Spirit AeroSystems Holdings Inc (SPR) 2009 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the Second Quarter 2009 Spirit AeroSystems Holdings Earnings Conference Call.

My name is Towanda and I'll be your coordinator today.

At this time all participants are in listen-only mode.

We will conduct a question-and-answer session towards the end of this conference.

(OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to Mr.

Phil Anderson, Treasurer and Vice President of Investor Relations.

Please proceed sir.

Good morning and welcome to Spirit's second quarter 2009 earnings call.

I'm Phil Anderson and with me today are Jeff Turner, Spirit's President and Chief Executive Officer; and Rick Schmidt, Spirit's Chief Financial Officer.

After comments by Jeff and Rick regarding our performance and outlook, we would be glad to take your questions.

In order to allow everyone to participate in the question-and-answer segment, we ask that you limit yourself to one or two questions.

And before we begin, I need to remind you that any projections or goals we may include in our discussion today are likely to involve risks which are detailed in our news release, in our SEC filings, and in the forward-looking statement at the end of this web presentation.

And as a reminder, you can follow today's broadcast and slide presentation on our website at www.spiritaero.com.

With that, I would like to turn the call over to Jeff Turner.

Thank you Phil and good morning.

First let me say that this is obviously a disappointing quarter for Spirit financially.

Our Wichita operations were disrupted as residual strike effects and the disruption associated with the implementation of our new ERP system reduced operating efficiencies.

The situation was further aggravated by the residual impact of the rework associated with nutplates.

Despite these disruptions, the company continued to meet customer deliveries and made good progress in returning to pre-strike operating performance levels.

I will discuss this in more detail in a moment.

While our core business in Wichita encountered several short-term challenges, our development efforts in Tulsa on the G250 program also experienced additional difficulty.

The team in Tulsa strived to meet our customer requirements and maintained profitability on the program.

However, the development costs have exceeded the plan and our ability to recover our investment in a soft market is uncertain.

As a result, we have recognized the financial impact of this situation in our second quarter results.

Let me take a moment to address the specific G250 program issues.

The overarching challenge on the G250 program was insufficient program management disciplines being applied in a constrained resource environment.

Combined these two dynamics helped create a situation where the initial development work has taken longer and been more expensive than expected.

More to the point, our program management processes and disciplines did not adequately manage and control engineering requirements and changes.

As a result of these challenges, we have taken aggressive action to assure implementation of our robust program management model in Tulsa and have used the experience to improve our program management disciplines across the enterprise.

We have also made a number of middle management and upper management changes at the Tulsa division, including the assignment of a new vice president and general manager this quarter.

Now let me spend a few moments on the unusually large, unfavorable [cumulative] catch-up adjustment this quarter.

Essentially, we forecast a more efficient return to normal production in Wichita following the strike than turned out to be the case.

Short-term loss of efficiency was due primarily to out-of-sequence work resulting from the strike, further compounded by part shortages related to the implementation of a new ERP system.

I believe these challenges for the most part are behind us, along with the residual nutplate disruption I mentioned earlier.

Finally, as you know, Textron Cessna terminated the Citation Columbus program earlier this month.

While we are currently in the early stages of termination discussions with Cessna, we think it is prudent to recognize a loss provision in this quarter.

We are disappointed that the program was cancelled as we were on track to meet customer requirements and deliver performance in line with our business plan.

Rick will provide you with additional details on these issues in just a few minutes.

Also during the quarter, we were selected to design and build the engine pylon for the Bombardier CSeries airplane.

This is another in a series of new business wins for our propulsion business unit and the beginning of a long relationship with a new customer.

And as you know, we remain cautious regarding the outlook for commercial aerospace.

While we firmly believe this is a great long-term market and that we are well positioned to take advantage of it, we are equally concerned and have positioned ourselves to deal with the current market uncertainties.

Now let's look at each of our segments beginning on Slide 3.

Revenue grew nicely over the same quarter last year as the fuselage segment returned to full rate production following the strike and benefited from higher revenues on development programs.

As I mentioned earlier, segment profitability was impacted by the unfavorable accumulated catch-up adjustment, driven by the residual effects of the strike and nutplate rework along with the ERP implementation.

This segment was also impacted by the Cessna Citation Columbus program termination charge.

The team accomplished several key milestones while managing through this difficult period including shipping the 3,000th 737 next generation fuselage, the 4th P-8A and the 6th 747-8 freighter.

The team continues making good progress on the Sikorsky CH-53 program.

On Slide 4, you see the propulsion team's results for the quarter.

Revenues were lower than last year's quarter as fewer 747 deliveries and slightly lower after-market sales were realized.

Segment profitability was impacted by the unfavorable cumulative catch-up adjustment, driven by the residual effects of the strike along with the ERP implementation.

Propulsion team shipped the first Rolls-Royce BR725 nacelle package and continues to make good progress on the Mitsubishi Regional Jet Pylon design.

And as I mentioned previously, the propulsion systems team won an important piece of new business on the Bombardier CSeries jet.

On Slide 5, you see the wing systems segment, which is comprised of our Spirit Europe, Spirit Malaysia and Oklahoma operations.

Revenues were lower as fewer 747 deliveries were made and the impact of foreign exchange rates created headwind.

The segment margins were heavily impacted by the G250 loss provision.

The team delivered the first G650 wings and shipped the 3rd 747-8 fixed leading edge wing section.

And the recently opened Prestwick Repair Center continues to gain traction in the market.

Now let me turn to Slide 6 and give you a brief update on the 787.

We delivered aircraft number seven and number eight forward fuselage in the second quarter.

