Spirit AeroSystems Holdings Inc (SPR) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Spirit AeroSystems Holdings Incorporated second-quarter 2014 earnings conference call.

My name is Vanessa and I will be your coordinator today.

(Operator Instructions)

Please note that this conference is been recorded.

And I would now like to turn the presentation over to Mrs.

Coleen Tabor, Director of Investor Relations.

Please proceed.

Thank you, Vanessa and good morning.

Welcome to Spirit's second-quarter 2014 earnings call.

I'm Coleen Tabor, and in the room with me today are Spirit's President and Chief Executive Officer, Larry Lawson; and Spirit's Senior Vice President and Chief Financial Officer, Sanjay Kapoor.

After opening comments by Larry and Sanjay regarding our performance and outlook, we will take your questions, then Larry will share some closing comments.

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

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 and our SEC filings and in the forward-looking statement at the end of this web presentation.

In addition, we refer you to our earnings release and presentation for disclosures and reconciliation of non-GAAP measures we use when discussing our results.

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

With that, I'd like to turn the call over to our Chief Executive Officer, Larry Lawson.

Thank you, Coleen, and good morning, everyone.

Welcome to Spirit's second-quarter earnings call.

Before we begin, I'd like to thank all our employees across the globe.

You continue to bring outstanding capability and teamwork as we delivered all-time high rates and our continue our transformation.

An important milestone for the quarter was the delivery of the 5000th 737 NG to Boeing.

The 737 production rate has doubled since divestiture, and looking forward, in less than two years we will celebrate 6000 units delivered.

We've also delivered 18 A350 units to Airbus and made significant progress on the remaining travelled work.

I will add that the 737 team is pleased to have a plan in place to rebuild the fuselages that made their way into a Montana river last month.

This is what our customers count on from Spirit.

Relative to the numbers, I will give you my thoughts about our progress on a number of fronts now that we're halfway through the year.

Our efforts are beginning to manifest positive results and there is still plenty of opportunity in front of us.

I think it's fair to say we're more disciplined in our decision-making, focused on the right measures, and just as importantly, customer aligned.

We are applying a rigor to our internal processes as well.

Our focus is on current execution as well as long-term growth, whether it is in our operations, supply chain efforts, make versus buy decisions, or our use of cash.

With respect to cash, during the recent secondary offering Bionix, we took the opportunity to execute a 4 million share repurchase.

The first in our history.

The number of shares repurchased is roughly equal to the dilution in our stocks since divestiture.

We also refinanced our debt the first quarter.

We will continue to be agile and opportunistic in how we deploy our cash going forward.

We recently announced a new Board member, John Plueger.

John is the President, COO, and a Board member of Air Lease Corporation.

John is a thought leader in the world of large commercial aircraft and we welcome his contribution to the Board.

He also saw us continue to recognize the natural opportunities in the commercial aerospace up cycle as we added talent and transformed our aftermarket business model with the recent addition of Bill Brown as the leader of our renamed Global Customer Support & Services.

Bill is an experienced and proven leader with a great background in commercial aftermarket.

We made the name change to more accurately reflect what we do in this segment of our business.

Meanwhile, the rest of the teams have more time to drill deeper into the details of our business, and I'm pleased with how we are working together on a common view of the future.

Now, to discuss our financial guidance and results.

We have upped our guidance for this year in sales, earnings, and cash flow.

We are now guiding revenue of $6.7 billion to $6.9 billion, earnings per share as $2.90 to $3.05, and free cash flow of $250 million.

Sanjay will go into greater detail on our full-year guidance.

For the second quarter, we reported revenues of $1.8 billion, which was up 19% year over year, and operating income of $216 million.

Operating margins were 12% and we reported earnings per share of $1.01.

Operating cash flow was $165 million and free cash flow was $128 million, an improvement of $123 million over a year ago.

Our backlog continues to be strong at $41 billion and further supported by recent new bookings.

To wrap up, we are halfway through 2014, we are seeing good operating performance, and improvements associated with the changes we made in 2013 to create program aligned teams, acutely focused, with strong accountability.

We have a real conviction about our value proposition and the market, and will continue to challenge ourselves to do better as we move forward.

At this point, I'll turn the call over to Sanjay and he can walk you through the details.

Sanjay?

Thank you, Larry.

Thank you very much and good morning, everybody.

I'm looking forward to sharing our quarterly results and updating our outlook for you today.

But before I begin, let me take you back to when I joined the Company late last year.

Our financial guidance was suspended as we conducted a strategic and financial review.

We were building the leadership team, we were beginning to identify the opportunities, and taking actions to reset our cost structure.

There was much work to be done and significant uncertainty.

Now almost a year later, the review is complete.

We are slowly, but surely, getting into our operating rhythm.

We've identified additional opportunities that we are working on.

And more importantly, we are mitigating our risks.

We are working together to execute the plans we put in place to deliver consistent results.

All of which is generating the strong results that you see today.

As I promised last quarter, we have also considered our performance to date and our future projections to provide you with an updated outlook today.

Now, let's start with the consolidated results in the quarter, then I'll review the quarterly segment results, and finally, we'll wrap up with our updated outlook for 2014.

So let's turn to slide 3 for the consolidated results of the Company.

Overall revenues for the second quarter were up 19% as compared to the same period last year, driven by higher deliveries.

Operating margin for the quarter was a solid 12%, compared to negative15.7% in 2013.

The quarterly results include positive contributions from our mature businesses and an overhead cost focus, as well as some favorable cumulative catch-up adjustments for periods behind us.

Earnings per share for the quarter were $1.01, driven by strong operating performance and the benefit of $19 million, or $0.09, for cumulative catch-up adjustments.

Again this quarter, it includes the partial release of the deferred tax asset valuation allowance of roughly $0.03.

As we previously communicated, we will continue to follow accounting guidance and assess the need to maintain our valuation allowance against our US net deferred tax assets.

The partial release of the deferred tax valuation allowance of about $4 million in the quarter represents the realization of certain deferred tax assets based on demonstrated performance within the quarter.

