Spirit AeroSystems Holdings Inc (SPR) 2016 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Spirit AeroSystems Holdings Inc.'s second-quarter 2016 earnings conference call. My name is Jonathan and I will be your coordinator today. (Operator Instructions) As a reminder, today's program is being recorded. I would now like to turn the presentation over to Mr. Ghassan Awwad, Director of Investor Relations. Please proceed.

Good morning and welcome to Spirit's second-quarter 2016 earnings call. I am Ghassan Awwad, and in the room with me today are Spirit's President and Chief Executive Officer, Tom Gentile; and Sprint's Senior Vice President and Chief Financial Officer, Sanjay Kapoor.

After opening comments by Tom and Sanjay regarding our performance and outlook, we will take your questions. 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 earnings release, in our SEC filings and in the forward-looking statements 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 broadcasting slide presentation on our website at SpiritAero.com.

With that I would like to turn the call over to our Chief Executive Officer, Tom Gentile.

Thank you, Ghassan, and good morning, everyone. Welcome to Spirit's second-quarter earnings call and my first earnings call as President and CEO of Spirit Aerosystems. I cannot emphasize enough how honored and privileged I am to lead the great team at Spirit. Since I joined Spirit four months ago as COO, I've had the opportunity to visit most of our domestic and international sites and meet many of our employees.

I'm very proud of our team and all their accomplishments. Their dedication, commitment, and expertise in aerostructures are unmatched. In addition to its global footprint, Spirit has a very solid foundation with work packages on every major platform of Boeing and Airbus, and merging work on some new platforms such as the Bombardier C series and the Mitsubishi MRJ, new inroads in defense and a backlog of $47 billion.

Our business is very well-positioned for the future.

Before getting to the Q2 results, I want to start by expressing my sincere appreciation and gratitude to Larry Lawson, who recently retired as CEO of Spirit. As leader of this Company over the last 3 1/2 years, Larry has done a tremendous job.

He transformed the Company's performance with a clear strategic vision and a disciplined focus on operational excellence. He helped stabilize critical programs, exited non-core activities and won new business which has strengthened Spirit's outlook.

During Larry's tenure, the business experienced remarkable growth by any measure. Revenue grew by 23%. Deliveries increased by 18%. Spirit's backlog improved by 34%. Earnings per share were up 10 times. And Spirit's stock price grew by 1.6 times.

But more importantly, Larry assembled a great team of subject matter experts that I will inherit. The Spirit Board and I have great confidence in our leadership team going forward. Larry left an incredible legacy at Spirit and we wish him well in retirement.

Over the last four months I have had the opportunity to meet most of our customers and many of our key suppliers. I've had the opportunity to spend significant time with Boeing and Airbus leadership. The Farnborough airshow came at a good time and we had several good meetings with Boeing and Airbus executives.

I've also been to both Seattle and Toulouse meetings and will continue active engagement with both of our largest customers. In addition, I met many of our shareholders and Wall Street analysts during the reception we had in New York in June.

At the Farnborough airshow I was very encouraged with what I saw and heard, relative to the health of our industry. The most powerful underlying trend in aviation is the continued growth of revenue passenger miles. The recent Deloitte industry report highlighted that less than 10% of the world's population has taken a flight yet. The roughly 5% annual growth in revenue passenger miles should continue to drive demand for aircraft long into the future.

While orders this year were softer than in the recent past, Boeing and Airbus still have a record backlog in excess of 12,500 aircraft, which translates into more than eight years of production and is driving higher rates of production of key programs such as the 737 and the A320.

With fuel prices still low, airline profits have been at record levels the past few years.

Overall, I remain optimistic about the macro factors driving the aviation industry.

Yet our industry remains incredibly dynamic and competitive. While Spirit has a good position right now, we can take nothing for granted. We must earn the trust of our customers every day by executing on cost, quality and delivery for current programs and remaining innovative so that we can win a place in the next generation of platforms.

My vision for Spirit is to be a trusted partner in our core aerostructures business while laying the groundwork for future growth. First and foremost, we will focus on meeting the cost, quality and delivery commitments of our current programs, and we will do that while keeping safety as a key priority.

Second, we will work to strengthen the relationships with our key customers.

Boeing is by far our biggest customer. Their success is our success. We have some open contract issues right now with Boeing and are engaged in active dialogue with them to reach a mutually satisfactory agreement.

Airbus is our second largest customer. I am pleased to report that we have reached a long-term agreement with them on the A350, which I will describe later.

Third, to be successful, Spirit must continue to drive down our cost. We are working actively with our supply chain using clean sheet approach to find the most competitive sources of supply.

In addition, we have rigorous [project fix] looking at all other aspects of our cost space.

Fourth, as we seek to grow, we will continue bidding on work packages in our core aerostructures business for both commercial and defense programs. We will look to build on our recent success of organic wins, such as the recently announced B-21 bomber program. We will also look opportunistically at inorganic opportunities that help to strengthen our supply chain, add to our core or move into a logical adjacency.

Over the next few months, we will be conducting a strategic review of opportunities and will discuss the outcome of that with our Board later in the year.

In any event, we will continue to be disciplined on capital allocation. We will only invest in inorganic growth if the returns meet our thresholds. We have a $600 million share buyback program in place today. We see our shares as undervalued and we plan to continue to buy Spirit shares under the existing buyback program, for which I will provide an update in a moment.

