we're saying that we're going to be breakeven. So, we do have some additional units in this year, but we'll see how everything flows out in terms of how much better we can do. But I would say that -- we said that 31 aircraft per month, we get back to breakeven. This year, we're going to be consistently at 31 aircraft per month plus some at the back end of the year, and we will be breakeven. All that said, as I said, there are some higher costs, no doubt about it in the system, which is putting pressure and we're working to offset those. What will help, though, is as we continue to go up in rate, we'll absorb more of the fixed cost, and we will naturally improve the margin as the rate goes up.

Yes, Ken, I would just say that the single biggest driver in the difference between being breakeven and the situation we're in now is the instability in the factory. Once we get to stable, we get the out-of-sequence work built down and behind schedule within the control limits will be right back to our previous expectations of being breakeven at 31%, but there's a lot of cost at this point in time an investment that we're making to drive the instability down in the factory to get the factory back within its control limits. And that's why we're making the investment now here in the first quarter to get that cost down so that we're in a good position to generate positive cash flow going forward and to make sure that we're more than well-prepared for the next breaks that happened in the back half of the year, right?

So, the headcount we're investing in right now is to make us capable of 42 and that's where we expect to end the year. So, by having those individuals in place now, they've got their training, they get experience on the job, and we'll be ready for those breaks as they happen.

Great. Thank you. Just one quick follow-up. Is the instability in the factory? It sounds like it's predominantly rate related to just the surge in hiring you're having to do to support rate down the road. But are you still seeing issues with supplier disruption and delays? Or is it predominantly just labor and the ramp-up and training associated with that?

No, it's both, Ken. Certainly, bringing all the new labor on and getting them trained is a factor, and we have seen higher levels of attrition. And it just -- it takes time for people to get up to the levels of productivity that we were at back in 2018 and 2019. They're getting there. It's just taking some time. But there's no doubt that there's also still supply chain disruption. We're seeing shortages probably two or three times higher than when the factory is in steady state. And when you have those kind of supply chain shortages, it creates traveled work, it creates disruption in the factory, it exacerbates all the other issues. So, it really is both things. It's the labor, but it's also the supply chain shortages. I would say though that the supply chain situation is under better control than we were last year. There are still challenges, but it's definitely improving. We can see that, but we just got to stay laser-focused on it.

Great. Thanks Tom, thanks Mark.

Thanks Ken.

Thank you, Ken. Our next question comes from Seth Seifman from JPMorgan. Seth, your line is now open.

Hey, thanks very much. Good morning everyone.

Good morning Seth.

I was wondering if you could talk a little bit about the guidance for 737 this year, the deliveries in the past, there have been plans for rate breaks later in the year that haven't really materialized, and that's left you guys in a tougher position in terms of kind of what you've told the investor community. So, can you talk a little bit about your level of confidence in the rate breaks for later this year versus in the past?

Well, you're right, the schedules have been more volatile over the past couple of years, but we've worked very closely with our customer Boeing in this case, to establish what the production rates are going to be for2023. And they've been very firm and committed to saying that that's what they will take from us. And by now, their own production rates may vary, but we know fairly well at this point that will deliver in the 420 units and that Boeing is committed to take those. And that's going to involve two rate breaks later in the year to achieve it. But we're staffing for it now so that we can make it. So, I would say there has been more volatility, but we're further along in the process and post-pandemic. And we do expect, with a fairly high degree of certainty at this point, that the projections that we have right now for the 420 units is what we'll deliver this year.

Great. Thanks very much.

Thank you, Seth. Our next question comes from George Shapiro from Shapiro Research. George, your line is now open.

Yes, good morning.

Morning.

Inventory was up $80 million in the fourth quarter from the third. Is that all pretty much due to the 19 737 deliveries that we missed?

George, as always, you're very -- you're intuitive as it relates to the numbers, you know our numbers very well. I would say, for the most part, we had expected to make those deliveries and burn that inventory down. We brought the parts in to support 300 shipsets on the 737. A lot of them are pretty well down the road by the end of the year, but we just -- with the disruption and some shortages, we just couldn't push those out the door. So, the biggest driver to that growth in inventory between the third and fourth quarter was due to the fact that we didn't make those additional 20 deliveries by the end of the year.

