Spirit AeroSystems Holdings Inc (SPR) 2016 Q4 法說會逐字稿

Good day, and welcome to the Spirit AeroSystems fourth-quarter and full-year 2016 earnings review conference call and webcast.

(Operator Instructions)

I would now like to turn the conference over to Mr. Ghassan Awwad, Director of Investor Relations.

Please go ahead.

Thank you, good morning.

Welcome to Spirit's fourth quarter and full-year 2016 earnings call.

I am Ghassan Awwad, and with me today are Spirit's President and Chief Executive Officer, Tom Gentile.

And Spirit's Executive 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 broadcast and slide presentation on our website at investor.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 2016 fourth quarter and full-year earnings call.

2016 was certainly an eventful year for Spirit.

Our team executed well and delivered a number of noteworthy accomplishments.

At a Company level, we delivered on our plans and commitments.

We achieved several key financial milestones as shown on slide 2.

In November, we celebrated our 10 year anniversary of Spirit's Initial Public Offering.

Earlier in the year, we refinanced our debt after Moody's and S&P upgraded Spirit to investment-grade credit rating.

Midyear, we transitioned the CEO role seamlessly.

I'm very excited and honored to be the CEO of Spirit.

And I'm grateful to all my colleagues who have helped me in my transition.

Over the course of the year, we deployed $650 million towards the repurchase of more than 14 million shares.

And we also initiated our first ever quarterly dividend of $0.10 per share.

In addition, we celebrated many significant operational milestones with our customers as shown on slide 3. Starting with Boeing.

In the fourth quarter, we delivered the first 737 MAX 9 hardware, and the first MAX Thrust Reverser with composite inner wall.

With the first MAX 8 flight during 2016 we are eagerly preparing for the launch of the MAX in 2017.

We also delivered the 500th shipset of the 787 program.

This was the fastest production ramp up for wide body aircraft and was a big deal for Spirit.

Our Governor from Kansas and several members of our Congressional Delegation were on hand in October to help us celebrate.

In addition, we successfully managed the execution of multiple production rate ramp-ups.

As well as ramp downs for Boeing.

For the 737 we are currently at rate 42 and are moving to rate 47.

We are actively planning for 52 and 57.

For 787 we are rate 12, and will be ready to achieve 14 when Boeing makes that decision.

On the 777, we are reducing rate from 7 to 5 in advance of the launch of the 777X.

For Airbus we also had a strong year.

In the second quarter, we reached a compromised and comprehensive long-term goal settlement agreement on the A350 program and extended the block size to 800 shipsets.

This agreement played a crucial role in stabilizing the program and providing better visibility over a long time horizon.

I'm pleased to announce today that as a direct result of this agreement, and the relentless, continuous improvement efforts of our team, the program achieved a cash positive position on a per unit basis.

During Q2, we also delivered the 100th shipset for the A350.

Other Airbus milestones throughout the year included the successful first flight of A350-1000 and the successful execution of production rate ramp-ups on the A320 and the A350.

We [were removed] to rate 8.4 by the end of the year.

And are on target to achieve 10 in 2018.

We are also proud of the accomplishments we achieved with our other commercial customers.

In the first quarter, we delivered the first Mitsubishi regional jet production unit, a pylon, on schedule.

We also celebrated with Bombardier, the first customer delivery of the C-Series to Swiss Airlines earlier in the year.

We supply the pylon for the C-Series.

On the defense front, we also had some significant accomplishments.

Most notably, in the first quarter, spirit was named by the Secretary of the Air Force as one of seven subcontractors on the B-21 Raider program.

We're very proud to be on the team with Northrup Grumman and are looking forward to growing our defense business.

We were also awarded a contract by Sikorsky in the fourth quarter, for two test articles and two production units for the CH-53K helicopter.

Now, let's take a look at full-year 2016 financial results.

In a moment, Sanjay will take you through the details of our financial results.

But I wanted to take this opportunity to express how proud I am of the way that Spirit team executed in 2016.

We overcame several challenges and operationally did better than 2015.

We delivered a record 1583 shipsets compared to 1457 shipsets in the prior year.

The number includes 127 787s, 96 777s, 500 737s, 69 A350s and 574 A320s.

For the year, we delivered results well within the guidance that we provided Wall Street.

Reported revenue of $6.8 billion was at the very upper end of the range.

Operating income was $725 million, and net income was $470 million.

Reported earnings per share were $3.70, $4.56 when adjusted to exclude $0.86 per share of one-time items recorded in Q2 of 2016.

We were able to execute a voluntary retirement program in Q4 that totaled $0.07 per share.

That will give us head start on our cost reduction initiatives for 2017.

Operating cash flow was $717 million and free cash flow was $463 million.

Or $420 million when we adjusted to exclude cash received in the first quarter of 2016 under the 787 interim pricing agreement.

Again this result was at the high end of our guidance range.

Our backlog at the end of the year increased to $47 billion, or seven years of sales visibility.

In the fourth quarter, our operations in Kinston, North Carolina were impacted by the aftermath of Hurricane Matthew.

Severe flooding led to some disruptions resulting in abnormal operating costs of $12.1 million, equivalent to approximately $0.07 of EPS.

