Spirit AeroSystems Holdings Inc (SPR) 2017 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to Spirit AeroSystems Holdings Incorporated Second Quarter 2017 Earnings Conference Call.

My name is Phil, and I will be your coordinator today.

(Operator Instructions) Please note that this event is being recorded.

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

Please proceed.

Thank you, and good morning, everyone.

Welcome to Spirit's Second Quarter 2017 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.

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 2017 Second Quarter Earnings Call.

Executing on our commitments to our customers and to our shareholders resulted in excellent operating performance in the second quarter.

But before I get to an overview of that outstanding performance, I want to take a minute to describe in more detail the exciting news that we have reached an agreement with our largest customer, Boeing, into 2022, on open commercial issues related to a range of programs, including the 737 MAX and the 787.

We have signed an MOU reflecting our agreement, and we'll now be working on formal amendments to the program agreements.

As described in the earnings release this morning, the MOU requires that the parties negotiate and execute Definitive Documentation in the third quarter of 2017, and both parties are motivated to do so.

Overall, by addressing a range of programs and not just the 787 pricing, the MOU reduces much uncertainty that has long existed in the relationships with our largest customer and preserves our ability to meet our long-term cash flow goals.

One of the biggest challenges in our discussions with Boeing has been 787 pricing.

As part of this new MOU with Boeing, we are extending the block from 1,003 units to 1,300 units and establishing a planning block through line unit 1,405.

Although the 787 contract had agreed price step-downs for the 787-8, we had never agreed with Boeing on pricing for the -9 and -10.

We have now agreed on modified step-down pricing for the 9 and 10 through line unit 1,405.

As a result of the MOU, we have recognized a reached-forward loss of $353 million on the 787 program.

This loss amount is based on a number of assumptions, including our estimates of the future cost of the program.

To that end, the agreement also includes a commitment from both organizations to work together on joint cost reduction efforts with financial incentives for both parties.

There are several other important elements to the MOU.

First, we have agreed with Boeing that we will jointly study advanced aerostructures and manufacturing processes.

And as part of our commitment to Partnering for Success, we agreed to productivity discounts tied to volume commitments from Boeing on the 737.

We have also agreed with Boeing to pricing on the MAX.

Boeing and Spirit have an agreement on investments for rate increases on both the 737 and 787.

In addition, as we expected, once Definitive Documentation is in place, we will return the $235 million received under the 787 interim pricing agreement.

As we have discussed in the past, our understanding has always been that we would return the interim payment once we reached agreement, and as a reminder, we have never recognized this as revenue or reported cash flow.

Finally, as part of the agreement, Spirit will move to industry standard payment terms.

We will leverage a vendor financing program so that this should not impact cash flow.

Sanjay will provide more details on the financial aspects of this agreement shortly.

I would like to turn now to the strong operating highlights from the quarter.

Excluding the impact of the MOU, our earnings per share were $1.57.

In the second quarter, we delivered a record 424 shipsets compared to 408 shipsets in the same period last year, primarily driven by the ramp up in production rates on the 737, the A320 and the A350 programs.

Our supply chain cost reduction initiatives are gaining traction, and we are finally fully recovered in Kinston and back to our normal mode of sea transportation, following Hurricane Matthew last October.

As we mentioned in last quarter's earnings calls, we have filed appropriate claims with our insurers and anticipate having a resolution before year-end.

With regard to capital deployment, in the second quarter, we've repurchased 2.2 million shares for $126 million.

Year-to-date, we have deployed a total of $208 million and repurchased 3.6 million shares under the existing authorization of up to $600 million.

Separately, we met with our board and conducted a strategic review of the market.

Presently, we do not see any large acquisitions that would meet our strategic and return thresholds.

The board has, therefore, authorized an increase of our share repurchase program by $400 million, resulting in a total program authorization of $1 billion.

Since we have already deployed $208 million, we have approximately $800 million remaining.

In addition, after paying our third quarterly dividend of $12 million in July, our Board of Directors declared another quarterly cash dividend of $0.10 per share to be paid in October.

Turning to some key milestones in the second quarter.

Early in the quarter, we celebrated with Boeing the first delivery of the 737 MAX to Malindo Air.

Spirit proudly produces 70% of the aerostructures on every derivative of the 737 plane.

The main highlight of the second quarter was the Paris Air Show.

As the aviation world converged on Paris in June, our Spirit team took full advantage of the opportunity and conducted hundreds of meetings with customers, suppliers, investors and government officials.

We also made several key announcements through multiple press releases regarding business growth opportunities and strategic technology collaboration with one of our suppliers.

One of the most exciting announcements came from our largest customer, Boeing, on day 1 of the air show when they announced the launch of the 737 MAX 10.

On the day of the announcement, the MAX 10 received more than 240 orders and commitments, and by the end of June, that number had increased to an impressive 361 orders and commitments.

The key design change for the MAX 10 is a fuselage stretch of 66 inches compared to the MAX 9. Spirit builds 100% of the fuselage structures of all current and future 737 derivatives right here in Wichita, and we are extremely proud to be a key enabler and a trusted partner in the successful launch of the MAX 10.

Spirit recently made several announcements regarding the growth of our global fabrication business.

We announced the creation of a new 5-axis fabrication center of excellence and the expansion of our chemical processing capabilities on our Wichita, Kansas, campus.

In addition, we announced the creation of a new 3- and 4-axis fabrication center of excellence in McAlester, Oklahoma, and the expansion of our manufacturing facilities in Malaysia.

All of these initiatives solidify Spirit as a world leader in the fabrication of detailed parts for the commercial and military aerospace industry.

Another announcement Spirit made in Paris was a technology collaboration with Norsk Titanium.

The agreement focuses on 3D printing of titanium parts, using Norsk Titanium's proprietary rapid plasma deposition technology to reduce our material costs substantially.

In addition, we have captured next-generation spoiler work on the A320 platform through application of our R&D technology strategy as part of our cost reduction partnership with Airbus.

We are very pleased with the range of technical interaction we are now having with Airbus, and this win positions us better in the future to win even more Airbus work.

