Good morning, ladies and gentlemen, and welcome to the Spirit AeroSystems Holdings, Inc.'s Second Quarter 2020 Earnings Conference Call. My name is Debbie, and I will be your coordinator today. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions.

[Operator Instructions] Please note, this event is being recorded. I would now like to turn the presentation over to Ryan Avey, Director of Investor Relations. Please proceed..

Thank you, Debbie, and good morning, everyone. Welcome to Spirit's second quarter 2020 earnings call. I'm Ryan Avey, Director of Investor Relations. And with me today are Spirit's President and Chief Executive Officer, Tom Gentile; and Spirit's Senior Vice President and Chief Financial Officer, Mark Suchinski.

After opening comments by Tom and Mark regarding our performance and outlook, we will take your questions. In order to allow everyone to participate in the question-and-answer segment, we ask that you limit yourself to one question, please.

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, which are detailed in our earnings release, in our SEC filings and in the forward-looking statement at the end of this web presentation.

In addition, we refer you to our earnings release and presentation for disclosures and reconciliation of non-GAAP measures we use when discussing our results. And as a reminder, you can follow today's broadcast and slide presentation on our website at investor.spiritaero.com.

With that, I would like to turn the call over to our Chief Executive Officer, Tom Gentile..

Thank you, Ryan, and good morning, everyone. Welcome to Spirit's 2020 second quarter earnings call. We continue to see the impact of the due challenges of the MAX grounding and COVID-19 on the global aviation industry.

While still grounded, it was encouraging to learn about the successful MAX certification flights and the subsequent comments issued by the FAA that demonstrate progress toward returning the MAX safely to service. Spirit’s a proud partner on the MAX program.

We supplied 70% of the structure of the MAX and it has historically represented 50% of our revenue. On June 19, Boeing directed us to produce 72 units this year, down from the previous rate of 125 for 2020 and the 606 units that we produced in 2019. We continue to monitor rates closely with our customer.

Once the MAX is safely back in service and Boeing has a better view of their delivery schedule, we will work with them to determine the right level of production in 2021 and beyond. COVID-19 remains a significant challenge to the aviation industry.

There has been a major impact to airlines with a steep drop in global passenger traffic that fell by more than 90% in April and May compared to last year. Currently, most industry analysts expect recovery to take several years with domestic travel rebounding first, followed sometime later by recovery in international travel.

According to IATA, airlines around the world have lost more than $415 billion of revenue in 2020 and more than $85 billion in profits. At one point, more than 16,000 or 65% of the global installed fleet was grounded.

Airlines are differing deliveries given their economic position, which is impacting production rates on all programs for both Boeing and Airbus. In the short-term, we are likely to see continued turbulence and we'll have to navigate our way through the uncertainty.

However, in the long-term, we believe the aviation industry is resilient and will return to robust growth. Projections for long-term air traffic are still strong, and both Boeing and Airbus each retain a significant backlog.

While many layers of uncertainty remain, the impact of the COVID-19 pandemic continues to be felt on many industries and alters everyone's lives.

Even the very dynamic nature of what we are experiencing, and the fact that both Boeing and Airbus completely stopped all production for a period of time during Q2, our Q2 deliveries decreased by 88% from 2019 and 51% from Q1 2020, which have had a negative impact on our financial condition.

In response, we have focused significant energy on reducing our cost to align with these lower levels of production and preserving liquidity. Since the beginning of the year, around the world, we have reduced the headcount of our commercial aviation programs by more than 8,000 people or about 44%.

Earlier in the year, we announced layoffs in Wichita and Tulsa of 3,200 employees. We also eliminated more than 200 contractor positions. In addition, we implemented a voluntary retirement program, which reduced our workforce by more than 850 employees.

We've also put salaried employees on a four-day work week through the remainder of the year and reduced executive compensation by 20%. When Boeing and Airbus announced full production suspensions in March, April and June, we initiated furloughs for thousands of hourly workers associated with those programs.

We also announced permanent layoffs for an additional 1,400 people in May. In July, we also decided to reduce the Kansas and Oklahoma workforce by an additional 1,100 people. These were all difficult decisions. In addition, we have cut non-labor costs significantly in line with the production cuts.

We have also been assessing our global footprint and machine capacity. In mid-July, we made a difficult decision not to renew the San Antonio Texas facility lease. This site was acquired in July 2019 from AIT, it manufacturers parts for the 787 and the MAX programs, as well as for other defense and commercial customers.

Over the next few months, the team will work to ensure an orderly transition using our established transfer processes to move work to other Spirit’s sites or suppliers. We will continue to assess our remaining capacity and take the necessary actions to adapt to the current environment.

In total, on an annualized basis, labor and non-labor, we have taken out more than $1 billion of costs or 40% of the non-material base of our business. During this period, when production rates are low, we're also taking additional actions to drive productivity and efficiency.

One major initiative is our new Global Digital Logistics Center, which has consolidated more than 450,000 square feet of warehouse space on our campus into a highly concentrated area of 156,000 square feet.

The facility can hold more than 2 million parts for all the Spirit’s Wichita based programs, and will be a key asset capable of processing thousands of parts and kits per day when production returns to higher levels. A second major initiative is an effort to reconfigure our 737 final assembly line.

We are shifting sub-assembly work out of our main production facility into different locations that enable more lean and efficient operations. One example is the wingbox of the 737 fuselage, which we are transferring to our Tulsa facility.

A second example is a 737 forward fuselage, which will move into a forward fuselage center of excellence on our Wichita campus. Both of these moves will free up space in our main production facility and enable more lean operations.

