Spirit AeroSystems Holdings Inc (SPR) Q1 2019 Earnings Call Transcript

This staggered delivery approach will enable Spirit and our supply base to provide better support to Boeing during this period of time while they are working with global regulators and airlines to return the 737 MAX fleet to service. As I've described in the past the approach Spirit has been implementing to go to 57 aircraft per month involves 3 production lines in our major plant in Wichita, where we manufacture the 737 fuselages.

At this point, we are now producing all MAX fuselages except P-8 aircraft and some minor models. Each production line will have the capacity to produce 21 aircraft per month. At a production rate of 57 aircraft per month, each line would have produced 19 aircraft per month and we would have had two days of buffer per month in each line. While we remain at 52 aircraft per month, we will add extra buffer days into each production line to achieve that production rate.

In total, we will have 11 or 12 buffer days each month across the three lines. The advantage of this approach is that our production system will be set up to produce at a rate of 57 aircraft per month, but will only deliver 52 aircraft per month with the buffer dates. These buffer days will enable us to reduce overtime in contractors significantly below our previous planned levels and remain poised to increased to 57 aircraft per month when directed to do so by Boeing. During this time, we will reduce hiring as attrition occurs to align headcount to the production rate of 52 aircraft per month. With these actions, we are not planning layoffs at this time.

The stability of remaining at 52 aircraft per month longer than we had previously planned will help us improve efficiency and quality, while enabling our supply chain to get healthier as well. We will take full advantage of this opportunity. Given the importance of the 737 program to Spirit, which accounts for about 50% of our annual revenue, the global grounding of these aircraft is a significant event. Our prior guidance for 2019 assumed we would produce 737 monthly production -- that we would increase the 737 monthly production in June 2019 to 57 aircraft.

As we now expect to remain at 52 aircraft per month for some period of time, the guidance does not reflect our current outlook. Due to these uncertainties we will issue updated guidance for 2019 when we receive more definitive information on the timing of the 737 MAX return to service and Boeing's new production schedule. What we do know is that we will produce fewer 737 MAX aircraft this year than we had previously forecasted by 5 units per month beginning in June for as long as we remain at a production rate of 52 aircraft per month.

We are taking a number of actions to mitigate the impact of this new production schedule as summarized on Slide 2. Given the reduction in production units and corresponding revenue, we have begun taking immediate actions to reduce expenses, deferred capital investments and redoubled our efforts on working capital improvements to mitigate the financial impacts of the production rate change. One action we have taken is to review all capital expenditure projects. We have deferred or delayed anything not an absolute priority for this year and we'll now spend only $200 million to $250 million rather than our previous forecast of $250 million to 300 million.

Along with initiatives to manage working capital more efficiently and in advance from Boeing to help with supply chain working capital requirements, we plan to mitigate the impact of the mass production change on cash flow. By reducing discretionary expenditures, managing indirect and non-labor expenses more efficiently and realigning our direct labor and variable cost to the new production levels, we plan to offset some of the impact of the 737 MAX production change on operating profit. But still expect some headwinds, which we will quantify as we get more certainty on our production rates for 2019.

We have a strong cash position with over $1.2 billion in cash on hand at the end of Q1. After we closed the Asco deal, which I will describe below and taking into account the cash we will generate in Q2, we will have approximately $800 million in cash on our balance sheet at the end of Q2.

Now let's take a closer look at first quarter results, which were very strong. At $1.968 billion revenue was up 13% over Q1 of 2018. Operating income was 46% up to $233 million. Adjusted earnings per share was up 53% at $1.68. Our segment operating margin was 15.3% which is down as we expected from Q4 because we had all of the costs in place to produce 57 aircraft per month in Q1, but we're still only delivering and getting paid for 52. Margins are on track to improve over the course of the year, although now of course we'll face the additional headwind of the 737, 52 aircraft per month production rate versus our plan of 57 for the back half of the year.

Jose will provide a more detailed financial overview in a few minutes. And now, a few other recent highlights on Slide 3, starting with Asco. We were pleased to receive conditional clearance from the European Commission for the acquisition of Asco on March 20th and expect to finalize the closing in Q2 after meeting the required conditions. The work that we are currently doing involves segregating data to which Asco had access as part of the Belairbus structure. Once we identify that data and treat it consistently with the Commission's requirements, we will be in a position to close the deal. That work is well under way and should be completed within the next few weeks.

Asco remains a compelling strategic fit for Spirit as the acquisition expands our Airbus content as new defense content and broadens our fabrication business. We are excited to begin executing the detailed integration of Asco into the Spirit family. As we have previously discussed, the closing process has been longer and more costly than we originally anticipated. Accordingly Spirit and Asco have negotiated a 7% purchase price reduction from $650 million to $604 million due to the incremental acquisition cost and the business impact from the delayed closing. We will provide a full update of the Asco deal economics when we close it in Q2.

In other growth developments we announced a collaboration agreement with Aerion for the preliminary design of the forward, pressurized fuselage for the AS2 Supersonic business jet program. Joining a project team this early allows us to apply our technical expertise and commercial best practices to make the most positive impact. We can create cost efficient, innovative engineering solutions that take into account Spirit's highly efficient manufacturing processes. We were proud to be selected by Aerion for this program and look forward to contributing to the success of this groundbreaking new airplane.

We also announced membership in the University of Strathclyde's Advanced Forming Research Centre or the AFRC. Located in Glasgow, Scotland the AFRC is one of the UK's leading research institutions concentrating on innovation and breakthrough technologies in manufacture. This relationship with the AFRC further leverages Spirit's investment in the creation of a new 70,000 square foot Aerospace Innovation Center at our manufacturing site in Prestwick, Scotland which will open in 2020.

In addition, we delivered the first low rate initial production unit the CH-53K program to Sikorsky. We continue to be very excited about the long-term prospects of this heavy-lift helicopter for the Marines and foreign military sales. Finally, we returned $88 million to shareholders with $75 million in share repurchases and $13 million in dividends. Given the uncertainty surrounding the 737 MAX, we have paused share repurchases until we have more clarity. As we continue forward to the remainder of 2019, we're obviously going to continue working hard to manage and mitigate all of the issues surrounding the MAX.

As I said earlier, we are proud to be on the MAX program and confident that it will be an outstanding aircraft for airlines and passengers in the years to come. At the same time, we remained focused on all other aspects of our business, which remain very strong and are taking actions to mitigate the impact of the MAX production changes in 2019.

With that, I'll ask Jose to lead you through the detailed financial results. Jose?

Jose I. Garcia -- Senior Vice President, Chief Financial Officer

Thank you, Tom, and good morning everyone. Let me summarize our first quarter financials. Let's start on Slide 4. Revenue for the quarter was approximately $2 billion, up 13% from the same period of 2018.