Howdy folks! It’s earnings time again at Spirit, and it’s the special one that not only has the 4^th quarter results, but also the year-end summary.

For folks who enjoy finance and numbers, this is “The One with Bonus Information.” For those of us who just enjoy bonuses, this is “The One That Matters.”

Let’s start with the usual summary, and throw in some of that delicious bonus information. We now know Spirit’s full-year performance, so we can compare ourselves against our financial guidance and see how we did!

And for good measure let’s throw in the cash statement too:

Okay, there’s a lot to unpack here, and I’ll try to keep it quick.

The word on the street regarding this quarter is… not good. Our shares were down between 4-6% all day, which is of course never a good look. However, myself, my finance buddies, and (most importantly) Spirit’s Chief Financial Officer, have a more… nuanced perspective. Frankly, I find the sharp drop in share price to be a bit of an overreaction.

Before opinion, data. Here’s how Spirit’s full-year numbers stacked up against our latest revised guidance and our original 2016 guidance. Let’s also include what we said for our 2017 guidance to see how we expect these to change this year as well.

Remember that we adjusted earnings guidance as a result of the A350 long-term pricing agreement in Q2, and that while we took a forward loss to do so, it was generally hailed as a good thing. Our stock was up 7% or so on that earnings day, despite a forward loss, despite lowered earnings guidance, because the deal signaled stability. This resulted in the creation of an “Adjusted EPS” flagnote with a difference of $0.86/share from GAAP earnings (Generally Accepted Accounting Principles – the Big Book of Formulas that companies have to use when presenting accounting info).

Our “official” earnings guidance is the second row above – we started the year expecting $4.15+ (Q1), lowered it by $0.86 or so to account for the A350 write-off (Q2), then raised it a little to account for better performance (Q3), and finally, closed it off in Q4 by beating our adjusted target and coming right in line with our official one. Confusing? Well, it’s all part of being honest – we adjusted our expectations as business items changed. Ultimately, we performed pretty well and reported it as honestly as possible.

So, why did our shares go up when we took the forward loss and lowered guidance, but down when we performed on-target to prior guidance? If it was a problem, why wasn’t it a problem then but it is now?

I have no idea.

Maybe someone smarter than me will reach out after reading this and inform me, as they often do. Maybe Wall Street is just a fickle mistress. One article led with “Spirit AeroSystems profit falls about 22 percent”, which is… true-ish; Q4 2016 net income was down 22% against Q4 2015, though our adjusted EPS in 2016 was 16% higher than 2015, so it’s not exactly like our profits are in freefall.

Alright, real talk. What I suspect is happening isn’t so much about the current numbers, but about the forecast. It’s not that we performed badly in 2016, it’s that the impacts of certain market shifts are at least as heavy, if not heavier, than the analysts predicted. A more telling article gives the following reasons for the gloomy outlook:

• Quarterly revenue was hurt by lower “pricing terms” for Boeing’s 787 program and fewer production deliveries on the 747 and 777 programs
• Boeing cut production of its cash cow 777 jetliner by 40 percent this year as it focuses on newer models
• Spirit also forecast 2017 profit and revenue below analysts’ estimates (our guidance was revenue of $6.8-$6.9B and earnings of $4.60-$4.85, analysts expected $6.92B of revenue and $4.86 of earnings)

We’ll dig into a few of these issues in the Q&A, but that’s my speculation on what’s happening. 2016 was fine, but 2017 looks like it might be a little soft, especially early on. What we inside Spirit are taking into account are the things on the horizon: 777 is declining, but we’re positioned for when 777X hits the market (we’re cannibalizing our own business, which is a good thing). We have rate increases on core programs, and we have new stuff that we’re looking at all the time. Markets don’t necessarily care about that. If we’re going to enter some doldrums in early 2017, investors are within the bounds of rationality to go elsewhere and come back when the wind is at our back again.

Yyyyyyyeah. Little bit heavy for an intro, huh? Luckily, the Q&A section is short this quarter. Let’s meander through the call and head boldly forward into 2017.

Executive Intros – Tom Gentile and Sanjay Kapoor

• From the results, you can see we hit well within our 2016 guidance.
• Big milestone: we achieved cash positive production on A350s! This even got its own slide in the earnings call presentation – see Slide 10 of SPR_2016_Q4_Presentation. This also means we’re now working to reduce the deferred inventory balance on the program, which is a great line to cross.
• We suffered a $0.14/share earnings decline due to Kinston hurricane recovery and the voluntary retirement program. Spirit’s a neat company but we don’t control the weather. Expect some positive adjustments for an insurance settlement someday.
• We made fewer 747 and 777 deliveries as demand for those is sunsetting. (This was a major theme of the call)
• Higher A350 deliveries, yay.
• Higher non-recurring revenues on development programs. (Hey, engineers made the company some money!)
• Achieved 6-8% target of revenue to free cash flow generation. (Like margins, cash flow conversion rate is a quick metric for tracking how efficiently Spirit’s financial machinery converts payments from customers – revenue – into money we can use – cash. We started talking about this rate a number of years ago theoretically, and now it has some actual parameters we try to hit)
• Volatility related to the Presidential election caused some caution in our cash deployment. (Heh, we’ve probably all had about enough of this subject, but basically, Spirit didn’t want to make any kind of drastic investing moves in the always-turbulent environment of election season)

Overall, pretty positive, nothing dramatic or overly exciting. But apparently the analysts had some fire in their bellies. Let’s get to the Q&A.

Analyst Discussion

Before getting to the actual questions and responses from our top brass, here’s a simple version of what analysts were asking about. It seemed, to me, a much narrower range of topics than recent quarters, but a bit more critical. Again, not sure where it was coming from, but that was the sense I got.

Top issues:

• There was quite a lot of heat on the Boeing long-term pricing agreement. I don’t know how long an agreement of this magnitude typically takes, so I can’t opine on it, but it seems like the analysts have gotten sick of being stiff-armed on the subject for a healthy handful of quarters. Tom/Sanjay seemed resigned to indicate that it has indeed gone on for quite a long time, but unfortunately no resolute news yet.
• What are we going to do with the $600M expected for capital deployment? Specifically, are we closing in on any ideas for mergers/acquisitions? I’ll discuss this in the questions, but I did observe that Tom and Sanjay spoke with a lot more specificity when the subject came up, so I’m inclined to believe that they’re getting a better idea of what they want to do in this arena. Stay tuned.
• What’s the outlook for the near-term future as 747 and 777 slow down? I think this is why our price was down. It seems like we’ve got a lull coming first half of 2017 until some of our other programs speed up or come online.

Q&A:

• Question: Your presentation says you’ve got $600M in cash deployment scheduled in 2017 – what’s the plan for that? Any inorganic opportunities?

o   Tom: We still feel that share repurchases are a good investment as we believe we’re underpriced compared to our peers. We’re looking to be more consistent, rather than opportunistic, to maximize shareholder return. We are still looking at inorganic stuff this year, including some vertical integration for higher margin tier 2 fabrication stuff and maybe some military stuff.

o   Travis: This was a pretty big one. Quick reminder: inorganic growth means mergers/acquisitions, where organic growth is adding to our usual business. Until now, our Commanders have kinda kicked around dirt in the merger and acquisition department, with a sort of “some of this, some of that” vagueness. But throughout this call, we started to hear some details. They look to be focusing in on utilizing our current fabrication expertise to start building parts that aren’t necessarily fed into larger subcomponents headed to our big OEM customers. It seems likely that we’re leaning toward vertical integration – building and selling more parts rather than expanding our major program assembly portfolio. With our “regular business” we’ll probably keep bidding programs like we always have, so count on this to be additional scope, not a replacement.

• Question: Boeing pricing negotiation.

o   Tom: It’s still an active negotiation. It’s still ongoing. We do know it’s been going on a long time and we want to get it done. We can and are working to control our internal costs and value so that whatever comes out of it, we’re prepared to do as well as we can.

o   Travis: No news here really, but another quick reminder on why this is important. The pricing negotiation affects how much “top line” revenue we get paid when we deliver products to our customers. That’s one of the most important components in our profitability. Of course there are things we can control internally – production costs, materials, labor, scrap, etc. – but all that is just one component of our doing profitable business. When we finalized the Airbus pricing agreement, we took a $135M forward loss to account for it, but it was celebrated because while it meant slightly lower long-term revenue and profit, it also meant significantly higher stability. Still, it illustrates how important and influential to our success these agreements are.

• Question: On making investments, talk more about vertical integration and 3^rd party fab, and how it translates into a long-term strategy.

o   Tom: We’re already one of the largest parts fabricators in the world. It’s all internally consumed though. However, in both commercial and defense markets, there’s some opportunity to sell those abilities outside our current scope. That market tends to be high margin, another plus. It also helps us with getting to an optimal supply chain setup. Regarding timing, we’ve already started on this, with some tangible revenue expectations in place for when we enter that business.

o   Sanjay: It’s also in line with what we already do. In many cases we already have the equipment, the space, and the experience. The market is there and we can already play. It’s potentially both a revenue and a margin booster.

o   Travis: There you have it. The reason we’re looking to expand vertically (doing more Tier 2 business alongside our regular Tier 1 stuff) is that, well, we already do it. We’ve already got the knowledge, experience, equipment, and space. And it seems like a good market to be in, with plenty of activity and lots of profit to capture.

• Interjection from Sanjay: He jumps into the conversation to say he’s been reading reports this morning. He hammers that various things happen quarter to quarter, that our guidance has been good, and that you have to look at the trends and segment margins to eliminate some of the concern over what happens on any given day.

o   Travis: This was an interesting deviation. Reading over this, I don’t think I’ve captured how antagonistic some of the questions were… and of course our share price being down 5-6% was its own sign. But Sanjay was completely right to jump in here. We hit our guidance, disclosed everything the best we could, and explained some of the dynamics in play over the long term. The analysts wanted a miracle; we gave them reality. Reality we had accurately predicted for them, no less, but I guess it wasn’t enough. I’ve ranted before on my irritation with the staunch focus on quarterly results over trending data, so I won’t do it again. But it bit us here. Such is life.

