Spirit AeroSystems – Q2 2015

Spirit had their 2nd quarter earnings report today, and it came alongside some exciting news: over the next two years, Spirit plans to repurchase $350M worth of their shares! Hooray! Who cares? Well… both Spirit’s investors and employees should care, since it means good things for both of them! I’ll talk a bit more about the share repurchase in the mini-lesson, but for now, you should know that it’s a good sign.

Before that, let’s talk about the call. As always, it’s worth listening even if you don’t necessarily understand all of the financial terminology, so if you missed it live this morning, I encourage you to listen to it on replay. As we usually do, let’s start with the handy financial results summary:

2015_Q2_1-Summary

Some things to immediately note. Revenue (money paid to us by customers) was down compared to this quarter last year. Two things primarily accounted for that. First, the Gulfstream divestiture. When we said we “weren’t making money” on the Gulfstream business, what we really meant was “not making profit.” We were getting paid for the work we were doing, and now we’re no longer doing it. Of course, without the drag on our profits, our margins are looking fantastic, meaning we’re a more efficient and profitable business overall, so we shouldn’t exactly mourn the loss of that revenue. Second, the 787 program experienced a price step-down, causing lower revenues. We talked about this loooong ago when the forward losses were coming out, because it was already costing us more to make those early planes than we sold them for, and if we didn’t fix that imbalance by the time the step-down hit, we’d have been in a whole new world of hurt. But it seems that we’ve come down the learning curve and are on a better course, so, while we like being paid lots of money, this loss of revenue seems expected and not worthy of concern.

On the rest, you’ll notice that even with reduced revenues, we saw incremental improvement on Operating Income (money left over after taking out the cost of planes that we built, sales, administration, and R&D), as well as net income (money left over after everything is accounted for). Our six month running net margin is almost 10%… which is really, really solid. Also noteworthy is that we paid less interest this quarter due to Mr. Kapoor’s refinancing efforts. Our interest expense in Q1 2015 was $17.9M; in Q2 2014 it was $20.8M. This quarter, it was $12.1M. Now if only I could refinance my house and put $5.8M in my pocket…

The last component is cash flow, of course. Profit is more or less in the aether, but how is Spirit’s savings account doing?

2015_Q2_2-CashFlow

Check out the cash balance at the end of the quarter. Uh, we’ve got almost a billion dollars in cash on hand. We generated $230M in free cash flow — money that’s left over at the end of the month — this quarter alone, and we stuffed $209M of it in the bank. And with our updated forecast, we plan to generate nearly half a billion more by year end. And this isn’t numbers on paper, it’s real folding money. Alright, digital numbers in a bank account, but you get the picture. Pretty cool.

While in previous quarters I’ve harped on and emphasized the importance of cash, there actually is a point where you can have too much. It’s a topic I’ll probably explore more thoroughly in a future lesson, but in short, the increases in Property, Plant, and Equipment (which are like home improvement projects for the company) and the share buybacks Spirit announced are intelligent uses of our beginning-to-be-excessive cash hoard.

As for the analyst questions, they were once again relatively tame and cordial, with a bit of company humor mixed in. Our boys at the helm were notably comfortable, a position that’s largely justified when sitting on numbers like we produced. I’ll share a couple of my favorite questions and answers and call it a quarter. As a side note, I take rather detailed notes of the Q&A section of the earnings calls; if anyone would like those notes leave me a comment or an email and I’ll provide them. Here we go:

  • Question: A350 deferred inventory per unit has been steadily decreasing… is it stabilizing or is there more improvement to come? Larry: Some of the big, early expenses are gone and change management is coming down, so some of the gains have been realized. However, what Spirit does best is go down the learning curve and get better as the rate increases. We’ll see further progress on unit cost and delivery as we start ramping up production. Travis: Deferred inventory is something that I came to fully understand just last quarter. I’ll probably compose another mini-lesson on that at some point. For now, know that deferred inventory is the precursor to forward losses, and that higher deferred inventory is bad. The biggest threat of deferred inventory comes early on in the production phase of programs when we’re trying to learn how to build stuff. Our top brass seems to believe that A350 production is on track and will continue to improve. The threat isn’t over, but it’s starting to shrink a bit.
  • Question: What’s the breakdown of capital expenditures? Where does the PP&E money go? Larry: $200M goes to maintenance expenses (he didn’t specify, but I assume that’s in a full year… either way, it’s a LOT!). This year we’ll probably spend $325-$375M on automation and improvements above and beyond simple maintenance. In the future, we would consider increasing capital expenditures considerably if it makes sense from an investment standpoint. Travis: When we talk about investing in ourselves, it’s not just share repurchases, it’s our home base too. I just found this to be an interesting question and absolutely crazy to think how much Spirit spends on keeping its high-capital business intact.
  • Question: A lot of previous questions have focused on the elephants in the room — A350, 787, Gulfstream — but how are the young programs doing? A350-1000, 737-MAX, 777X, and 787-10? Larry: “Our deliverables are delivering.” He thinks they’re all tracking to plan pretty well. These are all derivatives and you expect your ability to fulfill a derivative to be better than the original. We now have experience with Airbus, and we’re through the original 787, and the 737 and 777 are part of our longstanding business. So far, our young development programs seem pretty promising. Travis: Aha, now we know what people will be asking about when A350 and 787 are making the kind of money that 737 does currently. I was glad to hear this question because it indicates that the analysts are relatively satisfied with the company’s direction and performance on what were some of our toughest programs ever. They’re ready to move on to the future. Cool.
  • Question: It seems operations are under control and steady. So where do you want to take the company? Where do you see Spirit 5 years from now? Larry: Our goal has been to stabilize operations and be #1 in the industry. Our main goal is to deliver a high-quality product on time, whether the product is engineering or hardware. We do want to grow the business in line with stuff that fits with us. We’re looking at defense and would like that to be a bigger part of our business, but overall we have pretty tight definitions of what our business is and what we do. Our priorities are, in order: reduce costs, support increased rates for our customers, return value to shareholders, and pursue acquisitions if they make logical sense and it’s mutually valuable. Travis: I thought this was a really neat question and answer. I do wish though, that he had instead asked 5, 10, 20, 50 years out. I don’t suspect Mr. Lawson will be our CEO in 2065 (though in 2015 we drink to his well-being), but I am curious what he thinks Spirit is capable of over corporate eons. Maybe I’ll get my answer next time.

And that’s it! It was another great quarter… I suspect we’ll be hearing from Sam Marnick shortly with the STIP score, and I’d be extremely surprised if it was less than 1.1. But like always, don’t hunt me down with torches and pitchforks if I’m wrong.

In the meantime, good job everyone, I’ll bug you again next quarter!


Suggested Mini-Lesson

Returning Value to Shareholders

When I arrived at work this morning, I already had several emails and chats asking me about the share repurchase program that Spirit announced. Instead of responding one at a time, it made the most sense to just write up a thorough article explaining it to everybody! In short, share buybacks are one of the major ways that companies give back to their loyal investors. Check out the article, and feel free to email or comment with any questions!