We have filed appropriate claims with our insurance carriers.

But I'm proud to say that due to the extraordinary efforts of our team, we did not miss a single delivery to Airbus during that period.

Despite no share repurchases in the fourth quarter due to the uncertainty around the presidential election and our limited trading window, we remained committed to a balanced and disciplined approach to capital deployment.

We have our entire authorization of $600 million available as we enter 2017.

Now turning to 2017 guidance.

We're guiding 2017 revenue of between $6.8 billion and $6.9 billion and earnings per share between $4.60 and $4.85 per share for the year.

In terms of cash we're guiding free cash flow of between $450 million and $500 million.

This represents approximately 7% revenue to free cash flow conversion at the mid point of our guidance.

Which is consistent with our previously stated target of 6% to 8% free cash flow conversion.

These guided numbers incorporate all rate changes in 2017 announced by the OEMs.

Including the 777 rate reduction to five as well as the impact of the previously disclosed change in our aftermarket arrangements with Boeing.

Now let's turn our focus to 2017 and strategic objectives.

Early in January, we had the opportunity to gather all of our executives from across Spirit for two days in Wichita for our inaugural annual kickoff, where we outlined our strategic objectives and targets for 2017.

Some the highlights were the following.

First, our brand has been and will continue to be a trusted partner who delivers products on time, with high quality and competitive cost.

We've made a lot of progress in our relationships with Boeing and Airbus in several open issues last year.

And we strive to strengthen those partnerships with both of our major customers by continuing to improve our quality and position Spirit to win profitable new business.

A major focus in 2017 will revolve around executing our supply chain strategy, improving our productivity, digitizing our shop floor, and meeting our customer requirements for production rate changes.

Secondly, is growth and innovation.

As one of the largest structural component manufacturers in the world, we plan to leverage our internal capabilities to expand our third-party fabrication business.

Our team has already initiated several new business relationships, and we are expanding capacity.

We plan to leverage our commercial expertise to continue increasing our military presence.

We have a significant number of organic growth opportunities.

But we are also actively exploring inorganic opportunities for growth.

In R&D, our plan is to continue to make the right investments for the next generation of aircraft and partner with OEMs, as well as universities and technical institutions.

We view innovation in metallic and composite structures as a differentiator and a core competency for Spirit that will help us earn on our way into the next generation of aircraft.

Third is financial commitments.

We remain fully committed to improving our financial results year-over-year.

Our guidance for 2017 reflects our continued improvements in revenue, earnings, and cash flow, despite the rate reductions on the 777.

We also remain committed to returning cash to our shareholders.

We have a new share repurchase plan of up to $600 million that is currently in effect.

In addition, we initiated our first quarterly dividend of $0.10 per share last quarter.

And we will work to grow that dividend gradually over time.

Our focus will be on total shareholder return, using a balanced and disciplined approach to capital deployment.

Lastly is people and community.

Our greatest and most valuable assets are Spirit's almost 15,000 employees across the globe.

Customer focus, quality, delivery, and safety have always been part of our DNA.

In 2017 we are rolling out an expanded and refreshed set of corporate values which focus on transparency, collaboration, and innovation.

We are making investments in our people and have confidence that this team can execute and deliver on our commitments.

With that, I will ask Sanjay to lead you through the financials and give you more specifics about the fourth-quarter and full-year 2016.

Sanjay?

Thanks Tom.

And good morning everyone.

Let me take you through of the details of our 2016 financials.

As well as our outlook for 2017.

Let's start on slide 5. The revenue for the year was $6.8 billion, which is 2% higher compared to 2015.

During the year, we met all our customer requirements relative to production rates.

And delivered a record 1583 shipsets.

The increase was primarily driven by higher production deliveries on A350 and the 767 programs as well as higher nonrecurring revenue on certain Boeing programs, and slightly offset by lower production deliveries on the Boeing 747 and the 777 program.

For the year, we delivered 500 737s, 96 777s, 127 787s, as well as 574 A320s and 69 A350 shipsets.

We are managing changes to production rates very closely on all programs in order to meet our contractual requirements.

At the same time, we are finding ways to minimize our capital investments, and lower our risk profile for the future.

Our focus is to efficiently execute on our healthy backlog of $47 billion, which is almost 7 years of sales.

Moving to slide 6. We reported adjusted EPS of $4.56, consistent with our 2016 guidance of $4.50 to $4.65.

Compared to $3.92 in 2015.

This represents a healthy 16% year-over-year improvement in core earnings.

As Tom mentioned in his remarks, in 4Q our Kinston operations were unfortunately impacted by the aftermath of Hurricane Matthew.

Resulting in abnormal costs of over $12 million or $0.07 of earnings per share.

Excluding these costs, our core results would have been at the upper end of our guidance.

Also, as you may recall, EPS in 2Q was adjusted by $0.86 for three one-time items which were, the Airbus agreement, which was an impact of $0.68, charges we took for our former CEO's retirement for $0.11, and the cost associated with debt refinancing for $0.07.

The primary drivers for the year-over-year increase were higher deliveries, continued cost-reduction discipline, and a lower share count.