Now let's take a look at second quarter results.

For the quarter, we reported revenue of $1.8 billion, about flat with last year.

Operating income was a loss of $83 million, and net income was a loss of $57 million, taking into account the Boeing MOU.

Reported earnings per share were negative $0.48.

Adjusted for the impact of the MOU with Boeing, EPS was $1.57.

Operating cash flow was $222 million, and free cash flow was $175 million.

Our backlog at the end of the second quarter remains steady at $46 billion, with work packages on all the commercial platforms in the Boeing and Airbus backlog.

Sanjay will provide you with more specifics about the second quarter financials in a moment.

Now turning to 2017 guidance.

Given the strong performance in the first half of 2017, we are raising our full year adjusted earnings per share guidance by $0.40 to a new range of $5 to $5.25 per share from the previous range of $4.60 to $4.85.

Additionally, we are raising our free cash flow guidance to a new range of $500 million to $550 million from the previous range of $450 million to $500 million.

We continue to support the guidance we gave you last quarter for revenue to be between $6.8 billion and $6.9 billion.

With that, I'll turn it over to Sanjay to provide you with more specifics about the second quarter financials.

Sanjay?

Thank you, Tom, and a very good morning, everybody.

Obviously, a lot to talk about today.

I'm also reading that the Dow is flirting at about 22,000, so certainly, picked a good day to have our earnings call.

But first and foremost, we've had a terrific second quarter from an execution perspective.

And I want to thank the entire Spirit team for once again executing and demonstrating consistent and strong results.

And we will talk in detail about those results in a moment.

But before we jump into the quarter and given the importance of the MOU with Boeing, let me provide a bit more color on the components of the deal.

The MOU strengthens our relationship with our biggest customer, and further aligns the parties for future success.

It also enables us to spend additional time focusing on our operations and future growth opportunities.

While we are never happy about taking forward losses on any program, the 787 settlement, coupled with other aspects of our agreement, is an acceptable outcome for us and allows us to generate consistent and increasing cash flow going forward.

So on the 787 program, some additional color.

First, we are extending our block to 1,300 units, this is consistent with Boeing, and also establishing a planning block through the line unit 1,405, which is consistent with our pricing agreement.

And this reach-forward loss covers both of these blocks.

So now we are making estimates on our costs all the way into line unit 1,405, and while as required, we are making prudent assumptions on supply chain and learning costs over this extended period, I must stress that we have internal plans to do better on those cost goals.

Since delivery of these units is likely to stretch into 2022, we have some time to affect real change, to convert our opportunities and eliminate our risks.

Second, if there should be a rate increase from 12 aircraft per month to 14 aircraft per month as Boeing has talked about, there could be a modest benefit from that fixed cost absorption that should help with this effort to reduce costs further than assumed.

Third, both companies have agreed on mechanisms backed by shared financial incentives to help each other in bringing this cost further down.

Fourth, most of this reach-forward loss relates to units beyond our current block.

And so there is time to get some of our ideas in play, but also, as you know, after line unit 1,120, we should finally be done paying off the advanced payments of $700,000 per shipset and neutralize some of the cash flow headwind for the company on this program after that time frame.

Last and definitely not the least, we have a fantastic team on the 787 program, one of the best.

And as many of you know, they've demonstrated a steadfast performance relative to coming down some aggressive curves established during the execution of our first block, and in fact, at the end, performed slightly better than the original cost challenges we laid out for them in 2013.

So we have renewed confidence in their ability to once again perform.

Tom also talked about our agreements on the other programs that are part of our master agreement.

While we cannot discuss program by program details nor can we get too specific, I can repeat a few facts.

First, it locks in pricing into 2022.

Second, it has productivity discounts, which are cleanly tied to volume changes.

Third, we have agreed on investments to achieving these rate changes.

Fourth, it sets the price for the 737 MAX.

Fifth, it allows us to return the $235 million of interim cash net of some payments owed to us in 2017 that was part of our current year guidance.

Lastly, we are transitioning to industry standard payment terms, which will take effect upon us working through supply financing arrangements.

So finally, what does this mean in terms of our long-term outlook on our ability to generate cash?

Over the last few years, we have made tremendous progress on focusing the company on generating cash flow.

Since 2013, we have steadily improved our performance, reduced our risks, balanced our investments and consistently delivered increasing cash flow.

And all Spirit employees have this in our performance metrics.

We have also communicated on numerous occasions to you our goal to generate 6% to 8% free cash flow to revenue, which we believe is a good metric to measure our performance.

Our guidance for this year also is in that range.

Subject to concluding this arrangement with Boeing, we would like to increase our goal to a new range of 7% to 9% of revenue.

Let me repeat, while we are not giving guidance beyond this year, we are changing our goal from 6% to 8% to 7% to 9% going forward.

Also, this agreement will allow us to ensure that our cash flow will continue to improve each year, including next year, as we approach the higher end of that range.

In a nutshell, that summarizes our economic outlook.

We believe the agreement with Boeing is fair and allows the company to preserve the ability to generate meaningful cash flow consistently going forward.

This will also allow us to fuel the growth strategies that Thomas talked about in fabrication and defense.

So with that, let's now transition into the solid Q2 results and full year guidance.

Starting on Slide 4. Revenue for the quarter was $1.8 billion, consistent with the same period of 2016, driven by higher production deliveries on the 737 and the Airbus A350 programs, and offset by lower production deliveries on the 777 program and decreased aftermarket activity.

For the quarter, we delivered a record 424 shipsets, including 136 737s, 19 777s, 36 787s and 150 A320s and 23 A350 shipsets.

Our backlog at the end of the second quarter remains stable at $46 billion.

Moving to Slide 5. Second quarter reported EPS was negative $0.48 compared to $0.35 in the second quarter of 2016.

As we have disclosed, both periods included significant onetime events.

For comparison, adjusted EPS in the second quarter was $1.57 compared to $1.21 in the second quarter of 2016, reflecting a 30% year-over-year improvement.

2Q '17 EPS was adjusted by $2.05 per share to account for the impact of the MOU with Boeing compared to $0.86 in 2Q '16 for the Airbus settlements and other onetime charges.