Overall product quality remains high and we continue to work with the supply base to ensure a smooth production ramp up.

We are continuing to work closely with our customer as we incorporate the necessary engineering changes on the initial in-service airplanes.

Our internal efforts remain focused on productivity improvements and increased utilization of the capability and capacity that we have in place.

We had expected to restart forward fuselage production later in 2009.

However this plan may change once we receive a new customer delivery schedule.

Now let me turn it over to Rick, who will provide more details on our financial results and outlook.

Thanks Jeff and good morning everyone.

Slide 8 summarizes our financial results for the second quarter, which were heavily influenced by several unusual items, which we'll discuss in more detail today.

Revenues were about flat with the prior year period as FX headwind and fewer 747 deliveries, due to the transition to the 747-8 model were offset by higher Airbus and other new program revenues.

Operating profit for the quarter was a loss of $10 million and was impacted by three major items.

First was the recognition of a $93 million loss provision for our G250 production and tooling contracts.

Second was an $11 million inventory provision to recognize expected losses on the recent termination of the Cessna Columbus program.

Lastly was an unusually large $33 million negative cumulative catch adjustment recorded in the quarter.

I'll describe each of these items in more detail in a moment.

In the aggregate, these three items totaled $137 million and as a result moved operating profit into a loss position.

Earnings per share for the quarter were obviously also impacted.

$137 million pretax aggregate for the 3 items translated into $0.67 per share of earnings impact, resulting in a net loss of $0.06 for the quarter versus a $0.62 profit in the prior year period.

Cash flow from operations of negative $67 million and capital expenditures of $52 million for the quarter reflect our continuing investment in the 787 program and other new programs and the transition in 787 customer advances from cash inflows to cash outflows as the advances are liquidated.

Net cash tax payments of $65 million in the quarter also contributed to the negative cash flow.

Slide 9 highlights our progression on key P&L metrics over the trailing 4 quarters.

Second quarter revenues were flat with the prior year period but up 20% sequentially from the first quarter, which was still impacted by the short work week at Spirit after the conclusion of the IAM strike at Boeing.

The strengthening dollar lowered Q2 revenues by approximately $29 million versus the prior-year period, but was slightly improved from Q1 as the dollar has again begun to weaken.

Operating income margins were a loss for the quarter as the $137 million pretax for the 3 items mentioned represented 12.9% of sales for the quarter.

Lastly, second quarter EPS of a loss of $0.06 was down $0.51 sequentially and $0.68 over the prior year period due to the $0.67 recognized for the 3 unusual items that I mentioned earlier.

On Slide 10, R&D expense in the second quarter was $14 million, up slightly from the prior year period due to modest increases in spending for new program development in our propulsion and wing system segments.

Sequentially R&D was about flat with the first quarter.

SG&A expense for the quarter was $35 million, about 15% below the prior year period due primarily to tight expense control and lower non-cash stock compensation expense.

Sequentially SG&A was down slightly from the first quarter as the first quarter included some start-up costs for our Malaysia facility, which are now behind us.

With our revenue returning to pre-Boeing strike levels, SG&A and R&D spending as a percentage of sales are also resuming their historical downward trend, reaching 4.6% of revenue in total in the second quarter.

Slide 11 summarizes the P&L for the second quarter versus the same period in the prior year.

During the quarter in addition to the G250 and Cessna Columbus loss provisions, Spirit realized approximately $33 million of net unfavorable changes in contract estimates versus a net $4 million favorable adjustment in the prior year period.

All of the negative cumulative catch adjustment was recorded in our fuselage and propulsion segments.

The wing system segment recorded an $8 million favorable adjustment in the second quarter.

The negative cumulative catch in the fuselage and propulsion segments occurred exclusively in our Wichita operations and were largely the result of unexpected inefficiency and fixed cost absorption issues, resulting from the resumption of normal production and the simultaneous conversion of our legacy Wichita ERP systems to a fully integrated SAP platform.

The SAP conversion has been underway for over three years, but the final transition in the second quarter happened to coincide with the return to normal production after the Boeing strike.

As a result, the employee training and utilizing the new systems and loss of efficiency from short-term material shortages and other scheduling disruption such as the nutplate replacement process combined to produce manufacturing variances and unabsorbed overhead beyond what was expected.

We believe these issues are now behind us and Wichita operations at the beginning of the third quarter have returned to historical performance levels.

Overall while the cumulative catch booked in the quarter was large and unexpected, it represents only a 25 basis point average degradation in the profitability of our current legacy Boeing program contract blocks.

While the overall profit percentage impact is relatively small, it is magnified into a larger absolute dollar impact because it is spread over 4+ years in accumulated revenue and our current contract blocks, which are on average approximately 90% complete.

This excludes the 787 which was largely unaffected by this event as very little production was underway during this transition period.

Slide 12 details the 3 unusual items booked in the quarter and the impact they had on reported results.

I've described the negatives of cumulative catch in some detail, but would like to add some color to the other two items.

First for the G250, during the second quarter we continued to see further growth in both our development costs and in our estimates of future production costs.

At the same time, the business jet market continued to weaken and the expected pace of recovery continues to extend further out.

As a result of all of these factors, we concluded that the program was more likely than not in a loss position.

Consequently, we recognized $103 million loss for both our production and tooling contracts in the quarter.

We believe this loss provision fully accounts for the remaining development costs and provides for contingencies for potential risks in achieving future production cost target as well as a conservative first block size over which all of our development costs will be amortized.

Regarding the Cessna Columbus program, in our first quarter results, we disclosed our inventory exposure in the event the program moved from suspension to termination, which is exactly what happened when Textron announced the program termination on July 9th.