• Question: Okay so when we talk about next year’s guidance, we’re saying that 777 is declining, and 737 is increasing, but there’s some mismatched timing?

o   Tom: Yeah, we suffer from lower 777 rates through the full year and only benefit from about 6 months of 737 increase. So 2017 is uneven, but it’ll even out in 2018.

o   Travis: Here we have what I believe is the smoking gun with respect to the share price drop. It wasn’t bad numbers, it was the expectation of a soft open to 2017. Shareholders are well within their rights to take a walk if they believe business won’t be booming for the next 6 months.

• Question: Can we discuss revenue on B-21? Will we see defense impacts in 2017, or later?

o   Tom: No, it’s classified. Capital investments have been incorporated into guidance though. These programs have a lot of ramp time, so don’t expect material changes quickly. However, looking at 3^rd party business, we can capture that more immediately and that constitutes some growth outside of our current business.

o   Travis: The analysts’ last gasp for things that might make the first half of 2017 rosy. How about that secret defense thing you’ve been doing? Tom says it won’t affect us materially (aka notably or tangibly) until later on. Though our 3^rd party efforts (maybe including an acquisition or something) might close the gap a bit.

And that’s that!

At this point, we have confirmation in the form of our STIP score that the execs thought we did a fine job internally in 2016. If you were looking for confirmation that STIP is not secretly tied to stock price, here you go.

We did well, and the market reacted strongly to some of the risks we’re facing early this year. It happens. We know what’s on the horizon, and it looks pretty swell too. So we’ll keep doing our thing and see what 2017 brings!

You may also read the short mini-lesson titled “The Sweet Spot.” It was inspired by a question sent to me in a prior quarter, which I appreciate.

Thanks again… let’s go do 2017!

Whew, what a quarter.

This quarter’s call was equal parts entertaining and encouraging. There’s a lot to talk about, even if the call itself ended early (!!!), so let’s jump in!

Financial Summary

Let’s start with the top-level summaries that Spirit provides.

When looking at the year over year results here, it’s important to remember that Q3 2015 was buoyed up by a big one-time event in the deferred… tax… asset… thing. That’s why net income and earnings per share look like they’re way down in spite of better performance. The company provided the adjusted line (highlighted by me) to illustrate this. Cue usage of the term “lumpy.”

You may also note that the share count between the quarters is noticeably different. This is what we bought with our share repurchase program. It compounds the effects of our growth in net income by spreading those earnings out over fewer shares. The results are… well, see our stock price and STIP score.

Moving on to cash and liquidity, we see here Spirit’s continued aversion to having a billion dollars in the bank. Not that the share repurchases aren’t legitimate or helpful – we can see that in the first table – just that I continue to find it funny that whenever we would push past a billion in the bank, we throw down some cash somewhere. In this quarter, we spent $332M to repurchase 7.4M shares – without that purchase we’d have been at $670M (current balance) + $332M (share repurchase) = $1.002B. Lookie there.

This quarter, we once again positively revised our full-year guidance. What I’m about to do here is far from scientific, but it’s some interesting back-of-the-napkin math for you.

We revised our revenue guidance up 1.5% at the midpoints ($6.75B / $6.65B = 1.015), which is a pretty modest increase, but earnings per share (net income) increased by 5% ($3.725 / $3.55 = 1.049), and free cash flow by 10% ($412.5M / $375M = 1.10). Here’s a table, because table:

Keeping in mind what the various numbers mean (revenue is what we’re paid, earnings are what we keep, cash flow is what we bank), that’s telling us that we’re becoming more internally efficient. We’re growing our profits and cash flows at an outsized rate compared to revenue growth. In other words, capturing more of our revenue as profit rather than expense. All of those cost reduction efforts we’ve been talking about can be seen right there. Bullseye.

We’ll talk about this more throughout the summary, but the new dividend was obviously a big deal. We’ve talked about dividends a bit in the past, and how they, along with share repurchases, are a way of giving money back to shareholders and proactively controlling both internal financial metrics like earnings per share and external ones like share price. Mr. Gentile doubled down on Larry Lawson’s old message: we’re seriously undervalued in the market. Mr. Lawson engaged in the share repurchases to use our cash flow to strengthen our financials and show his faith in our consistency. Tom’s administration hammered down what Larry had committed to, then committed to more, and then kicked in a dividend, as if to say, “Still don’t think we’re underpriced? Watch this.” It was bold, and I dig it. Clearly, the street did too.

My overall thoughts out of the way, let’s get to the call!

Tom Talks

• In the press release and in his speech, Tom’s first statement was this: “We remain committed to a balanced and disciplined approach to capital deployment by utilizing all the different mechanisms in an opportunistic and timely way.” In non-CEO speak: $600M in shares wasn’t enough? Okay, double it, add a dividend, full steam ahead.
• Tom posits that it’s fitting to offer a $0.10 quarterly dividend to celebrate Spirit’s 10 years as a public company. It’s a cute number to start with. $0.40 annualized dividend yield on a $50+ share price is pretty meager, but it definitely sends a message.

Sanjay Talks

• Mr. Kapoor starts in on the numbers, first highlighting a 7% revenue increase year over year ($1,594 to $1,711), primarily from A350 and 767 deliveries
• Adjusted earnings per share experienced a 30% y/y increase ($0.89 to $1.16). Lower share count from repurchases helps in this, of course, but so does internal performance (net income). With the adjustment, year over year net income increased from about $125M to $145M (16%). We both increased the numerator and decreased the denominator of the earnings per share equation. Sweet.
• We nearly tripled our free cash flow y/y ($76M to $214M). Main drivers were capital expense budget and schedule, plus 787 and A350 performance.

Pretty straightforward and brief executive introductions, per the norm.

On to the questions. I didn’t parse out anything, so this is a commentated dump of my notes from the call.

Q&A

• Question: How big is the new 787 block and what kind of margin are we expecting on that?

o   Sanjay: 500 units. Can’t tell you program margins dude =P.

o   Travis: If you were playing Earnings Call Bingo, here’s your free space – analyst asks about a proprietary internal number that we won’t share publicly, gets told we won’t share it publicly.

• Question: There was a small-ish one-time benefit on A350. What was it? How do we see the program turning cash positive in 2017?

o   Tom: It basically comes down to efficiency and a lot of the cost savings efforts we’ve undertaken. It’s representative of a maturing program in a maturing business.

He continues to talk about some of the specifics in Kinston manufacturing and efficiency.

o   Travis: I don’t have good quotes from Mr. Gentile on this, but I don’t want to undersell it. Tom sounds like he’s impressed with the business, and really enjoys the details. His answer demonstrated a rapidly increasing knowledge of the business at a working level, and honestly, a passion for a lot of the initiatives we’re undertaking.

• Question: Regarding cash usage this quarter – completing Lawson’s share repurchase program, initiating a new one, announcing a dividend; it seems like things are going even better than you thought. What gave you the confidence to make these new moves on cash deployment?

o   Tom: Rate increases on 737, 787, and A350 give us lots of embedded, organic growth. We’re also pushing hard on cost reductions via supply chain sourcing and utilizing our buying power for raw material purchases, so that gives us a great cash outlook in the future. But over and above that, looking on the horizon we see promising new work with a high likelihood. We’re also exploring inorganic growth that would give us higher access to Airbus programs.

o   Travis: I’d like to say that the difference in Tom’s knowledge is notable between his first quarters and this one. He’s confident and well-informed, even at a highly granular level. Sometimes it’s easy to think of executives/CEOs… differently. Whether that means some sort of secret cabal, figureheads with no real impact, or whatever else, it’s been very cool to observe the real world and listen to Tom through the handful of quarters he’s been our top officer. I feel like I’ve bragged on Sanjay quite a bit in the last few quarters, but it’s Tom’s turn this time. He’s showed the transition from new hire to deep engagement at the executive level, and is now showing skillful knowledge of the business while maintaining the air of humility that I think a lot of us saw when he came in. Whether CEO or first level engineer, there’s an associated learning curve for anything worth doing. We’re seeing Tom go through that in real time, and it’s been a treat.

• Question: How should we look at dividend policy (and generally cash deployment), especially when talking about “inorganic growth” like you just said.

o   Tom: We still feel like we’re really undervalued, are confident with cash flow now and in the future, and as we’re always saying, “opportunistic.” We’re looking at horizontal, getting more Airbus work, and also some military work. Looking at low cost countries, expanding work with suppliers, and getting more from current partners.

o   Travis: phew. There was a lot here. We’ll talk about what he means by horizontal/vertical more in the mini-lesson, but what he’s saying here is that we’re full bore on almost every growth outlet a company can pursue. We’re bidding new work across the spectrum, looking at merger and acquisition opportunities, digging into our supply chain, and more. This is Tom’s “Keep your eyes on Spirit, big things are coming” pitch.

• Question: We’ve heard about working on supply chain agreements; how far are we into that process? Talking different terms or just pricing?

o   Sanjay: Supply chain is an obvious place to look for savings, because it’s a massive bucket. But it does move very slowly; we’re talking thousands of part numbers, suppliers, contracts. Over time, we’re trying to implement a “clean sheet” approach, where we do analysis on what we think things should cost if everything was perfect, which lets us have an honest talk with suppliers about closing that gap. It gives us leverage to talk to them, but also to help them get to where we think they should be. Those improvements very gradually work their way into our performance.

o   Tom: I see these clean sheets as reverse engineering. We look at every part we buy and ask all kinds of questions about what it should cost. For some examples, in one situation, we saved 35-40% by consolidating parts under one supplier instead of scattered over several. In another, we moved a part to a low cost country supplier. In another we brought down raw material costs by leveraging Spirit’s economy of purchasing scale. And in another, we insourced a part that we could do better than the supply base. Overall, we’re 30-40% into the journey, with a detailed, gated process in place for the future.

o   Travis: This was another detailed look at exactly how we’re employing our strategy. Sanjay points out that looking at supply chain is smart, because the vast majority of our costs come from there. In other words, you can save money by skipping Starbucks, but if you’re car-poor it won’t make much of a difference, so start with the big stuff. Tom lays out that we’re not just arbitrarily outsourcing or switching things up; it’s a tactical process that has led to a mixed bag of actions. We’re constantly trying to do the best thing we can with every single part.