We're proud to have delivered on our EPS commitment for the year while absorbing the impact of the 777 and the 747 production rate decreases, the appreciation of the US dollar to the British pound, and the severe weather event in Kinston.

Turning to free-cash flow on slide 7. Adjusted free cash flow for the year was $420 million, compared to $738 million of adjusted free cash flow reported in 2015.

The $738 million in 2015 included a number of significant positive one-time events including the tax refund received as a result of a Gulfstream program divestiture, the favorable settlement with GD, as well as the suspension of the 787 advance repayments we had in the early part of that year.

On a comparable basis, adjusted free cash flow in 2016 was higher than 2015.

And more importantly, is now inside our target range of 6% to 8% revenue to free cash flow conversion.

Which is one of our key financial commitments.

Core cash flow improvement remains our number one focus.

And we continue to drive year-over-year improvement in this metric.

Capital expenditure in 2016 was $254 million.

And includes the rate ramp-up investments, as well as investments to support new businesses, productivity improvements and regular maintenance activities.

Near term, we expect CapEx to remain consistent with the 2016 range of $250 million to $300 million.

Over the last four years, we have invested over $1.1 billion in capital projects.

This is slowly transforming our footprint, and should help us execute our $47 billion backlog more efficiently.

Turning next to capital deployment on slide 8. In 2016, we executed the repurchase of 14.2 million shares or 10% of the outstanding shares for $650 million.

The lack of repurchase activity in Q4 is not a reflection of a change in strategy or commitment to the share repurchase program.

Q4 was abnormal, given the presidential election, volatility in stock markets including the A&D sector, and last but not least, a very limited trading window.

As a reminder, our Board of Directors approved a new share purchase program of up to $600 million in October of 2016.

We also initiated our first ever quarterly dividend of $0.10 per share, which demonstrates our confidence in our business.

And we remain committed to a balanced and disciplined approach to capital deployment.

Our focus is on total shareholder return.

For our fuselage segment result let's turn to slide 9. Fuselage segment revenue in 2016 was $3.5 billion, up 2% from $3.4 billion in 2015, primarily driven by higher production deliveries on the A350 and the 767 programs.

Partially offset by lower net revenue on the 787 program due to price step downs and lower production deliveries on 747 and the 777 program.

Operating margin for the year was 13.4% as compared to 17.6% in 2015, due primarily to the net forward loss of $136 million recorded in Q2 2016 on the A350 program.

On a normalized basis, after reversing the changes in estimate charges recognized during 2016, fuselage segment margin was 17%.

Which is within the range we have always provided to you as a reference.

Turning now to Slide 10.

On the A350 program, we delivered 19 shipsets in the fourth quarter, or 69 shipsets in total for the year, compared to 37 shipsets in 2015.

Despite the disruption we experienced in our Kinston operation from the aftermath of Hurricane Matthew, we met our delivery commitments to Airbus.

We also met our financial commitments on the program and finally started to turn the corner and begin to achieve cash positive on a per unit basis at the end of 2016.

Our deferred inventory decreased in the fourth quarter by $21 million or $1.1 million per shipset.

And this was a combination of core performance improvement and the benefit of one-time events, such as foreign-exchange rates.

We remain committed to recovering approximately an additional $400 million on the remaining 667 shipsets in the block.

Obviously a lot more work to do here.

But we are proud of our teams and they are executing to plan.

Now turning to slide 11 for propulsion segment results.

Propulsion segment revenue in 2016 was $1.78 billion compared to $1.75 billion in 2015, driven by higher revenue on certain nonrecurring programs, higher production deliveries on the Boeing 767 program, and the Bombardier C-Series.

This was partially offset by lower production deliveries on the Boeing 747 program.

Operating margin for the year was 18.3%, as compared to 21.6% in 2015.

This year-over-year change was driven by cumulative catch-up adjustments in 2015, one time incentive payments recorded in 2015, and lower production deliveries on the Boeing 777 and 747 program in 2016.

On a normalized basis, after reversing the changes in estimate charges recognized during 2016, propulsion segment margin was 18%.

Which is also within the range that I have provided you as a reference in the past.

For our wing segment results let's turn to slide 12.

Wing segment revenue in 2016 was $1.5 billion up 5% compared to $1.4 billion in 2015, primarily driven by higher production deliveries on A350.

Operating margin for the year was 14.8% as compared to 12.4% in 2015.

The year-over-year increase was mainly driven by higher cumulative catch-up adjustments and changes in estimates on forward loss programs in 2016.

On a normalized basis, after reversing the changes in estimate charges recognized during 2016, wing segment margin was 13%.

Once again, which is also within the range that we have always provided you as a reference.

Turning to our 2017 guidance on slide 13.

We are guiding 2017 revenue to be between $6.8 billion to $6.9 billion.

On EPS we are guiding to a range of $4.60 to $4.85 and finally we're guiding free cash flow to between $450 million to $500 million.

Our guidance is based on an effective tax rate of 31% to 32%.

With that, now let me hand it back over to Tom for some closing contents.

Thanks, Sanjay.

In closing 2016, was a strong year for Spirit.