We consequently booked an $11 million charge in the quarter to recognize the expected loss net of anticipated claim settlements with our customer.

Slide 13 summarizes the trailing four quarter changes in our cash and debt balances.

Cash balances at the end of the second quarter of $89 million decreased $27 million from the prior quarter-- quarter end largely due to negative cash flow from operations, which I'll explain in more detail on the next slide.

So the debt balances increased $73 million in the quarter, entirely due to a $75 million draw on our revolver driven by expected negative free cash flow in the quarter.

At the end of the second quarter, our net debt-to-capital ratio was approximately 32%, up from 22% at year end 2008, due to the anticipated negative cash flow in the first half.

Additionally, at the end of the second quarter, the Company had almost $580 million of short-term liquidity available through our unutilized revolving credit agreements and available cash balances.

We continue to believe this level of liquidity is fully adequate to more than fund projected cash flow needs.

As previously disclosed during the quarter, Spirit amended its credit agreement to extend its maturity to mid-2012.

As part of this amendment, the revolver temporarily increases to $729 million through June of 2010 and then adjusts to $409 million for its duration.

As we'll discuss in our guidance section coming up, Spirit believes that free cash flow for the second half of the year will be net positive and the year-to-date revolver draw of $150 million will be fully repaid by year end.

Slide 14 details our cash flow for the 6 months of 2009 versus 2008.

Cash flow from operations was negative $216 million as lower profitability, growth in working capital, primarily for accounts receivable inventory and liquidation of customer advances for the 787 and cash taxes, $41 million above the book tax provision, all negatively impacted cash flows.

Accounts receivable balance increased due to the fact that year-end receivable balance are at the lowest point of the year based on the timing of year-end shipments and the scheduled Boeing payments.

Year-end 2008 was abnormally low versus other years.

This is due to the extended Christmas shutdown at Spirit related to the residual impact of the Boeing IAM strike which resulted in low December sales.

Inventory grew $203 million in the first half due to continuing investments in new programs, primarily our two Gulfstream programs on the 787.

This inventory growth is net of the loss provisions booked for the G250 program and the Cessna Columbus termination.

Advance payments were a negative $44 million in the first half as we begin to liquidate 787 customer advances as units are shipped.

In the first half of 2008, we received $184 million of net cash inflows from 787 customer advance payments, a net swing of $228 million between the two periods.

The difference in cash flows for accounts receivable and advance payments largely explains the total variance in cash flow from operations between the first half of 2009 and 2008.

Capital expenditures were $107 million in the first half versus $119 million in the prior year period as the installation of production capacity for the 787-8 program continues to wind down.

Slide 15 summarizes our updated guidance for 2009 compared to 2008 actual results.

This guidance has been updated to reflect the unusual items included in the second quarter results.

2009 revenues should be in a range of $4.2 billion to $4.3 billion, a 13% growth over 2008 using the mid-point of the range.

This growth results from the resumption of a prestrike level of unit deliveries to Boeing, ramp up of 787 deliveries in the second half, and growth in revenues from non-Boeing customers.

Offsetting some of this growth is currency headwind for our UK operations.

At the present dollar/pound exchange rate, negative currency headwind for 2009 revenues will approach $100 million, although the gap in the second half is narrowing as the dollar weakens.

On this projected revenue base, Spirit expects earnings per fully diluted share of $1.45 to $1.55, a 21% reduction from 2008, again using the midpoint of the range.

This guidance range includes the $0.67 of unusual items booked in the second quarter and the carry-forward impact of the negative cumulative catch.

SG&A and R&D expense in the aggregate for the year are projected to remain at approximately 5% of sales, slightly below 2008.

Included in our guidance is earnings headwind created by foreign exchange mentioned earlier and slightly higher projected net interest expense.

Our effective tax rate for the year at 31% to 32% should be slightly favorable to earlier expectations.

We expect cash flow from operations to be slightly stronger in the second half-- to be significantly stronger in the second half of 2009, largely as a result of inventory growth peaking in the third quarter.

For the total year, we expect free cash flow to be no more than a negative $100 million with approximately $250 million of capital expenditures.

This forecast is down from previous guidance due to higher development spending on the G250 program and lower profitability.

As mentioned earlier, we expect to generate enough cash in the second half to fully repay the $150 million revolver balance existing at the end of the second quarter.

In terms of risks to our guidance, the primary risk we see is the as yet to be announced new schedule for the 787.

Our guidance assumes we ship around ten ship sets in 2009, of which four have already been shipped in the first half.

We are also assuming a production ramp up in subsequent years consistent with expectations before the recent delays in the start of the flight test program.

If 787 schedules change, our 2009 guidance may be impacted accordingly.

And now I'd like to turn it back over to Jeff for some closing comments.

Thank you Rick and let me wrap up with just a few comments.

First, let me assure you that we have taken the necessary actions in Tulsa to improve future performance.

Strengthening the management team at various levels and implementing new program management disciplines was the right thing to do.

These changes will be the backbone of our future successes.

Second, we do not expect this situation to occur on other development programs.

Our program management disciplines in Wichita and Prestwick are and have been robust and have a track record of success that includes numerous Boeing and Airbus derivative programs as well as the 787.

Finally, while the second quarter financial performance in Wichita was disappointing, Wichita operating performance has returned to prestrike levels in the third quarter.

As our core operating performance recovers and our development programs progress, we remain well positioned to manage through this cycle.

We will now be glad to take your questions.

Thank you.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Howard Rubel with Jefferies.

Please proceed.

Thank you very much.