We're also developing a new automated production line using Spirit proprietary technologies to improve the assembly of single aisle airplane floor beams. The project is estimated to take a current cycle time of more than seven days per assembly down to just hours for that same assembly.

The project will also facilitate a significant reduction in work-in-process inventory and reduce the required footprint by more than 6,000 square feet. In our Airbus operations, we are implementing an enhanced composite spoiler production line that saw the completion of its first preproduction shipset this quarter. Each A320 has 10 spoilers.

This highly automated line is expected to reduce the cost of each spoiler shipset by 30%. The Prestwick team is targeting to have first part qualification components started in August, followed with a trial fit of the spoilers at the Airbus Broughton facility at the end of September.

On the quality front, we also have a number of exciting initiatives in various stages of development that will drive many benefits as we increase production rates. One example is a blue light scanner that is capable of inspecting the fuselage skins for many attributes, including faster location, haul location and fastener head height.

The scanner method is estimated to reduce a 767 fuselage skin inspection time by over 7 hours from the manual process and will allow us to send data digitally directly to our customer.

Another example where technology will enhance our inspection processes over large surface area is a system being developed on top of Spirit's cognitive robotics platform.

The system will scan entire sections of a fuselage, store the results in a database and generate automated inspection results that can be used for predictive analysis and process control. We are also taking this time of lower production to improve our inspectors’ work instructions.

We are overhauling our instructions to develop clear, visual guidelines to highlight what should be inspected, the tools needed for that inspection and the location on the airframe. The new visual instructions are a great improvement that will drive a reduction in inspection cycle times.

Our plan is to continue to evaluate and implement similar initiatives in this time of lower production rates so that when commercial air travel does begin to recover, we will be able to maintain Spirit's position as a leading aerostructure supplier to Boeing, Airbus and our defense customers. We also continue to grow and diversify.

The Spirit team continues to demonstrate our strong value proposition to our defense customers. For example, we recently achieved a production milestone with the 10th CH-53K production fuselage delivery.

The team continues working at a steady pace during the slow rate initial production phase, to fabricate the composite forward fuselage and assemble the whole fuselage with parts from other suppliers.

We are a proud Sikorsky partner in support of the Marines and their missions requiring transport of more than 27,000 pounds of payload with this heavy-lift helicopter. In June, we hosted a visit by the U.S. Air Force Secretary Barbara Barrett.

That same day Spirit was awarded an $80 million contract allocation through the Defense Production Act Title III funding provisions.

The contract will allow Spirit to expand its domestic production capability and capacity for advanced tooling, composite fabrication and metallic machining, as well as enable us to maintain and protect critical workforce capabilities caused by the COVID-19 disruption.

We've been able to start work on projects related to the $80 million and we'll see some benefit in 2020. However, we'll see a larger impact over the next few years. The defense pipeline is strong and we continue to be actively engaged in discussions with the defense primes on how to leverage the available capacity at Spirit to support them.

We are positioned and ready to compete for new growth opportunities to support the Spirit defense business. We also recently announced two exciting new agreements. The first agreement was with Virgin Hyperloop.

This collaboration will leverage Spirit’s engineering, certification, supply chain, fabrication and assembly capabilities to assist in Virgin Hyperloop's development of a new mode of transportation that can travel at speeds of up to 700 miles per hour using electric propulsion through a low-pressure tube.

The second agreement was with Aerion, which expanded our partnership for design to production of the forward fuselage for the AS2 supersonic business jet. This partnership is another exciting opportunity for Spirit to work with the company on the leading edge of development in the aviation industry.

Our composite engineering and production leadership fits well with the development of the forward pressure fuselage for the Aerion AS2 program. We look forward to continued collaboration and innovation with both companies to move these products forward in their development.

Also, I wanted to share an update on how we are helping our nation combat the global COVID-19 pandemic. We are working with Vyaire, the largest pure-play respiratory company in the world to produce ventilators for global distribution. Today, we have produced and shipped thousands of ventilators to the U.S. strategic stockpile, U.S.

customers and customers around the world. We now have over 800 workers assigned to the project and the capability to produce over 300 ventilators per day. The new factory that we have established will help Vyaire fulfill their order of producing over 22,000 ventilators for the U.S. government and fulfilling other orders around the world.

Spirit continues to increase our ventilator production rate on a steady pace. This project demonstrates the transferability of Spirit’s capabilities in design engineering, industrial engineering, supply chain management, fabrication, complex assembly, and functional system and testing to the manufacturer of other highly sophisticated products.

Our other efforts to grow and diversify are the two acquisitions that we have announced. We continue to see the long-term strategic value in both the Asco and Bombardier Aerostructures acquisitions. And remain engaged in discussions with both parties on the conditions needed for closure of those deals.

The long stop date of the Asco acquisition agreement is October 1. We are still working to meet the conditions of the European Commission on that deal. The long stop date for the Bombardier acquisition agreement is October 31. We continue to work with Bombardier to meet those conditions precedent, some of which remain outstanding.

With that, I'll ask Mark to lead you through a detailed second quarter 2020 financial review.

Mark?.

Thank you, Tom. Good morning, everyone. I hope everybody's well and staying safe. As Tom mentioned in his opening remarks, Spirit as well as the overall aviation industry has been significantly affected by COVID-19’s impact to global passenger traffic and demand for aircraft.

We've continued to adjust as our customers have reduced their production rates and we will continue to make every effort to adapt our cost structure to lower production levels, to ensure that spirit remains financially healthy during this crisis. Now let's move to our second quarter results. Please turn to Slide 4.

Revenue for the quarter was $645 million, down 68% from the same quarter last year. This reduction was primarily due to the lower production rate on the 737 MAX resulting from the continued grounding of the program and the significant impacts of COVID-19 pandemic.