Okay. And a follow-up, Mark, given the negative catches on the 320 and the 737, how much -- does that start to impact what you've said in the past that at 42 rate, you'd be able to get back to the 16% margins that you made in 2018?

I would say this, George, and we've talked about it the last couple of calls and in some of the earnings or some of the conferences that we've gone to. The 16.5% was a good proxy back in 2016. But I would tell you today, in 2023, when you think about the macroeconomic environment, when you think about the inflationary pressures overall from a cost standpoint, we're going to have to evaluate that at this point in time. I think that all of those things that I just talked about are going to put pressure on our ability to achieve the 16.5% margin. We're not backing off our goals to improve our segment margins and get back to the types of cashflow that you saw in 2019 and 2018. But there are a lot of things that are outside of our control at this point in time that are putting pressure on overall margins. We know that our pricing is fixed with our customer. And so the way we have to drive those margins is to manage our costs and take advantage of the higher production rates in front of us. But we'll continue to -- as we move throughout the year, we tackle these higher production rates. First things first, we've got to get our factories stable, we've got to get ourselves to cash flow positive. And that's what we're really focused on here in 2023 and then improving on that as we move into 2024. And we'll dialogue with you guys every call on our progress to those plans. But at this point in time, there's a lot that has taken place between when we had those conversations now. But our goals are continuing to stretch ourselves to improve our overall profitability and make sure that we're providing great value to our investors.

Okay. Thanks very much for it Mark.

Thank you, George. Our next question comes from Kristine Liwag from Morgan Stanley. Kristine, your line is now open.

Hey guys, good morning. On the 420 737 MAX production this year, can you guys talk about how you think about the inventory burndown that Boeing already had? Is that factored in? So, could we see true production rate and final assembly be higher than the 420 for the year that you have?

Great. Well, we have taken into account the inventory and the buffers. The 420 is what we will produce and deliver to Boeing and get paid for. Now, we still have roughly 90 units or so in buffer in Wichita. Those will continue to get burned down over time. But in the meantime, they also provide a cushion to the production system as rates go up. And honestly, it's quite a useful thing to have that buffer in place. Over the next two years, that buffer will get smaller at different times as Boeing's production rate exceeds Spirit's. But for right now, that buffer is in place and it's serving a very useful purpose to cushion the production system.

Great. Thank you.

And Kristine, I would just add. For clarity and what we're focused on is the 420, it's about 20 units that we didn't deliver in 2022 we'll carry over. And so we're planning on new production of 400 units. And that's what we expect to put and ship in place and to be paid for. What Boeing delivers to their customers is we have no purview, that's on the Boeing side. We're just trying to communicate to you what contract schedules we have and what we expect to produce internally and what we expect to ship the Boeing and to get paid for. And so again, I think you have to separate our production from what Boeing delivers because they have a production line, they have stored units. And we can't really opine on what Boeing is going to deliver to the customers. What we do know is we have contractual commitments to deliver to our customer, and that's what our production rates are--

And just to clarify, the production for the year is going to be 420 units, which includes 20 that carried over from last year. So, total units production this year and deliveries to Boeing is 420.

Thanks guys. And if I could do a follow-up question on margins. So, I mean before it was three per month, it's breakeven, now with your guide for 420 per year, if we just average that, that's 35 per month for breakeven. I mean when we get out to 42, how should we think about the margin progression? And also for when you get to the mid-40s, I mean it sounded like you guys are walking back the 16.5% segment margin. So, can you give us an idea of the magnitude of change and where margins could be when you get to that mid-40s rate and stable there?

Yes, well, what I would say is as production rates increase, margins will improve. We've certainly seen a lot of headwinds in terms of labor costs, inflation in utilities and freight and logistics and other things in terms of supply chain. And as the production rates increase, the margins will improve. Now at this point, there's been so much change in volatility is we're not making projections in terms of where we'll be at specific times, but they will certainly improve as the production rates increase.