Cash from operations for the second quarter of 2014 was $165 million source of cash.

Capital expenditures were $37 million for the quarter as we continue to make disciplined decisions on the deployment of our investments.

Free cash flow for the quarter is $123 million improvement year over year, and free cash flow year to date is a $241 million improvement over the prior year, reflecting operational improvements, lower capital expenditures, and also, the timing of cash taxes.

As you can see, we continue the process of resetting our cost structure through overhead reductions, balanced capital spending, and data driven decisions in areas like supply chain, our make versus buy strategies, as well as our uses of cash.

While we have taking steps in the right direction, we still have a lot more work to do.

Let's move to slide 4 that summarizes our cash and debt balances.

Cash balance at the end of the second quarter was $382 million, flat as compared to the previous quarter, reflecting the repurchase of 4 million shares, for the first time of the Company's history, for $129 million of cash on hand.

At the end of the quarter, our total debt to capital ratio was 41% and our net debt to total capital ratio was 32%.

Our US defined benefit pension plan remains fully funded.

Slide 5 summarizes net inventory balances at the end of the second quarter for 2014.

Deferred inventory balances increased by $91 million, driven by the A350 program and the Gulfstream programs, partially offset by mature programs and the 787.

$90 million of the deferred growth is on the A350 program as we delivered five ship sets in the quarter.

And as I have reminded you the past, while we are making very good progress, work completed on a customer's pre-final assembly and final assembly sites on previously shipped units is included in this number.

And it also includes engineering that winds down as we move through the year.

The 787 program realized a net decrease of $30 million in deferred inventory on 33 deliveries, or roughly $400,000 per unit.

Now, let's discuss our segment performance on slide 6. Fuselage segment revenues rose to $905 million in the quarter and operating income was $132 million, on higher deliveries and cumulative catch-up adjustments on our mature programs.

The fuselage segment 737 continues to perform well at all-time high rates, contributing to the $3 million in positive cumulative catch-up adjustment in the segment.

And as Larry shared, the A350 team is tracking to the plan we laid out for ramping down work on previously delivered units, and reducing the impact on deferred inventory build quarter over quarter.

In our propulsion segment, revenues grew $461 million and operating income was $86 million, driven by higher deliveries and cumulative catch-up adjustments on our mature programs.

The propulsion segment 737 and 777 production lines had solid performance, contributing to $5 million in positive cum.

catch-up adjustments.

Also in the quarter, the team achieved a significant milestone delivering the first MRJ pylon flight test unit to Mitsubishi.

And our wing segment revenues also grew, reaching $438 million on higher deliveries in the quarter.

Operating income was $71 million as the segment benefited from no forward losses as compared to the same period last year.

Our 777 slats production lines in Tulsa and the A320 wing program in Prestwick had solid performance in the quarter, both contributing to the $11 million of positive cumulative catch-up adjustments.

As highlighted by the current quarter's results, the segment is intensely focused on execution across a wide variety of programs and end items.

And consistent with what we have said before, we continue to work with potential buyers for a divestiture of our Oklahoma operations.

Let's move to slide 7. This quarter is a second step in the right direction and we still have work to do.

In the quarter, we saw consistent performance across our mature programs, along with development programs adhering to plans, as we meet our customers needs.

We transacted our first-ever share repurchase, and by realizing deferred tax assets, we also released a portion of our DTA valuation allowance back to income.

Given our performance in the first half and our outlook for the rest of the year, we are updating our full-year guidance with a revenue range of $6.7 billion to $6.9 billion, as half way through the year we have two planned on the production side and at the high-end of our non-production estimates.

Earnings per share is increased by $0.40 to a range of $2.90 to $3.05 to reflect the improvements you are seeing as we steadily realign our cost structure across the entire business and achieve an operating rhythm.

And we are increasing our free cash flow guidance to $250 million to reflect the improvement in operating cash and lower capital expense in the plan.

Full-year effective tax rate is updated to 30% to 31%.

I will remind you of some important notes to our guidance.

It includes all of the Oklahoma operations for 2014, and two, it excludes the impact of the year-to-date valuation allowance release, which is $0.25, and any potential future adjustments to the deferred tax asset valuation allowance.

While our guidance is not risk free, we are actively monitoring our performance and driving to consistently deliver on our commitments.

In conclusion, I can tell you the team is excited about the opportunities in front of us, and appropriately are tuned to managing the risks that are inherent in our industry and our business.

We are happy to take your questions now.

(Operator instructions)

Jason Gursky, Citi.

Good morning, everyone.

Sanjay, I have a quick question for you on something you mentioned earlier in your prepared remarks.

Which is, that you have identified several new opportunities with regard to, I don't know if it's restructuring or costs.

I was wondering if you might provide a little bit more detail on either, A, what those might be?

And what you view to be the timing of those opportunities?

Sure, Jason.

And a great question.

As not only me but the rest of the team is getting deeper into the business and we are getting into operating rhythm where we do our reviews, we're obviously looking at every nook and corner, particularly in our overheads.

And the overheads are a large component of our cost structure.

As you know, last year, we tried to tackle that with a headcount reduction, which we successfully managed.

And as I have said in the past, we maintained consistent deliveries even though we went down quite substantially in headcount.

But this year, we are starting to focus on all of the other stuff associated in the overhead, and any and every cost is up for scrutiny.

So, whether it be in our perishable tools, in our shop supplies, in our freight, it being even in our over time and the way we manage the productivity on the shop floor.

Every one of these accounts is being looked at.

And as you can imagine, in every one of those, there's always opportunity for us to go and do better.

And that is what we're trying to find and that's what we're trying to bake in.

Okay, that's helpful.

And then my follow-up question just is on cash flows.

It was a good quarter, obviously.

I just was wondering if you could talk a little bit about the sustainability of cash flows and what we might expect from a cadence perspective for the last two quarters of the year?

Yes, so traditionally, Jason, the last two quarters of the year are our stronger quarters, and I think we will continue to see cash flow in the balance half of the year.