Of course, we also remain committed to meeting our financial commitments and delivering on the guidance that we provide investors on revenue, EPS and cash flow.

Finally, we will continue to build a high-performance leadership team to attract, develop and retain top talent.

Let's turn now to a major milestone Q2. I am pleased to announce that after much collaboration with Airbus we reached a fair and equitable long-term agreement on the A350 program. As a result of that agreement, Spirit extended the block to 800 shipsets and recorded an additional forward loss of $135.7 million in the second quarter. Sanjay will provide additional detail on the financial impact of this agreement in just a few minutes.

We remain focused on making progress on this program and driving cost reduction while delivering the highest-quality product. This comprehensive agreement strengthens our partnership with Airbus and positions Spirit to extend our elaboration with them in the future. We continue to work very closely with Airbus senior leaders on technology collaboration and are actively pursuing new business opportunities with Airbus.

Now let's take a look at Q2 results. In the second quarter, we delivered a record 408 shipsets including 36 787s and 20 A350s. The deferred balance on the 787 program remained relatively stable compared to the first quarter, while on the A350 program the balance grew by $6.8 million or $341,000 per shipset compared to $411,000 per shipset in the first quarter and $1.9 million last year.

For the quarter, we reported revenue of $1.8 billion, up 8% compared to the same period of 2015. Operating income was $83 million and net income was $45 million, taking into account the A350 forward loss and some other one-time items which Sanjay will explain. Reported earnings per share were $0.35 or $1.21 per share, excluding the one-timers. Operating cash flow was $215 million and free cash flow was $161 million.

With regard to 2016 guidance, we are revising our earnings per share guidance to $3.45 to $3.65 per share, which reflects $0.86 per-share impact of one-time items. We are also increasing our free cash flow guidance to a new range of $350 million to $400 million. We continue to support the guidance we provided you last quarter for revenue to be between $6.6 billion and $6.7 billion.

With regard to capital deployment we remain committed to our strategy of utilizing an opportunistic and disciplined approach. In the second quarter, we repurchased 3.3 million shares for $152 million, which brings the total year-to-date to 6.9 million shares for $318 million. We plan to continue to execute on current repurchase program of up to $600 million through December 2017.

Some other notable accomplishments in this quarter include refinancing of our $300 million bond and our $500 million term loan. Having achieved investment-grade credit rating last quarter, these refinancing activities allow us to take advantage of lower interest rates while providing additional flexibility relative to capital deployment.

Delivery of the first C series to Swiss Airlines in June by our customer, Bombardier. We are very proud to be the design and build partner of the engine pylon on this program and congratulate Bombardier on the first delivery of the C series. In addition, delivery of the 100th A350 shipset to Airbus occurred in early July.

And finally, we are approaching the delivery of our 500th 787. Overall, a very eventful quarter.

With that, I will ask Sanjay to lead you through the financials and give you more specifics about the second quarter. Sanjay?

Thank you, Tom. And a very good morning, everyone.

Let me take you through our second-quarter financials, summarize our full-year outlook, and then we will take your questions.

Starting on slide 3 the revenue for the quarter was $1.8 billion, which is 8% higher compared to 1Q 2015. The increase was primarily driven by record deliveries and higher revenues recognized on nonrecurring programs.

In the quarter we delivered 128 737s, 25 777s, 36 787s as well as 145 A320s and 20 A350 shipsets. In addition, our wing segment revenue was positively impacted by some one-time claims settlements in the quarter.

Production rates on programs such as the 737, 787, the A320 and A350 are projected to increase through the rest of the decade, resulting in a very healthy backlog of $47 billion or seven years of sales visibility.

Moving to slide 4, we reported earnings per share of $0.35 for 2Q 2016 or $1.21 when adjusted for three one-time items, including the Airbus agreement that Tom mentioned, which was an impact of $0.68. The other one-time items were charges we took for our former CEO's retirement for $0.11 and the costs associated with debt refinancing for $0.07.

In total, the impact of all three was $0.86.

All of these charges were non-cash in the quarter. We refinanced our $300 million bond and lowered our going-forward interest rate from 6.75% to less than 4% and also reset our interest rate on our term loan to 150 bps over LIBOR. These refinancing activities should result in lowering our interest expense by almost $10 million on an annual basis going forward.

By comparison, in 2Q 2015 we reported adjusted EPS of $1.09. And the adjusted $1.21 in Q2 2016 represents a healthy 11% year-over-year increase.

Earnings per share for the quarter benefited from the continued focus on cost reduction initiatives and a lower share count. However, we also absorbed a significant impact due to the appreciation of the US dollar to the British pound.

Turning to free cash flow on slide 5, for the quarter we reported free cash flow of $161 million compared to $163 million of adjusted free cash flow reported in Q2 last year. Capital expenditure in the quarter was $54 million compared to $75 million in 2Q 2015. While CapEx was lower in the quarter compared to last year, and some of this is just timing, also record that, in 2015, we had nonrecurring payments from our customers that were offsetting the capital spend on the 787 program.

We also continued to absorb the natural higher working capital requirements on these programs as they ramp up in deliveries. Our focus on core cash flow improvement is steadfast. And when adjusted for the higher working capital, we continue to see year-over-year improvement in this metric.

