Spirit AeroSystems Holdings Inc (SPR) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Spirit AeroSystems Holdings, Inc.'s Second Quarter 2010 Earnings Conference Call.

My name is Steve and I will be your operator for today.

(Operator Instructions)

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

Alan Hermanson, Director of Investor Relations.

Please proceed, sir.

Good morning.

Welcome to Spirit's Second Quarter 2010 Earnings Call.

I'm Alan Hermanson and with me today are Jeff Turner, Spirit's President and Chief Executive Officer, and Phil Anderson, Sprit's Senior Vice President and Chief Financial Officer.

After brief comments by Jeff and Phil regarding our performance and outlook, we'll be glad to take your questions.

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

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, Alan, and good morning.

Let me welcome you to Spirit's Second Quarter Earnings Call.

I'll begin with a look at our business and associated performance, and then Phil will walk us through the financial results.

After that we'll be glad to take any questions you might have.

We continue to execute well across the company as our core business operating engine performed and delivered solid second quarter financial results.

While executing our core business during the quarter, we continued supporting numerous activities with our new programs.

With six airplane programs in their test phases, our teams are focused on working with their customers to accomplish program commitments.

While we are approximately two-thirds complete with the development of these programs in total, we remain cautious as we still have several significant development challenges remaining.

Program execution continues to be our priority, while moving these programs through their test and early production phases.

With our development programs diversifying our portfolio, the Company continues to take visible steps in our long-term strategy and implementation.

In particular, on July 1st, we were pleased to celebrate the grand opening of Spirit North Carolina in Kinston.

A significant milestone for Spirit, this facility will initially focus on the design and manufacture of the Airbus A350 XWB, Section 15 fuselage, and the forward wing spar, both employing state-of-the-art composite technology and processes.

In addition, on July 23, we took occupancy of our new Saint-Nazaire, France facility.

This facility will receive and assemble the A350 XWB fuselage panels for delivery to Airbus.

We're truly excited about our continued journey of diversification as we partner with Airbus to build their next generation of commercial aircraft.

As for the outlook for the commercial aerospace market, the large commercial aircraft sector appears very promising, as evidenced by the numerous orders announced recently by the OEMs at the [Farmville] air show.

This long-term perspective is exciting for our Company, because we are well positioned to meet the growing needs of the industry.

Having said that, we remain concerned about certain segments of the business jet market and we continue to monitor market dynamics.

Overall, the implementation of our long-term strategy is driving diversification and our business foundation remains substantial, with a backlog of $27 billion and growing demand for our core products.

Now let's talk about some of the specific accomplishments across the business during the quarter, beginning on Slide 3.

Fuselage systems delivered strong operating margins at 15.7% on $515 million in revenue during the second quarter.

Fuselage core business is anchored by the 737 production line, which continued to perform well as the group has now delivered more than 3,300 chipsets of the next generation fuselages.

The 787 team has also demonstrated continued progress by delivering airplane fuselage number 24.

The composite forward fuselage fabrication and systems installation areas are making good progress, as they have filled the factory with work-in-process units and their production flow continues to support our customers' requirements.

Another significant milestone for the Fuselage teams this quarter was the delivery of the first 747-8 intercontinental forward fuselage.

In addition, the 747-8 continues to mature, as we have now also delivered 17 of the freighter fuselage configuration.

The Sikorski CH-53K helicopter program continued development activities in the quarter.

The team is currently working closely with the customer as they begin the early stages of test hardware fabrication.

We are also in the early stages of building test units on another fuselage development program.

Our Airbus A350 XWB team took occupancy of the new Spirit North Carolina facility in the quarter, as they also initiated early activities for test hardware fabrication.

On Slide 4, you see the Propulsion team delivered solid operating performance of margins of 12.3% on $272 million in revenue during the second quarter.

Propulsion's core business continued to deliver high volumes of 737 next generation line units, surpassing line unit 3,300 in the quarter for both engine pylons and thrust reversers.

Additionally, we are progressing on our new customer hardware.

In particular, we delivered our 25th chipset for 787 engine pylons, our 8th 747-8 engine inlet, and our 13th 747-8 pylon chipset.

The segment continues to support the Rolls Royce BR725 engine resell program.

Our team is working closely with the customer during this important G650 test phase, while also focusing on initial production startup and efficiency.

In terms of our more recent development programs, the Pylon team continues to progress well in the early stages of development on Bombardier C Series and the Mitsubishi regional jet programs.