I think, again last year and again this year, we've set ourselves, we have said to cash flow is a focus for the Company, it is a focus not only for the leadership team but across the board.

And what that means is we are looking at every aspect of cash, whether it be through capital expenditure, whether it be through our cost of goods and our sourcing, and so on.

So, I think you will see good cash flow in the rest of the year, and that's one of the reasons why we feel comfortable in raising our guidance, as we have done for the second quarter in a row here, to $250 million.

That's helpful, thank you.

Carter Copeland, Barclays.

Hey, good morning, all, and good quarter.

Just a question for you on the A350, on the deferred, the $18 million a unit you talked about there.

Can you help us understand how much the relative difference are between the engineering work that you called out, Sanjay, and what you might think of as the recurring cost per unit that we looked at on the 787?

It's my understanding that the contracts and what you report is a little bit different.

Can you help us with apples-to-apples comparison there?

Sure, Carter.

So again, first of all, kudos to the team because as we had mentioned to you, I think Larry has talked about this even in the last quarter, we had been giving you the messaging that we are working really hard to drive down not only engineering costs, but also the work that's being traveled, which is very inefficient.

And as you can see in the first quarter, like you point out, we were basically two units and we had a deferred growth of about $28 million per unit.

This quarter, it has dropped quite significantly down to $18 million.

Now, partly that's due to the volume, clearly, because there is an absorption impact of higher rate.

But the engineering component is a significant portion of that as well, and so is some of the travel work.

And the efficiency with which we are producing and shipping our units from our Kingston facility, the quality of the units, the quantity of travel work is sharply getting down.

And this is what we have been talking about for the last -- for the first six months.

And we expect to see this going to continuously as we work through these issues by the end of the fall.

So we see that.

It's hard for me to give you specifics in terms of how much is engineering versus how much is travel worth, what its efficiency and absorption.

Because with these are very few units that go through, just based on our accounting systems which are based on standards, there's a fair amount of volatility.

And I would recommend that we stay on a look in terms of just dollars per unit at the higher level.

Yes, if I can jump in, I'd just say, Carter, look, we understand the three components of the costs.

We actually have a pretty good understanding of the specifics of the three components of cost.

It's why last quarter I could tell you, and again, I think what Sanjay is really saying is we don't want to give you a projection for next quarter, although we have a pretty good idea.

The three elements are the ones that Sanjay discussed and the ones I've brought up before.

There's three elements that contribute to the deferred.

One element that I talked about with the traveled work.

We are making progress there.

The second piece is another nonrecurring element which is tied to engineering.

And that engineering is mostly around changes that continue to go into the units.

And even though change [tryout's] diminishing or has been, quite a bit of work done there.

And frankly, we have invested some money in improving our quality.

So those of the nonrecurring pieces.

And then the third part is the recurring element of the cost.

And so, as you see this track toward the end of the year, you will see those nonrecurring pieces reduce at a -- frankly, you won't see it, but they will reduce at a higher rate and then you'll get more visibility into what the recurring piece is as time goes on.

And again --

And so what the recurring numbers will be more like we will see that improvement next year.

It's nonrecurring improvements that will be the line of this year?

This year is -- right, you'll see both.

We are coming down a good learning curve and I think what I would probably say about the 350, I'd maybe save somebody a question, is we are on plan.

The plan is always interesting with all of these things, we are on plan.

It isn't exactly -- there is always a twist here or there.

But in terms of we're doing better in some areas and a little more challenged temporarily in another.

But net-net, we're on our plan.

Okay, great, that's good color.

And then just as the follow up quickly, on the favorable cum.

catch adjustments you had in the quarter.

Can you tell us if that was related to one of the mature programs more than the other?

That I believe you finished the 777 block in the quarter.

Was that more of a 73 or a 777 impact in the quarter?

It is both of those programs, Carter.

It's 73 and the 777.

And you're right, we did have a close block in the quarter.

But it was both of those two programs.

Okay, great.

Thank you, both.

Howard Rubel, Jefferies.

Thank you very much.

To follow on your guidance, a $200 million increase is a pretty significant when normally we get a pretty good idea of production rates.

While I realize the Montana fuselages might be $40 million or $50 million, the rest of it is probably either engineering, some other work.

Could you elaborate a little bit, Larry?

Sure.

And you hit right on it.

If you look at the three segments, you can see a variation in the revenue growth.

So, Howard, that probably gives you a pretty good indication of what is rate related revenue growth.

And then we have a lot of, truthfully, is we have a lot of derivative development work going on right now and it gets reflected in those revenues as well, that causes maybe more revenue growth in one segment than another.

So if you think about whether it is the Dash 1000 or the Max.

In the case of the Max, it is not just the nonrecurring engineering, but it is the tooling as well.

You add the 777 or the Dash 10 in there and that's why you see an uneven growth.

But if you look at those three numbers that probably gives you a pretty good indication, and there's other moving parts as well.

Frankly, there's some quarters you pay bills, you make settlements that cost you money, and some quarters you make settlements that earn you money, and those are also in those numbers as well.

I'd just say, Howard, there's a lot of moving parts in there, but I hope that helps you get a better sense of rate related versus other contributors to our revenue growth.

I would, if I can just add to Larry, it's a smattering of things, right?

We do have some improvements in our Global Customer Support & Services.

It's small, but it's there.

It's largely the revenue recognition on some of the tooling activity that Larry talked about.

Clearly, it's a lot of the nonrecurring stuff.

So it is a whole bunch of little stuff, and I understand it adds up to that much, but that's what it is.

No, that's great.

And just as my follow up, I describe the wing business as you crush the numbers.

Could you for a moment, I know you tried to call out a couple of specifics, but these numbers are really a sharp departure from anything you have ever done there.

Can you provide a little more color as to why it is going to be sustainable?

Well, when you say numbers, Howard, I'm not sure if you're talking about --

The margins.

If we're talking margins, I think the conversation we have had with regard to margins is when we look at the total margins, we're talking about 12% as our total operating margin.