This improvement in adjusted EPS was driven by 3 equal factors: first, a lower share count; second, some benefits associated with lower tax rates; and most importantly, better operational performance.

Turning to free cash flow on Slide 6. Free cash flow for the quarter was $175 million compared to $161 million of free cash flow in the same period last year, a 9% year-over-year increase.

Capital expenditures for the quarter were $47 million compared to $54 million in the same period last year.

This is only a timing issue.

We still expect CapEx for the full year to remain steady in the range of $250 million to $300 million.

Turning next to capital deployment on Slide 7. In the second quarter, we repurchased 2.2 million shares for $126 million.

Year-to-date, we have purchased 3.6 million shares for $208 million.

Built on the foundation of a long-term agreement with our largest customer, our conservative balance sheet and our new goal of 7% to 9% free cash flow conversion, our Board of Directors has authorized an increase of $400 million to our existing share repurchase program, resulting in a total authorization of up to $1 billion, of which $792 million is now available to deploy.

In addition, our Board of Directors declared another quarterly cash dividend of $0.10 per share to be paid in October.

As we mentioned previously, our fundamental focus remains on generating strong free cash flow and then deploying it to our shareholders.

Now let's look at our segment performance.

For our Fuselage segment results, let's turn to Slide 7. Fuselage segment revenue in the quarter was $939 million, up 2% from $924 million in the same period last year, primarily due to higher production deliveries on the 737 program, increased defense-related activity, partially offset by lower production deliveries on the 777 program and lower aftermarket activity.

Operating margin for the quarter was negative 8.5% as compared to 2.3% in the same period last year, primarily due to the impact from the Boeing MOU.

On a normalized basis, after reversing the impact of the MOU and other changes in estimate charges recognized during 2Q '17, Fuselage segment margin was 17.6%.

In the quarter, we delivered the 600th 787 shipset to Boeing, and we are now operating at a steady drumbeat of 12 shipsets per month.

On the A350 program, we delivered 23 shipsets in the quarter compared to 20 shipsets in 2Q '16.

Deferred production balance decreased by $7.7 million in the second quarter despite an unfavorable foreign exchange impact.

We have now fully recovered in Kinston from the aftermath of Hurricane Matthew, and in the quarter, recognized a final residual charge of $9.1 million, which brings the total cost of this weather-related event to $32 million, for which we have filed appropriate claims with our insurers, and we have made an appropriate assumption for recovery on these claims in 2017.

Consistent with what we have said before, future Fuselage margins are forecasted to be in the 16% to 17% range.

Now turning to Slide 9 for our Propulsion segment results.

Propulsion segment revenue in the quarter was $437 million, down from $482 million in the same period last year, primarily driven by low production deliveries on the 777 program, lower revenue on the 787 program and decreased aftermarket activity, partially offset by higher production deliveries on the 737 program.

Operating margin for the quarter was 9.4% compared to 15.4% during the same period of 2016, primarily driven by the impact from the MOU with Boeing.

On a normalized basis, after reversing the impact of the MOU and other changes in estimate charges recognized during 2Q '17, Propulsion segment margin was 19.6%.

Future Propulsion margins are again forecasted to be in the 17% to 18% range.

For our Wing segment results, let's turn to Slide 9. Wing segment revenue in the quarter was $451 million, up 6% from $424 million in the same period last year, in part, due to higher production deliveries on the A350 and A320 programs as well as high revenue recognized on the Boeing 787, partially offset by the absence of onetime claim settlements with customers that took place in the second quarter of 2016.

Operator margin for the quarter decreased to 6.8% compared to 15.3% in the same period last year.

On a normalized basis, after reversing the impact of the MOU and other changes in estimate charges recognized during 2Q '17, Wing segment margin was 14.1%.

Future Wing margins are forecasted to be in the 13% to 14% range.

Turning now to 2017 guidance on Slide 10.

We are increasing our full year adjusted EPS guidance by $0.40 to a new range of $5 to $5.25.

We are also increasing our free cash flow guidance for 2017 by $50 million to a new range of $500 million to $550 million.

And we are reaffirming our revenue guidance for 2017 to be between $6.8 billion and $6.9 billion.

Our guidance is based on an effective tax rate of approximately 29%, which is reflective of the Q2 charge.

Lastly, I want to reiterate that we are increasing our goal for free cash flow conversion to be between 7% to 9%, instead of 6% to 8%.

Now let me hand it back over to Tom for some closing comments.

Thanks, Sanjay.

As you can see, we had a strong operating quarter and exceeded our target objectives.

Execution on our important long-term initiatives is proceeding on plan.

Most importantly, we are executing on our quality, delivery and rate commitments for our customers, including Boeing and Airbus.

In addition, our supply chain initiatives are delivering, and we are expanding our third-party fabrication capabilities, and we are making headway in a growing defense business.

But the big news in this quarter, of course, is the MOU with Boeing, on settling long-standing commercial issues on a range of programs, including the 737 MAX and the 787.

This agreement will help reduce the uncertainty surrounding the commercial terms with our largest customer and position us to be an even stronger partner with them going forward.

The MOU preserves our ability to deliver on our long-term cash flow objectives.

Overall, we are pleased to achieve this important milestone with Boeing, and it makes us even more optimistic about the future than ever.

With that, we'll be happy to take your questions.

(Operator Instructions) Our first question comes from Doug Harned with Bernstein.

So it wasn't very long ago when you were talking about the big gap between you and Boeing, and Boeing for the same thing.

Could you give us an idea of what happened here?

This seemed to come together pretty quickly.

And once -- once this agreement is finalized, how do you see it changing the way you work with Boeing from an operating standpoint, because this has been kind of a painful overhang for quite some time?

Right.

Well, Doug, as we mentioned in the last call, there was a significant gap.

Following that call, though we continued discussions with Boeing at very senior levels and they ebbed and flowed, but really in the last few weeks, they started to coalesce and we started -- we had a framework, and we started to -- reach some agreements on some key aspects of the agreement.