We successfully negotiated a global settlement with Airbus on the A350, refinanced our debt after achieving an investment grade rating, returned $650 million of capital to shareholders through share repurchases, initiated our first dividend of $0.10 per share, made a seamless leadership transition, and laid the groundwork for a successful 2017.

Our 2017 guidance of revenue and earnings growth, plus a significant increase in cash generation, reflects a strong confidence that we have in our business.

With that, we will be happy to take your questions.

We will now begin the question-and-answer session.

(Operator Instructions)

Our first question comes from Jason Gursky of Citi.

Please go ahead.

Hey, guys, it is actually [John Riva] on for Jason this morning.

Good morning, John.

Can you talk a little bit about cash deployment, just some added color on what you plan to do with the $600 million, how you're weighing the inorganic opportunity?

And especially how much cash deployment is in your guidance for 2017?

Thanks.

I'll start with that.

So first of all, we have the full amount of the authorization of $600 million available as we go into 2017.

And we are planning to execute some of that.

So our guidance reflects a normal amount of share repurchase in it.

As we go forward, as Sanjay mentioned, our focus is going to be on total shareholder return.

So rather than being opportunistic like we were in the past, there will be more regular, steady repurchases that reflect our focus on capital deployment.

In general, we still consider our shares to be undervalued.

We trade at a discount to our peers.

And so, we feel that share repurchases are a good investment and will yield a good return.

In terms of other capital allocation, as I mentioned, we're going to be looking at some inorganic growth opportunities this year.

But there again, the focus will be, it has to meet our thresholds for return.

We think we have some good opportunities perhaps with core bolt-ons in our major business, for structures.

But we also see some opportunities to expand into military through inorganic, and also to vertically integrate to get into some high-margin Tier 2 business to expand our fabrication business, shore up our supply chain, and build some additional third-party fabrication business, especially in defense.

Thank you.

Our next question comes from Cai von Rumohr, Cowen and Company.

Please go ahead.

Yes, thank you very much.

Two-part question: First, where do you stand with the Boeing negotiations?

Is there any timetable for expectations or hope of getting it done?

And secondly, maybe give us some color on how you're doing on the 787 program now that you've folded it in with the other Boeing programs?

Thanks.

Let me start with the first question on the Boeing negotiations.

The teams, this last quarter or so, have made some really good progress at the working level.

As we have mentioned in the past, one of the things we needed to do in the negotiations on the 737 and the 787 is establish some of the cost baselines.

And that required a lot of engineering work.

And there was a lot of engagement on that; the teams made very good progress.

I think both we and Boeing are quite pleased with that.

Still a little bit more work to do, but some major progress.

Our goal has always been, in this effort, is to get to a fair and equitable deal.

And so that has been our focus.

And I think it is shared with Boeing.

We've had a number of engagements and discussions at senior levels with Dennis Muilenburg, with Ray Conner, now Kevin McAllister, as well as some of the finance team.

Those discussions have all been constructive.

And we are, I think both interested in reaching a resolution.

There's no timetable for that.

But we both realize this has been going on for some time, and we need to get to closure.

And that's what the goal is going to be.

Beyond that, this is an active negotiation, so I'd prefer not to add some more comments, beyond the fact that the conversations are constructive.

Both sides would like to get to closure.

At the end of the day, Boeing is our biggest customer; we're their biggest supplier.

Their success is our success.

And we want to do something that is going to be productive and valuable for both organizations.

That's what I'll say on the Boeing.

On 787, again, a lot of progress operationally to continue to reduce costs and make sure we are delivering at quality and meeting delivery schedules.

Boeing has talked about moving to rate 14.

That could happen toward the end of the decade.

We will be ready when that occurs.

Right now we're at rate 12.

For more detailed financials, Sanjay, perhaps you could give us some more detail.

I think, Cai, I know it's a little tongue-in-cheek when you said I hope we will have a settlement.

Of course we will have a settlement.

Frankly, in a number of areas with Boeing every quarter what you guys don't see, there are numerous settlements that happen with Boeing, as we ramp up on rates-related activity or make changes to our product lines and things like that.

So we've always said that the fundamental tenets of our negotiations are founded on being fair and equitable, justifying our cost structure which we believe brings lots and lots of value to both sides, and making sure that we do this thing in a very disciplined manner so that it's not left to the vagaries of the future.

That discussion by default then requires a lot more time and energy and explanation and detail, and those are the kinds of things we are working on.

And as you can imagine, these negotiations can be a little complicated because they are comprehensive.

And they have aspects of recurring, non-recurring and other aspects.

So we are absolutely working on it.

And like Tom said, we are working at the highest levels and we have good conversations about that.

Having said that, at the end of the day, our goal is to get a fair and equitable solution for us, as well as for Boeing.

So, yes, we will make progress on that.

Our next question comes from Doug Harned, Bernstein.

Please go ahead.

Thank you, good morning.

Good morning, Doug.

On the guidance for free cash flow, I'd like to understand a little bit better how you are thinking about this and really the bridge from 2016 to 2017?

Your operating cash, the bottom end of your range is close to where you are today.

But there is significant upside in there.