On Slide 5, you see the Wing Systems segment which comprises our Sprit Europe, Sprit Malaysia, and Oklahoma operations.

The Wing team executed well, with operating margins of 10.6% on $265 million in revenue during the second quarter of 2010.

Our AeroStructures team in Tulsa continues to produce some of the newer derivatives of products.

In particular the group delivered the 18th 747-8 fixed leading-edge wing section.

Activities also continue in Tulsa on the Gulfstream G250 and G650 wing programs.

With both of these programs in the airplane test phase, the teams are heavily focused on initial production startup and efficiency.

On our new A350 XWB platform, the Prestwick team in Europe continues to make progress on the wing leading edge structure as they move ahead with development activities.

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

Thanks, Jeff, and good morning.

I'll begin with our key financial highlights of the second quarter on slide number 7.

Revenues for the quarter were $1 billion, essentially flat compared to the second quarter of 2009.

A small change in the product mix resulted in offsetting amounts.

Operating margins were a solid 8.1%, and fully diluted earnings per share were $0.39 per share in the quarter, compared to negative operating margins and EPS in the same period of 2009.

Prior year was impacted primarily by the unusual charges related to a [forward loss] program, a program termination, and an unusually large cum-catch adjusted, that did not occur in the current year quarter.

Current quarter pre-tax income reflects the anticipated performance in the current accounting blocks, the charge for the stock award granted in association with the ratification of the IAM contract, and higher interest expense.

These expenses were partially offset by favorable tax benefits in the current quarter.

Our effective tax rate in the current quarter was approximately 26%, reflecting an increase in the state tax credits realized in the current quarter.

Lastly, second quarter cash flow from operations was $7 million use of cash, an improvement of $60 million as compared to the second quarter of 2009, primarily reflecting working capital improvements compared to the prior year quarter, which reflected the benefit to cash flows of unusual charges, which were all recorded to inventory.

Spending on new program inventory continues to improve, and is down from the second quarter of 2009.

Capital expenditures were $61 million, as we continue to invest in our new programs.

On Slide 8, R&D expense in the second quarter was $13 million, which is essentially flat in terms of absolute dollars and as a percentage of sales, reflecting a sustaining level of spend.

SG&A expense for the quarter were $38 million, slightly up from the prior year as expected, due to the addition of Malaysia and the North Carolina facilities.

Slide 9 summarizes the first and second quarter 2010 cash and debt balances.

Cash balances at the end of the second quarter of 2010 were $118 million, as compared to the first quarter of 2010 balances of $187 million, largely reflecting new program spending.

Total debt balances decreased slightly in the quarter.

At the end of the quarter, our total debt-to-capital ratio was 34%, which was improved slightly to the first quarter of 2010.

In the second quarter, the Company's revolving credit facility was reduced from $729 million to $409 million as anticipated, and remained undrawn at the end of the second quarter of 2010.

This facility has a planned maturity of June 2012.

As of the end of the second quarter of 2010, we had approximately $500 million of short-term liquidity available through our revolving credit agreements and available cash balances.

Slide 10 details our cash flow for the second quarter of 2010 versus 2009.

Cash flow from operations was a $7 million use of cash, as spending on new programs continued but slowed as compared to the second quarter of 2009.

Prior year inventory performance reflects the benefit of the $137 million of unusual charges that were reported in 2009.

Additionally, we experienced net favorable accounts receivable and accounts payable performance in the second quarter of 2010.

The current year overall growth and inventory balances, primarily driven by continued investment in the 787 production and other new programs and partially offset by higher 787 unit deliveries.

Capital expenditures were $61 million for the quarter, up $9 million from 2009, primarily due to the investments in our North Carolina facility.

Slide 11 summarizes our previously issued guidance for 2010.

As you know, 2010 is a pivotal year for Spirit, as we grow and diversify our business.

The core components of our business remain strong as we work to bring the next generation of large commercial aircraft and business jets to the market.

We are maintaining our financial guidance for 2010.

Our revenue guidance remains at between $4 billion and $4.2 billion, with fully diluted earnings per share unchanged at between $1.50 and $1.70 per share.

Cash flow from operations remains at approximately $75 million and capital expenditure are expected to be approximately $325 million, as we continue to invest in growth.

And while our guidance factors in some risks, new programs continue to pose the most significant risk for our guidance, as we progress through the development, tests, and the initial production phases of these programs.

We continue to expect the 2010 tax rate to be approximately 27%.