As a result of our continued performance to improve cash flow, we are raising our 2016 free cash flow guidance to a range of $350 million to $400 million.

Turning next to capital deployment on slide 6, as Tom mentioned earlier, we remain committed to our disciplined and opportunistic capital deployment strategy. In 2Q 2016, we continued execution of our existing share repurchase program by purchasing 3.3 million shares for $152 million compared to $165 million in Q1 this year. Year-to-date, we have already repurchased a total of 6.9 million shares for $318 million, which leaves a balance of up to $332 million under our current share repurchase program.

For our segment results, let's turn to slide 7. [Fuselage] segment revenue in the quarter was $915 million, up from $888 million for the same period last year due to higher production deliveries on the A350 program and higher revenues recognized in certain nonrecurring programs.

Operating margin for the second quarter of 2016 was 2.1% as compared to 18.9% during the same period last year, primarily driven by $135.7 million net forward loss charge recorded on the A350 fuselage program.

Propulsion segment revenue in the second quarter was $482 million compared to $441 million for the same period last year, driven by higher revenue recognized on certain nonrecurring programs and some increased deliveries on the 787 program. Operating margin for the second quarter was 15.4% as compared to 20% in the second quarter of last year. In the quarter we recorded pretax $8.8 million unfavorable cumulative catch-up adjustments on mature programs and a $2.4 million unfavorable change in estimate on forward loss programs.

These charges were mainly the result of one-time supply chain decisions which will yield benefits in future years.

Wing segment revenue in the second quarter was $424 million, up from $368 million for the same period last year due to higher production deliveries on the A350 and the A320 programs. Operating margin for the second quarter was 15.3% as compared to 13.6% during the same period last year, due to favorable labor and material cost performance and a favorable impact of fixed overhead absorption as a result of higher production rates.

In the second quarter of 2016 the segment recorded pretax $9.8 million favorable cumulative catch-up adjustments, primarily due to the Airbus agreement and the favorable change in estimates on forward loss programs of $1.2 million.

On the 787 program, we delivered a total of 36 shipsets in the quarter and the deferred production balance remained fundamentally stable compared to the last quarter.

Our current block will end later this year and we remain on plan to our estimates and guidance. I would like to recognize the entire 787 for their relentless focus on executing cost reduction initiatives while simultaneously managing the ramp-up in production to 12 aircraft per month. This program has executed on plan to the cost and estimates that were re-baselined all the way back in Q4 of 2013.

Slide 8 summarizes our performance on the A350 program. We've delivered a total of 20 shipsets in 2Q 2016 compared to nine shipsets in 2Q 2015. The 100th shipset was also delivered in early July.

More importantly, the average deferred production per unit continued to decline and is now averaging approximately $300,000 per shipset. As we have repeatedly said, at this early stage of our major development program, deferred production per unit is sensitive to factors such as production rates, logistics and other costs. I want to remind you that additional forward loss of $135.7 million recorded in the quarter is a non-cash charge. And it results in major de-risking of the A350 program and helps strengthen our partnership with Airbus.

With firm orders in excess of 800 units, we felt comfortable extending the size of the block from 400 to 800 units. The teams continue to make good progress on our cost and invest in ramping up production rates. While we expect to become cash positive on a per-unit basis in 2017, there is always a lot more work to do.

Turning to our 2016 guidance on slide 9, our revenue guidance for the full year 2016 remains unchanged and is expected to be between $6.6 billion and $6.7 billion. On earnings per share, we are now revising our guidance to $3.45 to $3.65.

The new guidance reflects the impact of the one-time items that occurred in the second quarter, which were the Airbus agreement, our former CEO's retirement costs and debt refinancing charges, which collectively resulted in a net impact of $0.86 per share.

The guidance also includes the impact of the current foreign exchange rate and all the announced changes in production rates by Boeing on 747 and Airbus on the A380 program. So just for comparison, if you exclude one-time charges, this EPS guidance would be quite to approximately $4.30 to $4.50 compared to the previous guidance of $4.15 to $4.35.

We are also increasing our free cash flow guidance to a new range of $350 million and $400 million, which includes the investments on the defense program and the higher working capital requirements on the A350 program. Our guidance is now based on an effective tax rate of approximately 31%.

And with that now let me hand it back over to Tom for some closing comments.

Thanks, Sanjay. To wrap up this portion of the call, let me summarize the key highlights of Q2 which you will find on slide 10. After considerable effort we reached an agreement, a long-term comprehensive agreement with Airbus, on the A350 program which eliminates uncertainty and provides stability for the remainder of contract extended to 800 shipsets.

With this agreement in place we've strengthened the partnership with Airbus and we are now actively bidding on new work programs with them.

During the quarter we had record deliveries, surpassing the 400 shipset milestone for the first time with 408 deliveries. Our reported EPS is $0.35 per share or $1.21 per-share adjusted for one-time items, up 11% on a similar basis from 2Q 2015.

We are increasing cash guidance to $350 million to $400 million. We successfully refinanced our debt to lower interest rates. And, recognizing that we view our shares as undervalued during the quarter, we repurchased 3.3 million shares for $152 million. We plan to continue executing on our share repurchase program of $600 million.