Production rates across all of our commercial programs were negatively impacted by COVID-19 and the shutdown of commercial airplane production at Boeing and Airbus facilities for several weeks during the second quarter. We delivered 19, 737 shipsets this quarter compared to 147 in the same period of 2019.

Overall deliveries decreased to 159 shipsets compared to 449 shipsets in the same quarter last year. Let's turn to earnings per share on Slide 5. In the quarter, we reported earnings per share of negative $2.46 compared to $1.61 per share in the same quarter last year.

Adjusted EPS was negative $2.28 per share compared to positive EPS of $1.71 in the same period of 2019. Second quarter adjusted EPS excludes the impacts of planned acquisitions, restructuring costs and the non-cash voluntary retirement plan charges.

The second quarter operating margins declined as a result of costs incurred related to the Boeing directed 737 MAX production suspension and subsequent low rate of production, as well as impacts of COVID-19 pandemic and the associated production shutdowns at Boeing and Airbus.

We recognized excess capacity costs of $83 million, abnormal production costs related to COVID-19 of 19 million, restructuring expenses of 6 million for cost alignment and headcount reductions, and loss on disposals of 23 million related to certain long-lived assets on the Boeing 787 and Airbus A350 programs.

Further, we recognized a non-cash charge of 15 million resulting from the voluntary retirement program that was initiated during the first quarter of 2020.

In addition to the expenses I just described, we also recognized forward loss charges of 194 million during the quarter, primarily driven by lower future production rates announced on the 787 and A350 programs, as well as unfavorable cume catch adjustments of 38 million related to the recently announced production rate cuts on the majority of our other commercial airplane programs.

You may recall as part of the last quarter's earnings review, we provided preliminary forward loss estimates resulting from the lower production rates announced by Boeing and Airbus. These estimated forward losses were based upon data, which became available after the first quarter balance sheet date of April 2, 2020.

Throughout the second quarter, that dynamic of demand for wide-body aircraft continues to evolve from the facts and assumptions originally made as a result of the uncertainty regarding the timing and resolution of COVID-19 and the ultimate impact on the aviation and travel industries.

We evaluated additional schedule and production demand information as well as other market and analyst data, and as a result adjusted the expected results on the 787 and A350 programs to include a lower rate of production for a longer duration compared to the previous forecast.

This change in judgment from the first quarter resulted in any negative impact of fixed costs absorption on the 787 and A350 programs. And as a result, the forward-loss recognized for the second quarter of 2020 were 103 million on the 787 program and 84 million on the A350 program. Our year-to-date tax rate is approximately 38%.

As a result of the passage of the CARES Act, we have an opportunity to carry back our anticipated 2020 net operating loss to years where we paid tax at a rate of 35%. The CARES Act net operating loss benefit and the impact of state tax credits resulted in a favorable year-to-date tax rate compared to our expected normalized rate.

Now turning to the free cash flow on Slide 6. Free cash flow for the quarter was a use of 249 million compared to a source of 192 million in the same period of 2019. This year-over-year decrease is primarily due to the negative impact of working capital requirements and significantly lower deliveries across all of our commercial airplane programs.

Excluding the 215 million of Boeing advance payments received in the first quarter, free cash flow improved by 325 million from the first quarter.

This quarter-over-quarter improvement was a result of a decrease in working capital requirements, a reduction in capital expenditures, as well as the cost reduction actions we have taken throughout the first half of the year.

We expect to realize further benefits from these cost mitigation actions, which were required to align our cost base to the new lower production rates. We anticipate cash flow usage to continue to improve in the third and fourth quarters.

However, as a result of lower production rates due to COVID-19, we expect our cash use to continue for the remainder of the year. As Tom mentioned, we have focused significant energy on reducing our costs to align with lower levels of production and to preserve our liquidity.

In addition to the actions already discussed, we are taking advantage of the CARES Act to provide additional liquidity flexibility as we have elected to defer the payment of employer taxes, payroll taxes of which 50% is required to be paid in 2021 and the remainder in 2022.

We will continue to evaluate and take the necessary steps to adjust our cost base in order to minimize cash spend in light of the challenging environment. Additionally, we previously announced the need to revise our debt covenants as we projected a potential breach in the fourth quarter of this year.

Over the last few weeks, we have worked tirelessly with our banking groups and finalized the amendment on July 31. The amendment provides covenant relief through 2022, additionally as part of the terms of the amendment, the available revolver decreases to 500 million and we have paid down 100 million of the term loan.

We appreciate our bankers support throughout the process of amending our credit facilities. We ended the quarter at 1.9 billion of cash. We believe our liquidity is sufficient to complete the acquisitions if the conditions of both deals are met and fund our operations over the next 12 months.

Now let's turn to our Fuselage segment performance on Slide 7. Fuselage segment revenue in the quarter was 327 million, down compared to the same period of 2019, primarily due to lower production volumes on the 737, 787 and A350 programs. Operating margin for the quarter was negative 77% compared to 12% in the same period of the prior year.

The segment recorded 31 million of unfavorable cumulative catch-up adjustments and a 105 million – 155 million of net forward losses.

The decrease in segment profitability and operating margin was primarily a result of forward losses recognized in the 787 and A350 programs, lower profit recognized in the 737 program, including excess capacity costs of 61 million as well as abnormal costs related to COVID-19 of 11 million and loss on disposals of 23 million related to certain long lived-assets on the 787 and A350 programs.

If we turn to the Propulsion segment performance on Slide 8. In the second quarter, Propulsion revenue was 170 million down compared to the same period of the prior year, primarily due to lower production volumes in the 737 program. Operating margin for the quarter was negative 10% compared to 19% in the same quarter of 2019.