And I have said, this is the recurring question, what do think your long-term outlook is on margins?

And my answer always is, it's not too far way from our customers' margins.

Obviously, we have to have some margin room north of that to pay bills that we may have in any part of the cycle.

But where the long term my view is.

The sustainability of our business, again, this is -- the fundamentals are pretty good.

It's an 80/20 business that I've talked to you about in the past, the 80% of the businesses throws pretty decent margins, 20% tends to use a good amount of that, and we have to work our way through that, the challenges that relates to the 20%.

All I can tell you is that we're just making progress, marching along quarter after quarter taking on these challenges.

The things that we can do is reduce our cost of goods sold.

Now, I'll tell you we are attacking all elements of cost that Sanjay referred to.

I will tell you, having run a few businesses and looked at a lot of businesses, I'll tell you right now, our overheads are not out of line.

They're actually pretty reasonable, but that's not a reason not to, and I think that's the first time my staff as ever heard me say that, so -- (laughter).

I'm kind of perpetually dissatisfied.

But what I would say, so I don't want to leave people under the impression that we're out of sync there.

But what I would say is I think there's always opportunity and as we dig down into the minutia, it's a lot of small things that allow us to, I think, make a material difference in the long haul here.

So our plan is really on all fronts, Howard, it's to reduce cost of goods sold.

It is to address our going-forward contracts and take advantage of every part of the business that we can.

And so, I would say that don't look at, the one point I was trying to make there, though, Howard, was any one quarter, don't look at the margins in any one segment in any one quarter and draw a conclusion.

Because there's quite a bit of moving parts in any one of those particular segments.

Kind of look at the total bottom line and make your judgements from there.

Thank you.

Sanjay, do you want to -- ?

No.

Doug Harned, Sanford Bernstein.

Yes, thank you.

I wanted to go back to the A350, just to understand a little more about how this is proceeding?

In particular, I think the supply chain has been somewhat of an issue in the past.

Could you talk about where that stands today?

And what you have done there and what you are doing to ensure that that is no longer an issue going forward?

Doug, I guess when you say an issue, are you referring to performance, or are you referring to cost?

Well, if you could comment on each of those?

I know that the Airbus has been in, in the past, helping you with supply chain and so forth there.

More I think timing of deliveries and things like that.

So perhaps you could just speak across the board to those?

Yes, let me talk about performance.

On the performance front, the supply chain has been a big component of our challenge.

I think I would describe it in two fashions.

One was the actual performance, that is, shortages coming out of the supply base.

And the other one would be what I would call certifications.

Having actually all the suppliers certified.

I think we made, let me take the second one first, on the certification front, I think we are, gosh, we're most of the way through that.

We're kind of winding down to the last few folks.

As it relates to their ability to produce at rate, we still have a few outliers that continue to challenge us.

We are working those.

We have strategies in place to mitigate our risk there.

There will be some bumpiness, but we are actually doing quite well in general there.

I would say, how I have addressed the supply base, is in general we have a strategy for the guys that are struggling and the numbers are struggling.

The number of suppliers struggling is actually quite small at this point.

And on the cost front, we were doing a considerable number of spot buys.

This was driven a lot by, today, what little bit of spot buys we have are mostly driven by change traffic.

We are still early and 18 units is not a lot of airplanes.

And frankly, I'm not going to complain too much about the change traffic.

I think it's happening for the right reasons.

It does create, concurrency does create some real challenges, though, in terms of schedules.

And especially as you are going up in rate.

And so we work really, really closely with the entire supply base, as well as Airbus, to try to meter all of that in a way that makes this thing work.

So I don't know if that is adequate, Doug, if that answers your question.

But I would just say, in general, we've diminished most of that down.

We still have a few challenges out there, and I would say the biggest thing right now that we struggle with in terms of shortages is probably changes, with exception of I would say one or two suppliers.

That is helpful.

And as a follow up, as we head into the next 12 months, and you mentioned it briefly before, the Dash 1000 work will be increasing.

Can you comment on, from your standpoint, how much difference you see in the work on the Dash 1000?

And how you see that potentially impacting your path forward over the next two years?

Yes, well the Dash 1000 is substantially different.

It is a much different, especially for us, given that where kind of the center of the airplane, we are probably more impacted by the Dash 1000 change than anyone.

But the good news is we are on schedule.

And so we feel really good.

I think we learned a lot of lessons and I hope we learned them, Doug, instead of experienced them.

(laughter) I talk to my team all the time about lessons learned versus lessons experienced.

We certainly had some pain on the Dash 900.

So the 1000, I will just tell you right now, we are generally on schedule.

You always have a little stick out here or there, but in general, we are doing fairly well.

And doing extraordinarily well by comparison to the experience that we had on the earlier configurations, though.

Because there would be some differences on the wing spars as well, wouldn't there?

Actually, on the spar itself, I'm not familiar with a change on the spar.

There are differences on the components of the wing.

But I'd have to tell you I'd have to -- I'm not aware of a change on the spar itself, other than how you would --

Yes, that maybe more the trailing edge.

Yes, well, or leading.

So, yes.

Right it's the trailing edge.

Okay, thank you very much.

Thanks Doug.

Robert Spingarn, Credit Suisse.

Good morning.

Larry, just staying with that for a minute.

You have talked a lot about the A350, a lot of questions on it.

Clearly, you are improving.

Your customer called you out as improving at Farnborough, which is one of the more important signs, I suspect.

At what point can we get comfortable that we are through the risk window where we could see a meaningful charge on this program?

How do we think about that?

And then, Sanjay, I have a margin question afterwards.

Okay.

Robert, I think I'm starting to get a better sense.

I told you18 units, it's difficult to draw conclusion at the 18th unit.

My own experience, I have built a few airplanes, has been that you have probably your best solid assessment at about 100 airplanes.

What I would say is that there is still work in front of us to be done.

I think that you are going to see us continue to work on what we are building and how we build it.

And to improve where we are.

We are making, as you can see, we are making good progress.

And I really don't have anything.