• Question: M&A strategy. Trying to get a sense of the scale of the opportunity we’re considering.

o   Tom: Not just to grow for the sake of growing, but to add to our strength as a company. For horizontal, if we could find a company to get on a very attractive program within our core competencies, we’d look at it. Also looking at something that would get us into a low cost area like Southeast Asia or Mexico. Looking at improving our fabrication business, securing our supply chain, and capturing some of that available margin.

o   Travis: Once again, a whole lot here. It sounds to me like we’re still relatively early in the search for an M&A target. I interpret this as we’ve developed some criteria for what constitutes a solid growth opportunity via merger/acquisition. That’s more than knowing we want to start thinking about M&A, but less than having specific targets identified. I could easily be wrong, but I wouldn’t guess we’d hear Spirit making a tender offer on anything in Q4 2016. Partway through 2017 might be plausible. Boy, how I’d love to be a fly on the wall during these discussions though!

• Question: What does organic growth look like beyond rate increases and defense programs? Expand aftermarket as profit lever?

o   Tom: We’re bidding on a number of Airbus programs and some business jet and military too. A number of packages are out for bid. Aftermarket specifically, sure, it could grow.

o   Travis: Reminder – organic growth is the natural sorts of things we would expect, like rate increases on solid programs, securing more business from our existing customers, etc. Inorganic is when we do sort of a “step” function and buy some other company or start up something completely new. Mr. Gentile does seem to say we’re still pushing hard for organic growth and bidding on a number of programs, though the focus of this quarter has been the inorganic growth and what to expect in the future with that. In other words, Spirit still has pretty solid growth prospects, even if we don’t do something big and dramatic.

• Question: 737 deliveries down slightly in the quarter, what’s today’s rate, and was there anything unusual in the quarter? Also what rate we’re capitalized at (ready for)?

o   Tom: 42/month today, which, as a trivia fact, is almost double the rate from when we spun off from Boeing. On track for 47 early next year, and the capital is already in place. Deep into planning for 52/57 – capital is in the long-term plan. Some discussion still, but on track.

• Question: Talking bidding aggressively for Airbus work, how do we leverage lessons learned on A350, 787, and Gulfstream products in not getting ahead of ourselves on our bids?

o   Tom: We’ve learned a lot. Part of it is estimating. Some is based on program management and change control too. When I look at early contracts, they weren’t really “optimal.” We’re better at not only terms and conditions, but also change control and program management. There were some painful lessons, but we learned from them, and we’ll be able to apply those lessons going forward.

Tom doesn’t criticize the leadership early on, because they grew the company and got us on some really great programs, but we learned a lot of lessons and we’ll know to look for those mistakes in the future.

o   Travis: I just love Tom’s tone. The question was pretty skeptical, but completely justified. Long ago, there was excitement about Spirit’s growth prospect with new customers and an explosion of hot new programs. Then we got in trouble because we had committed to too much, too fast. Jeff Turner openly admitted as much in a prior call. Tom grasps both sides. He celebrates the growth that the original leadership obtained while accepting the tough lessons learned from overexpansion, and he does it with humility and steadiness. It’s really a confidence builder.

After that last question, something really bizarre happened: we ran out of questions. Sanjay asked if Tom had any closing remarks to fill the last 8 minutes or so. He offered a few quick points in summary, and we signed off. Oh, I also just have to note, the phrase deferred inventory wasn’t mentioned a single time. What a time to be alive.

Fewer questions typically means there’s less to criticize. It’s an important time in Spirit’s history… sort of an “All roads led to this moment” type of feel. We’ve been in some tough places, survived them, and came out stronger. We’re steadying our feet again, and preparing to make another leap into the next phase. What happens next? Tune in next time J.

Much of the conversation from this quarter focused around Spirit’s intentions in the realm of mergers and acquisitions (M&A). The mini-lesson “When Two Companies Love Each Other…” digs a little deeper into some of the common terms you might hear on that subject, and explains some of the opportunities and risks of these activities. Enjoy!

Happy earnings day, all!

Boy, what an exciting quarter this was! For a number of quarters now I’ve talked about how boring good performance can be. Appreciated, preferred, but a little uninteresting. This quarter was the best of both worlds – good performance and positive news coupled with some interesting financial concepts and a new personality to study in Mr. Gentile.

I’ll warn you, because of the richness of some of the ideas covered in this quarter’s call, this might be a little longer than the norm. Hopefully I’m able to add value and clarity. If not, file it under TL;DR (Travis Lane; Didn’t Read) and I’ll see you next time.

Financial Summary

Here’s the quick financial overview, then we’ll dig in:

This shows declines in incomes reflecting a one-time item occurring within the quarter, but otherwise continued strong performance.

I’ll also include the cash flow table for you to refer back to when the mini-lesson makes you curious about it:

This quarter reflected our continued evening-out on the financial front, showing a pretty good trendline from Q2 of last year on important metrics. We raised our guidance (estimates) for free cash flow, and also our earnings per share (EPS) after taking out an adjustment for a one-time item. Don’t worry, I know you’re all wondering about that “one-time item,” and I won’t leave you hanging.

Now let’s take a break before the actual details of the call to talk about the elephant in the room: the $135.7M forward loss on A350.

We’re all a little sensitive to the term “forward loss” from some catastrophic results experienced a few years back. We’re tuned to the idea that the words “forward loss” precede layoffs, executive shakeups, declining share prices, and general pandemonium.

And yet, Spirit’s shares were up about 7% on the day after accounting for this news. Our leadership is claiming solid and exciting results. Ummmm… what now?

Context is key. Gathering context is the reason I suggest you listen to the earnings calls even if you don’t fully understand them. Breaking slightly from convention, I’m going to lead with an explanation of why this forward loss isn’t a dire sign, then fill in some of the details via the Q&A. I want to take this approach because a large portion of the questions focused on this subject, and it would be rather deep and piecemeal to try to splice a coherent understanding from just the questions below. Let’s jump in.

We need to preface with a reminder of terminology. Note that these graphs are all rough representations, not actual program performance. (Professional driver on a closed course.)

Deferred inventory is a bucket that we keep track of that says whether we’re ahead or behind on our estimated production costs for a program. Each and every unit we produce will either add to or take away from the deferred inventory balance. If it cost more to make than forecast, it will add to DI and vice versa. Deferred inventory is a representation of our internal performance – our cost controls in supply chain, our build efficiency, and our cost estimate accuracy.

Revenue is what our customer pays us for each unit we deliver. Gross profit is our revenue (what we’re paid) minus what it cost for us to produce it (cost of goods sold).

A forward loss is taken when some of the deferred inventory balance is judged to be unrecoverable. In other words, as we’ve learned more about our production schedule, internal costs, and revenues from the customer, we found out that we can’t make up for some of that balance, and we write it off against our profits in order to adjust to the revised expectations. Put another way, due to a change in either revenue or cost estimates, the area under the curve between those two figures became smaller. Remember, it’s not a cash charge, it’s only an adjustment made in the current quarter to square us up with our future expectations.

Now, ordinarily, less profit is a sad time. As we’ve experienced in the past, forward losses are not a fun occasion. And really, all else equal, we’d have been happier without this forward loss. But, the context for this one is what makes it alright. Let’s dig into that now. I’d like to draw you an analogy.

Since 1928, the S&P 500 stock index has had a compounded annual growth rate of around 10%, meaning if you put money in the S&P in 1928, you could pretty closely calculate your present value using the basic compound interest formula and plugging in 10% for the rate. However, that smooth, parabolic curve is… not quite what has actually happened. Some years have been down more than 40%, and others have been up by more than 50%. 10% is the compounded rate, but it’s not the constant return you’d get every year. There was a whole lot of volatility involved.

As someone with a 401k, or an IRA, or a college fund for your kids, would you trade 1% of long-term returns in exchange for eliminating the ups and downs of the market?

If you’re in a bond fund or a stable value fund, your answer is almost certainly yes. Even some of the more intrepid investors would probably trade a bit of their overall return for far fewer headaches and fingernail biting along the way. It’s pretty universal that people prefer certainty over uncertainty. Even if we understand the mathematics in our rational brains, the emotional brain is always there nudging us toward stability.

Well, this is pretty close to what Spirit has done here. Certainty and stability are the reasons our shares are rallying and we’re celebrating a good quarter in spite of taking a 9 figure forward loss on one of our most critical new programs.

By reaching a contractual pricing agreement with Airbus, we have secured our revenues on that program going forward. The forward loss didn’t necessarily come from poor performance, but from aligning with what we are now legally entitled to receive in payment for our services. We adjusted our profits to account for going from 10% return (with crazy volatility) to 9% (steadily every year). But you can still retire pretty nicely on 9% annually. You’ll have a little less money in the end, but a lot fewer sleepless nights. It’s more or less analogous.

Although we’ll cover more details in the Q&A, that’s the gist of the whole quarter. We took a little loss, but it was in exchange for massive gains in long-term stability (as well as cash flow). Nothing is ever final; time is rather immutable and its realities become emergent. Spirit will never be completely finished with forward losses and cumulative catch-ups, because we will never be perfect at predicting the future. But we can be pretty confident that we’re improving, and that our position going forward is as steady, or steadier, than it was before.

Now let’s get to the actual earnings call.