So we have a lot of work to do at Spirit but we have got a good position in the industry with work packages on all the major programs and a very strong team. I'm optimistic about our future.

So with that we will be happy to take your questions.

(Operator Instructions) Howard Rubel, Jefferies.

Thank you very much. Good morning and, yes, nice results when you walk through it all. I just wanted to touch on the revenue outlook for a moment. Could you do a little bit of a walk, Sanjay, because unless I see some massive falloff in production rates in the second half of the year and even allowing for some rate payments, you still should show up above or at the high end of your revenue guidance as I see it.

Could you address the sustainability of the 320, the 350 and also the benefit of the 37 Max?

Sure, Howard. A fair question. And I think in the past we used to talk about it. We've gotten away a little bit from it.

But the first thing you got to remember, Howard, is -- at least in this year -- the number of calendar days in the fourth quarter is about 57 days. 3Q was 64, so the second half of the year has a fewer number of workdays.

Having said that, I also mentioned a little bit in the second quarter we did benefit a little bit from one-time settlements that we had, which obviously will not repeat themselves.

Having said all that, I have to tell you we are absolutely on track to meeting our customers' deliveries. That is our brand. That's our reputation. So we will make sure that we get those numbers. There's always volatility in the months of December. Things can move one day or two days to the left or the right, based on customer needs, particularly on these ramped up programs.

But having said all of that, it's quite likely, and I think you are right -- we're likely to be at the higher end of our guidance range in terms of revenue. So there's no underlying issue that we are not talking about. We are absolutely meeting our deliveries. There are, obviously, a fewer number of days. But we will deliver to our customer commitments. And if we do that, we probably are going to be at the higher numbers.

Thank you.

Cai von Rumohr, Cowen and Company.

This is Lucy on for Cai. First, Sanjay, if you can give us a little bit more detail on the moving parts of your raised free cash guidance? It looks like the adjusted net income will be up $20 million. But you mentioned there's also some additional investments in working capital requirements here. Is it higher versus your private prior expectations? And I have a follow-up.

Sure, Lucy. As you know, in the last three years -- and of course, Tom is continuing that focus -- our focus has been on managing our cost in all aspects of our costs: our labor costs, both our direct and our indirect G&A, our overhead costs in every aspect of what we spend in producing our parts, as well as working on our supply chain cost and so on.

At the end of the day, Lucy, that is what causes our cash flow improvement, something that we have targeted in the last few years, highlighted internally as well and for our teams. So I've got to tell you the working capital requirements are obviously a headwind. But those were baked into our numbers. These additional improvements are a result of all the things, all the cost reduction and performance things that we continue to do in our business.

So we see this, and we have talked about this quite a bit, that our targets are on free cash flow year-over-year improvements and eventually getting to those 6% to 8% of revenue kind of conversions. And we are absolutely on track to achieve all that.

Thank you for that. The second question is related to your Boeing negotiations. If you can maybe update us on or remind us on the approach to the negotiation? Are you looking at perhaps some piecemeal agreements on the 787 or the 737 programs?

And separately, Boeing has talked about potentially elongating their payment terms. Has that been a part of the negotiation with Spirit? And potentially what would they offer you in return on that.

Sure. Lucy, I'm almost missing Cai on the call because I've told Cai many times and I think I've shared with you as well we can't get into our negotiation stance in a public arena. We don't do that.

All I can tell you is we have fact-based negotiations with our primary customers, very similar to what we ended up with, with Airbus, as well. And those negotiations continue to happen in good faith, they happen at all the appropriate levels.

There has been a lot of noise about payment terms and things like that, and I don't want to get into all aspects. All I can tell you is we have appropriate contractual terms with our customers, with both our customers. And like we deliver on time to a quality, cost and schedule that they expect and we want to. We likewise get paid contractually as well. So there is no impact because of some of the noise that you are hearing.

Thanks very much, I'll pass it on.

Doug Harned, Bernstein.

I want to see if you could help us understand the A350 charge a little more because when you look at the block extension, that takes you to about 700 airplanes left or 700 shipsets left to deliver.

So it appears that the way you look at this program and the timing with which you get the cash that's coming out of deferred back is now much, much -- stretched out much farther than one would have not before. Can you talk about what has gone into this agreement, the puts and takes and what we should expect for a cash trajectory on the A350?

Maybe I'll just take a cut first. First of all, the block extension was really because of the way we negotiated with Airbus. We have a contract for 800 units. They have taken more than 800 orders at this point and we negotiated on that basis. And so it made sense to extend the block from 400 to 800 aircraft.

What we've also done is really identified all of the costs. And because we have the full look now across the entire contract, we thought it was appropriate to report it in that way. And so that's how the forward loss resulted.

But I'll turn it over to Sanjay to explain a little bit more of the specifics in terms of the pieces that you were mentioning.

Sure. And Doug -- and I apologize, Doug. I have been reading some of the early reports this morning from a number of folks. And I know this is something that's big. Let me just give you a little bit of a longer answer than normal. And frankly, first, before I do anything I just want to thank -- this has been a long effort on behalf of a number of folks on the Spirit team and, frankly, on the Airbus organization and over the last almost year or two now, lots of trips back and forth. And so this has been a huge effort.