While I appreciate your effort Jeff to sort of address the program management changes or the efforts to fix the G250, could you give us a little bit more of some metrics maybe that we might expect for you, so that we could say, gee the 650's on target, the CH-53 is okay and some of these other programs that or even the A350 going forward that we don't wake up one morning, 12 months from now and find out we have the same problem all over again?

I know it's like how often are you beating your wife, but I don't know how else to ask the question in a fair way.

Well I think Howard it's fair to ask the question.

I mean clearly the metrics that we use are detailed and identify the status of each program.

And the review process that we go through and will continue to go through, in fact will strengthen, will give us insight I think.

Asking the question and us answering where we're at, I think we've given answers that we've had some challenges on some programs.

Clearly the expectation of the market on the 250 was part of this decision process.

We've had some challenges on the 250 as well or 650 as well as we've mentioned before.

But I think we've got a very strong market there.

We've got a strong team.

We caught it earlier on some of the challenges they were having.

So I think our other programs are on track.

They experienced the challenges that we have with new developments.

But our program management disciplines are-- have been in place and we are actually queuing them to a much tighter standard now, across the board.

So we'll continue to report and answer questions on how we're doing on the development programs.

Thank you.

Thank you Howard.

Your next question comes from the line of Cai von Rumohr with Cowen and Company.

Please proceed.

Yes, thank you very much.

So you've delivered the wing on the G650 and I guess General Dynamics talked about first flight in the fourth quarter.

Where are we with the G250 wing?

I mean have you delivered it to them and where are we just in terms of physically what needs to get done there?

We have delivered the first wing and I think in fact we've delivered-- I'm sorry, we've delivered the second wing as well.

They fit well.

I think the issues which we've delineated are really our issues there.

We spent way too much getting there.

We allowed way too much engineering change to get in the way of cost effectively doing the development.

And we've revised frankly our outlook for how many we're going to be able to sell in a given period of time.

Okay and you know you had your investor meeting like right before the Paris air show as I recall, early June.

So you know a lot of these issues in terms of the ERP implementation, the nutplate, recovery from the strike, you know were kind of issues everyone had been aware of for some time.

So how come if at that point things looked okay that all of a sudden we had this surprise in the second quarter?

Cai that's-- I think that's a great question.

In a way I think we, although maybe it's a bit of hyperbole, we characterize it as maybe a perfect storm.

If you think about recovering from the strike, you end up in a disrupted mode but that's something you can swallow in a fairly straightforward way.

The nutplate issue, the same way, we had to shift people out of position that would have kept the production lines running smoothly, to put them on to the rework due to the issue with the nutplates.

We came out of that right into the implementation of the new ERP system.

Frankly, we had a good implementation plan.

We had good training.

We expected a little bit of an issue with it but I think the combination of all those things.

We looked at them individually.

And thought you know we can swallow this, we can manage through it.

I think there's probably one other factor in that we have tried to run our organization lean with the unknowns of the current market situation.

So we got into a mode here where we had to recover from two disruptions in the factory and we did it and implementation at the same time.

I think the combination of the three surprised us.

We overestimated our ability to swallow those.

Excellent.

Thank you very much gentlemen.

Thank you Cai.

Your next question comes from the line of David Strauss with UBS.

Please proceed.

Morning.

Good morning.

On the 250, could you maybe just break it out percentage wise?

I mean the move from where you were to a forward loss.

How much of that was to do with a change in the-- a view of the market versus just a change in terms of your costs on the program, your own costs?

Yes I'll ask Rick to do that.

Sure.

Yes David it's actually, as you can appreciate a combination of all of those factors.

We've been obviously following the progress of the 250 since we've won the program.

And we had continued to see the engineering costs, some development costs were running ahead of our schedule.

But that began to accelerate in the second quarter.

At the same time, the business jet market, as you know, has continued to trend downward.

And as we approached the period of having to decide what the first-- the size of the first contract block would be, we gravitated towards a more conservative view of what our first block ought to be, given you know how far into the future we would have to predict our costs.

So the combination of increasing development costs combined with a smaller block than we'd originally expected.

As you can imagine the-- that combination can create larger losses in a pretty big hurry.

You know the other big variable obviously is our recurring cost because, as you know, I mean we're very early days in this program.

To date, we've only spent roughly 20% to 25% of the cost of this program.

And all of that, largely all of that has been for development.

So we still have the preponderance of the cost in front of us.

But-- so it would be-- it is unusual in my experience to be in a position to recognize a forward loss this early in a program.

But given the information that we had available to us, including the development costs that we'd already spent, what we thought our recurring costs would be long term and what we thought a prudent first block size would be, you know that all came together to result in a loss on the order of what you saw being booked in the second quarter.

So it's hard to segregate one from the other.

I would say that-- I would weight them maybe roughly equally between overspending on the development costs and opting for a shorter first contract block.

That's great color.

Could you give, Rick, could you give similar color on the 650, kind of how your underlying assumptions have changed?

And how close would you be, if at all, to having to take a forward loss on that program?

Let me pick that up and a couple things.

I want to amplify a bit on the 250 as well if you'll allow me.

We are very excited about that airplane.

We think the technical performance of that airplane's going to be very good.

We think the cabin size.

We think that mid-range airplane that-- the market that it's in is going to be very receptive to the airplane when the-- when we and the customers get it out there.

So I wanted to make sure we emphasize that cause the last thing we want to do is imply we thought there was an issue with the airplane.

There is not.

Clearly that segment of the market has been hit pretty hard.

And our optimism as to how many units we'll be able to sell, how quickly, has been somewhat dampened.

The 650 program has had a bit of a different view, as we understand it from the marketplace, a very successful airplane in the marketplace.