Great. Thank you guys.

Thanks.

Thank you, Kristine. Our next question comes from Myles Walton from Wolfe Research. Myles, your line is now open.

Hey, good morning. You have [Indiscernible] on for Myles. Just a couple of quick cleanups here. Can you guys size the inventory charge in aftermarket in the fourth quarter?

I'm sorry, could you repeat that?

Sorry, can you size the inventory charge in the fourth quarter and aftermarket?

Inventory charge?

Sure. It was small. It was -- we had some excess and obsolete inventory that we had to dispose of in the fourth quarter. It was a couple of million dollars, $2 million, $3 million. If you think about aftermarket, it's $360 million of revenue. We did about $73 million in the fourth quarter. So $2 million or $3 million could have a pretty big impact on the overall profitability. That probably -- excluding that inventory reduction or charge that we took; aftermarket margins would have been in excess of 20%.

All right. Great. Thank you, Mark. And then just you mentioned there's going to be a pension charge in the first quarter, any way to guess size that as well?

At this point in time, we're finalizing that with our actuaries. We're probably thinking somewhere between $70 million and $100 million, but we're working through the final impacts of that. Again, that is the non-cash component of it. And then we'll also have some tax and excise that we'll have to deal with as part of that closure.

Okay, great. And then just last one, I guess with all the talk about the cash impact and the margins going forward, I believe you guys have an IAM agreement that expires in June. How, if at all, are you taking that into account for the guidance for this year? And just how do we think about that going forward, given potential cost increases on that?

Right. Well, our IAM agreement does expire on June 23rd and we have taken into account any potential impact in our projections that we've provided today. So, we naturally have seen several other agreements that the IAM has concluded with Boeing in St. Louis with Lockheed; with Pratt & Whitney; ULA, and so forth. So, we've taken into account that potential impact in our projections today.

Thank you.

Thank you. Our next question comes from Michael Ciarmoli from Truist Securities. Michael, your line is now open.

Hey, good morning guys. Thanks for taking the question. So, I guess just thinking about the production versus deliveries. It sounds like at 400, the implied rate's 33%, but I thought you said there were going to be potentially two rate breaks. It doesn't really imply too much of a step function increase in production. I mean, is that how we should look at that? Or are you guys anticipating higher monthly production rates in the second half of the year?

Well, the production rates will go up in the second half of the year. So, we'll have a break to 38, and then we'll have a break to 42. And we've taken that into account in the terms of the total number that we're going to produce this year is 420. But that's -- we'll have a production rate break. We'll go to 38 in August and 42 in October. That's the plan. And when you add it out -- and I think it's important always to focus not on the rates, but on the total numbers of deliveries. The rate break is what you're cycling at, at any given point, but what really matters, obviously, is the total number of deliveries in a period.

Michael, I would just add that the second rate break happens very late in the year. And so there is some investment in capital -- Working capital that we'll have, but that rate break has very little impact on deliveries. The benefit of deliveries will really mostly take effect in 2024.

Got it. That makes sense. And then just another one. I mean, do you guys have any opportunities to renegotiate these contracts? I mean we keep hearing most of the suppliers out there passing through cost, getting price increases. I mean, you guys seem to be structurally stuck here as a price taker. I mean you mentioned the 787 pricing that line unit 1405. I mean, is there anything on the 37 with new blocks? Or are you just here for the long haul at these prices or with these contracts?

Well, we're always in discussions with our customers about the current market environment and the pressures that we're facing. The 737 contract, the pricing on that is set all the way out to 2033. And it's indexed to rate as we've said in the past. But on all the programs, we're always in constant discussions with all of our customers in terms of the current market conditions.

Okay, got it. Thanks a lot guys.

Thank you, Michael. Our next question comes from Noah Poponak from Goldman Sachs. Noah, your line is now open.