The second thing we have always talked to you guys is that this negotiation was a fact-based negotiation. We bring a lot of value to the table. Larry used to talk about that as you get closer to 100 units you have a pretty good idea as to what your costs are and what your costs are likely to be in terms of working on, collectively, cost reduction initiatives in the future.

Like Tom said, we wanted to negotiate 800 units, not get into a constant [do loop] of negotiating 200 at a time or 400 at a time. So this made a lot of sense for us. It made a lot of sense for Airbus to economically negotiate over the long term. And frankly, independently, the 800-unit block made sense because, like Tom mentioned, they have more than that in orders. And we have certainty in revenue and we have certainty in our cost structure. So that all makes sense kind of independently.

Now, obviously, it's a lot easier to negotiate, going back to your question about 700 units left to go. And yes, we have roughly $700 million deferred balance. And so, if you add up the two forward losses between this time and the previous one, that [was sort of stated] about $450 million of cash that we would recover over the next 700 units, which would be about a little over $600,000, $650,000 a shipset.

So going forward, from a cash flow perspective this is a really, really good result.

It's always a lot easier and better to negotiate and settle. When you look at your costs going forward, some of the history -- and you can see the charts that I had in my presentation about back in 2012 and 2013 where we had a lot of travel work and we have a lot of engineering changes and a lot of inefficiencies. It's hard to negotiate and settle who caused all that.

I think at the end of the day this is a really, really, really good result for both of our companies. Nobody is happy about the forward loss.

But I can tell you on a cash flow basis this is a really, really good result going forward. And last but not least, I think this sets a relationship between our companies that provides for -- they understand the value we bring to them. They respect that value. And we, of course, with both our customers intend to delight them.

And this allows us to reset that relationship and build on it going forward. And we will see how we do on that. But I think that's a good reset.

So overall it was very fair and equitable. It was long-term. It was balanced. Obviously, we have a lot of work to do. But it was the right kind of decision that we all worked for the last two years to make happen.

I appreciate the logic in going to an 800 block. That all makes complete sense.

What I'm trying to understand is, if we back up a few weeks ago for this agreement and when you had -- you hadn't taken this forward loss. And one would think that you are expecting to recover this $700 million of deferred minus the first charge over 300 more airplanes.

Sure.

So that's why I'm trying to understand what was your thinking before this deal was done and the numbers we look at, versus what they are today.

Right. So Doug, I would tell you again, without getting the specifics of the negotiation I think with you should also read in here, that we not only set the prices associated with all the change activity that has happened in the current block but also the impact in the second block associated with those changes.

So we can keep second-guessing as to what it would have been on 400 versus 800. But the good news here is we reset our costs and our prices, not only for the first 400 units but also for the second 400 units.

And I would say, Doug, too, is that we just felt it was the most transparent, is to convey what the total impact was over the full block, the full 800, rather than try to piecemeal that over the first 400 and then the second 400.

Two other things I'd add is that on the deliveries you see that we have in reducing the amount of negative on the deferred production each quarter. And we should be positive by the end of this year or early next year. So we are on a good trajectory with that. And as Sanjay said, this has really improved the relationship with Airbus. We met with the senior guys at Farnborough. I had a lot of good discussions. We are actively bidding on some new packages. So overall, we felt this was a very solid agreement.

Okay.

Last thing, and I know a lot of people have a lot of questions -- this just makes, in our Company, de-risk our Company, our goal of converting 6% to 8% free cash flow in revenue. It just starts to put all the things in place so that we can, through our own performance, achieve those goals.

Okay, great. Thank you.

Jason Gursky, Citi.

It's [John] (technical difficulty) (inaudible) on for Jason. Tom, could you talk a little bit more about the strategic review you mentioned that you will be looking at over the next few months, what you consider a logical adjacency or expanding your portfolio? And in that context, can you give us a little on your view of the inorganic sorts of opportunities out there?

When I say strategic review, it's really more of a typical strategic planning exercise that any company would go through. Since I'm new, this first one will go into a little bit more detail. And we plan to review it with our Board at the next Board meeting in October.

And so we're going to look at a whole series of things. But first and foremost is going to be on the core and how we stabilize our core business, continue to meet our current requirements and improve the performance. And so that's going to include things in the supply chain to drive down costs as well as how we improve our overall processes and improve our quality and our delivery. So that's a key part of it.

Certainly, we will look at our growth agenda. That's an important thing to the Board is to understand our long-term growth agenda. And that's both organic and inorganic .

We've had some recent wins organically with the B-21 bomber. So we will talk about where we want to pursue additional commercial and defense organic pursuits.

And then the last area is really inorganically. And we will be opportunistic. As I said before, we are going to be disciplined on capital allocation. We have a share repurchase program in place right now that we will continue to execute.

But opportunistically, if we see opportunities come up that are inorganic in nature that either add to our core or help us strengthen our supply chain through vertical integration or our logical adjacency, we will look at those. But they will have to meet our return thresholds. And we'll take a look at that very carefully.

So overall, I would say comprehensive strategic review is more just a regular strategic planning exercise. We do it every year with the Board, and it takes place in October this year.

Thank you.

David Strauss, UBS.

Sanjay, to go back to A350, what can you tell us about the nature of the agreement? Is it a volume-based pricing agreement? Or are there set stepdowns? And then is there any change in zero margin assumption on the block right now?