I'd now like to turn the call back over to Jeff for some closing comments.

Thank you, Phil.

I'll wrap up on Slide 12 with a few brief comments.

We had a good second quarter that shows our core operating business is performing well.

We've come a long way with our development programs, although significant challenges lie ahead with multiple programs in their test phases and the factory areas transitioning to production.

Our primary focus is on solid execution and delivering on customer commitments, while managing costs and driving productivity and efficiency improvements.

With an improving outlook for core products, our Company remains well positioned within the aerospace industry.

Coupled with a strong backlog and growing diversification, our strategy continues to materialize with a steady focus on delivering long-term value to our customers, our employees, and our shareholders.

We will now be glad to take your questions.

(Operator Instructions) And your first question comes from the line of Howard Rubel with Jeffries.

Thank you.

I'm going to do two parts of one question.

First, Phil could you explain to us why you took the charge for the stock-based comp in the quarter, as opposed to spread it?

I would have thought it might an accrual.

And then I have a follow-up.

Sure, yes.

We essentially treated the stock charge the same as we treated the Union Equity Plan charge back in 2006.

Similar circumstances, it's the same kind of program, so that was the method we chose to do, which was consistent with past practices.

Okay.

And then can you talk a little bit, Jeff, maybe about productivity in the factory?

I mean the margins look decent, maybe not as good as what we've seen in the past.

What sort of progress or what sort of milestones should we look forward to, to see some improvement on the core programs first and then on the 78 secondarily?

Sure.

So clearly Howard, the most important thing for productivity is a steady drum beat in the factory, so we're having that.

And the areas where we have that don't have the destruction of going down or going back up, we can then begin to really focus on improvements.

We've been able to do that clearly on the 37 line.

We've got plans as you know to increase some rates, so we'll have some focus on bringing people in, getting them trained, where we need additional staffing.

We run a continuous stream of improvement activities.

As you know, we've just completed a new contract with the IAM in our Wichita and look forward to the improvements that that contract allows us, and also the partnership with the employees that are associated with that where they experience some of the gains as well.

On new programs, clearly there it's getting through the phases of the start-up, again getting production on a steady drum beat, and then you can begin to really work in improvement activities.

You can plan for them as you know, but until you actually get it into production, it's difficult to make a lot of improvements.

Okay, thank you.

Thanks Howard.

Thank you, Howard.

And your next question comes from the line Carter Leake with Davenport & Company.

Good morning.

Good morning.

Let's expand just on the significant challenges for meeting all the developmental programs.

Is that macro-related, is it fewer units sold in business jet, or is it -- just give me some color on that.

That concerns me a bit.

Sure, sure Carter, I'd be glad to.

Clearly when any product comes through the initial test units are built.

They go into the flight test, so you get any unintended consequences that flow back through, changes that may come from the flight on below.

As you start production up, you run into various issues that some you had anticipated and maybe not the severity, in terms of the impact on productivity or whatever it might be.

So there's some change associated with the manufacturing process, always is.

Don't see a way to get around that.

So the fact that we have six units in test at the same time, you could have relatively small risk on each of the six but you have the compounding impact of all six, so we're cautious there.

You mentioned the market.

We are concerned about the middle market on business jets and are hopeful that that market will return in the not-too-distant future.

We think we're on a very, very good airplane for that part of the market, but clearly we need the market to improve there.

So those are kind of the gamut that we think about and we face.

In addition to that you have derivative activity that began to come through at the same time.

So there's rate build-up, there's change that flows through on the airplane program, there's productivity, you need to get training for your team.

All of those things come together, and with six of them at the same time it's just a compounding of risk that Carter, we think we have adequately covered but we stay vigilant.

Great, thank you.

Yes, thank you.

And your next question comes from the line of Ron Epstein with Bank of America Merrill Lynch.

Yes, good morning.

Good morning, Ron.

I've just got maybe a question about 777.

Are you anticipating when Boeing decides to do what they're going to do with the 777 300, that that would require additional capital investment by Spirit?

Well Ron, as you can appreciate we think about those things and run some scenarios.

There's clearly no definitive answer to that question, but it would depend a lot on material sources.

So if they went with composite?

If they went with composite, I mean clearly we don't have capacity for composite production.

Okay, great.

That would require a facilitization plan that upgrade to the airplane that might or might not require.

Okay.

And then maybe just to follow onto that, how do the negotiations with Boeing stand right now on the changes in the pricing on 787?

We have very active conversations going on.

