Hey everyone,
I’ve been getting a ton of requests to do a special write up on the sale of Spirit’s Tulsa facility (Triumph’s Tulsa facility?) and its impact on the 2014 STIP score. I appreciate that many of you asked me directly or asked me through Matt Joyce as a proxy. I’m honored by your recognition.
Some of what’s happening is very complex. Additionally, a lot of what I’ll say regarding the STIP score in this email is pure speculation or personal opinion. Please don’t come at me with pitchforks and torches if the STIP score is low.
If there’s anyone left who hasn’t heard the news, Spirit sold its Tulsa facility and the historically troublesome Gulfstream programs to Triumph. We made a $160M cash payment to Triumph as part of the deal. Our CFO Mr. Sanjay Kapoor stated that we will be net cash positive over 2014-2015 after accounting for a $240M-$250M deferred tax asset valuation.
From a broad perspective, I think a lot of Spirit employees and our analysts see this as a good thing. The main question for employees is how it will impact our 2014 STIP score since we made a big cash payment out as part of the deal. There are two main things we need to think about: the financial impact of the transaction and how it impacts the factors that play into our STIP score, and the philosophy of the STIP payout in the first place.
The Finances
First, let me point out that in the Q3 results, I mentioned just how much of the free cash flow generated in Q3 that Spirit stuffed in a bank account and sat on. We used that as the lesson for the quarter and talked about what the company could do with that money. I said:
Our free cash flow for the quarter was $75M. Out of that, we socked away $71.2M, or 95%. And those numbers are after we spent $44M on property, plant, and equipment. Wow.
Now, we have to ask, “What could we do with that cash, and future free cash that we bring in?”
In general, there are only a few options.
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We could improve the company’s finances by building up our savings or paying off debt.
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We could invest back in the business by advertising, buying new equipment, expanding our product lines, or upgrading facilities.
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We could give back to our stakeholders, including employees, shareholders, and local community.
Although the Tulsa deal was… different than I expected, in the sense that we paid to dispose of business, what we stuffed all that cash away for was probably to lessen the pain of this transaction. In other words, our senior leaders were probably at the negotiating table and saw how the Tulsa sale was shaping up, and decided it would be prudent to save up for the payment they anticipated making when the sale was finalized. While the $160M will probably eat our cash flow from Q3 and Q4, we’ll probably still be cash positive for the year since we saved so much in Q3 and will probably do the same in Q4. I would expect, therefore, a Q4 cash flow between negative $80M and $100M – if we matched our free cash flow from Q3 in Q4 and paid the $160M in full, that’s what we’d see. If that’s the case, we’re looking at 2014 total free cash flow of $94M-$114M, based on my assumption about our Q4 result and the nine months running cash flow for 2014 from our 3rd quarter report:
Alright, so knowing that free cash flow is one of the three factors in our STIP score, how does that compare with, say, 2013?
Well, we lost $20M in cash in 2013, so anything positive is an improvement. Here again, I don’t know the targets, but it would take more than $160M to push us negative for the 2014 fiscal year. I’m betting we’re still in decent position.
The other pieces of the STIP score are EBIT and EBIT as a % of sales. Here’s where it gets interesting.
In the Q4/2013 summary, I described what exactly a forward loss is. As a refresher, here’s the chart I used:
As time has passed and those “estimates” have been overcome by whatever financial reality we experienced, some of that forward loss has been realized, but much of it is still, indeed, in the future. What’s gone is gone, but, depending on how we do our accounting, we may be able to reclaim the losses that we haven’t actually incurred yet, since we’ve disposed of the source of those losses and won’t incur them in reality. Here’s that graphically:
Luckily, the announcement of the Tulsa sale came with pro forma (estimated) financials that split out the effect of the Tulsa sale (“The Transaction” as it’s ominously referred to) and show what performance would have been like if we hadn’t been exposed to those losses. Remembering that EBIT is equivalent to Operating Income, take a look at this:
So what we actually reported as our EBIT for the 12 months ended 12/31/2013 was negative $364.3M. $530.1M of that was due to business we exited with “The Transaction.” We would’ve generated +$165.8M without that exposure.
To me, this sends the signal that they are indeed planning to making a positive cumulative catch-up adjustment, meaning we’ll get back the un-incurred portion of the forward losses. And that balloons our EBIT (and as a consequence, EBIT%sales) enormously. Generally, that’s good for our bonus.
Now, like I said, a lot of assumptions here, so don’t get too excited, but I think the impact to cash flow, while negative, won’t be catastrophic, and EBIT is actually more likely to rise than fall as a result of the sale. Coupled with a strong first three quarters in 2014, I would still suspect the STIP will be solid. But please, don’t pull a Clark W. Griswold Jr. and write a hot check on a new pool based on what I just said.
I said there would be a second thing to consider, so let’s jump to that now.
The Philosophy of the STIP
The idea of the STIP is to reward consistent, good performance of the employees by giving them a bonus related to the company’s success, which they’re a primary driver in. The moves to tie the STIP score with not only company, but program and individual performance signal this as well, and I think what they created is philosophically consistent with that, even if the sub-systems aren’t perfect (buy hey, what is?).
The performance and sale of the Tulsa facility are very far removed from any impact that you, as a first-level employee, can have. As my fellow MBA and friend Nic Hovey wisely pointed out, the Tulsa sale was a strategic decision, not a performance issue.
As such, I think the best way to handle the STIP score for employees this year, for better or worse, is to generate two sets of financial data, one that includes the sale of the Tulsa facility and one that doesn’t. It’s fairly likely that we’ll do this anyway; the Tulsa sale is a significant one-time event, and it really skews the data if you’re looking at it to glean our company’s trending performance. I realize part of the allure of the STIP score is to generate one score for the entire company (at least, for the 70% of the score that comes from the company’s performance), but the truth is that at the executive level, the job descriptions and influence are very different from ours. Maybe in cases where there’s a significant standalone event like acquisition or disposal of business, there should be a “performance score” based on the trend and a “strategic score” based on the overall results.
I should mention, as I say this, that I think it was probably a good strategic decision and that our leadership should be rewarded for that. I don’t have anything against Mr. Lawson or any of our other management; I want them to be paid abundantly well for their good efforts and decisions and I hope they feel the same about me/us. The reality is that their sphere of influence is much different than mine, and it should be acknowledged. If management makes good strategic decisions and the workers don’t execute, the reward structure should match that. If the workers execute well within a bad business setup, rewards should match that. If everyone knocks it out of the park, let’s all share the bounty. Lawson’s got tons more experience than me, a lot more knowledge, and far more stress due to his position. He should be paid accordingly as long as he’s making good decisions at his level. The same is true for all employees.
Final Thoughts
I apologize if I soapboxed too much for anyone. Overall, I would not be surprised if the STIP was still a 2.0, and I would be very surprised if it was <1.0. For one, the Tulsa sale shouldn’t negatively impact our financials enough to sink 2014, as detailed above. Second, since we don’t know what the STIP targets are or exactly how it’s calculated, for good or ill, whoever dishes out that score has the ability to fudge it a bit anyway. And like I mentioned in the last report, think it would be wise to have a good payout this year considering the mistrust that a huge letdown would cause after 3 quarters of expecting something big. Third, I believe that the Tulsa sale was a strategic and not performance related event, which is likely to be acknowledged by top management in some form or another.
But, I’m not the decision maker. Don’t write that pool down payment check until you hear from someone with more corporate muscle than me.
Good luck, happy new year, and see you all in a month for the year-end summary!