Executive Comments

Hey, there’s a new voice! Let’s welcome Mr. Gentile to his first earnings call session with Spirit. Tom introduced himself and laid out some of his priorities for Spirit moving forward. Other than that, he mostly said the usual stuff – talked about the Airbus contract, mentioned that deferred balances and growth on A350 and 787 are stable or improving, talked about Spirit achieving an investment-grade credit rating in the quarter (which saved us a handful of millions in refinancing debt to lower rates), and celebrated our first quarter delivering more than 400 units (I think I heard 408).

Mr. Kapoor added a few points, reinforcing our $47B backlog which gives around 7 years of revenue visibility, the $10M in annual interest we’re saving from our refinancing efforts, and the change of the A350 accounting block from 400 to 800 units. He also mentioned that Mr. Lawson’s retirement package was responsible for a one-time $0.11/share impact. Career goals: get a retirement package significant enough that it registers on a corporation’s quarterly earnings. For the curious, I’ll save you the effort of calculating: $0.11/share comes out to around $14.3M. Maybe if I run into Mr. Lawson around town he’ll buy me a Coke.

As Tom was getting warmed up this quarter, Sanjay did a lot of the heavy lifting on the call today. It’s been funny over Mr. Lawson’s tenure to hear the change in his diction and voice. When he first arrived, he was pretty heavy-laden, as was Mr. Kapoor. The calls tended to be of a much more serious and conciliatory tone, and there were definitely moments where they were notably concerned or disarmed a bit. As time went by, they both adjusted to the chair, and their confidence grew. There were fun moments on the calls, a few jokes, and a lot more polish. In my estimation, as a complete outsider, Mr. Gentile seemed to reflect a bit of the “New CEO” nerves on the call, which I found funny in contrast to Sanjay’s practiced evenness. That’s not to say Tom was jittery or presented poorly, just that the new-ness was there. Having said that, new CEO, new opportunity for me to get fired for personal observations on earnings analysis!

In all seriousness, I’m excited to see how things develop under a new captain. I have high hopes for what Spirit can become under Mr. Gentile, and I’m appreciative of his communication and character thus far. We’ll see what the future holds!

Now, ordinarily, the Q&A is the real content of the earnings call. This quarter, it was definitely good, but it was very dense, inspiring the separate section above. What you’ll find here is a lot more of the specifics of the stuff we did, so read on for more granularity.

Q&A

Due to the unusually high concentration of questions on pricing contracts with Airbus and Boeing and the fact that I’ve already discussed that key topic above, I’ve parsed the Q&A portion pretty heavily. If you’d like my full notes on the Q&A session, send me an email and I’ll pass it along.

As a side note before beginning, keep in mind I am far from an expert on these things. If I’ve made mistakes or misrepresentations, feel free to tell me. I try to learn as much as I can from compiling these reports, and I’m always open to input from those that know the subjects better than me. This quarter’s subject matter is pretty heavy, and I am naught but a stress engineer by day. There’s your disclaimer. Let’s rock.

• Question: How are the Boeing contract negotiations going?

o   Sanjay: We really can’t divulge the details of negotiations. However, for confidence, reference the successful, mutually beneficial agreement with Airbus this quarter.

o   Travis: After an incredibly slow start, we finally got to last quarter’s hot topic. And once again, we can’t openly discuss the terms of ongoing contract negotiations, or even details of finalized inter-business contracts. I swear, Mr. Kapoor could probably save himself some effort by recording that response and just playing it on repeat during the earnings calls. I get it – it’s a big deal and deserves follow-up, but… man. They’re not gonna tell ya secrets, guys.

• Question: On the Airbus agreement, now that we’ve stretched the block from 400-800 units, how do we feel about stretching out the timeframe for reclaiming deferred inventory?

o   Tom: Now that we have visibility over the full, extended block, we did our reassessment of the overall program, which resulted in the adjustments we made within this quarter.

o   Sanjay: There’s about $450M in cash that we would expect to recover over the next 700 units, which amortizes out to about $600k reclaimed per shipset over the block. We feel like this agreement is a really good result going forward, not only relationally with a major customer, but also financially via future cash flow gains and revenue certainty.

o   Travis: We went from slow-pitches to heaters reeeeeeal fast here, and it’s here where the dirty details start getting airtime. Refer to my explanation above of what our deferred inventory balance is. In short, it’s how much we’ve overrun our estimates so far. Our goal is to work it down to zero by program completion. Well, as part of our adjustments this quarter, we changed our estimates from half the program or so (400 units) to the entire program (800 units) because we now have contractually guaranteed revenue commitments from the customer – we know enough to make valid predictions over a longer timeframe. The analyst asking this question is wondering if our performance is worse than we expected, because we’re now burning down our deferred inventory over 800 units instead of 400. Read on for a further answer.

• Follow-up comment: Prior to this quarter’s adjustment, we would’ve expected to reclaim the $700M deferred balance over 300 units, and now we had an additional forward loss after having 400 extra units to use.

o   Sanjay: Keep in mind that we’re now incorporating not only cost but also revenue impacts over the 800 unit block, so this paints a fuller picture and we feel that all things considered, it’s a very solid result.

o   Tom: We felt it was most transparent to convey the full impact over the total 800 unit block rather than parsing it out over 2×400 units. Also note on deliveries we’re seeing declines in deferred inventory additions, and we should be positive by the end of the year.

o   Travis: The analyst asked a really good question. We’re spreading the same amount of butter over twice the toast – do we have a shortage of butter? Sanjay’s answer to his follow-up here, as I understand it, is basically saying that incorporating the last 400 units didn’t make much of an impact because we were already pretty close to the eventual agreement with our original estimates. In other words, our deferred inventory burn-down plan remains relatively unchanged over the next 300 units that were part of the original block, and the additional 400 units are pretty close to projections.

• Question: (Again on A350) Are we going to stay cash positive once we turn the corner, or is it going to be impacted by future price changes?

o   Sanjay: We expect to get cash flow positive and stay cash flow positive. We do expect to recover $450M over the block still, which amortizes out to some $600k per unit on average.

o   Travis: At one point, Tom said there’s a good chance we could be “positive” within 2016, and certainly within 2017. Referring to the deferred inventory chart above, what he means is that we’ll cross that transition point where we’re no longer addingto our DI balance on a unit basis, but instead subtracting from it (which is good). Now, cash flow positive as Mr. Kapoor answered would indicate profitability rather than deferred inventory, so I may be off-base. Either way, Sanjay believes throughout the twists and the turns of the program, once we achieve positive cash flow, we’ll stay there, and that’s the critical part of the message.

• Question: R&D declined slightly this quarter – why?

o   Sanjay: Mostly just timing of various expenses, nothing specific.

o   Tom: Reinvesting is a priority for us. We can probably even do more. Expect more internal reinvestment going forward.

o   Travis: This was a quick, tangential question, but it deserves inclusion. I’m intrigued to see what Tom’s directives will be on internal investment, and if his approach to retained earnings will vary from Mr. Lawson’s. It’s very early, but it’s worth highlighting so we can all keep an eye on how it develops.

• Question: 787 accounting block discussion – in the absence of a firm contract, are there going to be any surprises when we land a final contract?

o   Sanjay: This is why we didn’t put interim pricing assumptions in cash flow guidance. We separated those out to remind people they’re tentative, but they are based on realistic numbers.

o   Travis: He’s asking if when we sign the deal with Boeing, we’ll get an accompanying forward loss adjustment like A350 did this quarter. The answer is… well of course it’s a possibility. We don’t know until we know. However, Sanjay has been heavily emphasizing that the Airbus agreement was a positive, and that the forward loss adjustment was pretty minor when you consider the scope — $135.7M over 700 aircraft is less than $200k per unit that we adjusted for. It’s just not that bad. But, yeah, there might be a similar situation with Boeing. It shouldn’t be anything to fret over though.

• Question: Normally when you extend the accounting block, you get a benefit. My assumption since we have a loss is that we’re giving up a little bit on price with Airbus?

o   Sanjay: (sighs) True, but keep in mind we talked about pricing over the entire block, not just the short term. We’re relatively stable.

o   Travis: It’s pretty natural to have price stepdowns later in a program’s maturity. We made the forward loss adjustment because we did “give” a little in contract negotiations. But again, it’s to the tune of $200k per unit. It’s money, yeah, but it’s not big money that we need to be concerned about.

• Question: Based on calculations, I figure your non-recurring costs were about $60M this quarter? Is that accurate?

o   Sanjay: Not quite that high… we’re active on 737 MAX, 777X, and more. As we develop things, we have “lumpy” costs like tooling and studies, but we’re doing really well on development programs and meeting our commitments. (Good job, engineers)

o   Travis: Included this mostly to remind everyone that the engineering side matters too, and not just production. We know that engineers improve the end-product by designing it well, but we often feel a step removed from the bottom line financial data. Mr. Kapoor treated our current engineering efforts like a point of pride and called it out as a success. So good job.

• Question: 787 deferred balance growth was $1M last quarter and nothing this quarter, what’s with the efficiency? Is it getting to 12 units a month that de-risks the program?

o   Sanjay: We laid out a plan years ago and now it’s coming to fruition. (Sanjay credits the whole team, all 16,000 that have worked hard on our programs).

o   Travis: Another short one, the analyst was pretty impressed with our gains in production efficiency on 787. Sanjay says… yeah, we told you that was our plan, and we executed to it. Maybe stop asking me about Boeing contracts and have some faith.

• Question: (asked about both 787 and A350 by separate analysts) Looking at OEM’s deliveries of final products, it seems Spirit is delivering a lot more to them than they’re pushing out. Is that going to affect us or do we have conservatism baked into our plans to account for this?

o   Tom: Their deliveries are downstream, but they’re still requiring our upstream product at the rate we’re used to.

o   Sanjay: We should absolutely expect our production and delivery rates to stay steady and consistent.

o   Travis: Analysts are concerned that the OEMs are creating a logjam at the final assembly stage, and that that backup could cause them to delay receipt of Spirit’s units, costing us time and money. I’m not the person to answer things like this about the intricacies of supplier/OEM release schedules, but the two guys at Spirit’s helm probably are, and they don’t seem to think it’s an issue at all.