We have teams working on all the gamut of changes and going-forward plans.

They're frankly not moving as fast as I think either us or Boeing would like them to, but they are underway and we've seen some movement.

So I think we'll see more clearly in the future as we work through all the issues and our teams make step-wise resolution.

Great, thank you.

Yes, thank you.

And your next question comes from the line of Noah Poponak with Goldman Sachs.

Hi, good morning.

Good morning, Noah.

Can you guys expound a little upon this business jet market and G250 commentary, because I guess your comments for some time now have implied at least to us that we could have another G250 charge.

You're making similar comments on the market today.

But it's hard to see how that market really gets a lot worse from here, maybe it gets better at a slower rate than you're thinking.

Is that the case?

And just give us a little more color on what you're seeing there.

Sure Noah, I'd be glad to.

So without divulging exactly what we have in the forecast for the airplane, I mean we do have a production forecast that assumes -- not a robust, necessarily, but certainly an improving market from where it's been.

And the question is when are going to see that?

We have great confidence that we're going to see it, it's just a question of when.

So if we have it loaded into our planning too hot, then we're going to have to deal with that issue.

If it turns out that our forecasting, our crystal ball, is good then we'll be okay.

But that is our concern, if it doesn't improve, then we've got issues we have to deal with.

So there's probably a dozen G250s in the backlog at best, and I guess maybe is there a risk that we don't see much new order activity for that program until it's actually a product in service?

And I guess, help us think about how you make that call that it's worse than you thought.

Yes, hey Noah it's Phil.

I think it's roughly probably a 12- to 18-month window of roll-out to market development.

Right now we're halfway, at halftime in 2010 here, looking to 2011 we need to transition into production on the program and we need the market to develop a little around a forecast.

So, but I think that's the timeframe, 12 to 18 months for us to figure it out.

But if anything changes quarter to quarter, we'll assess it and if it moves out in time, of course that drives fixed costs, increases the price of the airplane or the cost of the airplane anyway, we have to deal with.

So I think it's a close-watch item for us.

Okay, that's very helpful.

And one other quick one, on D&A you guys highlighted it as a margin headwind in '10 versus '09, but it's actually been down year over year in each the first and second quarter.

What's the latest on that?

Yes, actually it is a block-to-block comparison, Noah.

It is a headwind from the initial blocks of the company to the current blocks.

There's clearly more depreciation expense we're dealing with.

It is a little bit lower than the coming [quarter] at least in parity with last year.

One of the things we did in the first quarter, we took a look at our asset lives to make sure they were well calibrated.

And so we made some slight adjustments to the asset lives, mainly on 787 tools.

And so that's why it's a little bit better than we expected here in 2010.

Okay, thanks.

And your next question comes from the line of Ken Herbert with Wedbush Morgan Securities.

Hi, good morning.

Good morning, Ken.

I just wanted to follow up again on the development programs.

I mean you've talked a lot now about 250 and obviously some of the others.

If you had to rank these in terms of which ones are perhaps of most concern to you right now, or on the flip side, which ones you feel are significantly where the most sort of risk is retired, how would you think about the various programs?

Well so Ken, the way we think about them is kind of through their development life cycle and then into production.

So the more we're through the development life cycle, the more risk you're retiring as you get through tests and get the certification then you've retired a lot of risk.

And then of course the risk shifts off of development more into production, the production rate build-up and the training of the people and getting the processes to work and the supply chain lined up.

So I mean clearly we have a number of programs that are not through their certification process yet, so there's still the risk associated with certification and both flight and ground tests associated with those.

The airplanes that are in that mode are the 87, the 47-8, P-8A, the G250, the G650, the BR725.

So those are the ones that have come through a lot of their development risk in terms of configuration change or things like that, but are in the flight test and the initial parts of production.

P-8A is probably the one that's come the furthest through, we've had that in production for really several years now and it's running well but it's not completely through its test cycles yet.

So the early builds are going well on them, we know what we need to do.

The issues there would be disruption from scheduled flies or changes that might flow out of the tests.

G250, G650 would be, or 725, a little bit behind the 787, 47-8 and the P-8A, a little bit behind them but clearly into production.

Sikorski and A350 coming through the development tunnel, if you will, and so there it's configuration, it's initial build, it's keeping weight and configuration balanced, keeping on top of the schedules.

But they've still got risk in front of them in terms of completing the configurations and concluding the detail design and getting those into flight test and then build.