And an agreement like this is very complicated.

It focuses on 737 and 787, but there's probably 13 or 14 elements to it, and Sanjay described some of those as I did.

But over, really, the last few weeks, everything came together, and we finally reached agreement.

So that's a big step.

And we still have some work to do on the detailed documentation in the program agreements.

But the good thing is, is that we pushed ourselves hard in the last few days even to put in place a fairly detailed MOU.

And by going through a lot of detail in that MOU, we flushed out all the big issues and we know where we are, and we documented that in some detail.

So we have that as we go into the detailed documentation, and we expect to get that done by the end of the third quarter.

Both parties are motivated to do that, so I'm quite confident that it will happen.

And so that was definitely worth the effort to do a detailed MOU.

On the operating side of things, this certainly helps.

We've always had a good relationship at the program level and between our factories.

We have mechanic-to-mechanic communication, we have regular program reviews, and so that relationship has always been healthy.

But there is, in fairness, always been an overhang because of these outstanding commercial issues.

Now that those are resolved, this should result in a better level of overall cooperation.

We will rejuvenate those technical cooperation initiatives.

And I mentioned that we have an agreement to have a study on advanced aerostructures and manufacturing processes.

And so I'm confident that by having this agreement now behind us, we can start to have a healthier relationship.

Still going to be focused on cost quality and delivery every day.

That's what being a partner is all about.

And we're really focused on the Partnering for Success that Boeing has initiated and making sure we are doing our part.

And this agreement really preserves that and strengthens the relationship, and makes it more likely that we'll work together in the future on different initiatives.

So all in all, a good outcome.

But would it be fair to say that the completion of this takes away, what I would say, any extra pressure related to Partnering for Success pressure on your margins, that sort of thing?

Not that you aren't going to still focus on cost; both of you will.

But there's not sort of a next shoe to drop or anything like that with respect to impact on your margins from Boeing.

Right.

We've agreed to what we're going to deliver, in terms of all the different programs.

And so it creates a level of certainty that didn't exist before.

So that's exactly right.

The next question comes from Myles Walton with Deutsche Bank.

The comments that you made, Sanjay, around the forward loss and more tied to the aircraft's deliveries inside of the extension of the block.

I'm just curious -- so if you hadn't had the extension of the block, presumably this charge would have been pretty de minimis, but when you entered the next block, that's when you would have absorbed all of this negativity.

Is that the way to think about it?

I think, Myles, that would be a fair way to look -- think about it.

Obviously, like I tried to hint to you, when you extend your block, you have to make cost assumptions that are quite a bit out there.

And obviously, we have, like Tom talked about, agreed to modify step-down pricing in the context between now and 1,405.

So yes -- and again, I give you the best color I could which -- by telling you that most of this cash flow would be in both out-years.

And we have some time to go and effect real change, and open our opportunity so that we can bring some of that home and derisk some of the other risks that we have.

So that's the way we look at it.

Yes?

So just to clarify, so that means in the near term -- nearer term, 787 kind of cost to margins or unit margins would be about breakeven consistent with what the...

Well, again, I won't get into that specific, Myles, because we never told you program by program.

I think what we've hinted to you always is measure of some free cash flow that all programs generate in totality and collectively.

But we have a good plan.

I think the way you should look at this, Myles, is we have a good plan now on the 787.

I certainly take a lot of confidence in the fact that the last time we laid out a plan, we slightly beat it.

So we have full confidence in the way we've done this, both in terms of our costs in supply chain or our own learning curve, et cetera.

And we have the added benefit that we are going to work, like Tom said, really hard with Boeing together, very collaboratively, to try and work on supply chain costs that are a big part of any program even harder, and there are good mechanisms that will facilitate that.

So we feel pretty good about the 787 program from here on out.

And just one clarification, the payables.

You are probably going from, what, 45 days to 60 or 75?

Well, again, the numbers are commercially confidential.

We did accept industry payment terms.

And I think the way we view this is -- when Spirit was formed, as a brand-new entity, obviously, Boeing gave us some pretty generous terms.

And it's been 10 years, as you know, and today, we stand on our own feet.

And we can absorb going to what is commercial normal aerospace kinds of payment terms.

And we're going to establish some financing to facilitate that, so overall, it should not affect our free cash flow.

I mean, one of the ways I look at it is, we're kind of growing up and maturing as a company.

And as Sanjay said, in the early years, Boeing was very generous with payment terms to help get us off the ground.

But now we're more mature, we're generating a lot of free cash flow.

And just like the young adult gets a job and moves out of their parent's basement, that's kind of how we look at this.

We're ready to stand a little bit more on our own and have industry-standard payment terms.

And the good news is, with Boeing's assistance, we're going to be able to get a vendor-financing program using their credit rating, which will help lower the interest rate charges on that.

And because it's vendor financing, it won't impact our cash flow.

The next question comes from Rajeev Lalwani with Morgan Stanley.

Tom and Sanjay, not just 5 to 6 years of visibility ahead of you, can you talk about how you're thinking about growth, margins, free cash flow?

I know, Sanjay, you talked about it a bit earlier but -- and just more on, whether or not 2017 is going to be a year for you to grow off of?

Well, I mean, let me just take a first cut at that.

That -- the MOU with Boeing, and then eventually the definitive agreement, enables us to stabilize the relationship with our largest customer, and therefore, turn our attention to some of those growth initiatives.

And one of the things that we've been talking about is, we still have opportunity to grow with Boeing.

On the margin, there's lots of ways for us to continue to grow, and we'll compete for future generation programs as well with them.

So this enables us and it positions us to compete better for future Boeing work.

So that's one thing.

But the other thing is we're continuing to look at growth opportunities with Airbus.

We've had a lot of technical interchanges with them.

I mentioned we won some work on a spoiler, which is a nice piece of work, relatively small, but a good start, and it positions us for more in the future.

And then we're also looking at more defense work.

I mean, today, defense is less than 5% of what we do, but with the work packages that we have on not only the military derivatives of the commercial Boeing aircraft, like the 767 Tanker or the P8, which is a 737 derivative, but we're also on the CH-53K heavy-lift helicopter, and we've won -- we're 1 of 7 suppliers named on the B21.