Continued strong demand.

And I think an airplane that we foresee a long and very successful production run and one, like I said, we've had some challenges getting it off the drawing board and getting it through the process.

But in relative terms, much less of an issue than what we had with the 250.

And specific to your question, we just-- we don't see that-- we don't see that program going down this same path.

Just a follow-up, obviously the market assumptions on the 650 are much better than the 250, but have you had, you know on a percentage basis, have you had similar kind of cost growth on the 650 as you have had on the 250?

Directionally, we've had them-- magnitude wise, percentage wise not the same.

Okay.

Thank you.

Yes, thank you.

Your next question comes from the line of Robert Spingarn with Credit Suisse.

Please proceed.

Good morning.

Good morning Rob.

Rick, could you size for us the various contributing issues in the $0.16 unfavorable cumulative catch?

Sure.

Well the $0.16 is the $33 million that I referred to in my remarks, which as I mentioned, were recognized exclusively in the propulsion and fuselage segments.

We actually had a favorable cumulative catch in our wing system segment.

And the net of those-- the three segments was the $33 million.

As we tried to highlight in our comments, you know the vast majority of that relates to the forecast that we had expected for coming out of the strike and for the level of disruption that we felt would be incurred through the, you know through the SAP transition.

We actually had anticipated that we would recover after, you know get back up to normal production.

And just to kind of refresh everyone's memory on the timing of this, we were still working a short work week into March of this year and we didn't deliver our last ship and place unit from the strike until towards the end of March.

So I mean all of this really was fully underway as we were closing our books for the first quarter and became much more visible to us during the months of April, May and June as we then closed the books for the second quarter.

But during that period, we had expected to come out of the strike you know fairly smoothly, had underestimated the level of disruption from material shortages and closing old work orders, opening new work orders, had underestimated the impact of that during the SAP transition.

And that resulted in basically a higher cost, higher overtime, less efficient manufacturing operations in the shop, resulted in unabsorbed overhead and higher process rates than we had expected.

We believe, as we said in our comments, that you know as we look at our cost trends and our productivity trends, we can see that there was clearly a spike up in April, May, June and that we're now returning to kind of normal levels, more normal historical levels in-- at the beginning of the third quarter.

So we do believe that this transition period has been-- you know while it's been painful and more than we expected, but we certainly do believe that it is now behind us.

So are you saying that these are related items or-- cause where I-- what I was looking for was how do we think about the $33 million in pieces?

And then the other part of this question is the way your release is written, you talk about $0.67 in costs that we could exclude from the reported number.

But on the other hand, we don't exclude the $8 million cumulative catch gain.

Absolutely not.

We weren't suggesting that we'd exclude it Rob.

We were just trying to identify it.

Okay, well how do we think about the pieces of this?

And is there any lingering expense?

You just said you think you're coming to the conclusion of this thing.

But is there any lingering expense?

Can we expect some kind of cumulative catch number in the current quarter or maybe in the fourth quarter to wrap this up?

Right, no the only lingering impact would be, again as I mentioned earlier we, you know we took a sample of our largest contracts, which make up about close to 90% of our Boeing activity.

And we looked at what was the degradation and margins over the entire contract block.

And that's the 25 basis points that I mentioned.

That impact, obviously the cumulative catch takes an adjustment going all the way back to the revenue-- all the revenues that we've recognized in these current blocks, which goes back to the start of the company in mid-2005.

There also is the small carry-forward impact of that as well.

So what you'll see is slightly lower margins in our third and fourth quarter as a result of the carry-forward impact.

But the actual expenses themselves that we saw in the kind of April, May, June time period, the inefficiency, unproductive costs.

I mean those costs we believe are isolated to those months.

And we should-- we are seeing our productivity ratios and metrics kind of return to what we would have expected prior to the Boeing strike and the short work week.

Okay and then just on-- related to that, but on cash flow, two things.

How should we think about the cash flow related to the G250 charge?

What's already happened?

What happens here?

And how much is on a forward basis?

And then separately, just to clarify, you said and I apologize for maybe taking you too literally here, you said no more than $100 million loss, I think when you talked about cash flow guidance.

Did you mean a maximum decline of $100 million or a minimum decline of $100 million?

No well what I meant was that we would have a no more than $100 million of negative free cash flow for the year.

Okay.

So that-- it could be cash flow from operations plus capital expenditures plus the capital reimbursement that we have remaining from Boeing.

So the sum of those 3 items would be not more than $100 million negative for the year.

Got it.

So it could be better?

Yes.

So that would mean that obviously in order to achieve that, you know we would have to be significantly better cash flow in the second half of the year, which we think we've got a good handle on.

And we're still comfortable with that forecast.

Okay and then just on the cash component of the G250--

Yes, no the answer to that question and then-- that's an excellent question Rob.

The way I think about it is that the forward loss that we've taken and I'll focus strictly on the production contract, which is the $90 million of the $93 million.

The forward loss that we've taken on the production contract basically equates to roughly the total amount of development costs that we've incurred to date on that program.

So that says that we're basically taking a provision to recognize a write-off if you will of all of the development costs that we've incurred to date.

Now we expect that there will be some development costs yet to go.

You know the program hasn't started flight test yet.

But if you look at what's in front of us, what's in front of us now is just the revenue on the units that we're going to deliver plus the costs associated with delivering those units in effect.

So there will be some excess average early on but on average what we've said is that we expect the program to be breakeven going forward.

So you know think about it from a revenue and cost being largely breakeven going forward.

And we've basically taken a write-off of all the development costs that are behind us.

So again a lot of cash behind us for the development.