Hey good morning everybody. Just going to stay on that MAX discussion. Just want to confirm what you're saying is there are rate breaks going on in the system on the MAX to that 38 and that 42, but one, because you're doing them late in the year; and then two, you kind of get your system there, you break there before you're actually sustainably delivering there that those don't really generate a significant amount of units for you this year? Is that correct?

In particular, the 42 a month it happens way late in the year, that is correct.

Okay. But should we then think about 2024, shipments as running off of that underlying 42 rate?

Yes, we'll end the year at 42 and we'd expect to continue at that rate throughout 2024.

Okay. And I mean, I know there's always a little bit of interesting or difficult -- I don't know the right word, but a dynamic of you don't want to get ahead of Boeing, but you physically produce ahead of Boeing and Boeing wants to be conservative and cautious and everybody is still trying to figure out the health of the supply chain. But I guess I'll just ask it anyway. I mean, how do I foot what you're saying there on MAX rate breaks and when they occur compared to the latest from Boeing is sort of there's still a scenario that they're at 31 a month through this entire year. And if supply chain is a little better, maybe they can break into the high 30s sometime in the back half of the year?

Right. Well, what we've given you is the production schedule that we have from our customer. What they determine is their production rate and how they -- you'll have to talk to them. But what we wanted to do here is give you what we have -- I mean these schedules have to be put in place for us long in advance. And that's a schedule that we have right now is to produce 420 units and to have two rate breaks in the back half of the year. So, we just wanted to give you clarity and transparency into what our production schedule is.

No, I would also think of it this way. Boeing has said by in 2025, they're going to go to 52 aircraft per month. So, that's -- we're getting close to 18 months away from that time frame. So, at some point in time, in order to hit 52 aircraft per month, there's going to have to be rate breaks. All of that can happen in 2024. So again, I think, again, what Boeing is saying they're delivering to their customers, that's what they do. We're focused on what do we have to do to meet our contractual commitments to deliver to Boeing and what they pull from us is their decision at this point in time. But again, Tom talked about two rate breaks. One of them will help us get to the 420 deliveries this year, the other one will bring people in and working capital, but the real benefit from a delivery standpoint really doesn't take place until 2024.

Okay. And maybe just one more on the topic. Is supply chain actually better? Are the bottlenecks coming to you, coming to Boeing saying, hey, we're now ready to go? Or is it you and Boeing and those that aren't bottlenecks are saying, let's just start gunning for it and that will help pull the bottlenecks along?

No, the supply chain is better. The way I would measure it is just shortages -- part shortages. And our shortages are still elevated, as I said, two or three times higher than what they would be at steady state, but they're less than half of what they were at some point in 2022. So, we've definitely seen improvement in the supply chain. Now that said, there's always about a dozen suppliers that are in deep distress that we're having to work with. And often, by the way, we're working closely with Boeing on those suppliers. We actually have right now about 70 people out in the field, Spirit People as well as contractors, working with individual suppliers on the rate deliveries. And in addition to that, we are working on bringing some work in. We have our fab unit, which can help cover, and we also move work to other suppliers that have capacity to level load the system. But the shortages are still higher than they should be, but they're less than half of what they were and so that's why I can say there's been some improvement in the supply chain.

Appreciate all the detail. Thank you

Thank you, Noah. We have our next question from Peter Arment from Baird. Peter, your line is now open.

Thanks so much. Hey Tom, just quickly, just on the rate breaks going to 38 and then eventually 42, historically, we've always kind of understood that kind of they've done a little more methodically kind of at least six-month increments. It seems like August and October pretty close. Just maybe if you want to highlight how you're thinking about that or whether I'm wrong in my assumption on those rate break increments?

It's closer than we -- yes thanks, Peter. It is closer than we would normally do. But that's why we've made the investment now in getting up to the 42 headcount so that we can practice cycling there essentially all year, that will help us do the 38 break in August and then to go to 42 in October. So, it's a little closer, but because we have the 42 heads now which is well in advance of when we would normally have them, we were confident that we could do that, and we discussed it in a lot of detail with Boeing, and we both agreed that, that was the right plan.

Appreciate the color. Thanks Tom.

thank you.