So we see defense becoming a much bigger part of our growth initiatives as we go forward.

And then finally, fabrication.

We're already one of the biggest third-party fab companies in the world, but we consume everything internally.

And so what we're going to look to do now is to sell more of our detailed parts: machining, sheet metal, composite fabrication assembly to third-parties, including Boeing and Airbus, but also defense companies and potentially other Tier 1s.

So we see a number of growth initiatives that we can really pursue now with a little bit more focus that we are close to finalizing the agreement with Boeing.

And that will enable us to drive the top line.

And as we've talked about a lot, the supply chain initiatives that we have are enabling us to drive productivity, which will help us offset some of the pressures in terms of escalation and customer price-downs on margin and continue to deliver healthy free cash flows.

And as Sanjay said, we are absolutely committed to our long-term goals that we have stated in the past, and we're going to even look to improve on those.

That's helpful.

So Tom, I think what you're saying that it's not off the table for you to maybe grow not just revenues and free cash flows from here, but maybe margins as well?

Well, that's always going to be the goal.

But I would say that this is a tough industry in the sense of there's escalations on materials, there's escalation on labor.

Customers are always looking for productivity, and we're committed to delivering that.

So all the initiatives that we are doing, first, it will offset those pressures, and then we'll be looking at increasing margins as well.

But we got a very healthy pipeline of initiatives across our cost base material, supply chain, core operations.

We are digitizing our factories, so we've got a healthy pipeline.

And we're very confident we can offset the pressures and even improve on those for long-term margin improvement.

And Sanjay, just a quick direct one for you.

Can you just bridge the old and new earnings and free cash flow guidance?

Just, what some of the big drivers were?

The $50 million for the sale?

Right.

Well, some of that -- you saw the operational improvement.

That clearly is a big driver.

The second, obviously, we are benefiting from a lower tax rate.

So there will be some improvement because of that.

But it's fundamentally the operations.

Rajeev, we have done this thing now for the last 3 or 4 years.

We've sort of set ourselves some internal aggressive plans, our teams are very focused on that.

I think I may even have mentioned this on the last quarter, we get into sometime in the second quarter time frame.

In August, we have a good perspective on how well we are doing and how well we intend to do in the future.

And this is around the time that we feel confident that we can generate the cash flows that we have now guided to.

So it is operational improvement.

There are a couple of other small things like the tax, and et cetera, but we're continuously focused on getting to that 7% to 9% now.

The next question comes from Jason Gursky with Citigroup.

Sanjay, just a quick clarification for you.

The 7% to 9% cash flow target, would there be upward bias on that range of 7% to 9% should you find some of those savings, which you'll end up sharing with Boeing over time?

Jason, Tom and I were joking about this.

We were all with the 6% to 8%, and people would push us towards the higher end.

I think I had mentioned to you, we're going to be now 7% to 9%, and I know you would like to push us to the -- our goal is to stay in that range and be consistent inside that range.

And yes, do we have aspirations to go to the higher end and eventually even higher than that?

Of course, we do.

But our methodology in our company has always been to give you guidance and ranges and goals that we feel comfortable achieving.

Now this is an industry that's fraught with all kinds of challenges.

Even just take rates in the last year, it can go up and down.

We've got some massive supply chain initiatives that you guys are very familiar with.

They are now in the execution phase of that program.

If we execute it well, there's lots of upside.

And yes, do we have internal plans to get to the higher end of those ranges?

Of course, we do.

But we feel comfortable telling you that we think we can set a goal inside 7% to 9%.

Okay.

Good enough.

And then I was intrigued by the comments that were made during the prepared remarks around some of the new initiatives that you are engaged with on Boeing around aerostructure.

Can you talk a little bit more about what's going on there?

And whether that sets you up to participate in a middle of the market aircraft if that aircraft ends up getting launched?

Right.

Well, first of all, there is no agreement to be on the middle of the market.

That's going to be in the future, we will compete.

I think what this agreement does is it enables us to compete and have an opportunity to win.

But this doesn't include anything on that.

What we've agreed is that we'll work together with technological exchanges on advanced aerostructure concepts and also manufacturing processes.

And let me just give you a couple of examples.

For example, I mentioned that we had signed an agreement with Norsk Titanium to use their 3D printing technology called Rapid Plasma Deposition to create near-net shapes of titanium, which we then machine to create parts.

And what that does is, it enables you to reduce the material cost substantially, because right now, when you do machining and you're reducing metal, we may take off 80% or 90% of a block of titanium, which is all waste.

By creating a near-net shape using Rapid Plasma Deposition, we can reduce the waste by 70% or 75%.

Now we've got some parts that are getting close to production, but so does Boeing with the same technology.

So there's an opportunity for us to collaborate more on a very exciting technology for the future.

The other thing is we've talked about technical exchanges in terms of production systems.

Boeing has made huge amount of progress by adapting the Toyota Production System into a Boeing Production System to reduce slow days and achieve what they call champion times.

And this is very high impact.

They're getting great results.

And as part of this agreement, we've talked about how they can share some more of that technology, and we can get involved and apply that to different programs, including the 787 program.

So those things will help us achieve some of these targets that we set for ourselves.

And then we've talked about -- in the past, we've had a lot of technology exchanges in areas like propulsion.

And those have waned recently, but this gives us an opportunity to rejuvenate those efforts.

So those are the kinds of things that this entails, and we're very excited about those.

There's a lot that we can learn from Boeing, and if we can apply it in the appropriate way to our programs, there's quite a bit of savings that we can achieve.

So that's a very exciting aspect to this whole agreement that we have reached with Boeing.

The next question comes from Ron Epstein with Bank of America.

Sanjay, if you could talk about -- in the cash flow from operations, quarter-to-quarter, there was about $190 million of Other.

What was that?

Cash flow from operations of $190 million of Other?

Yes, there's another line.

You've got $190 million of cash in your -- CFO?

The only thing that could have happened here is we re-classed our $235 million that we said we were going to pay back.