But what's in front of us should be we expect no worse than breakeven cash flow.

Okay, thanks.

Your next question comes from the line of Ron Epstein with Banc of America.

Please proceed.

Yes, good afternoon guys.

Hi Ron.

Hey Ron.

Back to the 250 and the question that David asked about kind of the impact that the market view had on the forward loss.

If that market view proves to be conservative, what happens?

Right, so if you end up selling more of these things than you think, how does that impact the forward loss?

And how you-- I guess it doesn't impact that but how does that impact how you would record margin going forward?

Does that make sense?

Sure, absolutely.

No what it would imply Ron is that the next block, so we're going to amortize all of our-- basically all of our development costs are going to be amortized in this first block.

And we've again provided for the loss now that we expect to see in that first block.

So that says in subsequent blocks, which we certainly expect there to be one, as Jeff pointed out about the market expectations, in subsequent blocks that block would not carry any amortization of development costs because they would all be behind us.

So the next block would theoretically you'd be obviously much further down the learning curve at that point cause you'd built quite a few units at that point.

So the next block we would expect to have a normal kind of profitability.

Very similar to what we've talked about before on the 787 program.

It's a very similar scenario.

Where on the 87 we're going to amortize all of our development costs, our capitalized pre-production costs over those first 500 units.

That obviously constrains the margin on that first 500 unit block, but it means that for subsequent blocks you obviously don't-- you no longer have that cost and profitability should be improved.

Okay, okay.

And then a question for Jeff, when you've been working with let's say non-Boeing customers, right so you're working with other OEs.

How is it different?

I mean when this program ran into the problems it did, the 250 and maybe some of the things that you found early on in the 650.

Does it just have to do with just a different engineering process?

Is it just kind of a different way of working with the customer?

Can you elaborate on that?

Sure, be glad to Ron.

I think I mean clearly there are different processes, sometimes there's different tools.

Often the bigger differences are in the business arrangements.

The-- and again when we talked about strengthening our program management discipline.

There's-- even some subtleties in engineering to engineering conversation that you make the assumption how that'll get handled and flow into the business arrangement.

It may or may not be right.

So there's a lot of subtleties in learning the customer.

And absent of real strong implementation of a good set of program management disciplines.

Those things will worsen before you know.

And it'll be worse than you think.

And that's what we found on the 250.

And we had a good set of disciplines.

We hadn't applied as tightly as we could.

And you know frankly Ron I was slower to take action than I should have been.

But again those are things we learn with our first new program.

And I think we've got them cleaned up and they've been frankly good lessons for other programs.

Okay great.

Thank you.

Yes, thank you.

Your next question comes from the line of Joe Nadol with JPMorgan.

Please proceed.

Thanks.

Good morning.

Good morning.

Jeff just on these developments-- development programs, can you take a step back.

I mean you attributed the over runs on both the 250 and the 650 to just discipline.

I'm wondering if you could maybe get into how the contracts and the forecasting was done.

You guys clearly had been aggressively looking to expand your OE exposure beyond Boeing and diversify.

And you know to what degree is this a case of discipline?

To what degree do you think it's a case of maybe being over eager to diversify?

Joe, I think that's a good question and you can appreciate that we've asked ourselves that frequently, had those kinds of conversations with our board.

I think that's a little bit of the chicken and the egg.

You know but again remember that we, if you have the program management disciplines and you exercise them well and you have the team well staffed, you can usually meet-- you can usually meet the requirements of the program.

We had a couple things going on here where we and we mentioned earlier, we staffed this first program in a resource-constrained environment.

We were expecting some engineers to be available off of some other programs and they were not.

So you can argue well did you underestimate that or did you underperform it?

You know clearly with the resources available to us and the disciplines we put in place, we both underestimated what it would take and underperformed it.

I'm a firm believer that you can perform well to estimates that come out of a solid, disciplined estimating environment.

And you know we've shored that up.

We're seeing other programs where we're performing to the estimates.

This one we did not.

And we've had to make some changes to make sure we shore up both sides of that equation.

So have you gone back or at least thought-- I'm sure you've thought through, you know looked at your 350-- your A350 deal in the context of these, both these Gulfstream programs running over.

And I mean can you say you feel as confident now in the business plan and the forecasting and the execution as you did when you signed it?

Yes I do.

I do.

I feel as good, as solid in it.

Now it's going to have issues like every program has.

We've got solid program management disciplines in place.

We've got a solid team, a solid program manager on that team.

And we are-- and frankly monitoring it more closely than we did early on some of these other programs and digging deeper because of our experience here.

So now I feel like this has been a lesson, a painful lesson but one well learned.

Okay, understood.

Rick, on the guidance, you noted 787, the current schedule is embedded.

I think it's pretty well recognized including by Boeing that the schedule is going to change you know fairly significantly.

Can you just walk through-- let's say there's four or five month delay, which I think is probably a broad consensus or approaching consensus anyway, you know what kind of implications that would have for your '09 financial guidance?

Well I think the real key Joe is what is-- if that kind of a schedule slide would materialize, would that flow all the way down to the supply base and impact our deliveries accordingly?

I mean it's entirely possible that Boeing may experience that delay at their level and want to keep the supply base hot to get ready for the ramp up.

So you know at this point it'd be very hard to tell.

If it were of that magnitude, I think clearly we'd see some-- most likely see some units slip out of 2009 and into 2010.

I think the real key for us becomes you know what is the subsequent ramp up look like?

Because again as you all know we have a 500-unit block for the 787 and a key element of block profitability is how long does it take you to complete those 500 units?