• Question: It’s unusual, you’d almost call it “extraordinary” to extend an accounting block – why not take a big loss now instead of extending that into the next?

o   Tom: We thought it would be best to give the full picture over 800 units. We could have addressed risk and made adjustments within 400 units, but it would have left uncertainty on the table regarding the back half.

o   Sanjay: We have orders and contracts for more than 800 units. We have certainty for costs and revenues for that whole block. It’s true that we rarely change blocks, but it’s been very methodical, with oversight from the board and from our auditors. We just thought this was the best way to communicate our current positions with respect to the information we have now.

o   Travis: This has been the theme… why did we change so much about how we’re reporting financials on A350? The answer seems to be full transparency, which is a reasonable answer considering the nature of the pricing agreement. As we’ve explored in this writeup, there are lots of complexities associated with something of this magnitude and timescale. The takeaway is that Spirit is moving forward with production, customer relations, and financial integrity. It’s an analyst’s job to prod and pry and ask the hard questions with a bit of a cynical approach, looking for problems that could cost their investors. Spirit’s reasoning seems sound and valid, and is a continuation of the stability that we’ve gradually seen added over the last several years.

Boy, this feels like it’s even longer than usual… brevity really is not my strong suit. I think it’s justified – I’ve had many people already asking me about the forward loss even though the STIP and share price tell a pretty positive story, so hopefully the extra explanation has been valuable in understanding what’s going on.

I had another pre-written mini-lesson for the quarter based on something I wanted to study on my own time, so I’m going to go ahead and include it, but if this has already been an overwhelming “summary,” I wouldn’t blame you for putting it on hold or giving it a miss. If that’s the case, thanks for reading and see ya next time! If you’re sticking around, let me think of a tie-in here…

If you think Spirit’s finances are complicated or seem to be “fudged” sometimes (I hear this sentiment frequently enough to know you’re out there), part of it may be because you haven’t seen what real manipulation looks like. So this quarter, I submit for your comparison and consideration the mini-lesson Enron: A Story of Forensic Accounting.

Hey folks, Spirit announced 2016 first quarter earnings on April 29^th. I had some family business to attend to and was out immediately after the call and most of the following week, so I’m even tardier than usual. I’m going to be fairly brief on the earnings call portion, but don’t worry, you’re not being shortchanged. It was a pretty run-of-the-mill call, and the biggest takeaway for me was Mr. Lawson flexing a bit of his military knowledge regarding the bomber program and its impact for our future. He offered some pretty good insights into the differences between military and commercial programs from a high-level perspective. The “lesson” this quarter is a bit off the beaten path. I assigned myself a little homework project on something I was curious about and thought it might make for an interesting take on business in general. Hope you enjoy. Let’s jump in!

Financial Summary

The numbers here are pretty cut and dry. Revenues were slightly down, because of some seasonal delivery oddities and rate decreases on stuff like 747, but operating income (money made from selling planes after taking out part and labor costs) was up, which is probably indicative of more programs transitioning into a production mode rather than design. In spite of operating income being up, net income was down, which is probably because we’re keeping money sort of “in circulation” to support rate increases and other buildup projects.

The most obvious difference in the high-level financials was free cash flow. My good friend, Spirit analyst George Shapiro, who I love because he always asks super technical financial questions (he seems like he might’ve been an engineer in another life), painted a little clearer picture: after removing a lot of one-time items that were included in Q1 of 2015, the real difference in trending free cash flow is about a $50M downtick. Mr. Kapoor attributes this to “working capital,” which I’ll explain a bit more in the Q&A portion, but is basically just what I said – keeping money warm on the bench and ready to jump into the action when needed instead of sending it to the showers and calling it “free cash.”

Overall, the numbers show a few things. One is a transition into production mode on several programs. One is an increase in investment in future growth (“working capital,” as mentioned, but also an $11M increase in purchases of property, plant, and equipment vs. Q1 of 2015, as shown). And of course, aside from these things, Spirit’s continued improvement in stable, predictable earnings.

Now let’s quickly hear what our leadership had to say, then we’ll jump to analyst Q&A.

Executive Introductions

• Larry mentions the A350 deferred inventory improvement. Last quarter we had brought it down to $1.2M per plane. This quarter, it was $400k per plane. It’s really getting to a good point pretty quickly!
• He mentioned that during the quarter we achieved “investment grade” credit ratings. To put it in personal terms, it’s sort of like getting your credit score above 800. It might not really make a huge difference in your everyday life, but it’s a good barometer of your performance, and can have some small practical impacts like lower rates if you need to borrow.
• Sanjay noted that revenue was weighed down by fewer 737 and 747 deliveries (one seasonal, the other systematic), but was partially compensated by higher A350 and A320 deliveries. It’s kind of an interesting point, because we’re seeing a little bit of transition happening out of the 747 “jumbo” era and into the era of the new lean programs like A350.
• Free cash flow was lower because of seasonality (Q1 is kinda slow) and also because of incentive payouts – all those greedy engineers wanting their bonuses 😉
• We had a few small, favorable cumulative catchups on mature fuselage programs.

I’ll talk about this a bit more in my commentary on the Q&A portion, but this quarter we get to learn something about how Wall Street operates. By any measure, it was a fine quarter. We met expectations, we delivered on our guidance, and we didn’t have any surprises except a few small positive ones. You would think that would mean the stock price would go up, or at least stay about the same. We actually took a small hit on the day of earnings. Why? Analysts have a bit of an obsession about companies beating expectations. They like it when companies upwardly revise their guidance a couple of times like they’re doing even better than they expected. This can cause companies to issue overly conservative guidance and then positively revise it to stay in favor.

But really, we (and by “we” I mean on a huge scale – not just “we, Spirit” but American business, corporate employees, investors, banks) put a lot of weight on quarterly reports. Quarterlies are a fine snapshot of the health of a business at the most fundamental financial level. Financial reports are important. But some of the culture around these things can get a little silly, like the beat vs. meet expectations and guidance thing we saw this quarter. Last quarter, Lawson’s jab at the analysts was the “9 P/E” thing, where he basically said we’re underpriced and being undersold. Well, this quarter, my jab is that the whole “beating guidance is the new meeting guidance” culture is counterproductive if our goal is to get accurate representations of a business’ finances each quarter. Side thought, if you get frustrated about your manager “raising the bar” on your performance reviews, well, right or wrong, even your CEO isn’t immune to that treatment.

Anyway, I can’t complain too much since I love writing these reports for you fine people, so I’ll leave that at that and hop off my pedestal. To the Q&A!