The segment recorded 5 million of unfavorable cumulative catch up adjustments and 16 million of net forward losses.

The decrease in the segment profitability and operating margin was primarily a result of forward losses recognized in the 787 program, lower margin recognized on the 737 program, including excess capacity costs of 18 million, as well as abnormal cost related to COVID-19. Now let's turn to Wing segment performance on Slide 9.

During the second quarter Wing revenue was 123 million down compared to the same period last year, primarily due to lower production volumes on 737, A320 and A350 programs. Operating margin for the quarter was negative 35% compared to 14% in the same quarter of 2019.

The segment recorded 2 million of unfavorable cume catch up adjustments and 23 million of net forward losses. The decrease in segment profitability was primarily a result of forward losses recognized in the 787 program, lower margin recognized on 737, including excess capacity costs and abnormal costs related to COVID-19 of $19 million.

In closing, these last several months have been very challenging and we have had to make some very difficult decisions, while the dual challenges of the MAX grounding and COVID-19 are out of our control, we are taking the necessary actions to adapt to the rapidly changing environment.

As we have demonstrated throughout this year, we quickly implemented cost mitigation actions and we are constantly assessing our business against the current environment and potential future scenarios, identifying areas of improvement and developing plans for various scenarios. The second quarter was one of the toughest quarters in our history.

As we continue to move forward, our focus is on addressing the challenges that remain ahead of us over the next couple of years. With that, I will turn it back over to Tom for closing comments..

Thanks Mark. The COVID-19 pandemic has resulted in a significant reduction in air traffic. That has had a major impact on airlines and aircraft production. It will take several years for production to resume to the previous levels of 2019. We will also continue to support Boeing as they work with the FAA to return the MAX safely to service.

In the meantime, our focus remains on managing our costs to align with the lower production rates and preserving liquidity through these uncertain times in our commercial business. Our team is making great progress to adapt with new, better ways of working while continuing to keep all of our employees safe and healthy.

We also see opportunity to expand our defense business and leverage some of our open capacity to demonstrate our unique capabilities to customers willing to partner with a team that has decades of design and manufacturing experience.

While we will have course corrections as we navigate through the turbulence of COVID, we are confident in the resilience of the Spirit team. Our focus will be to maintain sufficient liquidity and continue to adjust operations to the evolving environment. With that, we will be happy to take your questions..

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Jon Raviv with Citi. Please go ahead..

Jon, are you on mute?.

Can you hear me?.

Yes, now we can hear you..

Sorry about. Thank you. Tom and Mark, can you just go over some of the things you talked about in terms of liquidity? So first of all, cash breakeven. I think previously, you were talking about mid-21.

Should we expect cash use to continue through all of next year as well now? And then also, you mentioned that you feel good about liquidity for supporting operations for the next 12 months.

At what point over the next 12 months do you have to decide if you have to do something more from a liquidity perspective? You need to go back to the market? And does renegotiating M&A play any role in that? I know your covenant changes mentioned that topic as well. So a big question on cash and liquidity. Thank you..

Right. So I'll start and then Mark can add on. But in terms of cash flow, we did say at the last call, based on the production levels that we had at that time, that we thought we would start to get into cash flow-positive in 2021. With the reduction on the 737 from what was 125 down to 72, it's going to push that out.

So we expect next year, the cash burn will be significantly less than it was this year, but it will still be a cash burn. But we are looking at 2022 as when we will be cash flow-positive again. Now in terms of cash operations and liquidity position, Mark did mention that our liquidity position is good for 12 months.

We don't expect that we will get to a position where we would need to raise additional capital based on the current projections and the scenarios that we have. But we have a very clear line of sight to the 12 months. It actually goes beyond that.

But we just wanted to bound it by saying it's very solid for the next 12 months, even if we included the full amount of the deals that are currently under consideration.

Mark, anything else to add?.

No. I think Tom covered it. We have a line of sight to the liquidity needs over the next 12 months or so. We do have access to capital markets, if needed. And that's a lever that we can pull if we need to at some point in time in the future. But based on the current production rates, I think Tom summarized our situation pretty well..

Thank you..

Thanks..

The next question comes from Greg Konrad with Jefferies. Please go ahead..

Good morning..

Good morning..

Tom, you announced a number of initiatives in the prepared remarks. I mean if we look at Q2, there were several costs around forward losses, abnormal costs and excess capacity costs.

With these initiatives, how do we think about areas such as the latter two going forward? Is there a normalized margin target at these lower production rates?.

Right. Well, we did have all of these abnormal events based on the lower production, which drove the forward losses. And with this 737 in a much reduced production capacity that also drove some abnormal costs. The cost actions that we've taken are meant to offset that and to really align the business to these lower levels of production.

And our goal with all the initiatives that I described is to continue to improve the productivity and the efficiency of our operations so that when production rates do return to higher levels, we'll be more productive and be able to achieve higher levels of margin, all things being equal.

So if you recall, last year, when we were at 52 rate of production, our targets for margins were 16.5%, and our cash flow targets were 7% to 9%. Now our goal would be to get back to those levels of margin and cash flow when, say, the MAX gets back to the 40s in terms of production rate. Now that's about where we were in 2016.

Of course, in 2016, we also had much higher rates of 777 production, which we won't have this time around. But again, the goal of all those productivity initiatives was to reset the business so that we can be more profitable with better margins at lower rates of production.

And we would see a return to our previous targets when we get into the 40s on MAX production, along with all of the other projections for the different programs of Boeing and Airbus and defense..

Thank you..