Could you talk through what that bridge is on operating cash?

And then perhaps also how you're thinking about the CapEx trajectory going forward this year and subsequently?

Let me take that, Doug.

Good question.

As far as CapEx is concerned, I know it's a wide range.

It is $250 million to $300 million -- very consistent with what we told you in 2016.

Frankly, for the next few years, it is likely to be in that range, like I mentioned in my remarks, because we are investing, frankly, in the rate increases that you know about.

But we are also investing in productivity improvements, as we have been in the last two or three years.

And frankly, you saw that in 2016, early part of last year where we announced some new business activity.

So we are also investing in some organic new business stuff that we are doing here.

So it's likely to be in that $250 million to $300 million range.

I've got to tell you we are being very judicious about that, particularly as we manage the rates increasing and the rates decreasing in some areas, to find equipment that can make use in the common fashion, to find equipment that can actually enhance our productivity and our efficiency and so on.

So that's going to continue.

Now, year over year we've always said we want to improve our cash flow.

And this journey started almost three years ago when we said we're going to improve cash flow, not just on the programs that are doing well -- back we used to say the 80% of the portfolio -- but also the 20% of the portfolio that is not doing very well.

And A350 is a component of that.

You started to see we have turned the corner associated with the A350 program.

We've obviously still got lots more work to do and can sometimes have hiccups like we saw in Q4 with things outside of our control.

Having said that, that should help in terms of cash flow.

Our core improvements in cost reductions across the supply chain and those areas, also improvement in cash flow.

And again, some of you may have seen this.

You know we did a small [ERP] in Q4.

This was all to try and manage, proactively, all the costs associated with the shifts that are happening in our industry in terms of rates, as well as to try and get better cost structure and discipline and become the best value aerostructure provider.

So across the board, it will be in cost, it will be some good performance on programs that in the past were consuming cash and obviously, supply chain strategies and so on.

All of that will get us, I think, to our eventual goal of getting consistently within 6% to 8% free cash flow to revenue.

I would just add to that, that the capital expenditures, as Sanjay mentioned, it includes all the investments for rate on 737, plus all the Airbus programs.

So that's all incorporated.

We've also included all the capital expenditures for our defense program.

So that's included within that guidance.

And as we start to think about organic growth, particularly in third-party fab, there are some investments we want to make in capacity and in capability which we've also included in that.

As well as, we are driving our supply chain strategy and looking to get to the best optimal cost.

There is some transfers of work, there are some investments in tooling, all that is included.

It's a full number.

And I'd also say, on cash flow for next year, Doug, there's a lot of working capital blocking and tackling that we are starting to look at quite vigorously.

So whether it's inventory, accounts payable, accounts receivable, there's a lot of incremental improvements that should also help with cash flow as we go forward.

But, Sanjay, on what you said earlier, is it correct to say that from an operating standpoint that the A350 improvement, would that be the single largest driver of additional cash in 2017?

It's certainly a sizable component, Doug.

But it's not the only driver.

Again, cash flow as you can imagine is a little lumpy.

Tom just mentioned working capital improvements as we get to more stability on certain programs, we should start to see some benefits there.

But, yes, it is a big driver, absolutely.

Okay, great.

Thank you.

Our next question comes from Robert Spingarn of Credit Suisse.

Please go ahead.

Good morning.

Good morning, Robert.

A couple of things, just on that last part: Tom or Sanjay, making all these investments, I wanted to ask Tom to expand a little bit on your interest in vertical integration.

And then maybe, Sanjay, how does this all translate into a long-term margin?

What kind of opportunity is there?

So let me start with that on vertical integration and expanding our third-party fab business.

Right now, Spirit's one of the largest fabrication companies in the world.

We have well over $500 million of activity.

We make about 38,000 different parts, in terms of machining, sheet metal, skin fabrication.

We do processing; we do a lot of plate cutting.

We have all that capability.

All of it is internally consumed though, right now.

And as we look at the market, there's certainly a lot of opportunity to sell some of those services to third parties, not only commercial, but also in defense.

The other thing is, as we look at tier 2, even tier 3 supply chain in aerostructures, is there's often very strong margins in those areas.

So that's an opportunity for us to take advantage of that and capture some of that margin.

And then from a supply-chain standpoint, this gives us additional opportunity to manage with our suppliers to figure out the right configuration of what we want to buy and what we want to make to get to the optimal cost structure.

And so it gives us a lot of flexibility as we pursue our supply chain strategy.

So, there's a number of different reasons that we have been pursuing this.

It's profitable business, we are already doing it, it's low risk, we know how to execute.

There's a lot of market opportunity.

And it expands the flexibility that we have in our supply chain.

And, Robert, the only thing I would add, and you know the long-term strategy is important, not just because it's the right thing to do here because of all that scale and capability that Tom mentioned.

But think about it this way: If, in fact, we can tap into some of the excess capacity that we have, given the fact that we are the largest fabricator anyways or if you can absorb some of this inside our footprint, with the same management teams or certain fixed costs that we have, to that extent this should be incrementally accretive to us and be a pretty good business going forward.

We know how to do this.

We have certainly the expertise to do it.