And then way earlier in the cycle is the MRJ and C Series pylons, which are earlier in their development cycle.

So we look at this as we're about two-thirds of the way through this entire slug, so you could say two-thirds of the risks are behind us and a third are still in front of us, from a 40,000-foot view.

Sure, no that's very helpful, Jeff.

I appreciate the details.

And just one quick follow-up, specifically for the facility in Saint-Nazaire in France, what are you looking at in terms of a volume ramp there to support that particular endeavor?

Okay so that facility is a finishing facility for us.

We send large Section 15 fuselage panels for the A350 XWB.

We sea-ship them from North Carolina to Saint-Nazaire, and then Saint-Nazaire does the final assembly of those into a body section which is then wheeled across the road, across the runway, to the facility where Airbus will do some additional assembly on it.

Now it's a relatively large building, because it's a relatively large airplane section.

We don't see a large staff there, as they'll just do the finishing product and the presentation of it to the customer.

Its ramp-up in terms of size of the building, I think we built the building we're going to need for the anticipated production rates that we see on the A350.

There may need to be a little bit of expansion, depending on how high the rates on that airplane.

But then the people will be hired, trained, and brought on as the production rates increase.

So they'll be done to match the production rates on the A350.

Great, thank you very much.

Yes, thank you Ken.

And your next question comes from the line of Cai von Rumohr with Cowen & Company.

Yes, thank you very much.

Not to beat a dead horse, but the G250, I think last year when you went from 300 units you came down, I believe you came to 200 to 250.

Could you kind of A, tell us what is the size over what time frame, and kind of what is the sensitivity if that quantity came down by another 10%?

Yes Cai, the accounting quantity hasn't changed since a year ago now.

It's really the order in which that accounting quantity gets filled right now.

I think we spread this out roughly seven to eight years, sort of ramping up as we go through time.

And that's the source of the uncertainty, in how we fill that accounting quantity in what timeframe.

So I don't have any sensitivity analysis to share with you really, Cai.

I think at the time, a year ago now, we reestablished some reserve on the program for future risks.

And so we've kind of managed through some of those over the last year, and the question is if significant things start moving around in the program, including the market, my question is going to be is our risk robust enough to handle the risks out there for US programs.

So that's kind of where it's at right now.

So we're watching it close, we're watching the market and making sure our performance is tracking to our plan and it's just going to be quarter to quarter for while until we all understand how the market unfolds.

Terrific.

And then just you mentioned the six programs and the other ones in development, and it kind of sounded like the P-8 is the one that sort of has the least risk.

Maybe tell us the two to three that you have the greatest concern about, and maybe the two to three that you feel are closest to coming out of the woods.

Well, so, it kind of goes in the order I talked about.

So the more we have it into production, the less technical risk we have on the program.

So we've got the 250 here extensively.

So just going down the list, you have 650 and BR725, you know we've got to get them flowing in production, get them through test.

So they probably have the heaviest focus now along with the 787.

And then of course in A350 we're starting to build the test hardware on those programs, so there's lots of configuration issues, schedule issues, weight issues, all the things that go along with that part of development.

And then you just keep watching the ones that are newer to make sure they stay on track.

But I don't particularly have a favorite, Cai, I try to watch them all.

Okay.

So really, you highlighted the 250 because it's special, because you this one issue and all the others, it's kind of hard to say.

Is that right?

Is that essentially --?

Well I, that didn't sound as intelligent as I'd like to, but --.

Yes that's fine.

They've all got the pleasure of development program risks associated with them that we stay on top of to the best of our ability on a day-to-day basis.

Terrific.

Thank you very much.

Thank you, Cai.

And your next question comes from the line of Troy Lahr with Stifel Nicolaus.

Thanks.

I wonder if you could talk a little bit about R&D.

It kind of went up sequentially but it's still down year over year.

How should we think that trends over the next, say, two quarters into 2011?

Yes, hey Troy.

You know I think we've got a nice runway right now.

I think it's a little bit lower that it has been historically.

It's obviously something we're managing very, very closely as we go through time.

And I still think of it as kind of 1.5% of sales, frankly.

It'll cycle up sometimes and down sometimes as we go through years, but I think it's still a good way of thinking about it.

Even into 2011, still kind of --?

Yes, fundamentally, I think that's right Troy, yes.

Okay.

And then Jeff, can you maybe talk about just the morale of the employees, given the 10-year contract, I guess since 57% of the employees voted against it?

I know there wasn't enough to strike.