The next question is from Seth Seifman with JPMorgan. Please go ahead..

Hey, good morning. This is actually Ben Arnstein on for Seth..

Hey, Ben..

Good morning..

Hey. I was hoping if you could kind of give us a little bit more color and some insight onto how you're thinking about the MAX production ramp. I mean the production rate through the end of the year is implied at about five to six units per month.

And so I guess how do you kind of think about your ramp back up in your production system for a target maybe one or two years from now?.

fuselages plus thrust reversers, pylons, wing slats and flaps and so forth. We've got about 130 of those stored. The goal is to burn that buffer off over the next 12 months, which will mean that we'll lag Boeing by about five aircraft per month during this ramp build.

But the good news is that buffer will give us a chance to manage our production increases in a more methodical way. So Boeing has some pretty sharp production rate increases over the time period. Because we have that buffer, we'll be able to smooth it out a little bit.

The goal is, at the end of that 24 months, we'll have about 20, 25 units remaining in buffer that will create a permanent cushion for the production system.

But that's basically the rate ramp that we expect, is we're going to lag Boeing over the next 24 months as we burn down our own inventory, but that buffer will allow us to go up in rate and manage that more smoothly and efficiently..

The next question is from Myles Walton with UBS. Please go ahead..

Good morning. This is Lou Raffetto on for Myles..

Good morning, Lou..

Good morning..

Just wanted to drill on the 787. I guess previously, you said you thought it would be 1405 in 2023.

I guess any updated thoughts around when that might be now?.

Yes. So with the lower production rates that were announced by Boeing, obviously, what we've done is we've looked at our contract accounting estimates over that timeframe. And so the accounting contract or block, if you want to call it that, extended and – because of lower production rates.

And that's going to drive some additional fixed costs into the block, which obviously caused more pressure as it relates to the current block that we have. And so we've updated that, and as a result of that, we recorded a forward loss of about $103 million due to the block extension. A lot of that cost is noncash.

It's depreciation expense that we're going to incur on the units over the next several years. So I would say 20% or 30% of that is cash burn over the next couple of years, so fairly minor. But we still do have a good line of sight at line unit 1405 to hit our breakeven target on the 787 program. And so really a couple of things.

It allows us a little additional time to further develop the cost-reduction initiatives that we have. We have a variety of different projects that were being implemented over the next couple of years, and that's going to give us a line of sight to breakeven.

But this lower production rates are going to put some pressure, and that's why we recorded the forward loss..

But I would just say that the original projection was we were going to hit 1405 – line unit 1405 in about the 2023 time frame. That's going to get pushed out to the 2024 time frame. So that's what Mark said, is we'll have additional time now to get to our cost-reduction targets. So that by line unit 1405 price is exceeding cost.

The other thing I would say is before then, the 787 program is burning cash for every unit. So by reducing the number of units between now and line unit 1405, we actually burn less cash as a result..

Okay, great. Thank you..

Thanks..

The next question comes from Carter Copeland with Melius Research. Please go ahead..

Hey, guys. Good morning..

Good morning, Carter..

Good morning, Carter..

Sorry for – I'm trying to listen to two calls here, so I apologize if I missed something here. But the – on the Bombardier transaction, I think you said that there were still some closing conditions to be satisfied. I'm not sure if you can elaborate on what those are. And give us some color on what remains, but – if so, that will be appreciated.

And then secondly, on the 777X and the pushout there, I don't know if there's any difference in working capital there versus your prior plans. Or help us think about where things stand on that program with respect to the revised schedule there. Thank you..

Okay. All right. Thanks, Carter. And we are aware that there are a couple of other aerospace companies going at the same time. So apologies for that conflict, but thanks for joining us. With regard to the deals, the contracts for both the Asco and Bombardier deals are public. So you can see the conditions.

As we have discussed, there are conditions to close both deals. And if the conditions are met, we are obligated by those contracts to close the deals. However, if the conditions are not met by the long stop dates, the deals will terminate by their terms. So we're working with both Bombardier and Asco to meet all of the conditions.

The conditions are not yet met for either deal. And as I mentioned in my remarks, the long stop date for Asco is October 1 and the long stop date for Bombardier is October 31. So that's with regard to the deals.

With regard to 777, Boeing has announced now that the 777-9 will push out in terms of its entry into service and that they will have lower production levels for the 777 program. So that does – because we have our fixed cost already in place, that does create more fixed cost for the program at lower numbers of units.

So we've taken that into account in terms of our forward projections and in terms of our cash flow projections. And so we're comfortable with those projections and we've built into our plans what we have heard from Boeing in terms of what their expected production rates are for the 777 program and for their entry into service for the 777-9..

With respect to your working capital balances, just since you're running ahead and that stretches out, is there a working capital burn-off that needs to happen as you rightsize that? Just trying to get a sense of as you step from 2020 to 2021, is there something that we should be aware of?.

Well, in general, on working capital, Carter, we did accumulate more inventories, particularly over Q1 and Q2, just because everybody had been set at 52 and – for the 737 and for higher rates of production across all the programs. So the inventory has built up through the first half of the year.

It will now start to burn down because we've adjusted all the POs for the discrete purchase orders and all the min/max levels for inventory. But because the production levels are lower, that inventory burn down will take longer than we had previously planned. But that's the working capital equation based on the production rate.

So it rose up during the first two quarters of this year. We'll start burning it up. But the burn-off will be slightly slower because production rates now are lower across all programs than we had previously forecast..

And Carter, specific to working capital on 777X, I think that's where you're going. I would tell you that we've been shipping product to Boeing, so we're not carrying a significant amount of work-in-process or parts inventory specific to 777X. There will be a little bit of a drag into 2021, and we won't be able to fully burn that off until 2022.