We certainly have the footprint and, in some cases, even the equipment and the spare capacity to do it.

So we think it will be a good thing.

So obviously this is both a revenue- and a margin-enhancement opportunity?

Yes, everything we are trying to do, Robert, is to try and do both of those things.

Plus it will also help in our supply chain to drive down costs and get to the most optimal cost (multiple speakers).

And that's what I mean by margins; it works both ways.

So what's the time frame on this?

Well, we're starting now.

We've initiated some new business relationships.

As Sanjay mentioned, we've got a fair amount of excess capacity in some sheet-metal, as well as machining and processing.

And we can start basically monetizing that right away and we are doing that.

(Multiple speakers) so this is going to build gradually, but we've got some material revenue targets in place for this year that we want to achieve.

Okay.

I guess you don't want to share those at this point, but you know --?

Not yet.

Okay.

One last question -- high-level Boeing negotiations.

Does a final agreement with Boeing, is that incumbent upon some kind of decision on the next program, MoM?

No, it's independent of that.

Okay.

I will say that the middle of the market is something that we would like to be on.

We have to earn our way onto it.

We think we bring unique capabilities that would make us a valuable partner.

And that's really the way we're presenting it to Boeing is it's something we want to be on.

Robert, one more time, just for everybody because I know this comes up.

The fundamental tenet of our negotiation settlement with Boeing is based on the concepts of having a fair and equitable arrangement.

And, yes, based on everything we are doing to manage our costs and bring the best value to our customer.

But at the end of the day, it has to be fair and equitable in its current context.

Our next question comes from George Shapiro, Shapiro Research.

Please go ahead.

Yes, just a follow-up on the contract negotiation with Boeing.

It looks like you certainly didn't return the money that Boeing had asked you to return.

Is there a time frame on when you have to reach a deal before you return that or is it open ended?

And the second part is, are you still comfortable with the interim agreement?

So you've been saying all along, if you don't reach an agreement, you're happy with the interim one.

And I just want to know whether that's still the case.

So, implication would be that any deal would have to be at least as good as the interim agreement.

Thanks.

Well, with regard to the cash, that's going to be part of the final negotiation.

So, we will resolve that as part of the negotiation, and determine the actions to take.

In terms of the interim agreement, as we have said, it's satisfactory.

In terms of timing, though, our goal with Boeing is to reach closure.

This has gone on for quite some time, as you know.

And both of us would like to reach closure, so that's what the objective is.

So, you put a time -- is it like this year or there's no time frame on it?

There's no time frame on it, but sooner the better.

Okay.

Thank you.

Our next question comes from Seth Seifman, JPMorgan.

Please go ahead.

Thanks very much, and good morning.

Good morning, Seth.

Sanjay, I wonder if you could walk a little bit through the profitability in 2016 versus 2017?

And we can back into what a margin might be.

I'm not sure if you want to say exactly how much share repurchase you plan to do.

But do you plan for the share count to be down off of the Q4 level in your guidance, or flat?

And then given the increasing A350 and the changes on 737 and 777, the changes in your underlying profitability through the year?

Sure.

So the first question, yes, we've got a certain amount of assumptions in terms of share repurchase, like Tom mentioned.

And that is bounded inside our guidance.

At this stage, our guidance is wide, and the number of share repurchase, which will be fairly balanced.

We're migrating, like Tom mentioned in his remarks as well, is getting balance from a -- in terms of a total shareholder return perspective.

We've obviously got some numbers in there.

And we'll see how the year works out.

And then if it changes, then we will see the impact.

More importantly, let's just talk in terms of profitability.

Because I was reading some reports earlier this morning in preparation for this call from a number of you, and the core question in terms of, is the margin segments looking good?

That's why I modulated my remarks to make sure you understood that if you really look at our fuselage, propulsion, and wing segments, the margins have been pretty consistent in the context of what we said in the past and how we performed.

On a quarter-by-quarter basis, and sometimes even slightly, things do modulate because we make certain investments, and there are certain expenses in our factory that allocate their way into either the fuselage or the propulsion or the wing areas.

Sometimes there are some small charges that happen associated with small impairments or tooling, et cetera.

But at the end of the day, what we've been guiding you guys is to say, look at our fuselage segment around 17%, and look at our propulsion 18%, and wing at 13%, and those should be consistent.

The trick here is to continue to take our costs down in the future, to make sure we manage all the challenges that come out of rate increases.

Because sometimes rate increases are not the easiest things to do.

It sounds easy, but sometimes you have to make investments in people, and training, and other costs that can create a little bit of volatility inside a quarter.

At the end of the day, we think our profitability in our core business should be around those stable numbers.

And if we did that, and then going back to Doug's question, we should be able to generate the appropriate cash, including in some of the other areas that are 0% margin programs, to deliver the 6% to 8% free cash flow we want to deliver.

And that is, at the end of the day, what we are striving to do here.

Let me just stop for one additional comment.

As we look at next year, I mentioned in my opening remarks that our guidance for next year includes the rate adjustment on the 777, which goes from 7 to 5. In a full-year basis, as the 737 ramps up in rate from 42 to 47 and beyond, It would more than offset the impact on the 777.