There's not really anything I could tell you definitively other than we are on plan.

I think that is probably the best I could say is that we are tracking to the plan we've laid in.

And that plan is a mix of work and off nonrecurring and attacking recurring.

And on the attack on the recurring side, there is a piece that is tied to the supply chain and there's a piece tied to our in-house execution.

So far, we are moving right to that plan.

And as we move into next year and as we move towards the 100th unit, I think we are going to have a much more solid idea about exactly what the numbers will be going forward.

And at that point, we will figure out how to disposition, if we need to, any deferred that exists at that point.

My recommendation, the best I can offer you, Robert, is watch us quarter to quarter.

And we will continue to comment on this.

Okay.

But that is a very helpful milestone, the100th unit.

And then just moving to the margin.

Sanjay, your segment margins, ex cum.

catches, has been firmly in the mid-14%s here.

And when I think about the $1.50 or so you earned in the first half, and the implied guidance is like a $1.40 at the low end, and frankly you don't need made mid-14% margins to get there.

How should we think about the conservatism in the guidance?

Or is it instead reflecting some price step downs or mix or something else?

Thanks, Robert.

Hey, this is a fair question and I think, let me try to and tackle it from a guidance perspective because I think that's where I want to go.

If you remember, we have come through a pretty couple of tough years in our Company.

Not years that one wants to remember or be proud of.

We had very good first quarter.

We've had very good second quarter.

I think I even talked about this at the last time that we are trying to create a culture here that always meets our commitments to you and to our shareholders.

We want to make sure we set our bar so that we can always achieve that.

So we had a first good quarter, we had a second good quarter.

We upped the guidance, like I told you, in the first quarter we would.

We've gone up $0.40.

I would also tell you are guidance is fairly clean.

Only two things that I caveated out of them was one was the DTA and the other one was Tulsa.

Outside of that, everything else was in my numbers, including, and I'll give you couple of examples, where, for example, in the first quarter we refinanced our debt and it cost me about $20 million, or about $0.10 a share.

But I wasn't going to change guidance because of things like that.

These are good things to do.

I think as a business, we are expected to do the right kinds of trade offs between short term and long term.

We did those things.

And so, what I see in terms of where we are today and where we are comfortable for the rest of the year, that's the number I put out there.

It's a pretty good growth.

And clearly, our teams, I'm real proud of the entire Spirit organization, we have delivered two healthy quarters.

And we will continue to do better.

Our internal plans are always to do better.

And there are really two ways to manage this thing.

One is to, like Larry said, we are managing our risks.

The other way is we are trying to come up with additional opportunities, so that if risks do materialize we'll offset them with the opportunities that we're working on.

And as we do better, then we will keep you updated.

But I'm quite comfortable with the guidance and that's where we are.

Okay, so just understanding that, but based on the balance you just talked about, is there any reason to believe that the segment margins, again mid-14% ex cum.

catches, that there would be any reason for different performance in the second half than what you have done in the first?

No.

So again, I would take us, I think even Larry was talking about this, each quarter you have some puts and takes.

We had some assertions this quarter, particularly in our wing segment, you see that spike up a little bit.

That is more consistent with the normalized margins that we have seen in the prior quarters.

Likewise, on the fuselage, you saw some pretty healthy growth.

The margins improved because of the cum.

catches.

But it also got diluted because of the growth in our 787, 350 programs.

I would recommend you look at our margins in the first quarter.

They were more representative.

But even with that, I think we have got good guidance for you.

Okay.

Thank you very much.

David Strauss, UBS.

Good morning.

I wanted to ask about the 787.

Obviously, we're two quarters or so past the big charge.

Deferred continues to come down.

Can you just talk about progress that you are making relative to when what was assumed in the charge?

And have the big pricing step downs that you have assumed are baked into that chart.

Have those already come through?

Are we now seeing those in the numbers?

So on 787, what I would say, and I'll probably just give you the big answer, is that the we're tracking to plan.

So we are right on the plan that we put forward last year.

And did it come out exactly the way we thought it would?

No.

We had to do some things.

I mean getting to the 10% rate was a bit more challenging.

We did not miss any of our deliveries or anything, but it took a lot more energy to get to 10%.

And again, the basics of that were, for the most part, manifested in our supply.

We had a couple of suppliers that struggled with their yields and we were able to go correct that.

And stabilize all of that, and again, we did not miss any deliveries, but it took a lot more energy than we thought it would.

On the other hand, we had some opportunities we were able to avail ourselves of.

And so, put and takes, we were dead on plan.

We have not changed anything as it relates to -- matter of fact, we are right back down on the lines that we laid in.

So, I think that's probably all I can really say as it relates to the 787.

So we're tracking right to what we had disclosed to in, it was 4Q, I guess.

Yes.

Okay.

As a follow-up, Sanjay, on cash, it looks like you received a cash tax benefit this quarter.

Can you talk about what you are assuming for cash taxes for the year?

And then also, you have talked about cash overall, cash generation improving 2015 and 2016.

Is that still the case off of these higher numbers that we are seeing come through in 2014?

Thanks.

Sure, David.

And you're right, we did get a cash tax refund this year.

But I will tell you my guidance for the full year, the $250 million guidance, we have assumed cash tax payments are quite consistent with what we need to do, as well as consistent with the numbers that we had, for example, for 2013.

So that is all baked in and we are not taking any relief of advantage because of that.

For 2015 and 2016, David, I think we have given you directional input a couple of times now that we intend every quarter to do better.

Every year to do better.

And of course, I'm not going to get into 2015 cash guidance right now.

Other than to say that that is the direction that Larry has set for us and the team.

And we are starting to lay out plans to achieve those goals.

And that's what we will show you when we discuss that early next year.

All right, thank you.

Peter Arment, Sterne Agee.

Yes, thank you.

Good morning, Larry, Sanjay.

Good morning.

Just first, Sanjay, just on CapEx.

I know you mentioned it in your prepared remarks, it seems to be running a little bit of a lower run rate.

I mean, what is the assumption we should be using for 2014?

