Ready for some horrible, completely unfunny, Halloween-based jokes about the earnings call Friday?
Spirit spared the tricks and gave us all treats.
Spirit is all dressed up for a scary-good quarter.
Spirit’s financial results are rising from the grave.
The full moon is out and Spirit has turned into an earnings monster.
Having now sacrificed all dignity and credibility with those terrible half-baked jokes, let’s dig into Spirit’s 3rd quarter earnings. The short summary for those who don’t want to read the rest is in the form of a single question:
What will you do with your bonus?
At this point it would take financial Armageddon for us to not have a respectable STIP payout this year. As I’ve said the last few quarters, don’t come at me if that happens; we’ve certainly seen it in the past. However, because Spirit has raised their financial guidance three times this year, the amount of egg we’ll have on our face if we drop a bomb in Q4 it would probably cause heads to roll at a very high level. That’s speculation from a mere peon, but the level of trust that it would shatter would be monumental. Given that, I’m choosing to believe that Q4 will be mostly good as well, and I’m preparing my bank account for a big deposit early 2015 :). I will also note that since I’ve started sending these out at large, we haven’t had a major forward loss. I am prepared to take a disproportionate amount of credit based on this correlation.
First, let’s go over what was said in the call, then we’ll look at a summary of the financials, and finally I’ll do my best to explain anything that stands out. Click here for a good summary; if you read one thing (other than this email of course), this is probably the best resource. It mixes plain-English statements about our performance with supporting financial data.
Earnings Call with Larry Lawson and Sanjay Kapoor
Points of interest from Mr. Lawson’s and Mr. Kapoor’s presentations:
- As of this quarter, Onex is now fully divested and owns no shares. This is a new era for Spirit as a company, as control of the board is now fully public without a majority shareholder holding the reigns.
- Happy Halloween to you too, Mr. Kapoor J
- Operating margins are ridiculously good now. Both gross and net. As a reminder, here’s what operating margins are: they’re the amount of profit (revenues minus expenses) that we made compared to the amount of revenue we brought in. Gross profit margin (also “operating income as a % of revenues”) is an indicator of how good we are at our core business of turning metal into airplanes and selling them for more than it costs us to make them. Net profit margin (also “net income as a % of revenues”) also indicates how strong we are at our core business, but includes some other factors like debt-load and taxes. 9.9% net margin is pretty darn impressive, and we should celebrate that. Good job everyone J.
- $0.16 of $1.20 earnings per share (EPS) were from favorable cumulative catchups. It’s sort of (but not exactly) the opposite of a forward loss. We made unexpected improvements in the last quarter that caused our performance to exceed our own expectations. Again, congratulations!
- One noteworthy expense that we should expect in the future is investment in facilities to support rate increases. This will be an expense that will affect our cash flow, but will reap long-term benefits. To illustrate this on a smaller scale: my grandpa used to own a trucking company – this would be like him buying a new truck on loan with a monthly payment. It would cost him money in the short term while he was making payments on it, but it would enable him to do more or faster business.
- Spirit saved a lot of the free cash flow we had available this quarter. Like, in a literal sense, put it in a savings account. I’ll talk about this later.
- For my friends on the A350, the immediate financial impact from staffing down, both overseas and locally, was apparent this quarter. That’s not to say anything about the long-term impact, but it certainly made this quarter look different.
- From this isolated quarter, it seems that the wing segment has balanced out, even without a sale of Tulsa or an offloading of the troublesome Gulfstream programs.
Okay, so as usual, the interesting stuff was in the analyst questions. And to reiterate my standard warning, it was a good quarter, and good quarters tend to be boring. I prefer positive and boring to negative and interesting, but it does make it that much more difficult to write an engaging summary.
Analyst Q&A:
- Q: Lawson’s grand cost improvement strategy… what inning are we in?
o A: Lawson says we’ve shifted from labor-focused cost improvements to supply chain and overhead. He said to expect more marginal improvements in the future. He also mentioned (likely accurately) that the full financial impacts of the cost saving strategy are yet to be felt or fully manifest in the financial statements.
o Travis: In layman’s speak, that means that there aren’t likely to be mass layoffs in the immediate future, and that Lawson believes we have a roughly right-sized workforce at the moment. To answer in the vernacular of the original question, I guess I’d say 7th inning stretch. But that’s coming from some guy, not your CEO. Your mileage may vary.
- Q: Regarding the strong results for this quarter, is this a new baseline we should expect? Is there something specific that made these results so good?
o A: Mr. Lawson says again to expect marginal and steady improvement in the future as we run out of changes and non-recurring costs.
o Travis: Our business is maturing, or at least, entering a period where a majority of our current programs are mature. We have some major programs like A350 and 787 exiting the bulk of their developmental period and transitioning to a production environment. Spirit is pretty great at that part, and simply by definition, we need to make planes to make money, so it makes intuitive sense that as our programs mature, we’ll shift into an earnings mode.