But next year is a little bit unusual because we're going to get most of the full-year impact on the 777 rate decline, but the 737 rate increase doesn't kick in until toward the latter half of the year.

So there's a little bit of a mismatch next year, and that's obviously also impacting on margins and revenues.

Great, thank you very much.

Thanks, Seth.

Our next question comes from Howard Rubel, Jefferies.

Please go ahead.

Thank you very much.

You were proactive in resizing the workforce and offering some early retirement.

Tom, could you address how you think about continuing to work productivity, and manage the labor force and the opportunities?

Right.

Howard, as we go forward, one thing, as rates go up, we've got to make sure we size for that.

So there's a lot of moving parts in the whole equation.

But we have a lot of cost-reduction activities across all of our different buckets.

So there is significant effort in terms of supply chain.

We have a lot of focus on our non-labor costs.

But in terms of labor, it's really all about productivity and digitization.

I mentioned that we have a lot of effort around our shop floor digitization.

And we have a program for example that we call, mobile mechanic.

And what that is, is really empowering our shop floor employees to have ready access to work instructions, but also the ability to start and stop their tasks on an automated basis.

That allows us to become much more productive.

With Boeing we have been working a lot with the Boeing production system and looking at, as we segment activities into tasks, what's the champion level time that we've ever achieved for a certain task?

And if we add that up and accumulate it across the entire set of tasks, what's the champion time for a whole aircraft, for example?

So as we move forward with those initiatives, and we get more and more granular, we will be able to drive direct labor cross-productivity.

At the same time, we looked at our support to touch ratios, and make sure we are optimizing our support labor in the factories.

That could be inspections, could be logistics, could be quality, as well as all the other support activities.

So it's really a comprehensive set of initiatives to address not only the material costs and the non-labor costs, but also direct labor and indirect support labor.

Why wouldn't this lead to improved profitability as opposed to the stable numbers that Sanjay talks about?

Well, a couple reasons.

As we go forward in terms of the overall economics, we're always facing escalation in labor rates, we have material escalation.

We're offsetting those things.

And as you know, we have some supplier stepdowns in different programs.

So, it's a mix of all those things.

Our target really has been to keep margin stable as we go through all of that volatility.

Thanks, Tom.

Our next question comes from Robert Stallard of Vertical Research.

Please go ahead.

Thanks very much, good morning.

Good morning, Robert.

On the 2017 guidance, you said you've anticipated the 777 rate cut, and obviously that program is going to keep trending down from there.

What's your sense of the inventory in the chain on this aircraft?

And what sort of threat do you have from destocking, and what sort of opportunity is there?

Well, I mean the 777, the rate guidance that Boeing has given, we've taken that into account.

I don't think that the working inventory is at all unusual for a program of this size.

That's not something that's going to be necessarily a big driver for us.

Our focus on 777 is really to make sure that we get the cost aligned with the rate reductions.

We've done a lot of work to restructure the workforce around the wide bodies and to streamline so that we get the leverage of all the volume we're doing here in Wichita across all the Boeing programs.

And that's enabled us to take quite a bit of management layers out, as well as to reduce support ratios.

Because we've really aggregated the activities into bigger buckets.

Going forward, we're actually quite optimistic about the 777, as the 777X comes online.

You heard Boeing CEO Dennis Muilenburg last week say that 2017 looks sold out, 2018 and 2019 mostly sold out.

And so they're going to be working on filling up those gaps.

But going into the 2020s, if you look at revenue passenger growth is still strong.

There's going to be a retirement wave of the wide-body aircraft.

So, we're very optimistic that program will pick up, and that the current rate is really for this current period of time.

Okay, thank you.

Our next question comes from Sam Pearlstein, Wells Fargo.

Please go ahead.

Good morning.

Good morning, Sam.

Morning, Sam.

Could you talk a little bit more about the A350?

You had good sequential improvement; last quarter you talked about some one-time items.

This time you mentioned some also, like FX.

So I guess I'm wondering, can you give us at all any estimate as to where deferred would be at the end of this year?

And I know it's a multi-part question, but adding in A350 1000, is that also seeing a decrease or are we going to get an increase as you see more 1000s?

Sam, let me take that.

Clearly, deferred at the end of 2017 should be lower based on our plans, because we just talked like to Doug in terms of it's a cash generator for us.

And we expect that to happen.

It's true that there was some benefits in terms of the foreign exchange, because as the dollar has strengthened, some of our inventory, et cetera, in Prestwick it valued lower.

But I will tell you the majority of the improvement that we saw in the $1.1 million, not all of it, but the majority of it was operationally driven.

So we're feeling good about the fact that the program is delivering what it says it's going to deliver.

The key there obviously is also going to be on rates and how we manage, not just ourselves but also our customer, and keep going on the trajectory we're working with them on.

And so far everything there we see is on track.

So, I can't give you a number in terms of specific.

We don't want to get into program-by-program level deferred inventory that's out on the A350.

It will be down.

We are making good progress, and it's mainly operational progress.

And do you still complete the advance repayment in the second half of the year?

Yes, it's towards the end of the year, but, yes.