I'm just going through -- let's keep going to the next question, I'll come back to this question.

Yes, sure, sure.

No problem.

Then maybe, Tom, there's a big, big picture question for you, all right.

When we look at 787 kind of the history there, and it's kind of -- this program has been -- Spirit made great technical strides and all that, but financially, it's been a thorn in the side of the company for a long time.

A350 isn't hugely profitable either.

How should we think about that next airplane you guys do, right?

Like how come we feel comfortable that if you get on the middle of the market airplane, or whatever airplane it is, right, just use that as an example, that the profitably there will be any better than what's been on the last 2, right?

And then the second part of this is, shouldn't that -- maybe you guys should spend less on share buybacks and a little more on just investment for the future?

Right.

Well, what I would say on 787 and A350 is those programs go back all the way to the point where Spirit split off from Boeing.

Fairly new -- and many onus of the 787 program were kind of already taking shape.

The A350 is work that we bid on subsequently.

And the company at that time was less experienced in terms of bidding on and winning work on new programs, and setting them up and managing not only the execution of the development but then also into the recurring stage where we're focusing on getting down a learning curve.

We have learned a lot of lessons, not only in terms of how to bid on work, how to execute development programs and how to work through the initial stages of manufacturing to get down the learning curve.

And those are lessons that we would apply to any future program in terms of how we would bid it and execute on it.

So we've learned a lot and I expect that we would be better as we bid on new generation of programs to put in place economics that are achievable and are acceptable over the long term.

So no doubt about it.

We struggled on these 2 programs, but we now have a path forward that we feel is stable and consistent.

We know what the specific targets are.

We have the experience to execute, and we're confident that we're going to deliver as we have laid out for both the A350 program and the 787 program.

In terms of capital deployment, and should we'll be spending more on investing for the future.

We try to be balanced.

As we look at our cash flow, we apply a certain amount of it toward buybacks and dividends, and we think that's appropriate because our shares historically have been undervalued, and our stock and investing in our company in that way has always proved to be a good investment with good returns.

But it doesn't mean that we are not investing for the future.

Each year, our capital expenditure has been in the $250 million to $300 million range.

A lot of that is about investing in growing rates on the best programs in the industry, the 737, the A320, the A350, the 787.

And so those are great investments, and we'll continue to make those.

We're also investing some money in R&D and that's going to increase.

We just had our strategy review session with our board, and we're going to triple our investment in R&D over the next few years, not necessarily all in our own nickel, but in terms of using other people's money, in terms of contract research and development as well as leveraging third-party institutions to get leverage on the investments that we make.

But by increasing substantially R&D, we're going to look to generate ideas on the next-generation aerostructures, which will position us as an indispensable partner for our customers in the future.

So we are doing buybacks today but it doesn't mean we aren't investing in the future as well to make ourselves a better company and to advance our technology.

We think that's critical to remaining a trusted partner and winning work on future generation programs.

Yes.

And Ron, just to -- that is the $235 million -- I'm looking at the same cash flow sheet as you're looking at in our press release.

And if you look at the deferred revenue or the deferred credits, that's the negative impact, and you see the Other as a positive impact.

That's just a re-class of the $235 million that we talked about, that was interim that we are returning to Boeing.

So net-net, it doesn't have any impact on our cash flow.

The next question comes from Howard Rubel with Jefferies.

Just a couple.

First, Sanjay, you talked about the insurance recovery.

Did you factor that into '17 numbers?

I wanted to make sure...

Yes, I did.

Howard, it's a -- we made a prudent assumption, and it's certainly inside the bounds of our guide.

And again, we're progressing well.

It's been a year, almost.

There's a lot of data and facts and figures that we have exchanged.

So we made a prudent assumption in terms of the recovery there.

Okay.

Airbus has had challenges with a couple of its suppliers, and they've been not shy about talking about it.

Have you had further conversations with them with regard to aerostructure opportunities other than just this modest spoiler?

Yes.

We've been in discussion with them about some of the initiatives they have around dual sourcing, some rather large packages.

And we've been on some of those in the past, and we're continuing to bid on those.

And as they decide to do that in the future, we'll be open to it.

One of our stated objectives is to grow Airbus content.

And so if they are looking to dual-source some of their aerostructures' work, we are absolutely going to be trying to bid on it.

And we're bidding on some programs now.

So they'll make their decisions in due time, but it's something that we're interested in doing, and we are actively engaged with them on that.

I would -- if I can just add in here.

I just want to throw a little kudo out to -- I mean, often in these calls, at least today, we are not talking too much about our Airbus activity.

And whether it be in Kinston, where we've really done some good performance to get back on so-called the boat shipments, or in Prestwick, where the team's worked really, really hard on the A320 rates that are also going up, and some good cum cash is out of -- as you saw in our Wing margin as well.

And what I wanted to tie back here was, at the end of the day, whether it would be with Boeing or with Airbus, everybody wants good cost and good performance, whether it be a new bid or an existing program.

And I think we have demonstrated that repeatedly in the last few years, and we continue to make progress there.

So at some stage, we hope to get some traction on that with Airbus as well.

Okay.

And maybe, Sanjay, that sort of brings me to the last question.

There's 2 parts to it.

One is, the agreement sort of indicates that globally you are low cost and reasonably good quality, because if you hadn't reached an agreement and Boeing decided to move the work, you would have -- they're obviously looking for best value.

So maybe you could talk about that?

But also, just with regard to Airbus, you did allude -- or you were very specific and said, you dug a little bit into the deferred costs on the 350.

And with all of these things that you've learned of late of how to produce large structures, is that sort of also giving you some confidence that maybe the bogey you set for the 350 has some room for you to perform better?

So let me -- probably let me start at 30,000 feet.

I'm sure Tom will jump in on this because -- one of the benefits that we've had in the last 2 or 3 years is, we've took a very determined and maybe a longer route into figuring out what it should cost when we started off in our clean sheet processes, particularly for our suppliers.

But as part of that process, we also tried to benchmark ourselves and try and see how we are performing compared to what it should cost or it should be.