Q&A

• Question: Guidance question – seems based on Q1 that estimates should be higher. What’s the negative drag?
  • Sanjay: Rate ramp-ups can be expensive, so we retained some conservatism since we sometimes have to expedite or do extreme things to meet our commitments. Also share repurchases are not included in guidance (could be a positive factor
  • Travis: So here’s what I was just ranting about… and it’s not surprising that it’s the first question. We met our estimates for the quarter, so why isn’t our annual forecast better? Mr. Kapoor says, well, we gave you an accurate forecast and here’s proof that we know what we’re talking about. Then he gave some of the factors that went into this quarter’s numbers and some expectation of significant events later in the year. Ah well. You did what you could do, buddy. Quick reminder: we talked about share repurchases in a recent quarter, but keep in mind that if we buy back shares, it means fewer shares to divide things like profits into, meaning higher earnings per share (EPS), all else constant. So there’s potential that our numbers show improvement as the repurchase program kicks in, and Sanjay briefly reminds us of that here.
• Question: A350 cost progression looks good. When is break-even expected? Have Airbus delivery delays affected our work?
  • Larry: The front end of the line runs faster than the back end (our production goes faster than Airbus’ final assembly). We haven’t seen any slowdown from plan in regards to demand/delivery from our customer. At this point, we’re still very rate sensitive (he mentioned this last time) because each “step” unit is huge on both revenue and utilization of fixed cost. We do pay a little extra early on for expediting cost to react to unknowns early in production. The proof is in the pudding though – look at our deferred curves over the last year
  • Travis: Our analysts keep worrying about Airbus getting behind on their deliveries and more or less gumming up the end of the pipeline. And… so far it continues to not be a problem for our production or a concern for our top brass. Mr. Lawson’s answer touches on several financial concepts we’ve talked about before. Notably, it’s all stuff that they mentioned in their executive introductions this quarter. It’s almost like they were smart enough to anticipate what the questions would be. Hm. Larry basically says, again, we’re keeping some extra money in the game to deal with unexpected stuff that can happen, and we’re early enough in the program that single units still matter. Dividing tool, machine, and plant costs by 3 instead of 2 makes a huge incremental difference; dividing by 20 instead of 19 makes much less.
• Question: Address the possibility of taking a “step function” in recovering costs. (he’s asking about how we’ve taken relatively small catchups against the big historical losses we’ve taken on some programs).
  • Larry: Don’t expect any large changes, especially losses
  • Travis: I feel for Mr. Lawson here. A lot of the work Larry and Co. did early on was a clean-sweep on program estimates and costs. This was a bit of a silly question, since we spent like 8 quarters talking about making sure we had everything estimated and accounted properly. I’m going to sound like a fool if we ever have a huge forward loss, but Lawson spent a great deal of time and effort on arrival to level-set the finances of every program. He put great pains into making sure we were going to have smooth numbers going forward. Not to say that he would be able to fix every deficit we ever had, no one would, simply that we would much more firmly know where we actually stand on an ongoing basis rather than constant, major surprises. It seems like the last few quarters that has really come to fruition in the numbers, and now they’re asking him if we’re going to get any happy surprises on writing off former losses! A year ago you were asking for stability, and now that you’ve got it, you want big surprises!
• Question: Cash flow Q1-15 vs. Q1-16 when taking corrections into account looks like about a $50M loss – is that correct? Also, the favorable cumulative catch-ups come from what programs?
  • Sanjay: A little inventory build-up on 787 and A350, but it’s representative of rampup. So it’s working capital. Also a big impact from incentive payouts. Not really any particular program on cumulative catches
  • Travis: It’s a pretty self-explanatory term, but “working capital” basically means money that’s ready to go if something unexpected happens. The technical definition of working capital is “current assets less current liabilities.” In accounting terms, “current” generally means an asset or liability that can be turned within a year. Inventory is typically a current asset, so Sanjay’s answer that we’ve got more inventory and less cash is another accurate way of saying that the money is at work. To use a personal finance metaphor, I increased my “working capital” last year because I expected my air conditioner to go out. Instead of spending or investing that money, I kept it ready to jump into the game because I had some inclination that I would need that money at the ready to respond to needs in the short term. Spirit’s doing the same thing.
• Question: Where do we see Tom’s responsibilities focusing and where does that leave you (Larry) focusing?
  • Larry: We’re a manufacturing company. And an engineering company, but manufacturing is the biggest thing financially. That means our ability (and efficiency) in meeting delivery commitments is the most critical piece of our business. Tom is going to be in charge of that. Ideally, my meetings start going down when he gets ramped up
  • Travis: This question intrigued me. And with all the rumors about Tom Gentile being brought in to be groomed to be Lawson’s replacement (you guys’ rumor mill is funny), it was an interesting question from an analyst. I won’t speculate about Spirit’s leadership plans; part of an executive’s job is ensuring continuity, and they’re people that are allowed to have their own life plans too. But I will expound on Larry’s answer. Basically, we build stuff. The top job managing how we build stuff was open. That’s a huge gap. We brought in someone who we thought was a great fit to manage how we build stuff, so the guy whose job it is to strategize and plan stuff can do that, instead of always managing how we build stuff. Is Tom a future CEO candidate? Eh, sure. But for today, it really is as simple as we had a huge hole in our executive team, and we finally filled it with someone we hope is going to do a great job.
• Question: Larry said would be disappointed if we didn’t win some more defense projects longer term. Do you have a target mix for the company in, say, 5 years?
  • Larry: I don’t ever really see defense being more than 20% of the company. Especially unless we expanded the things that we do with rate and design and stuff. For it to become a bigger part, we’d have to do some M&A (buy some defense companies and integrate them into Spirit). Attractive M&A companies are ones that have high rate on long-term programs, but military work is an additional bonus. Discussions on Trainer and Unmanned are always in the air, but for us also M&A
  • Travis: Suuuuper interesting answer. Ya’ll remember when Lawson signed on as CEO and it seemed like everyone was talking about the company becoming Lockheed 2.0? In this answer, Lawson concretely says his target mix for military-to-commercial is no more than 20:80. What this tells me is that, yeah, he’s got lots of experience and connections with military stuff, but he’s here to advance Spirit within our core competencies, which is designing high quality aircraft and then building a crapload of them. It’s been several years now he’s been our CEO, and this question says a lot for me. When he came on, people seemed worried about the company becoming “Larry Lawson presents Spirit AeroSystems,” but what we’ve seen is still Spirit AeroSystems, shaped by new leadership, but essentially the same core company.
• Question: During the quarter, there was some news on aftermarket arrangements with Boeing. What was the arrangement in the past and what will it be going forward?
  • Larry: We don’t describe contract terms, but we sold parts and provided services to the market and to Boeing. Now, we’ll sell all the parts to Boeing. Our business will continue. Boeing thinks it can capture some of a growing market, we think it’s just representative growth for a larger fleet with less retirements. I’ve never said “It’s my objective to grow aftermarket.
  • Travis: Mr. Lawson pretty much covered it. Boeing thinks they’re getting some great deal on a big growing market segment. Spirit execs just think aftermarket is growing because the overall market is growing. It’d be like investing in iPhone cases when you could just invest in Apple. The overall market drives auxiliary markets; those auxiliary markets rarely grow on their own. Either way, we’re retaining our business in that space with small changes, and it’s not a huge deal in the scope of our portfolio anyway.
• Question: On B-21, can you sell analysts/shareholders on why we should be excited about this? It’s low volume, if it goes like other DoD programs it’ll be overbudget, etc.
  • Larry: (lightheartedly) Seems to me the defense guys are doing quite well when you look at their share price. First, it doesn’t expose you to losses, so there’s no real commercial risk. Margins aren’t as attractive as what you end up with on the commercial side, but then there’s huge investments you have to make using your own coin on commercial programs. I’ve seen (and run) a lot of big DoD programs. The service has been incredibly disciplined on this one; never seen this level of discipline on defined requirements. What are the benefits though – as I mentioned, I’d be disappointed if it didn’t lead to more future business. It should show that we’re a capable partner for this type of business moving forward. On its own, it’s fine, not huge. Honestly can’t think of negatives unless someone’s thinking of really small margin dilution
  • Travis: We saved the best for last. Since Mr. Lawson’s answer was so good, I’m just not gonna add much. Neat to hear the differences between military and commercial highlighted by someone who really knows both markets. Commercial has more risk and more reward, military less. B-21 is cool, but on its own, it’s just okay. Hopefully it’s a starting point to get Spirit into more new and exciting stuff in the future.

Well, I ended up taking more space than I thought I would, so I’m gonna tie it off there. As reflected in the STIP score, it was a good quarter, and we did our part. The stock market may have disagreed, but hey, forget ‘em. We keep doing our thing, and Spirit’s in a great – and improving – position moving forward.

This quarter’s “lesson” was actually born out of a curiosity, rather than inspired by our financials. I often find myself asking questions that I can’t immediately find an answer to, but then think, “Hm, maybe I have the skills to just answer it myself.” It’s not directly Spirit related, but I think it’s well enough in the corporate finance realm that you’ll find it useful for learning, and hopefully just interesting in general.

Hey everybody. Welcome to the 2015 wrap-up. Forewarning: since this wasn’t just a quarterly report but a year-end summary, and because all parts of the call were really good, I have a lot to talk about. If it’s too much, feel free to break it into sessions, send it straight to the trash, or compose anonymous, vitriolic emails to me about my excess. But I hope you find it enjoyable and maybe a bit educational too.

In many of these earnings call write-ups I’ve said how sometimes what you want to hear as an employee of Spirit isn’t what you want to hear from a “let’s talk about finance” perspective. Good performance is often, frankly, pretty boring, and doesn’t tend to bring up a lot of fun or interesting topics. Now, as I’ve always tried to qualify, I’ll take good and boring numbers over exciting and poor. But it sure would be nice to have both now, wouldn’t it?

Well, I’m happy to say that that’s exactly what this quarter delivered! There are ordinarily a number of questions I zone out for, especially as the session drags on, and the introductory statements from the executives are usually pretty stoic. Not to say they aren’t fine orators, just that the introductions are just that, and usually breeze through the highlights rather than diving deep into the substance of the call (my apologies to Mr. Lawson and Mr. Kapoor if I’ve inadvertently insulted a blossoming corporate comedy sketch). I mentioned last quarter that Mr. Kapoor has started really providing pretty outstanding insight in his opening bit, and that trend continues here, where his summary even gave me a detail or two to teach you folks about.

Okay first off, the “too long; didn’t read” version: performance continued to improve in the 4th quarter, and Spirit’s 2015 full year results show marked improvement in the growth and stability of the company. There shall be bonuses.

If there’s any of you who just read these to see if the bonus will be good or not (can’t say I blame you), there you have it. Actually, you engineers are some crafty folks — someone emailed me the final STIP score before the call even started. You people are hilarious in your dedication and skill in finding stuff out.

Before getting into the call, I will also say (because this quarter I’ve abandoned any pretense of brevity) that many of you are becoming quite savvy with the financial statements. I don’t know if I can claim any credit at all for inspiring people to look into the finances, but it encourages me every time someone shares an observation, comment, or thought. This stuff is good for you to understand as you progress through your career (at least that’s what my business professors said), and it’s good for Spirit to have more people understanding the heartbeat of the business. So keep digging in!

Alright, the results. Let’s start off with the usual summary table:

As we look at this, there are a couple of things to note:

• 2014 was a pretty good year — recall that the operating loss in the Q4 comparison was primarily attributable to the Gulfstream divestiture shenanigans. But 2015 was better still.
• The reduced revenue in 2015 is due to two major factors: elimination of Gulfstream programs, which, though they weren’t profitable still generated revenue, and the Boeing 787 price stepdowns (more on that later). In other words, the reduced revenue is not a worrisome figure.
• 13% operating margin is… really good.

Let’s also take a peek at free cash flow — how much actual cash is left after making necessary investments in our growth and other such things:

This also tells us a few things:

• We’re improving in big ways on converting the money people pay us for stuff (revenue) into money we get to keep and choose what to do with (free cash flow).
• PPE (Property, Plant, & Equipment) increased pretty significantly in 2015. This is a leading indicator of rate increases, which means the company’s business is growing. We might be concerned about this number in a vacuum, but we also know from many calls now that the expanded costs are to fuel rate increases, and we like doing more business in stuff we know is profitable.
• We’re hanging steady around a billion dollars in cash. It’s a more philosophical thing, but it seems to me that our leaders are targeting a certain debt-equity ratio (one of the tons of measures of financial well-being), and they’ll probably increase investments like share repurchases to maintain it. That’s just a guess based on their actions so far with the surplus cash we’ve been generating the last several quarters.

Last thing before getting into the call itself (yes, we’ve only just begun!) is looking back at the company’s performance versus its estimates (guidance). These figures are from the updated guidance provided after Q3:

And notes on this one:

• The original guidance from February of 2015 was minimally different — $3.60-$3.80 EPS and $600M-$700M FCF.
• Revenues were $6.64B, right in the middle of the guidance.
• Adjusted EPS was $3.92 per share, right in line with the upper end guidance. Our non-adjusted EPS was higher, but included the one-time deferred tax asset… whatever. A bit more on this in a minute.
• Adjusted FCF was $738M, again right in the middle of the guidance, and slightly above the original guidance provided at the beginning of the year. If the “adjusted” figures are starting to raise your eyebrows, stay tuned. They really do make sense, I promise. I’ll talk about them in the mini-lesson, Defer, Defer, Defer.