Based on the rates, et cetera, by the end of the year thankfully that's the cigar that I am waiting to smoke when we are done paying our advance payments to Airbus.

Okay, thank you.

Our next question comes from Myles Walton, Deutsche Bank.

Please go ahead.

Thanks, good morning.

Sanjay, I was hoping to touch on the fuselage margin, the 17%.

And if that was you think still going to be, over the next few years, a good number given the rate reduction on the 777?

I imagine this accounting block, you have got some of the headwind but you don't have the step down to 3.5 a month as delivery rate, the higher A350.

And just, is 17% a good number for 2017 and 2018 as a percent?

Everything that you mentioned, and this goes back also to Howard's question.

Listen, we're going to take cost out to maintain our margins.

It is true that as the A350 ramps up and the margin on the A350 is 0%, it obviously dilutes the fuselage segment margin, and obviously has a decent impact there, likewise the 777 also.

But this is where we're doing everything we can to take our costs down, in some cases faster than the rate impacts that affect us, to make sure that we maintain these margins.

So, yes, I see, we ended up, if I look at the full year in 2016, it's about 16.8%.

So in that 16%, 17% range, yes, we see that for 2017.

Just a clarification: The 787 deliveries in the second half of the year looks below production rate, is there a catch-up in 2017?

No, that was just timing.

Like we said in our prepared remarks, we met all of our customer requirements.

So this goes back to little bit of timing flow with our customer in terms of the quarterly and quarterly deliveries.

There's nothing other than timing.

Okay.

Thanks.

Our next question comes from Rajeev Lalwani of Morgan Stanley.

Please go ahead.

Thanks for the time.

Two questions for you -- two quick ones rather.

On the 737, can you talk about when the rate step-ups happen in 2017 and 2018, in particular?

And then, Sanjay, on the guidance that you put out on earnings for the year, does that incorporate a fair and equitable arrangement with Boeing?

So let me take the 737 question first.

The plan is that 47 will kick in at mid-year for 47 this year.

And then the next rate ramp is really mid-year next year for 52, is what the indication is that Boeing has given us.

So we're obviously prepared to move to 47 because that's imminent.

And then the planning is well under way for 52 and then 57.

And, Rajeev, in terms of guidance, yes, I think -- at the end of the day, we are getting interim payments, like Tom mentioned, [was] satisfactory, and those are the foundation of what we guide to you.

And our negotiations are on the basis of fair and equitable arrangements.

So, theoretically, yes, our guidance assumes that we will conclude, and we will conclude in a fair and equitable manner.

Very helpful.

Thank you, gentlemen.

Thanks.

Our next question comes from Ken Herbert of Canaccord.

Please go ahead.

Hi, good morning.

Good morning.

Just wanted to clarify something, based on the timing of the rate break on the 737 and the 777, is it fair to say that -- I know, Tom, you mentioned earlier that from a cash standpoint you expect the increase on the 737 to more than offset the decline on the 777.

But is it fair to say that maybe, because of the timing, you're not seeing that full recapture in the FY17 free cash flow guide?

Yes.

That's exactly right.

There's a mismatch in the timing, so we don't get the full-year benefit of the 737, but we see the rate decline on the 777.

So there is a mismatch.

Okay.

So then that obviously -- you should see that catch up and then some in 2018 I'd imagine?

Correct.

Okay.

All right, thank you very much.

I just wanted to clarify that.

You're welcome.

Operator, we have time for one more question, please.

Yes, our next question comes from Richard Safran, Buckingham Research.

Please go ahead.

Tom, Sanjay, Ghassan, good morning.

Good morning, Richard.

Morning.

So just to close out here, a bit of a multi-part question on defense that follows up on your remarks.

I may have missed something you said.

So first off, on your B-21 contract program, are you in a position to discuss the revenue you're expecting on the program this year, and maybe size that just in terms of the other programs?

And on defense in general, I take it from your remarks that you're thinking more positively, that there are incremental opportunities on new programs.

Do you expect those opportunities to materialize in 2017 or are they later than that?

And lastly, if you do win these new opportunities you were discussing, do they come with a commitment to make additional technology or capacity investments?

Let me start with B-21.

It's a classified program, so we can't really discuss what the revenues will be this year.

But what I did say is that the capital investments have all been incorporated into our guidance on that.

The second question you had was, if we're working on defense programs, if we will see the impact of that in 2017 or later?

Most of the programs obviously have a long lead time in terms of gestation.

So, the biggest impacts will be down the road.

So, for example, with the CH-53K, that is going to be a very nice program for Spirit.

But it will be several years before we start to see material impact.

What we are going to be doing is looking at opportunities to expand our work packages in the component area.

That will have a little bit more of a near-term opportunity for us as we go forward and inorganically, again, looking at companies that are already on packages.

So those are the ways that we will try to pull in some of the impact of defense spending.

Thanks very much.

Okay, you had another question about capital investment, which I think we addressed in terms of how we've incorporated all of it into our guidance.

On the cost side programs, obviously we can't go into more detail.

Thanks, Richard.

Okay.

Thank you.

That concludes our earnings call.

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The conference is now concluded.

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