And so our internal targets are all focused on that.

And as we get closer and closer to those utopian goals, but clearly, good goals -- and everybody has a different way of looking at it.

You can look at it in terms of champion times or ultra champion times, or you can look at it in terms of chute costs or -- we think we made good progress.

Now a big component of this in any aerostructure company is material.

Because we, like every other company, buy 2/3 of our stuff of that size on the outside.

So we have done a lot of homework and a lot of very determined, slow, methodical implementation of how we go and source and what we buy and what we make and what we buy where.

And that is now in the execution phase.

So as we get closer and closer to implementing that, I think we'll become a really good aerostructures company that has good quality, not just acceptable quality but good quality, and the right cost structure.

And if we do that, then, yes, I think we will earn the right to be on multiple platforms, either new ones or existing ones.

And I'll just add -- I'll turn it over to Tom, if, Tom, you want to add something to that?

Well, there's no doubt, Boeing is looking -- as Airbus, this is a competitive industry.

They are always looking for productivity, and they push themselves hard, they push all their suppliers hard.

So in the case of Boeing with this MOU, they were rightfully looking for us to be a good partner as part of the Partnering for Success program and deliver productivity on an ongoing basis.

And so we're confident that we have met those expectations.

And I think the fact that they are willing to enter into this agreement with us would support that.

Just one last thing since you asked a specific thing on the A350.

We are making good progress on the 350.

We're confident about the plan we set.

Having said that, one of the things that's obviously key is rate.

And we are absolutely on track now, and like I said, we are back on the board.

And we're -- it's hard to go up and rate and take your cost down, but we are there now.

But rates are going to be important going in the future as well.

The next question comes from David Strauss with UBS.

Sanjay, just want to go back, I think it was Myles' question on the timing on the forward loss on 787.

So as I understand, it seems what you are seeing is the step-downs were fairly modest out to the end of this block.

Around that time, your advances will -- your advance payback will end, and that's where you see more aggressive step-downs, so kind of it levels out the cash hit.

Well, I was trying to give you both sides.

I mean, obviously, the 787 step-downs are what we've agreed to.

And I was just trying to remind everybody that, yes, in the future, after line unit 1,120, we certainly, from a cash flow perspective, have finished paying off the advances.

So there will be sort of $700,000 shipset less impact in those years.

So yes, that's what I was hinting at.

Okay.

And then wanted to follow up on the A350 deferred.

You comment the progress there.

The progress has slowed the last couple of quarters, I know with the hurricane impact.

Is that mainly what we are seeing in the numbers?

Or is it step-down pricing that's hit you the last 2 quarters?

And should -- with the hurricane impact behind you, should we see an acceleration in the deferred progress here over the near term?

Well, the hurricane was captured outside that program.

But David, as we've talked about in the past, deferred for shipset is a good measure but not a completely accurate measure on performance, because unfortunately on a program, even today, even though we're shipping our 23 units per quarter, FX can make a difference.

There are sometimes settlements on a supplier or other issues that we incur in terms of cost that can make a difference.

But are we on plan on that project?

Absolutely.

We are tracking to that plan, a big part of going down that plan is to achieve the supply chain savings that we had articulated and laid up for ourselves, and we feel we are absolutely on track on that.

So as long as we make the rates and we are certainly making them and we expect to make them and all of that, I think we'll continue to see that burn down commitment to -- remember, when we said that forward loss, we said we will recover about $450 million over the next -- till line unit 800.

And yes, we are on track for that.

The next question comes from George Shapiro with Shapiro Research.

A couple of questions.

I assume the 737 wasn't changed much from any agreement, because otherwise, you would have spelled something out about it?

I mean, (inaudible) fine with your expectation?

Right.

We just -- we indicated on the 737, a, we agreed on the price for the MAX, which for us is an important milestone; and b, we agreed to some productivity achievements and discounts linked to the volume requirements.

So as volume goes up -- and volume is going up on the 737 from 42 to 47 and to 52 then to 57.

And so there's a lot of fixed cost absorption.

And so Boeing would rightfully expect to see some of that reflected in discounts and then plus just ongoing productivity improvements.

And we're getting much better at driving those.

And so we've got a -- just like Boeing is expecting it from themselves and expecting it from their other suppliers as part of Partnering for Success, we've committed to deliver those.

And so our supply chain initiatives and all the other cost-out initiatives that we have will help us offset those commitments and continue to contribute to the rest of our business.

But we did make some assumptions in terms of productivity discounts on the 737 as part of the overall agreement.

Okay.

And just the 7% to 9% free cash flow yield, I assume you are expecting the revenues to grow some next year.

George, we are on the right programs.

We've always said to you, we want to grow this company.

Tom has articulated areas of growth outside of our current portfolio and clearly in growing Airbus, growing Boeing, growing defense, growing fabrication.

So yes, we expect top line growth as well.

And then a last one.

Sanjay, did you just reconcile, like, particularly in Wings, your normalized margin is $50.4 million MOU impact, but on the front page, you say there's something, like, $70 million -- let me get the precise number, $70 million of net loss in Wings.

So what's the reconciliation there?

And the other sectors, it's a little different but not a lot, but this one is pretty significant.

Yes.

Well, you are right.

There is some volatility in the Wing segment.

Some of it has to relate -- we can't get into the specifics, George, but some of it has to relate to some of the settlements we've done as part of this MOU.

There were certain recoveries that we had, but that's why -- when I give you segment information, I try and take all the clutter out, and I also try and give you information on where margins are likely to be on a more normalized basis going forward as well.

So yes, there were some recovery of some shipments that we had made, and it was part of a settlement.

And like Tom said, this MOU is terrific because not only does it set the stage for -- between now and the next 5, 6 years, but it also cleaned up several other payments that were historic and small payments that are inside our businesses needed to get cleaned up.

So a little bit of this is just onetime thing.

And then actually let me get one last one.

The litigation reserve reversal, I assume, pertains to the settlement by the -- or the agreement by the Delaware court to rule in your favor.

Where is that spread in the income statement?

So that's spread across in each one of the segments.