And the lower production rates next year will be a bit of a headwind to both gross profit and cash. But we're still coordinating with Boeing and trying to get the final schedules. And as Tom indicated, at a macro level, we've kind of factored that in.

But I wouldn't anticipate any significant carrying cost as it relates to working capital related to the 777X. We're in pretty good concert with Boeing as it relates to what their needs were. We'll just factor that in. It will be a little bit of a headwind for us..

Great. Thanks for the color, gentlemen..

The next question comes from George Shapiro with Shapiro Research. Please go ahead..

Yes. Good morning..

Hey, George..

When you make the statement that you'll be cash-positive in 2022, what are you assuming in terms of rates going up on the MAX, I guess, particularly?.

Right. We've just really built in what Boeing's projections are in terms of what they've communicated publicly and how that will translate for us. So we're really just taking their forecast and plugging it in..

Yes. George, I think what – to be a little bit more specific, Boeing, on their earnings call said that they would be at 31 a month in the early part of 2022. And so as Tom indicated, we do have fuselage stored here, so we're going to lag them a little bit by five or six shipsets.

But if they go to the 31 at the beginning of 2022, the back half of 2022 will be higher than that. And so think about those types of production rates in 2022, which will give us line of sight to slightly positive cash in that time frame..

And as I mentioned, our working assumptions are that we burn off our excess buffer by middle of – 24 months, so middle of 2022. And so the back half of 2022, we would be basically back in lockstep with Boeing on rate..

Hope it helps, George?.

Yes. And just a follow-up on a separate subject. The receivables were down like a little over $200 million in the quarter. I assume that you've still been selling receivables. At what point does that end? Or does it just keep going on? Because it's usually a significant amount of dollars that helps the cash flow in the quarter..

Yes. George, just – I think if you look a little deeper at the numbers, our revenue in the second quarter was roughly 40% lower than the revenue we recorded in the first quarter. Our receivable balances were the drop in the receivables from the first – at the end of March to the end of June, receivables were down 39.7%.

So the drop in receivables were in concert with the drop in revenue. And we've communicated with you guys publicly, we do take advantage of the supplier financing program that Boeing offers us. But there isn't, I would say, that the receivables dropped in alignment with the revenue. There was no – nothing different from that perspective..

Okay. Thanks very much, Mark..

Sure..

The next question is from David Strauss with Barclays. Please go ahead..

Hey. Good morning, guys. It’s actually Matt Akers on for David..

Hey. Good morning..

Could you just – on the forward loss charges for 787 and A350 you're forecasting in Q3, why is it that they're so much smaller than what you saw in Q2? I think you said in the remarks, there was something about an adjustment for kind of lower wide-body demand you saw in the second quarter.

Is that it? Or is anything else going on there?.

Yes. So basically, what happened is we took into consideration – in the first quarter earnings call, Boeing said that they were going to change their production. They were going to go from 12 to 10.

And then they updated and said production rates on 87 would be 10 for the remainder of this year, and then they would move to seven a month middle of next year.

In their second quarter earnings release, they've indicated that the production rate will now drop faster than that, and that the 787 production rates starting in the middle of next year will be down to six. So post our balance sheet data was a subsequent event. What we've done is in the out-years, we've kind of updated our forward loss.

And it's just the disclosure. We'll book it in the third quarter. It's just a one unit. It's going from seven a month to six a month. And so that's why the 787 forward loss that we'll book in the third quarter is lower than what we just booked now. And A350 is the same way.

Airbus indicated that for the balance of this year and next year, instead of producing A350s at six a month, they're going to produce them at five a month. So the forward loss, again, that was announced after we closed our quarter.

And we've come up with initial estimates of the additional forward losses to go, just to tweak the system and factor in the lower production rates..

Okay. Got it. And I guess just a quick follow-up.

How do you think about kind of when you could get to those new production rates on 787 and A350? Are you there yet? Or sort of how long does it take to get down there?.

Yes. So on A350, we're right now producing roughly at five airplanes per month, delivering to our customer's schedule. And I would say in the – we're going to be producing about 10 a month on 787 between now and the end of the year. And then as we move into January, production will shift down to six a month..

Got it. Thanks guys..

The next question is from Doug Harned with Bernstein. Please go ahead..

Good morning, thank you..

Hey Doug..

If we go back to when the world was more normal, you would work through accounting blocks on each of your programs. You negotiated pricing on these. You talked earlier about the 1405 block on the 787.

Can you give us a sense of what are the discussions like now with Boeing and Airbus? In other words, all of the predictability that was there before has changed.

How do these accounting blocks even stay the same? And from the two OEMs, when do you typically get an idea of when a rate change or some change in the program structure would happen? How much lead time do you get?.

Well, Doug, you're right, that times are definitely not normal. And the accounting blocks have just become longer. The accounting blocks on the 737, for example, for ASC 606 are about 200 units. And last year, we were doing that in less than a quarter. Now that accounting block could take us all the way to the end of next year.

So the accounting blocks have just spread out. The dialogue with both Boeing and Airbus, I would say, has been very strong. Both of those companies have held a number of supplier calls. And they've even held some calls for the bigger suppliers, which are smaller, which allow for more discussion and questions.

And on those calls, they obviously can't disclose information that's not public. But what they can do is talk about scenarios and ask for feedback and give their impressions of the market and what they're doing in order to estimate production.

One of the things that they've been doing, both of the companies, is having detailed discussions with airlines and essentially rebuilding their delivery schedule, aircraft by aircraft, airline by airline based on what aircraft/airlines can take and when they can take them.