Okay, the numbers say we did pretty well. We’re actually getting to keep some of the massive piles of money our customers pay us now. The business is growing nicely — not too fast, but at a healthy and sustainable rate. Now we’ll turn to the call to see what our leaders, and the analysts scrutinizing our stock, think are the big issues and questions facing us moving forward!

Mr. Lawson and Mr. Kapoor’s introductory statements were the usual highlights, going over the vital numbers and adding a few comments on major developments and such. Some of the points were notable though and deserve a little expanding upon for those less versed in finance-ese.

• A350 deferred inventory balances per shipset decreased from $2.3M to $1.2M between Q3 and Q4. What this means is that the amount we’re “over budget” on each A350 is decreasing, rapidly. $1.2M might still sound like a lot of money, but it’s actually really darn good. An analyst goes on later in the call to ask if Airbus is going to want to renegotiate pricing, insinuating that our improvement is so good it might make them think they didn’t get a good deal.
• On the topic of deferred inventory, overall 787 deferred inventory (not per unit, but total) increased by $7M. This is also not too bad. We lost some revenue due to price stepdowns (Boeing pays us less per plane in this accounting block), but we made up for almost all of it with production performance improvements.
• Our “adjusted” Earnings Per Share (EPS) was $3.92 versus non-adjusted of $5.66. Most of that difference is due to the deferred tax asset valuation allowance, which isn’t worth going into here, but basically is a one-time gain related to the Tulsa divestiture. This is a great opportunity to remind you what the analysts are looking for in Spirit’s numbers. We want to remove significant one-time events in order to see what the overall trend is in the performance. Let’s use a personal finance example that’s relevant right now: tax returns. If you get a substantial tax return, it’s going to significantly help your budget out in the month that you receive it. But you also shouldn’t base your financial health on that, because the difference between your income and outflow is a truer measure of your actual performance on a continuing basis. We want to recognize this distinction and provide that insight to illustrate what the future might hold without some of the more odd events that have occurred.
• Last thing from the executive intros: we received $192M under the interim pricing agreement for 787 that we considered “deferred revenue.” That means we got paid for work that we haven’t actually done yet; another name for deferred revenues is “unearned revenues.” We got cash but we also have a liability of work that we have to provide that offsets it. More description of this in the mini-lesson.

Alright, so the big bosses think we did pretty well, and gave us some info on top of the numbers to expound on it. This quarter our leadership gave us an excellent appetizer. Now let’s turn to the main course of the call — analyst Q&A.

This quarter, I wanted to do something new. To help illustrate what I’m always trying to get across about how the nature of the analyst questions is as important as the questions (or answers) themselves, I actually wrote down every single question so I could categorize them. The topics asked about more frequently are likely to be those that represent the largest concerns someone looking at Spirit critically might have. It’s not a perfect method, but it’s helpful to paint a picture of what to listen for in the Q&A section. Here’s the count:

1. Financials (Numbers Question/Clarification): 7
2. A350 Production: 4
3. Mature Boeing Program Rates: 4
4. 787 Pricing/Contract/Production: 3
5. New Business/Future Opportunities: 3
6. Executive Search: 1

Now, given that it’s a call centered around the financials, it’s not surprising that the top category usually has something to do with the numbers. I double counted some questions since they had a numbers-based question but also related to something else. But peel away the given top category (earnings calls are gonna be about the financials), and you start to see what people are asking about: A350 (specifically production costs), 787 (specifically Boeing pricing contracts), Spirit’s capability to support rate increases (737) and not be harmed by rate decreases (777/747), and a little bit about what kinds of things are in the future. Those are our hot spots. So what did they ask, and how did Spirit’s top brass answer? Let’s find out!

• Question: So uhhhh, we heard you’re looking for a new Chief Operating Officer. Talking about succession maybe. Sup?
  • Answer: (Mr. Lawson jokes that Sanjay answered the last question so well that he should take this one too.) Lawson says we’ve done a lot of executive team building — 89 of the top 98 jobs are people that are new to the company or new to the position (I’m… not sure if we should be proud of that number or not). He mentions that it’s interesting that this time around, looking for qualified executives piqued peoples’ interest. He says we’ve slowed down searching at the executive level, but we’re still looking to build talent. We don’t have an existing succession plan, but we do want to build something comprehensive. He mentions that his contract, which was part of the speculation, is auto-renewing, so that component isn’t a big deal. Succession planning is a good thing, but there’s nothing imminent. Mr. Kapoor tosses in that the number of Saturdays that Larry is here hasn’t changed recently or anything.
  • Travis: It was interesting to hear this question on the call after this Reuters article got the rumor mill churning. I had a whole spiel on this when people kept asking me about it, but the short of it is this — executives are people too. People have strengths and weaknesses. Having a top position in the company open leaves the possibility for someone to be acting in a weak subject when we could instead have someone there who’s strong in that area. They teach you in business class to “hire your weakness.” I don’t traipse about with Spirit’s execs a lot, so it’s not my place to say who among them might be strong or weak in various facets. The point is, searching for an executive, even as part of a succession plan, doesn’t mean that Larry Lawson is fixing to abandon us at his first chance. It may simply be a smart move to plan for the future. It may be to cover a gap in the skill set of the head honchos. Or it may in fact be to replace Mr. Lawson when his contract expires. People, even executives, also have their own lives, goals, priorities, and plans. What’s important is to not get caught up on undetermined futures that may or may not come to pass. If Lawson does leave soon, all we can do is judge him on what he did while here, which, if you go strictly by the financials, has been a lot of good. People can (and certainly will) talk about whatever other aspect of his leadership they like, but these summaries are about the earnings, and there’s been substantial improvement there under Lawson’s tenure. And I’ll leave my potentially career-ending speculation at that.
• (So uhhhh, back to the numbers…) Question: In the 2016 guidance numbers, we would’ve expected higher cash flow given your numbers for the last two years. Why is 2016 lower?
  • Answer: Mr. Kapoor answers that we’re working against a pretty big headwind due to the deferred revenue we’ve received (as discussed earlier and more in the mini-lesson). Other major factors include a need for working capital as A350 production rates increase, and 777/747 rate reductions will impact our cash flow too.
  • Travis: George Shapiro, my favorite Spirit analyst, asked a great question. It always excites me when Shapiro’s name is mentioned in the call because you just know he’s going to ask some unbelievably technical, numbers-based question. Engineers listening into the call would resonate with this guy. Anyway, Sanjay’s answer is thorough and gives some important factors to remember as we start on 2016. We’ve got rate decreases on mature programs that would ordinarily generate lots of cash, we’re ramping up on developing programs that consume a lot of cash, and we’ve got this deferred revenue situation where we’re working “for free” against a pre-payment we’ve already received. So keep those in mind as we go through 2016.
• Question: We’re 50 units or so into A350. We’ve been hearing that 100 units is the sort of “stability point” when it comes to getting things working smoothly. What’s the status on that?
  • Answer: Mr. Lawson says it’s becoming even more clear as our deferred inventory per plane comes down that the most important component in the cost picture is rate. He continues to be confident in the production learning curve and stable costs.
  • Travis: Lawson alluded to fixed costs in his explanation of why rate is so important. He brings up a great point and a concept I’m not sure I’ve discussed before. If building an A350 requires $100M in tooling, then to build the very first airplane, you need $100M in stuff before even thinking about materials and, you know, the actual airplane. That is a fixed cost. But as you make more and more of them, those fixed costs get sort of amortized over the number of planes you’ve made… at 50 planes in, if you’ve used the same tools, then it’s cost you $2M per plane. These massive fixed costs are what we mean when we say that Spirit is a “high capital business.” Apple can design a phone and send orders to existing manufacturers in China that already make phones for a dozen other phone companies. We’ve got to cough up 9-digit money to build airplane #1. As for how A350 is doing, another analyst later on would ask if Airbus is going to want to renegotiate because our current deferred inventory cost per plane is already better than break-even. The program has had its struggles, but it’s improving a lot, based on these numbers. We’ve gone from $26M per unit in deferred at the end of 2013 to $13M at the end of 2014 to $1.2M now. It’s not totally free from concern, but Spirit is starting to do what Spirit does — make lots of expensive planes pretty darn well.
• Question: Can you give us an apples-to-apples comparison between 2015 and what we expect in 2016?
  • Answer: Sanjay says that 2016 will be a lot “cleaner” with fewer one-time events (in other words, fewer “adjustments” and stuff needed to show the trends). There are still variables, like the need for working capital, and the deferred revenue stuff, but year over year, we’re making good improvements. That’s why the baseline free cash flow is improving so well over the scope of years. We have a long-term goal of 6-8% for cash flow conversion.
  • Travis: I had to bring this one up for the cash flow conversion thing. It was funny to hear a target number out of them, because several quarters prior, Larry said they didn’t have a particular goal for cash flow conversion. It’s nothing vital, it just made me chuckle a bit that they’ve decided on a target for it. For the record, cash flow conversion could also be called “cash margin,” just like the different tiers of “profit margins” we’ve discussed before. In 2016 “adjusted free cash flow margin” (AFCF / Revenue) was 11.1%, but the 2016 guidance estimates a little below 6%. Be looking for that number in future earnings calls. It’ll be fun to see how it evolves as things smooth out.
• Question: The step up in share repurchases was a little faster than expected. Has there been a change in philosophy on that? Or on M&A opportunities?
  • Answer: Lawson responds simply with the phrase, “9 P/E”. Lawson knows how well his business runs. He says sometimes he wishes he could ask the analysts questions. We’re the best investment we can make right now.
  • Travis: Ohhhhh my gosh, this was such a great answer from Lawson. First, remember that share repurchases are generally a good thing, so it’s a good sign that we’re ramping that activity up faster than expected. Now, to the fun stuff. P/E is price-to-earnings ratio, probably the most common indicator of whether a company’s stock is over- or under-priced. When you buy a stock, what you’re buying is a hope of future earnings. If the share price is low compared to the earnings, then you’re potentially getting those future earnings at a good value. A P/E ratio of 9 is pretty low compared to the broader market and historical averages. I don’t know about aerospace specifically, but Lawson is basically saying we’re underpriced, and his quip about wanting to ask the analysts questions during the calls was basically saying, “Why aren’t you sending investors our way? We’re waaaaay stronger than our current stock price indicates.” Bold. Direct. Awesome. Another finance term you may have missed in this question — M&A. M&A stands for “mergers and acquisitions.” Another question would be centered around this as well, asking if we were considering cash deployment to M&A to supplement our growth outlook. In other words, are we thinking about maybe buying other companies to support our growth? For me, this is an exciting thing to be in the air. Lawson says that they’re still looking at options. We’re in a cash and cash flow position now to where we can do share repurchases and think about M&A (buying other companies out) because we’re not highly leveraged. Lawson says it needs to be the right situation, so we’ll see what the future holds. I’m happy with their stated approach so far. We’re in a position now where we could start doing exciting, sexy M&A stuff, but our leaders aren’t doing that just to grow for growth’s sake. It needs to make sense to our overall business. So while it’s exciting to start hearing about these things, they should be done carefully and correctly, and it seems that they’re being properly cautious while still looking into really neat stuff for our future.