And yes, that was something that we -- it was obviously a benefit to us in the quarter.

Likewise -- I know we didn't get too much time this quarter.

It was fantastic results, I think, in the second quarter.

We didn't get time.

There were some offsetting charges as well.

So that's why when I was in my prepared remarks talking about the EPS improvement year-over-year, there are lots of pluses and minuses, like the one we just mentioned, there were a couple of other minuses as well.

We had some inventory issues, some obsolete stuff, et cetera.

That all neutralized itself, and that's why when I gave you the color in terms of EPS improvements year-over-year, I broke it down fundamentally into those 3 categories of share count, axis and operational benefits, and they were about in equal measure.

The next question comes from Rob Spingarn from Crédit Suisse.

Going back to something that George just asked on the 737.

As you get these rate increases of about, let's call it, 10% per annum for the next few years as the rate rises, would you say that under the new assumptions that your EBIT growth in 737 will track that increase?

Or will it exceed or be below?

So that's my first question.

The second question, Sanjay, could you quantify maybe a little bit more specifically, what percentage of the 787 provision is backward looking?

In other words, is repricing of aircraft already shipped?

And therefore, I would imagine noncash.

In other words, what's the forward cash shortfall relative to the charge?

Yes.

Let me take the second question first, and then Tom maybe want to talk about 737.

No, none of this is backward looking, or if it is, it's very small, like I said, some clean-up activity that happened.

But most of this is forward looking.

And it's between now and line unit 1,405.

So this is not sort of cash behind us.

It's sort of in front of us, but it's accounted for in the new sort of goal we've established for ourselves in terms of 7% to 9%, as is...

It's all cash?

Yes.

Just to respond to your 737 question.

Obviously, with rates going up so high, the revenue on 737 will go up.

We've committed to productivity savings for Boeing, and our goal would be to drive our own internal initiatives to offset those to keep EBIT, basically, constant.

So that's the EBIT percent obviously.

So that's what the goal is, and we have a lot of work to do that in internal execution, but we're quite confident we can do that given what we have already achieved with our supply chain initiatives.

Okay.

And then just to further -- back to 787, Sanjay.

Beyond the block, how do you think about the cash profitability of the program once we get into, either a new extension or a clean block, once we're done with this?

Are you cash-flow-positive?

Well, again, so -- if you are talking about questions associated with what happens on line unit 1,406, no, again, there is no pricing agreement that we've talked about today associated with beyond line unit 1,405.

And so like any -- that's something that will have to get negotiated at that stage, based on where the costs are, where the market is and what the contract is and so on and so forth.

So...

But the good news is that 1,405 won't occur any time before 2022.

So we have a little bit of time.

Yes.

The next question comes from Sam Pearlstein with Wells Fargo.

Can I follow-up on the 737, on the productivity discounts, time to volume?

Just trying -- since there isn't a deferred balance to or forward loss to look at, how do we tell what that pricing, how it compared to what you're planning was?

And I assume it does affect some of the revenues for the units that you've already booked today.

Well, it's more of a go-forward situation.

Yes.

It's not anything booked today.

This is a -- again, I have to remind everybody, just cautiously, we've got an MOU in place.

We are working to get the definitive agreement in place as well, which we are confident we'll get done, but it has to get done.

Having said that, this is a going forward deal.

And I know you're concentrating now on the 737, like we have been on 787.

That's one of the reasons why we feel it's a fair deal.

And we feel that with this deal, we are now able to generate 7% to 9%.

So inside that is productivity discounts offset by our own cost reductions, which we have internal goals to always do better.

Inside that is whatever the assumptions are on the 787 and so on.

So I know it's a macro view from the outside, but there are 5 or 6 components of the deal that we discussed.

We agreed on a variety of things, 787, 737 MAX pricing, the rate increases, investments required, productivity initiatives, shared initiatives on cost reductions, et cetera, et cetera.

We believe it's a fair deal, and it's something that allows us now to focus on our future and deliver higher cash flow returns.

Can I just follow-up just in terms of just some of the more macro pieces of it?

Who is spending the money in terms of the capital investments, because you talked about an agreement?

Is it you or you are getting help for some of the capital investment?

And I guess related, is the volume discounts of the master agreement originally tied all of the Boeing programs ex the 787 in terms of the volume?

Does this start to separate them into the volume of individual programs?

So first on capital, what we've agreed is, the capital that needs to be spent for these programs and the rate increases.

Who pays for what is not something that we really have focused on publicly, so I'd rather not get into that.

But what we have agreed is what the capital investments need to be for those rate increases.

In terms of the volume discounts, the agreement really blocked things into kind of twin-aisle programs, legacy twin-aisle programs 737 and then 787.

And so there were very specific focus areas for each of those.

And I think we've highlighted those.

The twin-aisle programs, we are not a major part of this agreement.

The majority of the focus was on the 737 and the 787.

The next question comes from Cai Von Rumohr with Cowen and Company.

Yes.

So just on the cash flow, does the $500 million to $550 million, is that after paying the $235 million, so that's really $700 million plus?

No, no, Cai.

The $235 million was never included in our cash flow numbers in prior years when we got it.

So that's just sitting on our balance sheet.

Free cash flow, as we generate free cash flow this year, that's $500 million to $550 million.

Okay.

And then looking forward, I think you said, Sanjay, you expected cash flow to continue to increase over the next couple of years.

How far are we looking out?

To 2022 or 2020?

Or give us some color on that?

Okay.

Well, I think I purposely said in my prepared remarks, including next year.

And we're not giving guidance for next year, but I did try to tell you that this is a major outcome, and I was trying to give you some color at least beyond this year.

So we're not giving you guidance for 2018 today, we will do that sometime in January, but I did tell you that our journey has been -- our goal has changed.

It's no longer 6% to 8%, it's now 7% to 9%.

And I also said, it allows -- this agreement allows us to increase our cash flow year-over-year, including next year.

And that's how I would leave it.

Okay.

This concludes our earnings call for today.

Thank you for your participation.

The conference has now concluded.

Thank you for attending today's presentation.

You may now disconnect.