Peter, I think we do call that out in our press release and we did lower the CapEx numbers for the year by about $20 million.

And that is the number that you should use.

Now again, cash CapEx, I will tell you, we have a very stringent process in terms of how we measure ourselves to a return on investment on each project that we have to make investments on.

And we are very careful and diligent about how we do that.

I also want to make sure that you understand that we are not under investing or anything like that in our business.

Any need that the business has, either for rate increases or for efficiency improvements or for just natural replacement, we are, obviously, we have the capacity to and we have the capability to make those investments.

So, some of this is just the lumpiness associated with capital.

As you know, some of these projects sometimes get launched later than you had anticipated, or in other cases, bills come due at different times.

So some of that is just a little bit of timing.

But overall, capital, we guided you in our press release of between $210 million to $235 million.

And that includes all CapEx.

That includes anything.

There was some very small remnants of our donator spending, very, very small, but that is all included in that number.

Thank you.

And as a follow up, just, Larry, if I could ask about productivity gains in the base business?

You have given us a lot of color on the development programs.

But could you maybe talk about what you are seeing in terms of the productivity gains in the base business?

Because it seems like that continues to be a positive contributor to the cash flow?

Right.

And so, this was always, I hate to be redundant, I apologize if I am.

When I looked at our strategy showing up here and getting a sense of this 80/20 mix, it was clear that to work our way through this, that we couldn't pass on the opportunity to attack the 80% of the business as well as the 20%.

And so you have to do both.

So obviously, 10% improvement in 20% is 2%, and 10% improvement in 80% is 8%.

So the folks sitting over in the 80% of the business are contributing.

So what we are seeing is, I think for us as we break the parts of the business down into its pieces where all of the moving parts are, obviously, we have to go look at that.

Now just to be clear, our direct labor content is part of our total cost structure.

It's not gigantic.

But its collateral benefits are huge.

So for example, improving quality has a benefit, not only to your direct labor costs, whether that's manifested reduction of scrap or rework, but it also has an indirect impact in your overhead in terms of the number of people required to go disposition those things, or into your supply base as it relates to the cost there.

If the origins of the problem exist with the suppliers, then we want the suppliers to make sure that they're responsible for their quality.

And so, as we go at this, what we have done is even though direct labor is not the biggest percentage of the business, it's actually probably a relatively, I don't want to say small chunk, but as we attack that, with metrics, and it's pretty tight.

To be honest with you, every Monday in my office the team is in there, we work all weekend on the metrics, the book comes, it actually comes out, it take them three days of chunking and then they want to.

Sunday I get it, and then Monday morning in the office, and we're talking about how many heads we're going to add or subtract to the 737 or the 777 or 350, or you name it.

It doesn't matter whether the heads are in Malaysia or Prestwick or Tulsa or Wichita.

We really are tight.

And I think we're really getting to the point where we are getting a rhythm and probably have squeezed a good portion of the juice out of that part of the equation.

And so that's why, as Sanjay said, hey look, we are just as equally energized and looking at what our opportunities are on the overhead piece.

Again, I don't want to leave anybody with the impression that, I mean, I've run a lot of businesses, and I don't want to leave anyone with the impression that we're kind of heavy.

But I think all of us could afford to lose a few pounds.

(laughter) And so we are going after that.

We are also looking at, frankly, the things that we do versus the things that we could buy.

And whether those things are core to our business, whether they are important to our customers, and where in the value proposition.

And so, we are attacking that part of the business model as well.

And then on the supply chain, which is nearly half of our overall structure of our Company, we are working very, very hard.

Not just on individual product negotiations, but on the overall strategy as it relates to who we're going to do business with, how we're going to do business.

Because frankly, I am a believer in the organic value of scale.

And so, we would like to aggregate what we do and find out how to get some leverage out of the scale as we pass it on or potentially offer it up to the supply base.

Excellent.

That's great color, thanks.

Obviously, the last thing you do is you get rid of your bleeders.

(laughter) And so, we have a few bleeders here or there and we just work those little guys off and we attack those as well.

Sorry for the long answer, Peter, but it's a lot of moving parts.

No, thank you.

I appreciate that.

George Shapiro, Shapiro Research.

Good morning.

Hey there, George.

Good performance.

Thank you.

I wanted to ask, Larry, given though wing margin was much better this quarter and comparable to the other sectors, does that mean you have got less incentive or less desire to sell it?

Yes, well, just to be clear, so our wing business really has two pieces to it.

There is an Airbus portion and then there is a Boeing portion.

Actually, the three, and the Gulfstream portion.

And George, we were trying to allude to the margins in the quarter.

They are a bit higher than you would normally see and it's principally because of some things that occurred in the quarter as opposed to a recurring theme.

But we are doing better, there's no doubt we are doing better.

And so, as we look at the business, we always reflect on this.

Look, we put Tulsa up for sale.

I'm not changing my mind about that.

We're going to finish out this cycle and see what happens.

Obviously, we want to make deals that are in the interest of our Company.

If we find out that the deals are not in the interest of our Company, then we will make a decision about whether we hold onto those assets are we go for cycle two, because, frankly, there's a lot of interest in those facilities.

And frankly, there's an opportunity to do this again if we wanted to.

So we are going to keep doing it.

George, I'm always astounded how long these things take, I'm sure you are as well.

I would say I think the timing of these deals are exponentially proportional to the number of stakeholders.

And so, hey listen, we made a decision, we are going to stick with the decision.

We're going to go through the cycle and then we will make a decision from there.

But that's kind of where we are, George.

And then a follow up, if I look at the Gulfstream programs specifically, and Sanjay, I did not give the exact number, but it looks like the deferred probably went up $30 million maybe $40 million, comparable to last quarter deliveries.

Looked like there were somewhat comparable.

So do I assume that Gulfstream is not doing much better in this agenda?

Or do I have some of the numbers off or if you provide some more good color on Gulfstream?

George, what I would say is we are executing to the plan.

That's probably all I could say is that we are on the plan that we laid out.