- Q: Spirit’s accounts receivable increased notably this quarter. Is there something behind that?
o A: Sanjay says it’s a timing issue. Which it is.
o Travis: This was kind of a surprising question for an analyst to ask, I felt, and Mr. Kapoor’s answer was as succinct and accurate as it needed to be. In fact, I only included it to give a short little lesson. Accounts receivable is like a tab for products and services that Spirit has provided. Accounts receivable (A/R, AR) count toward our assets and revenues, but not to our cash, as we haven’t collected yet. This goes back to what I talked about last quarter, where we could be “profitable” but still “cash negative.” Though that wasn’t the case for us this quarter, in a high-capital industry, these things do tend to shift. A personal example to put it in context is “magic month” – the month when you get 3 paychecks instead of 2. Since there are 52 weeks in a year, 26 paychecks, an average of 2 per month leaves 2 checks unaccounted for. Due to nothing more than timing, your personal cash inflow for those two months of the year will be 1.5x your normal, even though you’re doing the same work every day and week.
- Q: Since our cash flow is improving and stabilizing, what do we plan to do with all that cash?
o A: Larry chuckles. As he said in his introduction summary, we may invest in equipment or supply chain improvements to become more efficient, we may invest for growth, or we may do some dividends/share repurchases. Ultimately, it’s in the future, and we’ve been focused on the operational side, so we don’t have a firm and specific plan for use of the cash.
o Travis: Ooh. Question of the day. Well done. The guy asking essentially wanted to know if Spirit shareholders could expect a dividend policy given our improving cash flows. If you don’t know what a dividend is, it’s a cash payment that the company rewards to stockholders for each share they have. For instance, Exxon Mobil (XOM) issued quarterly dividends of $0.69 per share in 2014. Dividends are a way for a company to keep investors interested when their capital appreciation (stock price, essentially) is limited in growth. Microsoft, as an example, is used worldwide on a huge majority of computing systems… they really can’t grow that much anymore and are a cash generating machine. Now, regarding Larry’s answer. Ready for my CEO-speak? Don’t put the dividends cart before the operations horse. We have to reliably and consistently make high cash flows before we think about utilizing them for activities outside our current core business. Mr. Lawson may have given a non-answer, but it was the correct one in my opinion. We’re still focused on stabilizing Spirit and making it a reliable, lean, efficient business, and it’s a bit premature to be asking about dividends. Still, a very good question to ask to prime our senior leadership for the future, because if we keep seeing results like this quarter, the dividend question will only come up more and more. It also inspired the short lesson for this quarter that you can find below.
- Q: What is Larry’s goal for our cash flow conversion rate?
o Travis: Honestly, I don’t even remember what response was given to this question, because to me, the question itself is indicative of our performance. When we start fielding philosophical questions in the earnings call, you know we’re doing well. Who really cares what Lawson’s philosophy on FCF conversion is? If we were on a sinking ship, we wouldn’t be stargazing, pondering philosophy. That’s why these kinds of questions are always encouraging to me. As a lesson, what is “cash flow conversion”? Just like our operating margin (operating income / revenue) shows how good we are at our core business, and our net margin (net income / revenue) shows both how good we are at our core business and how well we’re structured financially, cash flow conversion (cash flow / revenue – currently around 4%) shows how good we are end-to-end, from revenue to the bank. Cash is king. How much revenue and profit we make are moot unless we generate cash. Fun fact, this was one of the major “forensic accounting” red flags that got Enron caught. They advertised their growth in revenues and profits, but they never had any cash. It tipped savvy analysts off to the fact that they were artificially inflating revenues, but in the actual here-and-now, they were flat broke. If you’re interested in a great read about that, check out this link. In particular, see Table 3 for what I’m talking about with cash flows being a clue to funky accounting.
One more comment on the call, and it’s just my personal opinion so you can skip it if you’d like. Honestly, I’m getting to like this Lawson guy. I only spend an hour with him every quarter, and even then we’re not exactly talking as close friends, but his demeanor and his answers on these calls have been pretty appropriate, with few notable missteps. I don’t work close to him at all, but he mostly talks in plain English and gives straightforward answers as much as possible. He doesn’t come across as cocky the way some sort of “pump and dump” turnaround CEO might. I tend to ignore the staged videos and interviews because they can be scripted and edited. The calls are live and are high pressure. They’re as close as I can get to seeing him at work, and more and more I like what I see. Sure, I’m making a ton of guesses here, and I could be wrong, but I think we’re in pretty good hands, and hopefully we’ll start seeing the benefits to our own bottom dollar very soon.
Suggested Mini-Lesson