Well, by default, David, there is no change in assumption on the zero margin for the block, which is, I think, where Doug was also poking at.

And in terms of trying to help you a little bit more with the agreement, listen, I hate to say this, but I can't get into the specifics of the agreement. I know we use words like fair and equitable, and I really mean that.

The good news here was we agreed on long-term pricing. Like in all agreements, there are aspects of working together on costs, which we always do with our customers. Obviously, there are specific prices for specific shipsets and things like that.

But beyond that, I'm not sure I can give you too much information, David, on the agreement. At the end of the day, going forward, given the value we bring and our costs that we know -- and, like Tom just mentioned, we expect to actually, with the agreement that we have now, get cash flow positive -- I said it in my prepared remarks as well -- very shortly, at least in 2017.

So all in all, it was a good agreement. And it was comprehensive. And it was fact-based.

As a follow-up, turning to the '87, given that we are going to move into the next block sometime in Q3, can you tell us the size of the block at this point, Sanjay, and what your margin assumption is on the next block? Thanks.

Sure, Dave. And that's a fair question. And you are absolutely right; towards the end of this year we will be establishing our next block. Quite candidly, we are going through all of the assumptions that have to be made prior to establishing that second block. And whether it be in terms of our pricing assumptions, our cost in curves as well as the size and so on.

So we're making those decisions, David. We are not ready to announce any of that yet. I will tell you that we will obviously follow appropriate accounting guidance and conservative aspects as we establish that. And all of that is baked into our guidance.

So you shouldn't be surprised this year about anything associated with it. When we establish that we will talk about it. We are going through that process write-down internally and then, obviously, with our auditors and so on.

All right, thank you.

Sam Pearlstein, Wells Fargo.

I'm going to try again on the A350 a little bit. Which is, you had assumptions before; you had various assertions. And so I'm presuming as part of this you are either getting paid or not getting paid for those assertions.

So what I'm trying to just think through is, is the price of what you are getting paid what allows you to get to the point where you are going to be cash positive? And then after you recoup whatever you asserted, it might go back down. So I'm just trying to parse together, when you said it will be cash positive on a unit basis for 2017, is that on a few units or is that for the full year we are going to see a cash-positive impact from the A350?

Sam, fair question. And again, that's why in my prepared remarks I did tell you when you look at deferred balances growing, particularly when you are at fewer number of units, it does bounce around a little bit because just the nature of -- in the early development sometimes, including in -- I think Larry may have even talked about it in previous calls, we are ramping up right now. And we are incurring certain expediting costs. And sometimes these are lumpy in nature and can cause a bit of a blip up or down in a particular quarter.

Having said that, like we talked about with Doug, over the next 700 units we expect to recover at least $650,000 of cash per unit going forward, on average. And I think you will see that and you will see that benefit.

And going to your original question of how much was this the price negotiation, was it a cost impact --? Well, it was a combination of both. That's why I said we had fact-based discussions with Airbus where we shared with them what it does cost and what the value we bring to the table. And likewise, we just did pricing to reflect what it takes to produce these units today, given all the change activity that happened between our two companies and the engineering activity and so on.

So it is a combination of price and cost in negotiation. We expect to get cash flow positive and remain cash flow positive because, over time, that's the only way you get to the $450 million of cash recovery between now and the end of the block.

That's great. If I can follow up, can you just explain what happened with R&D this quarter, why it dropped a couple million dollars?

Nothing specific, Sam. It's a little bit of timing. These things are -- our R&D expenditures are not that huge. And sometimes just some bills and some timing activity happens. So we are on track to a number very similar to last year. We are not not investing in ourselves. That's not the message here.

Frankly, one of the things that Tom has brought is making investments in innovation and R&D. And that's a focus. And so, it's got nothing to do with changing our behavior. This is all just timing activity.

Sam, I'll reinforce that. It definitely is timing. Coming in, looking at our R&D is -- we can even do more. If we are going to be successful in the next-generation platform, we really have to be driving innovation in the core aerostructures areas that are going to make us really desirable as a partner for the next generation.

So it's a priority for us. It's something we are going to be talking about in our strategic review. It's important to the Board. And I think the little dip that you saw this quarter should not be indicative of anything. It's going to be a priority for us going forward.

Thank you.

Robert Spingarn, Credit Suisse.

On the 787, just going back, your block determination that you are going through now -- will that use the interim pricing agreement or some expectation of whatever the future agreement is?

So the interim pricing that we have talked about multiple times, Robert, which is not in my cash flow guidance, by default, is definitely not in my assumptions for earnings share or anything like that. And that is part of the comprehensive negotiation that we are undergoing with Boeing.

And again, that's something that we can't really comment on too much.

But it sounds like, if you haven't reached that agreement yet with Boeing and you are not using the interim agreement, then there will be some variability, once the Boeing agreement is done, relative to what you put into the block assumptions?

Right. That's what I said. I didn't put in any of the interim payments associated with that in my block or in my cash flow guidance. I was absolutely [pure] with that, and we kept you informed that we took those interim payments outside of our guidance.

I guess what I'm asking you, Sanjay, is do you have a pricing assumption that's based on a reliable number?

Absolutely.

If you don't have a final -- okay. That's where I'm struggling a little bit.