But how is the employee base, are they comfortable with that?

And then what's preventing them from coming back in three years and through work slowdowns trying to renegotiate a new contract, when maybe industry trends are a little better?

Yes, let me give you a little color on it.

First of all, and these are rough numbers, but we have about 6,000 employees in that unit.

And Kansas is a right-to-work state, so people chose whether or not to be part of the union.

So about two-thirds of the eligible employees have joined the union.

So you begin to get a feel for the number of, you take 57% of that unit if 100% of them voted.

You get a less-than-50% of the represented people voted against the contract.

The IAM bylaws call for a ratification of the contract in the situation which occurred, so people came back to work.

We have gone through this negotiation with, in my opinion, an unprecedented sense of partnership between the union negotiating team and our production leaders who were on the negotiating team.

You talked about the specter of three years when the market is different, what prevents them from coming back unhappy with the contract.

I mean clearly, we have 6,000 people so to expect all of them to be happy all the time is probably not in the cards.

But the morale is quite good.

The partnership is growing in its intensity.

We purposely structured the contract so that we all share in the challenges and the rewards of this business.

So clearly if the market improves and the performance of the company improves, and specifically the performance of the Wichita unit improves, then this contract is structured in such a way that employees of Wichita share that, that the employees that are represented in this union share that.

And it's designed not to put us in a position where the question in each three years is who's on top this time?

It's designed to be a partnership where together we protect the health of our company and we share in the reward, and we keep the team we need for the future intact, together, and helping us be a successful company.

Now I think that message is coming home to the team.

Clearly the union negotiating team helped structure it and recommended it and liked it, and frankly have worked very hard with our management team to help people understand the value of this contract for the employees that are represented by it and for the long-term health of the company.

That's helpful, thanks.

Thank you Troy.

And your next question comes from the line of Richard Safran with Buckingham Research.

Hi, good morning.

Good morning, Rich.

I just had a question on the new North Carolina facility.

Can you tell us what rates of A350 production that facility is sized for?

And also is there room in that facility if you want to house other programs there?

And then finally, if you have to expand production in the future to accommodate programs, is it logical to assume that you might favor North Carolina versus, let's say, Wichita?

So North Carolina is sized, the initial production is sized for I think five to seven, somewhere in that range and that will depend upon the productivity and frankly how quickly we'd be faced with a rate build-up.

The facility in North Carolina is built on a modular, not modular on construction obviously, but the idea of modules that you can add down the road.

So clearly we think that's a site that will be attractive for certain kinds of business.

Clearly the airbus business fit in a place in a place like that.

Sea shipments out of Wichita to Europe is a difficult challenge, so Wichita wasn't a great location for that, North Carolina was.

So it will depend on the location of the customer, it will depend on shipment requirements.

Clearly we see North Carolina as a key node in the Spirit network, if you will.

Wichita, obviously a key a node; Oklahoma, Scotland, key nodes in our network.

Malaysia is a growing node.

So what we see as a node, set of nodes, in our network that gives us lots of options in terms of where we would build.

And several of those nodes have design capabilities, so it's not a foregone conclusion where product would go as we expand or have new customers.

But clearly we have good options in lots of places in Spirit and we can take advantage of those.

Thanks Jeff.

Yes, thank you.

And your next question comes from the line of Rob Spingarn with Credit Suisse.

Good morning, guys.

Good morning, Rob.

Good morning, Rob.

A couple questions, Phil I'll just start with one for you and this is really clarification.

I just want to make sure that the $0.10 that we saw in the quarter on the labor negotiation, the stock comp, was embedded in your previous guidance, you expected some level of expense.

Sure, yes.

Okay.

Now this next one, I don't know Jeff if this is for you or for Phil, but it's sort of a broad-based question on rate hikes on the narrow body side.

But with regard to what Airbus has just said on the A320, and we know Boeing's going to 35, could you talk about what cost is involved there, to what extent we should think about margins on those programs?

You get the benefit from scaling up but I suspect there's some cost.

And then if you could address what kind of incremental investment we might require if Boeing went to 38 or 40, which seems to be under heavy discussion?

Yes, I think, Rob, the way to think about that as frankly, we've talked when we went to 31, was we try to get the maximum level of productivity we can get out of existing assets, out of our capital plans and tooling plans.

We look for the constraint-relieving equipment adds or tooling adds, and put those in our process to relieve our constraint points.

So making incremental jumps is clearly not major reconfigurations.