And so they've been very open and transparent with us and with the other suppliers so that we get some indication of when they might make rate changes, what to expect. So they've got their disclosure requirements, so they can't disclose things that are not public information. But they can discuss scenarios with us, and they have done that.

And then they have provided us with – in this environment, with as much lead time as they practically can. And then we've had to adapt.

And as you've seen, when we get production rate changes, we've adapted very quickly to adjust our cost base to those with announcements of employment reductions or facility closures or the reduction of nonlabor costs..

Yes. Doug, the only thing I would add to what Tom said is, yes, constant communication. I think COVID provide – I mean has resulted in a lot of uncertainty. And so we have received more production schedule changes this year than I think we've seen in the last five years.

So it's really challenging from a financial planning standpoint where you go through and you model what the impacts of it are. And then a few weeks later, you get another update. And so it's a constantly changing scenario from a scenario planning. And so as Tom indicated, we are moving very quickly to reduce our head count.

We started that back in January. But there's always a lag between when you become notified of a production schedule change and then implementing the – whether it's a head count reduction or some other action that you have.

So we're continuing to chase the cost down, and it's always a lag between when we become aware of the production schedule change and our ability to take those costs out, in some instances, via the WARN process. There's a 60-day notification process. So we're – the cost-reduction activities lag a little bit, and so we're chasing that cost down.

But I think we've gotten pretty close to the bottom on 737 for the remainder of the year. So the cost-reduction activities that we've taken, we should see some level of stability at least for the next six months. I think next year is still a lot of uncertainty out there.

But I think that will allow us some time to really start taking the benefits of the cost reduction activities that Tom just talked about. And we should see a little bit more stable performance in the back half of the year..

But it's a dynamic environment. We understand that. And we just have to be agile, so when we do get the official notification, just take the appropriate action to adjust the production rate and also adjust our costs to the new production level..

But what seems so hard here is when you were talking about the steps you're taking, which totally makes sense with related to lean manufacturing. So when you're back up, that should lead to better performance.

But how do you do that? In other words, what kind of rates are you thinking of for the 737 or the A320? Because we're not going to be back at 57 a month for the 737 or 63 a month for the A320 for quite some time, I would expect..

That's right. I mean Boeing has indicated what their schedule is for next year. Airbus has done the same based on what they currently know. But I would say, Doug, there's still a lot of uncertainty in the market in terms of – the MAX is not back into service yet. Still don't know how the whole COVID-19 pandemic will play out.

I think as those things get better understood, Boeing and Airbus both will be able to project their production schedules better, and therefore, our production schedules. But we just have to stay agile in the meantime. It's a dynamic environment..

Okay, thank you..

The next question is from Mariana Perez Mora of Bank of America. Please go ahead..

So, my first question is going to be related to the 737 MAX, although the issues with the aircraft are not your fault.

How can you manage, in the context of a long-term relationship with Boeing, to kind of like offset your fault in the future of all the impact that the MAX has?.

I'm sorry. Could you repeat the question again? I didn't quite get the whole thing..

Sure. So the issues on the 737 MAX were not your fault.

Is there any way that you can indemnify Spirit in the future?.

Well, I understand. So we work closely with our customers, in this case, Boeing, on all of the changes that come. Our relationship is governed by a contract – a sustaining contract that went into a fact Spirit from Boeing back in 2005.

One of the things that we did negotiate a while back was an extension of our pricing agreement, and now, it goes all the way out to 2033. And with Boeing on the 737, it's essentially indexed to rate. So as the rates go up, Boeing gets more of discount. But as the rates go down, then Spirit gets a higher price.

And that's one of the ways that we've been able to insulate the 737 MAX program from these production changes..

And if I were to think about the cash margins you get on 737 MAX according to that agreement, what would be a reasonable range?.

Well, we don't really talk about margins for individual programs. But again, on an overall basis, Spirit has indicated that our target for margins is 16.5%. And obviously, the MAX, being half our revenue, has a big influence on that.

And as I mentioned earlier, our goal would be to be back up to that range of margins once the productions get back into the 40s per month, 42 per month..

Okay. And then the last one is.

As you lever on the learned lessons so far, how do you think – do you think you are too dependent on Boeing? What are the plans that you have to protect yourself from this, like dependence in the future?.

You mean in terms of diversifying from Boeing?.

Yes..

Well first of all, Boeing is our largest customer, and we are very proud to be one of their largest suppliers. And we've always worked extremely well with Boeing and want to continue to grow with them. They're a very important customer, and we have won additional work over the years.

At the same time, it's clear that, that concentration is something that we want to change, and we want to have a more diverse and broad-based customer group. And so we have been working over the years to diversify, to grow our Airbus content.

And that was one of the reasons that we announced the acquisitions of Asco and the Bombardier aerostructures assets. But we've also been working to win new work with Airbus, and we have been successful in doing that on some wing components and the spoilers that I mentioned earlier. And in addition, we've been growing our defense business.

And our defense business this year is going to grow about 20%. We've had some significant new wins with the defense primes. We did get that Title III award from the Department of Defense for $80 million.

And after the FMI acquisition that we completed at the beginning of this year, we're very well positioned to be a leader in areas like hypersonic weapons. So we see significant opportunity on the defense business. And then probably the last area of diversification that I'll mention is aftermarket.

We've always had a relatively small aftermarket MRO as well as spare parts. We see opportunities for that to grow in the future. And we have made a number of changes in that part of the business in order to facilitate the growth..

The next question comes from Robert Spingarn with Credit Suisse. Thank you. Please go ahead..

I guess it’s good afternoon here anyway..

Hi, Robert..