Yes. No, that's fair. We've obviously make an assumption, Robert, in our blocks as to what we believe is the [-9] price. And we follow accounting guidelines, we follow conservative accounting appropriate principles to do that. And when we settle on what it ends up being, that's what the impact will be. But we are quite confident --

So there could be a true up of some type?

Yes.

Okay. Sanjay, on the proportion margin you mentioned some mature programs where behind the adjustments, the negative adjustments. Could you speak to that a little bit? And even after backing those out, is that margin perhaps a little bit lower than normal? And what we should expect going forward?

Sure. And it's a fair question again, Robert. The propulsion segment is roughly a $400 million business for us on a quarterly basis. So even a few million dollars, which are the right kind of investments we make, sometimes can swing these margins quite a bit in a particular quarter again.

I think a better way for me to try and answer these questions for you is between the [kum caches] that we took in the last quarter, for example, and some of the negative equity that happened in this quarter, but at the end of the day we always said to you and I'm pretty confident of that, that the propulsion segment margins, which are roughly about 100-150 basis points higher than our fuselage segment, which is about [17%] on fuselage, so let's say it's about 18%-18.5% on propulsion -- one-time things do happen. Some of this one-time that I talked about in my prepared remarks were related to the right kinds of decisions we make sometimes with changes in our suppliers or costs that we have to incur to move things around or sometimes savings that don't show up on time, but in the future will yield many times the amount of money that we are putting into these efforts, which we've talked about and explain to you under the sort of [make buy and make wear] principles that we have been applying along with our clean sheet activity.

So nothing to concern on propulsion margins going forward or on average as a whole. This should be in line with what I just mentioned.

George Shapiro, Shapiro Research.

I want to try and get one more shot at this 350. It would seem that normally when you extend a pool, you get a benefit. But since you are increasing the loss, my assumption would be that you probably gave back some in pricing this negotiation contract with Airbus.

True. Again, it was a comprehensive negotiation, George. Like I said, we [talked] and agreed on pricing structure and, obviously, values not just in the near-term but over the entire 800-unit block. And they were fact-based, very transparent negotiation.

I can assure you -- in some of this you guys don't see normally. But there were lots and lots of teams from Airbus visiting our factories and walking through the way we produce things, looking at suppliers together, trying to figure out how we can shave cost together and so on. And so at the end of the day, given that the program is fairly stable now that we are at 100 units, both on the -900 and the -1000, it's a lot easier to look at what costs are and what prices need to be and so on going forward.

So yes, it was a reset on all of our claims and the change activity and pricing assumptions but also we still have to, obviously, work on our cost going forward as well.

Okay, thanks. And then a quick one -- estimating that the nonrecurring sales this quarter are somewhere around $60 million -- is that a fair number?

Not that high, but it's getting there. Again, these are lumpy things, George, as you know. We are pretty active on both the 737 Max, the 777X, the 787-N, all of these nonrecurring programs, pretty active. And when you get some development, tooling costs, and these are lumpy in nature, you end up with a little bit of volatility in a particular quarter.

More importantly, I don't know if -- you didn't ask this. We continue to perform really well on these development programs. I think if you really look at the engineering commitments that our teams have made to both Boeing and Airbus, we are performing really well as far as that's concerned.

And I can't resist one other one. The '87 deferred was $1 million last quarter and zero this quarter. So the significant improvement is what risked retirement by getting o the 12 per month? Or what am I missing?

Well, again, it's all of the above, but -- George, I think particularly with you I had many conversations where we've said to you, please, we set a plan of three years ago, almost. We are absolutely meeting those numbers. And we continue to work on our cost.

Obviously, there's an impact in terms of pricing and stepdowns. But we are absolutely on track with the plan that we established back in 2013.

Well, you've done a great job. I give you a lot of credit.

Thank you. It's the team, all 16,000 people in Spirit.

Okay, thanks.

Seth Seifman, JPMorgan.

One a little deep in the weeds for you, Sanjay. The advance burndown was down from last quarter, even though you delivered more A350s, more 787s. What's the cause of that?

So again, I don't want to get into all specifics. Right? But at the end of the day if you look at the full year, you are going to see that our full-year advance payments this year are going to be higher compared to last year, just because of the higher number of shipments in the '87 and the 350 that we are doing. There are some aspects of what we worked with our customers, but I don't want to get into specifics on that.

Okay. And then as a quick follow-up, Boeing has told us that they are not going to be delivering 787s in 2017 at a rate of 12 month because they have the initial 77-10s running through the factory. But we should think about your delivery rate as remaining constant at the stated production rate. Right?

Absolutely. Absolutely.

Great, thank you.

Richard Safran, Buckingham Research.

I have two nonrelated items I wanted to ask you about. First is I want to know if you could talk about longer-term CapEx trends. I know you revised u[ to include the B-21 not too long ago. So I just thought maybe you could comment on how we are going to see that CapEx trending longer-term.

Separately and back on the A350, we are all aware of the issues that Airbus has been having in the buildup of A350s on the ramp in Toulouse. Just wanted to know if you could discuss what Airbus is telling you about the ramp. And given what you are seeing, what you are doing to manage risk on that program. Are you confident in the rate ramp? Is there any conservatism or anything baked into your A350 expectations?

Let me handle the CapEx. And then Tom has set a number of good, solid meetings with the customers on Airbus including the one that we mentioned in Farnborough. Maybe Tom can comment on the 350, which, by the way, is going quite well.