Oooooooookay, since this post is already massive, it’s time for me to sign out for the (financial) year. It’s been a ton of fun writing these and having you all read them. I appreciate so much the support I get, and the implied recognition when people send me questions or comments on Spirit stuff. 2015 showed continued improvement, and 2016 will have its challenges, but seems promisingly headed in the right direction.

If you’re not quite tired of me yet, head on to the mini-lesson Defer, Defer, Defer, that fleshes out some of the financial concepts from this call a bit more thoroughly.

Thanks again for the opportunity to share some of this stuff with you. I hope I can continue to provide value (and maybe a little entertainment) through these summaries. And I always welcome questions and comments if you have them.

Until next time!

Another quarter has come and gone, and with it comes the latest update on Spirit’s performance. While the earnings call was pretty benign, I did pick up on some trends in what Spirit’s analysts have been laying down. I know I’m already late this quarter, so let’s dive right in. Here’s the usual summary of financial results:

I usually talk about how the question and answer session is the real meat and potatoes of the conference. While that’s still true this quarter as always, Mr. Kapoor’s introductory statement had a lot of really good information in it. Here were some of the highlights:

• Just for clarification, he confirmed that the earnings per share (EPS) metric excluded the one-time shenanigans from the deferred tax asset valuation. As I’m not an accountant, I can freely admit that that whole deal is way out of my league, so I’m glad that it seems to be concluding. And although Sanjay as our Chief Financial Officer obviously comprehends the nature of the deal far better than I, he joked a bit and said he would be glad to say the term “deferred tax asset valuation” for the last time. I had to giggle when he said that. Here it is in the Appendix of the earnings release (guidance is $3.80-$3.95 after this quarter’s revision):
  
• Last quarter we revised our free cash flow guidance for the year upwards; this quarter we moved EPS upwards. These upward revisions are an indicator of two things. First, that Spirit’s financial guidance to Wall Street for the year was conservative at first (something engineers can certainly relate to), and second, as the year has gone by, we’ve become more confident in achieving the uncertain cash flow and earnings numbers that we thought we could achieve internally.
• You may notice that as of the end of Q3, we’re actually in our target range for year-end free cash flow (target is $700M-$800M, with $753M achieved through the nine months ended in Q3). Mr. Kapoor addressed this by noting that the guidance doesn’t include certain revenues that are flaky due to interim contract pricing on the 787. We’re also ramping up capital expenditures (stuff like tools, equipment, renovations) to prepare for rate increases on a number of programs. And lastly, we repurchased $46M worth of shares in Q3; there’s no schedule, but over the next several quarters expect to see some free cash diverted to the share repurchase program.
• Oh, P.S. We have a billion dollars in cash now.
  

Sanjay’s final comments were on increases in deferred inventory on the 787 and A350 programs. As this keeps coming up, I’m going to talk in more detail about deferred inventory next quarter. If I get a ton of feedback from you guys, I’ll put something together before next quarter’s call, so let me know. It’s a big topic, and I’ve only come to really grasp it in the last few months thanks to the help of some great, knowledgeable folks (thanks to Craig Bayless in particular).

Anyway, deferred inventory (DI just for convenience) is basically excess manufacturing cost above and beyond the planned cost per unit. As long as we can recover it in the future, it sits in the DI balance for the program. When we come in under cost for a unit, the DI shrinks. Here’s the fun part: if it becomes clear that we will never recover those costs, the unrecoverable amount becomes what we all affectionately know as a forward loss. I now understand why the analysts, still timid from historical “corrections” to our profitability, are very very attentive to growth in DI. This quarter, 787 added $25M to their DI balance ($800k/unit over 31 units), while A350 added $16M ($2M/unit over 8 units). While that’s not something to celebrate, of course, Mr. Lawson assures us that this is typical for the developmental stages of these programs, and that we’re on plan regarding manufacturing learning curves.

On that note, let’s turn to the analyst Q&A session!

There were two major trends in the analyst questions, emerging from the mixed bag of topics that always gets discussed during this majority portion of the conference.

The first was the deferred inventory issue. In response to one question, Mr. Lawson mentioned that when A350 started, we were running over cost by $28M/unit on the A350, and this quarter we’re down to $2M per, and that that alone represents tremendous progress. He says that considering all factors, we should be able to beat the 100 airplane “stability point” where we more or less know what to do when building these things and can do it consistently.

One analyst asked about Spirit’s accounting method of utilizing deferred inventory/forward losses/cumulative catch-ups (the opposite of forward losses, issued when we outperform planned costs per unit) rather than just accounting block-by-block or quarter-by-quarter or something. I’m willing to bet many of you have asked the same kind of question. Larry and Sanjay answered that pretty well, so here ya go. For one, it’s mentioned that we’re taking a lot fewer of these accounting ups and downs than historically, and that the dollar amount on them is smaller all the time (this is a true statement if you dig through the financials). We have a pretty strong concept of our costs now. Another piece of the answer came later when an analyst asked about missing one A350 delivery this quarter. I really appreciated Larry’s answer on this one. He clarified that the long-term outlook is that the program has strong demand and backlog. Let me riff on this for a minute. This is one of those things where, as a business culture, our focus on quarterly results doesn’t always paint the whole picture. Larry’s answer acknowledged this. It’s a bit of a ticky-tack question to ask about one plane here, one plane there, when we’re planning to build a full production run of dozens to hundreds of planes. Yes, it matters for quarterly results (especially early in a program’s life), but eh… it’s a rather small impact long-term.

The second major trend was our contracts and pricing agreements with customers. I’m a little embarrassed that I’ve been missing this for so long. There are usually questions on how contract negotiations are going, and I sort of just put them on my mental backburner and wait for more interesting questions. Well it finally clicked for me this quarter. After our top brass answered the analyst about using forward losses and cumulative catch-ups, saying that we’re using those less, but that they’re a good way to bundle the big numbers associated with airplane making and that we have pretty good cost control now, the analyst mentioned that he wasn’t as concerned about uncertainty in costs like historical write-offs have been based on, but about pricing.

See, cost control is what Spirit does. The stuff that goes on inside our facilities, we have policies and procedures to control, we have people who get experienced and better at their jobs, we can hire new people in, increase training, decrease overhead, whatever. We have a great deal of control over that part of the business. What the analyst is concerned about is the higher-level business-to-business workings that determine how much revenue our programs generate. We can control costs as well as we want, but if there’s no money coming in, our margins aren’t going to be there, and we won’t be profitable. So while I’ve been more or less dismissing this issue, it occurs to me now that it’s literally what drives the top line of Spirit’s earnings.

At any rate, Mr. Lawson seems quite confident that the negotiations are favorable to all parties, and that we have symbiotic relationships with our customers and partners. Due to the nature of these discussions, there’s very little he can disclose, and that makes sense. But it will certainly be an item for the Spirit analysts, and all of us, to listen for in the future.

One last question that I found particularly interesting. An analyst asked Lawson where growth was going to come from as our business stabilizes and even our big development programs mature. Of course there was the normal bit about “organic” growth happening via rate increases on existing programs and leveraging relationships with current customers. And there are always opportunities for “inorganic” growth through new business opportunities and securing work on new programs. But for perhaps the first time I’ve heard, Lawson mentioned the possibility of acquisitions in the future. At least for a nerd like me who just digs business finance, I’ll be watching closely to see if there are any plans on that front. Our company gobbling up other companies might incite some of that excitement that’s been lost since the forward losses have slowed down, without all the stress and worry over losing my job.

Okay folks, as with every quarter, thank you for your time reading this! While I started doing this just for the fun of it and as a service to those immediately near me, and still keep writing on our earnings because I enjoy it, I do always appreciate feedback, questions, comments, and your own observations. I have a list that grows every quarter of those who want to receive future emails directly from me. If you want to be on it, just email me. Also, each quarter I get lots of chat conversations and emails during and surrounding earnings calls, which I am always honored by (and hope I can answer or respond to well). Some of you are becoming quite shrewd with the financial data! I don’t know how much credit I can take for that, but if it’s even a tiny portion, I’ve accomplished what I originally set out to do. Maybe in the future, I’ll even be able to take a quarter off or something!

Ah, yes, mini-lesson. This quarter, Spirit passed one billion dollars in cash. While this is definitely a good situation… well, let’s say I’m glad to hear about some ways we’re planning to spend the free cash flow that we’re hauling in. Learn more in this quarter’s lesson, Can a Company Have Too Much Cash?