The only cautionary note I would give there is how quickly you make those jumps has a very large impact, because remember changes in production drives instability.

If you get through that instability point and get a drum beat established again, so there's some disruptive costs, that's clearly offset when you have more volume.

And ultimately there are points where you've run out of certain kinds of capacity, and constraint relieving becomes a bit more expensive.

So the timing to go to 35, we think we have a good plan and we think it's within our things that we've forecasted certainly for 2010.

We've not guided anything yet beyond 2010.

But it's within the envelope of what's in our current plans.

Should we --?

Higher rates faster, or we'll just have to look at those as they come.

Should we assume that any pricing changes that come under these new agreements are more than offset by the cost of scaling, the improved cost, and therefore that margins would rise with higher volumes?

Yes, I think that's safe to assume, Rob.

I think this is a --.

That would clearly be our goal.

Yes, this is a capital-intensive business and so you get positive margins out of it.

Typically we do have the volume discount on the Boeing products, right, which, so the payback as we increase production.

But we think it's generally positive to margin.

So the last part to this question is if it's generally positive, to what extent can these rate increases across the narrow bodies and on the 777 offset the 787 margin dilution as that ramps at the same time?

Yes, well that's difficult to do.

As we go through time, the 787 has below 5% gross margin and as volume comes up, that's difficult to offset, Rob.

I mean that's clearly one of the headwinds of this company.

I think 777 has got some good, it's got some upside to this block which you're seeing flow through our guidance today.

So our 777 2011 rate increases are part of our guidance.

The higher volumes on 37 that have been announced recently are clearly more, you'll see the benefit of those in the next accounting blocks, which fundamentally 2012 and on.

So back to your, 787 is a challenge regardless of additional volume on the other development programs.

Okay.

Thanks for the help.

Sure.

Thank you, Rob.

And your next question comes from the line of Joe Nadol with JP Morgan.

Thanks, good morning.

Good morning, Joe.

As we look at the three segments, two of them were very consistent margin-wise Q1 to Q2.

And then in Wing, there was a big step up, this is contract accounting, and you took no cum adjustments so there must have been a pretty significant mix shift and I'm just wondering if you could shed any light on what's going on there.

And I guess most importantly, what's more of the runway going forward?

Is it Q1 or Q2?

Yes, I think the first quarter of '10 we did have some negative cum-catch for the hawker exit, if you'll recall, roughly $3 million negative cum-catch.

Now if you take that out of the equation, you're still seeing some nice margin improvement into the second quarter, which is largely driven from productivity improvements.

I think when you look at Wing, it's kind of a 9% to 10% operating margin segment on a repetitive basis and clearly we're trying to work hard to improve that, but I think that's a good way to think about it.

Okay.

And the second question is as you think about the balance sheet and the cash flow profile the next few quarters, we're halfway through the year and you're pretty much on your free cash flow outflow estimate for the year at negative 250.

So I guess the back half of the year we're seeing is going to be flat.

Presumably it's going to be worse than that in Q3 and then better than that in Q4, but correct me if I'm wrong.

And then usually Q1 is a negative quarter, just given that the flow of working capital.

So you have a negative, a positive, and a negative, presumably.

Can you help us just think about the balance sheet, you have the revolver or the credit facility, are you going to tap that in Q3 or Q1, have you not decided yet?

How is all of that going to play out?

Yes, no I think your timing is pretty accurate, right.

The second half tends to be where we've got some of the non-production revenues and cash that we work hard on all year.

And we typically get those down in the third and fourth quarters.

So I think your timing is okay, really.

Yes, I mean we feel good about the liquidity.

It's $500 million, we are in the second quarter, Jeff mentioned, two-thirds of the way through some of these development programs.

So we feel okay about it.

I think as we perform and go through the second half of the year and into 2011, we'll stay close to it.

But I think for now we're just fine.

Are there any covenants or any other restrictions on that credit facility, Phil, that you're at all even concerned about?

No.

I think we're in fine shape as far as any of the covenants inside the credit agreements, yes.

Okay.

Thank you.

Yes.

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

Good morning.

Good morning, Doug.

Just following on the cash flow question, can you talk about the outlook for CapEx over the next, I would say, 18 months, how you're thinking about that as these development programs, you get the facility online in North Carolina?

Should we expect this to come down?

Yes, I think CapEx clearly is going to sustain itself at 325 into the future years, but there's still investment required in these facilities as we bring 350 online, get it into production, and navigate rate increases on other programs.