Richard, CapEx -- we've talked about two things in the past. One is our core CapEx, which is just the routine investments that we make in our facilities and so on. And it's whether it's $100 million, $150 million a year, that sounds like a good number. Beyond that, it depends on the rate increases which we are investing in and how we end up negotiating that with our customers. So the lumpiness on capital will depend on the negotiations.

As far as the B-21 program is concerned, we are absolutely committed to that program. And like we did this year, we shared with you overall [and] defense, not just on the program, we've made some investments. Those investments will continue in the next few years. And as we get into guidance for 2017 and beyond, we'll talk about CapEx based on those agreements.

So I think, again, CapEx is baked into our overall goal of getting to 6% to 8% of free cash flow conversions.

With that, let me just turn over to Tom. Maybe you can talk about the 350.

Great. Well, the 350 -- for Airbus, and obviously they've had some challenges with it. At Farnborough, when we spoke to them, they were still committed to getting 50 out this year. And they may have adjusted that slightly. But that's all downstream.

Upstream and at the front of the line, they are still requiring the deliveries for us at the rates that they have that communicated. So we haven't slowed down at all. In fact, we have been running, paddling under the water furiously to keep up with it because the front of their line is still moving at the normal rates.

Whatever they ship out the back end, they will decide that based on the delivery of the downstream supplies. But further up the line, for us, nothing has changed.

Okay, thanks very much.

Ken Herbert, Canaccord.

Sanjay and Tom, I just wanted to follow up on two things.

First, taking a different tack here and maybe a little bigger picture, coming out of the air show -- there was obviously a lot more commentary and concern around wide-body rates. It sounds like, Sanjay, you've reflected everything that has at least in publicly announced in the near-term and longer-term thinking on these programs. How do you feel like, from a CapEx standpoint, you are relatively well-positioned or hedged, assuming incremental downside in 777 or maybe 787 rates staying at 12 a month?

I'm just trying to get a sense as to the sensitivity to the CapEx, to perhaps further downside on wide-body rates, in particular.

On 77, we have just achieved the 12 aircraft a month. And really there is no investments. These are things that we are in discussions with, always, with Boeing. And we will follow that cue and direction as they decide to go up to 14 or not towards the end of this decade. Those are conversations that, obviously, they have.

The 777 (technical difficulty) to the rates that we are currently producing at. And there are some incremental changes in our capital needs or in our tooling builds associated with the migration to 777X. But I don't think capital is going to swing because of these kinds of rate changes on at least those two programs.

We will obviously wait and see how the wide-body market does in the future years. Today, we are on track to meeting our customers' requirements on what they have announced as the current rates on both of these programs.

Okay. And just finally, on the [37], which rate are you capitalized for today? And can you just talk -- I know obviously it's all part of the broader negotiations. But can you talk about requirements to support [rate 57] on that plane?

Sure. We are completely committed to our 47, which is next year. And that is part of our commitment with Boeing. And obviously, we are obviously committed to going to the higher rates, but those are part of the ongoing conversations with Boeing on the best way to achieve those rates in the future.

Okay, great. Thank you.

Myles Walton, Deutsche Bank.

I'm going to touch on a couple things that have already been -- but hoping you can add a little more detail, Sanjay. So accounting block extension for you at Spirit is pretty unusual, I call it almost extraordinary in terms of extending any kind of quantity as opposed to moving into a new block. Can you just touch on what hurdles you had to meet to do that?

And also, if you had not done it, forward loss would have been somewhere in the $500 million to $600 million, I would imagine. So just, Tom, as you look at it in terms of managing risk as opposed to extending this risk into the next block, if there was a choice, can you go into the logic of why not take the charge now and then go into a new accounting block in 2018?

I'll answer that question first, and then I'll let Sanjay explain the process of extending the block. When we were looking at this whole package, we obviously negotiated it over the full 800 units. And rather than piecemeal it and -- because we would have only been able to communicate where we were in the first block, and that would have left some uncertainty for the remainder of it -- we decided to be as transparent as we could and give you the full picture over that 800 units. And that was as simple as that.

So Sanjay, maybe you can now explain the process that we went through with [EY] and (technical difficulty) (multiple speakers) therefore.

Sure. The process is a pretty standard process that -- like all good companies, we have our standard policy. We adhere to this policy. And we adhere to accounting principles that -- frankly, this is not a we want to do this or we want to do that. At the end of the day, like Tom explained as well, we have orders for more than 800 units. Airbus has orders for more than 800. We are on contract for 800 units and beyond. We have certainty in terms of our cost and our revenues for the entirety of that block.

And the way we negotiated, the economic process in which we negotiated the contract, also was best, like Tom said, to be transparent to everybody about the value that was created inside this negotiation. And so, all of those factors coupled into our discussions, and it was all the returns with our Board, with our auditors and our internal process.

So I won't say we don't change blocks. We change blocks rarely; that's true. But we have a process where we go and very methodically and do that. And we absolutely follow that process.

And you disclose in the Qs and Ks the advance burn down on the 350. I imagine you will do it again. Has that number changed from the $1.25 million per aircraft?

It did not.

Thanks.

That concludes our earnings call. Thank you for your participation today.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.