And we have not lost any ground.

I think if we get into the details, we are doing quite well on 280.

We are probably, I would say, ahead of plan.

650 has been more challenging.

Mostly layover, George, from, if you remember those shortages we have at the end of last year, they couldn't have hit us at a worse time because we were actually going up in rate.

And it really banged us hard in the first quarter.

We are still, I would say, we would have been further along on 650 minus those part numbers.

Kind of a combination events of those shortages and going up in rate, but we are executing our plan and moving along smartly, and I don't think there's anything really more I can add to that.

Okay, thanks very much.

Myles Walton, Deutsche Bank.

Thanks.

Good morning and good quarter.

Thanks for bringing a little sunshine in an otherwise murky rainy season.

(laughter) Yes, well, Myles, I was thinking about this yesterday, I think you all had seven calls yesterday.

So we thought this might be a respite, just one call to deal with, so -- (laughter)

Yes, and it was good news as opposed to the others.

So one question I have for you, just maybe go back and revisit the topic of this insourcing versus outsourcing, make versus buy.

I was hoping, Larry, you can put a construct around?

Maybe in sizing it, whether that's in gross COGS or absolute dollars?

And then, how far along you are, and I know it's a journey, how far you're along in your process versus where maybe the prior approach stood?

And the last piece of it is it looks like a lot of the benefit comes through capital expenditure avoidance to some extent, or least that's what I would imagine.

And then you would have a fall through of cost benefit realization, as well.

And so, can you just talk about each of those three items as they apply to date?

Yes, Myles, I probably cannot say the size of it.

But it is a healthy piece of the business.

And it's well executed.

The team, we do a good job on the things.

We're still in the, when I say in the early phase, we are out.

We're in the phase of going out and testing the market, is what I would say.

And no decisions have been made because we're testing the market.

And so, we are out there looking to see what the economics look like overall and to, frankly, to be able to answer the questions you asked for ourselves.

And the benefits, or as you described, the net-net effect is less cost, whether that is a reduction in -- again, the terms of the deal have to be worked out, so the question would be, how does this work out?

But for sure, it would be lower capital requirements.

And certainly would require less management on our part.

And then, of course, the most important piece for us, really the two most important factors in any consideration is to make sure we don't take on risk.

And I don't mean financial risk, I mean execution risk.

We can never, ever, ever, ever put any of our customers at risk.

That is not in our DNA nor we will not let that happen.

And then finally, whatever it means to the Company in terms of however it translates to the bottom line.

Whether that is in cash or in reduced prices.

So we are just exploring right now and really that's where we are.

So just to underline that there, if I looked at the internal plans of CapEx two years ago, they would have probably had projections running $300 million plus.

The run rate you are at now does not yet reflect your make-buy strategy is what I get from this?

It does not.

But Myles, look, it's not, in the scheme of things it is not insignificant against that number.

But it's not a large piece either.

It's not the biggest piece of that number.

The annual bill, recap bill there is a fraction of that number, but it's not a big fraction.

Okay, got it.

Thanks again.

(Operator instructions)

John Godyn, Morgan Stanley.

Hey, thank you for taking my question and I'll just have one question.

Larry and Sanjay, I was hoping you could update us on the thoughts on capital allocation from here, now that you are generating free cash flow there?

Larry, you have used the words agile and opportunistic deployment of cash.

Just trying to think about M&A versus buybacks, capital returns?

How do you think about these issues?

Yes, so, look, we are, first of all, happy to have some cash.

(laughter) Step one was to start generating cash.

And as you saw in the quarter, we actually used it.

And that was kind of the point I was trying to make.

And then we used it in a way we thought it was the healthiest way to return value back to the shareholder, given the opportunities we had right there at the time.

Timing was good for us and I thought it was a good decision for our shareholders.

We have not yet committed to a share buyback plan, I'll say on an annual basis.

We are not that far along in our thinking.

It's not that it's not on the agenda.

It's not that it's not discussed with the Board.

But it's, certainly, we have not formalized on an annual basis we are going to buyback this many shares.

But it is certainly one of the top, in terms of our list of things that we would consider, in terms of deployment of cash.

Look, we are very -- when we think about, I have talked about reducing cost of goods sold.

There will probably be some investments required to do that.

And so we look at the factory and when we do, we look at, I guess probably shouldn't get into the details, but we look at where our opportunities are to invest in ourselves.

And that is certainly something that we are going to do, because we are going to invest in our future and, frankly, our customers view of the future.

And then, finally, the question about growth is, will you grow organically or through M&A?

And I think you will see some of both.

What we will do on the growth side, we did not really talk much about defense today.

It's a small piece of our business today.

I think there's some natural opportunities.

I would say, most likely you would see probably organic growth there.

It's opportunistic.

So what that means is, from our standpoint is, in defense you're going to pick and choose or people are going to pick and choose us.

We are going to, if we were to invest, it will be in things that we have high confidence that's going to come to fruition.

We are not just going to just make a gamble to go play in defense, especially given that I think, overall, I'd say the view is that defense spending is on a downturn.

So any move would make in that direction will be in things with high probability.

And we have got a good start.

Whether it's the Tank or the P8 or the V280 or the CH53, those are good starts.

It still not big overall.

But we have a number of irons in the fire I can't really talk about that I think offer us some good upside.

On M&A and commercial, yes, that is certainly going to have to be something we think about next year.

And then the question really becomes what makes sense?

You won't see us stray far from what we do.

I can assure you that.

We are not going to become, if I think about my prior job, I used to have to develop software.

I'm not anxious to develop software anymore.

I have lived through that, I've got the bruises.

I don't want to do that.

I used to write algorithms for sensor fusion, sensor intelligence, and all that kind of stuff.

Probably not going to do that.

So you are not going to see is go do things just because I have some experience in it.

You'll see us stay pretty close to home.

And it will be things related to aerostructures, either becoming more vertical or just expanding the products that we build.

Does that answer your question?

Oh, good.

I guess, right.

(laughter)

Joe Nadol, JPMorgan.