So I'm not going to guide to 2011 yet, but I think there's still not an insignificant amount of capital to spend on these development programs.

But I don't think it's 325 year after year.

And then when you look at the discussion about potential re-engining on the 320 and on the 737, how do you think about those engine situations in terms of the protection of your position ultimately on the 737, and the opportunity to compete for new work potentially on either engine?

Well that's exactly how we think about it, Doug.

We see it as an opportunity and then really an opportunity to potentially grow some business, but also an opportunity to support our customers, to make sure they get what they need for their products.

So as we look at that, we just see it as clearly, again, an opportunity to support the customer and to expand the market potential.

But is this, would you view this as a net positive or a net negative, given your current positions?

I think it's a net positive opportunity.

Okay.

Okay good, thanks.

Thanks Doug.

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

Good morning.

Good morning, David.

Hey David.

Phil, on the blocks contract accounting, can you just give a little bit more detail?

You've now adjusted your 777 assumptions, it seems like you were saying, but on 37 you haven't adjusted.

37 looks like you had been assuming 28 a month, you are obviously going to get through the block there much quicker than you had originally assumed.

Can you just explain what's going on?

Sure.

Well much of the 37, so we have forecasted the increased production rates 37, to be clear.

There's not much, if any, current block impact that flows into our 2010 guidance.

The higher rates are, we won't transition into those higher rates until later next year to support the customer's 2012 requirements.

I think that's how it's timed out right now.

So we're clearly looking at plans in the factory and working capital to go to support those faster rates, but there's really nothing flowing into the current period that would affect the 2010 guidance.

As you said, 777, we have fully accounted for that in the guidance and that's kind of the status of it.

Okay, because I was just looking at your block with 700 airplanes, 23 to 27 months --.

Yes.

But you're, with Boeing just being at 31.5 a month you're going to get through that block more quickly.

We will, no that's true, we will get through it more quickly but it still takes you into late 2011.

Okay.

And then on the labor contract side, how did the labor contract come in, relative to kind of what your expectations were baked into your contract accounting?

No, you know you can't ever make the perfect pitch on these things, but we certainly have been working with the partners, the machinists, and other unions through the years, right?

And so we also take the shot at modeling those things financially and ultimately we have a greater understanding of what that means financially and we put them out there on the table.

So we feel pretty good about it and we really account for most of it that we know of.

We have offered an early retirement program to the machinists.

That's getting ready to wrap re-enrollment period here pretty soon, so we'll be looking at that as we go through the second half.

We think we fundamentally have most of it all accounted for in the guidance.

Okay.

Thanks a lot.

Thank you, David.

Operator, we have time for one more question please.

Certainly, sir.

And your last question comes from the line of George Shapiro with Access 342.

Yes, good morning.

Good morning, George.

Good morning.

One for you, Phil.

The tax rate in the first half is like 25.2%.

I assume that R&D tax credit isn't in there, so why did it go up to 29% in the second half to get you your 27% guidance?

Yes, great detail question, George.

The first quarters of this year, one and two, both had discrete events.

The first quarter it was around our settlement of the 2005-2006 IRS audit.

And then here in second quarter we had some advantage from some tax credits coming out of one of our new factory states.

So without those discrete events, you're exactly right, it'll move more towards 29% in the second half of the year, for a full-year rate of 27%.

Okay, and then just one quick follow-up.

Can you give us the ending inventory number for the 787?

You know, I don't have it in front of me now, George.

It'll be in the queue here when we file in a few days.

Clearly it's gone up as we deliver products and defer production, balances have gone up.

So you'll see 787 increasing without a doubt.

Okay, let me ask one more since I didn't get my answer to that one.

The deliveries in the first half of the year you got were 249.

Now the second half of the year, are you going to deliver somewhat less planes, or are you going to still run somewhat ahead of Boeing?

Because it looked like the 777 rate would go down to 15 in one of those quarters' budgets, and the others would hold flat.

Is that correct?

No, I think 777 was 18.25 right?

And that's the run rate.

There's always some fourth quarter deliveries that are a little bit lighter, that's just the historical cycle of the company, right, where we have some plant in shutdowns toward the end of the year, so our fourth quarter tends to be a little bit lighter.

But other than that, it's really normal timing and nothing significant.

Okay.

Thanks a lot.

You bet, George, thank you.

And ladies and gentlemen, that concludes today's conference.

Thank you for your participation.

You may now disconnect.

Have a great day.