So as we've seen in prior delays on the program, that has served to obviously depress our margin because you drag more fixed cost into the block because you're going to ship the same number of units over a longer period of time.

If there's a lengthy delay here, then that scenario could play itself out again.

It would most likely put additional downward pressure on our margins, which you know as we've said are fairly thin at this point already.

Is it possible you could get to the point, if they string you out more?

I mean obviously this is pending conversations on-- that you have not cleaned up yet with them, being reimbursed.

But is it possible at some point you could recognize a forward loss on that as well?

I think it's way too early to speculate on that Joe.

It really just does depend on what does the new schedule look like and again not so much how many units did we ship in '09, but what's the pace of ramp up for the remainder of the program.

Yes.

Okay and then just one more Rick.

On the cash flow profile, you are looking for at least $165 million in the second half of the year.

Can you say that Q3 will be free cash flow positive?

And then Q4 more free cash flow positive?

Or is it possible Q3 could be negative and then Q4 a big number?

Yes as you know cash in this business is pretty lumpy.

So I think it'd be hard to identify third quarter versus fourth quarter because it's just a question of timing.

But clearly third quarter cash flow will be improved over what we saw in the first quarter.

In the second quarter you saw-- you know first quarter was typically our weakest quarter of the year.

Second quarter, while it was still negative, was quite a bit better than the [second] quarter.

I would expect the third quarter to be significantly better than the second quarter.

You know whether or not that tilts it all the way over into a-- in a positive cash flow, I think is somewhat difficult to determine.

And then we would expect a strong fourth quarter after that.

So I think we're generally comfortable with our guidance for the year and having a stronger second half.

But you know whether or not it's going to fully manifest itself already in the third quarter I think it's difficult to say at this point.

(OPERATOR INSTRUCTIONS) Your next question comes from the line of Joe Campbell with Barclays Capital.

Please proceed.

Good morning.

It's Carter and Joe.

Hey guys.

Rick, just a question for you on the 787.

Not related to schedule, but in terms of the block accounting are your margin estimates in the block incorporating outstanding claims you have with Boeing on the program?

And if so, is that a material portion of your profit calculation?

Well we do factor in-- we certainly have factored in the cost associated with the various engineering changes that we've experienced on their program.

And we do factor in a conservative assessment of what kind of recovery we will have on those costs.

So yes, to answer your question, we do make an effort to again conservatively estimate what the recovery would be.

And it's recovery not only of the initial kind of non-recurring costs that we incurred in order to in effect make the change but it's also the impact that that change has on the recurring costs going forward.

Cause almost all of these changes have some impact on the future costs of the unit, some good, some bad.

You know some increased costs, some decreased costs.

But on the net, they'll have some impact.

And we do attempt to estimate that in our contract block.

Well the question really we have Rick is whether it's material?

I mean Boeing is telling us most of these claims are without merit, not yours particularly but in the aggregate in their own calculations of how they're doing you know that most of these supplier claims won't have to be paid.

And so what we're asking of you is whether you need them to be paid in order to not have a loss?

Well I think it'd be fair to say that if we were to get zero for these claims that obviously would have an impact on our overall contract profitability.

But given the nature of our contractual relationship, we don't see that as likely.

And you-- and you would characterize--

The level--

Recovery assumption as conservative?

Yes I would.

But are they large or small?

It's a large program.

Yes it's a big program.

Right, I mean 500 units at our selling price, you know you're talking about a $5 billion program.

So large becomes a relative term.

I mean there is-- I would say the impact on our recurring costs, you know the upfront portion of this in terms of the non-recurring engineering effort to make the change and to process the change, you know that is I would say relatively small relative to the size of the entire program.

The bigger impact is on what the recurring price estimate is going to be.

Terrific.

That's great.

Thank you very much.

Thank you guys.

Your next question comes from the line of Doug Harned with Sanford Bernstein.

Please proceed.

Good morning.

Morning Doug.

Going back to Tulsa.

On the 650 and the 250, where are you on the schedule relative to your expectations for the 2 airplanes?

Be more specific.

Are you talking about Doug the delivery schedule, the--

I would say both on the delivery schedule and the plans for production.

So on the delivery schedule we have delivered wings to both of the customers.

And they are in the process of fitting those on the flight test and the static test units and moving through the development phase.

The production phase is still in front of us on those programs.

But is that the schedule?

Is that-- if you have slippages scheduling those deliveries or was that done pretty much on track?

There was some slippage to that, but within the margin and within the overall schedule for their programs.

And when you look at the 650 and the 250 together, when you talked about making management changes in Tulsa, addressing process issues there as well.

What I'm trying to understand is if those issues have manifested themselves differently on the two programs.

In the 650 started a little earlier it's more complex I would expect for you.

But has it gone materially better from--?

I'm sorry.

Did you say 650 started earlier?

Didn't your work start a little earlier on that?

No actually the 250 predated the 650.

So--

Yes by quite a ways.

So--

Like I said earlier Doug there were some similarities but lessons learned coming off the 250 have gone quickly on to the 650 and the 650 being a little later in the cycle.

Though it's had challenges has not had to the extent that the 250 did.

But that means that on the 650 is it the case when there are two things-- two ways this can go.

One is that you may have not gotten to the point where you see some of the issues that you've seen on the 250.

And the other side is, as you just said, you have some lessons learned you can incorporate.

But can you be very confident here on the 650 at this stage that you're not going to see some of the same issues on the cost side that you're seeing on the 250?

We have high confidence on the 650 that we won't see the loss provision need on it that we have on the 250.

And then one last thing, when you look at the cash balance that you would like to have from an operating standpoint.

I mean what is that?

In terms of our minimum cash balance Doug do you think?