Thanks.

Good afternoon, here, East Coast time now.

So I say this only partially in jest.

But I have been ticking along here on the call and listening to your update on A350 and 787 and Gulfstream and they're all on plan.

But we don't know what the plan is.

So it's great to hear that, and you had a great quarter here, but at some point, Larry, will you feel comfortable sharing exactly what that plan is as we look out into the next couple of years?

And really, in particular, I'm interested in the A350.

Does the plan contemplate a charge?

We know you are on plan, but what is at the end of the plan?

Joe, to be perfectly candid, if it did I would have to declare it.

So currently, our estimate to complete shows that obviously there is not a charge.

If there were, I'd disclosed it.

And Joe, work pretty hard to try to clean the books the best -- get all this stuff out there.

But the truth is, when I look at it, there's nothing in there that you say is grossly unreasonable.

Now, there is the doing.

And so, when we go back and we take a look at it and we say, okay, and you do this and can you do -- there's the actual execution.

And part of the 350 plan is obviously a substantial amount of cost reduction, both in our labor, as well as in the material that we buy.

As time goes on, we go do that.

So that's all I can really tell you on 350 as we built 18 airplanes and there's a lot of work yet to be done.

On the 787, I think the best I'm going to be able to do for you is that when we get to 2015, we're going to give you guidance on the enterprise in general and you'll see the specifics for that year on the 87.

But we are probably not going to lay out the details of the estimate to complete.

So other than that, I don't know what to say.

So when I say I am on plan -- and your skepticism I understand.

So when we say we're on plan --

I would not call it skepticism, I'm just trying to understand exactly what it is?

Because you clearly have a defined internal plan that everyone is tacking towards.

It would just be great if we knew a little bit more about it, that's all.

Yes, I understand.

I don't know what else to say, other than watch us quarter to quarter, and I will talk to Sanjay about what we can say and not say here going forward in terms of more detail or more color on those programs.

Other than that, I don't know what else to say, Joe.

Sam Pearlstein, Wells Fargo.

Good afternoon.

I wanted to go back to a question on the margins.

Just if I back out all of the cum.

adjustments this year and last year, especially in the fuselage, there really wasn't much in terms of a profit gain on the revenue.

And so, I'm just trying to think through how did these, whether it is the tooling or milestones or other payments, kind of flow through?

And is that a factor in the sequential margin degradation?

And is this a better level?

You mentioned wing was not sustainable.

But is this one a better level with regards to fuselage?

Sure, Sam So fuselage is, again, it's our largest segment and it has two things going on, right?

Yes, we are making improvements in our mature businesses, and that is the cumulative catch ups.

But it is also impacted because we are seeing growth in revenue associated with the 787 program, which has doubled, and the A350 program, which has doubled.

And the reality is that those programs are zero margin programs.

So there is a dilution effect associated with the revenue growth in the fuselage segment because of those two programs.

Now again, our goal here is to continue down the plan that we have laid out for those two programs, Larry just talked about it.

And then find ways to try and improve our mature businesses so that we can continue to create some catch ups and so on.

But yes, that is really what is happening in the fuselage segment.

And I would say, Sam, again, those are zero margin businesses, zero margin programs today.

And we are going to continue to attack.

Again, that is part of the strategy about trying to address cost of goods sold, as well as, frankly, address the open negotiations that we have.

No, I understood the mix.

I guess you had mentioned when you look at the percentage change year over year, where that would imply some of the tooling and other pieces were.

And it would have seemed to have implied significantly more was in fuselage than the others?

No, I don't --

No.

I would say there probably is a higher tooling bill on the Max in fuselage than in propulsion.

There could be, some of the nonrecurring pieces could be probably, most likely they are probably heavier over in fuselage than they would be -- there certainly then they would be in wing.

Okay, thank you.

Thank you, Sam.

We have time for one more question, Operator.

Ken Herbert, Canaccord Genuity.

Hello, good morning.

Just quickly, Larry, it's been just a few months now since you put the pricing agreement in place with Boeing.

I'm just wondering if you can comment if there has been anything that has surprised you since you put the agreement in place?

And then, specifically, as you start to ramp the 787 Dash 9 and the pricing agreement on that, is there anything you can comment in terms of how that learning curve should look relative to what you have accomplished on the Dash 8?

Yes.

Well, okay, so there are no surprises as it relates to the operation in the master agreement.

So I would say that's all positive.

As it relates to 787, Dash 9 versus Dash 8. It's actually, when I said tracking to plan, it's following our predictive model.

We have delivered 228.

I know exactly how many units, it's always how many did we deliver in the quarter, 228 of these aircrafts.

So we should have a good idea of the cost.

The configuration delta between the 8 and 9 is really well understood.

And so the numbers are pretty much following what our expectations were.

Thank you, we have no further questions.

At this time I like to turn the call back over to Coleen Tabor.

Thank you, Vanessa, and I'll now turn the call over to our President and Chief Executive Officer, Larry Lawson, for some closing comments.

Thanks, Coleen.

Well listen, I know that you all had, it's a busy season, and thank you for your questions.

I am pleased, we are halfway through the year.

I can say I am pleased with the fact that we're making progress in our transformation.

I do think the question comes up, how do you feel about the cycle and I know that was one of the big questions coming out of the air show.

My sense is that when I talk to folks and do my homework, that the cycle is strong.

And the fundamentals under that are you are seeing about 5% annual growth in travel.

And in the fleet of 22,000 airplanes, the replacement rate looks like it's right around 1000 airplanes a year.

It does not appear that the cost of fuel is going to make a major leap down, and therefore, the motivation to buy aircraft would lower operating cost is high.

So the market looks good.

And I feel good about our value proposition.

Someone said, I was perpetually dissatisfied, and maybe I am, but I think there's opportunity for us to continue to make sure that we keep our value proposition attractive.

And so, my view is we are making progress, more work to be done, and this was another step in the right direction.

And I look forward to seeing some of you soon, and certainly speaking with the rest of you before the next quarter.

Thanks.

And thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.