Tom, I might have missed this in your monologue, and maybe you could get pieced together.

But I was wondering if I could ask you, at a high level, to maybe give us a reset and reconcile what you have – and I'm talking about all of your major Boeing programs, so 737, 787, 777, to reconcile how many shipsets you have on hand, whether they're yours or they're Boeing's, so we can get some kind of sense as to what level of underproduction you need to do on the non-MAX programs..

Right..

Because I imagine – word has it, there's 57 787s in Everett. I’m sure some of those are taken, but others aren't. And I imagine now, with the change in the 777 rate, we're going to have a timing issue there as well.

So if we could just level set this whole thing?.

Yes. It's fairly straightforward. On the MAX, as I mentioned, we have about 130 shipsets in buffer. But Boeing owns all of those. So our terms and conditions were FOB. When we finished the product, they took possession of it. They paid us after the payment term period, and then we stored them in place.

And we do that on behalf of Boeing, but Boeing owns those. So all of the buffer is owned by Boeing. On the 787 and 777, we essentially ship those products as we produce them. We don't hold any inventory at all at Spirit in Wichita on those programs..

Okay.

So that – so there's nothing – there's no cash to release any where?.

Not on those Boeing programs in terms of inventory that Spirit is holding..

Yes, I mean, Robert, we actually product work-in-process in the factory just based on the flow of the factory. But no, we don't have any completed units just sitting here waiting to be delivered. We produce what Boeing asked us, and we deliver. And for the most part, all of our product is FOB our plant of FOP origin.

So as Tom indicated, we're not carrying a lot of finished goods inventory because of the production slowdowns..

Okay. Fair enough. But they are. So the question you already addressed on your difference in production between your rate and Boeing's rate on the MAX, how would we think about that same question on the other two programs, 787 and 777? In other words, if we look at….

We just ship to their demand. There's no buffer at all..

Well, except for the fact that, again, they have inventory – clearly, have inventory. So your rates and theirs won’t match..

Well, again, Robert, I guess, let's just talk about 787 specifically. So we have a production schedule from Boeing. Starting in the third quarter, we're delivering at 10 airplanes per month. They are accepting 10 airplanes per month. That plan continues until the end of the year.

Starting in January of next year, the plan is for us to produce at six aircraft per month and deliver to Boeing six aircraft per month. Our production system is tied to the delivery schedule….

Our production system is tied to their production system. So you probably should just differentiate between deliveries and production..

Yes..

So our production on 787 and 777 is absolutely lockstep with Boeing's. The delivery may be different if they are – if they have their own finished goods. But our production schedules are absolutely lockstepped with them..

And you're being paid through production? So you're fine there?.

Correct..

And then, same implies to 777?.

Yes..

Okay. Thank you..

The next question is from Hunter Keay with Wolfe Research. Please go ahead..

Thank you everybody for getting me on. Tom, you mentioned the calls with Boeing and the scenarios that you guys consider on these calls.

When you talk about these scenarios, to the extent, obviously, you can share those conversations with us, is there a scenario where the 777X is delayed indefinitely or maybe even permanently? And I know you mentioned, Mark, the work-in-process you have there being not particularly significant, but how many other investments or even assets you have tied up in the 777X program right now? Thank you..

Well, we have not had any discussions with Boeing about anything on the 777X other than what they have released publicly now. So nothing different there. In terms of the working assets, we have invested in the appropriate capital for an infrastructure for the 777X. Boeing owns the tooling on those programs. It's a sustaining program.

But we are basically set up to produce to their production levels in the future. And that investment has already been made, so that's past us. And when the production rates do increase on that program, we will have the capacity to meet the demand..

Yes. Hunter, I would also say that the majority of the production assets are common for us, across the 777 and 777X. Obviously, the big difference for Boeing is a composite wing. So we don't have a significant set of production assets just for the 777 versus the 777X. There's a lot of commonality there and a lot of interchange.

So I don't think that there would be anything significant. If Boeing decided not to do the X, we would just continue to produce the historical 777s..

Okay. Thank you..

The next question is from Michael Ciarmoli with SunTrust. Please go ahead..

Hey, good morning.

Thanks for taking the questions that I jumped on a little bit late here, but just on the, on the two acquisitions, both Asco and Bombardier, can you give us a sense of what the current revenue run rates are? You know I mean, quite a lot's changed since, since those have been announced, and then even with Bombar, obviously not having the nacelle contract anymore, does that change anything regarding the contract terms, the price being paid, just looking for a little color on those deals and the trajectory..

Yes, well the Asco deal that when we announced it, the public information and its revenues were about 400 million, Bombardier a little over $1 billion.

Obviously like the rest of the aviation industry with COVID, those numbers will be impacted and we continue to monitor it, but it's in line with what you'd expect in terms of the COVID impact, but with the opportunity to recover as production rates recover. With regard to specific work packages we've obviously, we keep track of everything.

On the one you mentioned Airbus hasn't made everything completely public yet, so we're watching it carefully and talking to Bombardier about what the potential impact could be..

Okay. Would that change any of the terms? I mean, was that presumably those were in the financial projections that nacelle opportunity granted it was going to be competed I think, with Raytheon.

So, but if, once you get more clarity from Airbus, I mean could that materially change the financials, valuation and potential price being paid for those assets?.

Well, we're going to monitor it carefully. I mean, there's nothing, there's no specific trigger that ties one thing to another. But it's all about meeting the overall conditions of the deal. And as I said earlier, we're working with both Bombardier and Asco to meet the conditions of the deals..

Got it. Thanks guys..

This concludes our question-and-answer session and the conference. Thank you for attending today's presentation. You may now disconnect..