Right, right.

Is that the question you have?

Well we estimate that we need on the order of $40 million to $50 million as the minimum cash balance to kind of operate the day-to-day needs of the business.

Because when you talk about going forward and for instance being breakeven on the 250 now, breakeven presumably means you'll have a cash deficit early on in this before you move down the learning curve.

So you would have some cash strain on each of these programs if you're not-- the 650 as well if you're not well above breakeven?

No that's correct.

And that would be the normal sequence of events in a new development program.

Until you start to come down the learning curve, your early units are going to cost you more than the later units.

But and your price is generally fixed.

So you're right.

That would imply that there would be some-- you know for the early units on the 250 and the 650 and any of our other new programs other than perhaps the military stuff that you know you would have negative cash along the lines of what we've seen in the 87.

But that typically you would cross that breakeven point pretty quickly and then start to reach a positive cash position.

But you believe that-- I mean that's all incorporated then in what you're looking at as cash flow over the next--?

Absolutely.

Absolutely right.

Okay, okay.

Thank you.

Your next question comes from the line of Heidi Wood with Morgan Stanley.

Please proceed.

Yes, thank you.

A couple of follow-up questions visa vie questions that were asked earlier.

If we-- you talked about the margin impact on a delay on 787.

But I was wondering Rick if you could thumbnail through the puts and takes on cash flow in 2010 with a-- if we assume that the 787 doesn't deliver until 2011 and you know and if we also incorporate a change in the 737 rate down to the 20's?

Kind of does cash flow go negative in 2010?

Well we obviously haven't provided any guidance for 2010 yet and won't until our third quarter earnings release.

But the 787 because of the situation with the advanced payments on the 787 and the fact that all of our early units have already been paid for.

So from the standpoint of our deliveries and cash receipts, a slide in schedule really doesn't make a whole lot of difference, cause again those units have already been paid for.

It certainly does make difference on costs incurred, especially if the program is subsequently delayed.

You know 737, the cash impact largely follows the volume and the profitability of that program.

If there's a decline in the rate, we have lower sales, we have less profit on those sales and that profit is a cash profit that ultimately would not be realized.

But you'd have a build up in 787 inventory in 2010 in anticipation of ramp and deliveries--?

That's exactly right.

So that-- if there were subsequent delays, it just means that we're going to be carrying that inventory longer.

Not necessarily that we're going to be adding to it.

That's why again I don't think the 787 is quite-- doesn't quite have the same dynamics as perhaps some of our mature programs.

Right.

I'm just trying to get a sense as to whether these things can start-- you know how they trip up in terms of-- and I know you'll give us more full-- some guidance later.

But you know sort of directionally is it-- does it-- can still stay positive as you guys look at the scenarios?

Or does it meaningfully go into the red?

Yes as you said there are an awful lot of moving parts Heidi to really draw a conclusion on that.

Alright, well the other thing is that we saw in the Vought deal with Boeing that some of the ways that the claims that Vought had on the 787 included some additional work that Boeing gave them on the 37 and 47 in lieu of cash.

Is that the kind of thing that perhaps one can contemplate in your discussions with Boeing as well?

I guess Heidi if it were offered, it would be contemplated.

I mean we try to look at this holistically.

I mean we have a long-term-- set of long-term programs.

There's a lot of moving parts.

We tend to-- frankly we tend to deal with things on a program-by-program basis.

But clearly-- I mean I read the same releases that you did and there are a lot of cards to play in a game like this.

So we'd be open to anything that was offered.

Alright, great.

Thanks very much.

Operator, we have time for one more question please.

Your final question comes from the line of Noah Poponak with Goldman Sachs.

Please proceed.

Hi.

I guess I'll echo the confusion with regard to the lack of discussion of some of these challenges at the investor conference in June.

And you've talked a lot about the 250.

But particularly on the strike part of it, I mean that's you know a challenge that's coming out of the first quarter.

I'm still confused on how that cropped up.

I thought in the first quarter you were kind of saying that that was behind you and you were looking forward.

Well it was behind us in the sense that we thought that the recovery in the second quarter would be fairly swift and fairly smooth.

Ultimately as we've said, it wasn't nearly as swift and as smooth as we'd expected.

And that's what drove a lot of these inefficiencies.

And then come, you know obviously exacerbated by the transition to a new system and all that that entails.

So when we did our investor conference in early June, at that point we were looking at April actual data.

You know we hadn't even seen May data yet.

You know we hadn't fully closed our books in May.

So we were only really looking at one month of additional data beyond the end of the first quarter.

And you know that data was just one part of the larger puzzle that wasn't fully apparent to us until we went through our normal forecasting process during-- towards the end of the second quarter.

Okay and was the COO change that you filed during the quarter related to some of these challenges?

No, it was not.

Let me just speak to that.

I understand there have been some questions about that.

That the change there was part of our succession process we've been reviewing with our board and internally for a number of quarters.

We had that planned for the first of July where we made several management changes to continue to growth of a number of people.

Ron Brunton specifically has had a long successful career with Boeing and with Spirit, done a great job helping us build this company.

He was frankly a big part of the analysis and recommendations and implementation of changes that we needed to make to shore up Tulsa.

Frankly, the bottom line is Ron told me he'd stay two years when we started Spirit.

And it's now been four.

He's still here.

And I've asked him to delay his retirement plans a while longer and help us with some specific focus areas we want for the rest of this year and into next year.

So no it wasn't related.

Okay, thanks a lot.

Alright.

Thank you.

Ladies and gentlemen, thank you for joining today's conference.

This concludes the presentation.

You may now disconnect and have a wonderful day.