Spirit AeroSystems Holdings Management Discusses Q4 2013 Results - Earnings Call Transcript

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 |  About: Spirit AeroSystems Holdings, Inc. (SPR)
by: SA Transcripts

Spirit AeroSystems Holdings (NYSE:SPR)

Q4 2013 Earnings Call

February 06, 2014 11:00 am ET

Executives

Coleen Tabor - Investor Relations Director

Larry A. Lawson - Chief Executive Officer, President, Director, Member of US Government Security Committee, Chief Executive Officer of Spirit Aerosystems Inc and President of Spirit Aerosystems Inc

Sanjay Kapoor - Chief Financial Officer and Senior Vice President

Analysts

Robert Spingarn - Crédit Suisse AG, Research Division

Howard A. Rubel - Jefferies LLC, Research Division

Carter Copeland - Barclays Capital, Research Division

Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division

David E. Strauss - UBS Investment Bank, Research Division

Ronald J. Epstein - BofA Merrill Lynch, Research Division

George Shapiro

Samuel J. Pearlstein - Wells Fargo Securities, LLC, Research Division

John D. Godyn - Morgan Stanley, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Spirit AeroSystem Holdings Inc. Fourth Quarter and Full Year 2013 Earnings Conference Call. My name is Tricia, and I'll be your coordinator for today. [Operator Instructions] Please note that this conference is being recorded. I would now like to turn the presentation over to Ms. Coleen Tabor, Director of Investor Relations. Please proceed.

Coleen Tabor

Thank you, and good morning. Welcome to Spirit's fourth quarter and full year 2013 earnings call. I'm Coleen Tabor. And in the room with me today are Spirit's President and Chief Executive Officer, Larry Lawson; and Spirit's Senior Vice President and Chief Financial Officer, Sanjay Kapoor.

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

Before we begin, I need to remind you that any projections or goals we may include in our discussion today are likely to involve risks, which are detailed in our news release, in our SEC filings and in the forward-looking statement at the end of this web presentation. In addition, we refer you to our earnings release and presentation for disclosures and reconciliation of non-GAAP measures we use when discussing our results. As a reminder, you can follow today's broadcast and slide presentation on our website at spiritaero.com.

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

Larry A. Lawson

Thank you, Coleen, and good morning, everyone. Welcome to Spirit's fourth quarter and full year earnings call. First of all, I'd like to thank all our employees around the globe for your hard work this year. Your teamwork was instrumental in Spirit reaching all-time highs in aircraft production rates. As we increased rate, we also recognized an overall improvement in quality. We made great progress this year, but we've not yet reached our destination.

In addition, a tremendous effort went into concluding the strategic and financial review, and the management team has been instrumental in mapping our path forward. I also want to thank the investment community for your patience this year. It's been a year of change, you stayed with us when we announced the strategic and financial review and suspended guidance in May.

I will share with you some thoughts about the outcome of this review and give some color about the future, and then Sanjay will walk you through all the numbers in more detail, and then we will answer your questions.

2013 was a transformational year for Spirit and really the beginning of our efforts, as opposed to a conclusion. I first want to take a moment to summarize some of the key findings and actions from the strategic and financial review.

Transformation starts with people. The strategic review helped us to see where we needed to strengthen our team and a number of industry experts have joined us and are working and living in Wichita, Tulsa, Kinston and St. Nazaire. We had a new leadership at my staff level and the next staff level down, and we're now focused on the entire organization.

In the last 10 months, we've added 15 experienced executives, including our CFO; the Senior Vice President of Operations; and of course, the Senior Vice President of Strategy and Investor Relations. We've been very fortunate to be able to add new leaders in quality, procurement, new site leaders in Kinston and St. Nazaire, and 2 Senior Deputies in our aerostructures' P&L.

In addition, we've moved many of our talented internal team members around to better align their strengths with our business needs. We will continue to strengthen and align with a focus on promoting highly confident and motivated people that understand our customers' needs.

Next, in the areas of processes and decision-making. We have realigned and integrated our organization. We have a strong emphasis on markets, business management, program management and production. We are driving to a fully integrated management of the Spirit enterprise, and we've reinforced our planning, data and metrics to communicate among ourselves and with our customers.

In addition to the overhead reductions we made, we began to centralize a number of functions. We're balancing our made-by strategy, with the associated timelines against the production volume demands we have in 2014, and we also continue to make progress in our overall supply strategy.

With regard to the business we're in. We do believe in our value proposition. Spirit's value-added design and manufacturing capabilities in the commercial aerospace and defense markets are differentiated. We are a partner of choice when taking on challenging projects and programs. We put Tulsa up for sale to determine if there was a better fit in the industry, and we continue to work with potential buyers.

At the same time, we're adding new strategic customers, like Bell Helicopter. In simple terms, the commercial aerospace up-cycle looks to be long-lived and it continues to provide growth opportunities for us. In the near term, our efforts will be to digest the newer programs while optimizing performance around our core business.

Longer term, we are looking to grow. There's a natural growth of opportunities for us where our core competencies apply, such as the defense sector.

Finally, our focus on cash flow is beginning to manifest results, as you can see in our 2013 performance and in our 2014 guidance. We believe we've set a path to stabilize and grow our business. So let's talk about 2013.

For the full year, we reported revenues of $6 million, with an operating loss of $364 million, including the charges. Operating cash flow was $261 million, and adjusted free cash flow was $57 million, an improvement of $141 million over a year ago.

Our backlog grew to a record high of $41 billion, excluding the tax asset valuation allowance we reported and adjusted loss per share for the full year of $1.70. Including the DTA, we reported a loss per share for the full year of $4.40.

The fourth quarter results included net $546 million of forward loss charges, which was primarily due to the 787. So let's talk about the 787. We've updated our financials based on our actual performance and the achievable near-term cost reductions. The result is a $385 million forward loss provision, which offsets the deferred inventory. This estimate is well-reserved with opportunities in front of us, and we're working closely with our customer to realize these savings.

Turning to another item in the release. We also reported a $381 million of deferred tax asset valuation allowance. This is an accounting treatment associated with the performance over the last 3 years, which will be released as we perform in the future. Sanjay will give you more details on this.

So 2013 was the year of identifying Spirit's transformation needs, then 2014 is the first full year where we put the plan into action, and it's about making our commitments. We started with the reorganization and followed by putting the right team in place. This is our team's plan and commitment. We believe we have the right incentives, and we see it paying dividends in quality, productivity and flowing operating income to the bottom line. So here's our guidance for 2014.

We are guiding revenues of $6.5 billion to $6.7 billion; earnings per share of $2.50 to $2.65; and free cash flow, excluding severe weather expense, of approximately $150 million. It's a good start, it's well above what we did last year, and we have more work to do.

So in conclusion, we've made progress. Our commitment remains to the 4 key focus areas I've been sharing with you. Number one, we are making disciplined decisions around markets and customers. We continue to work on the divestiture of our Oklahoma sites, and we're adding strategic customers.

Two, our focus on performance is sharpening the way we serve our customers. We are seeing improved performance in development, quality and delivery. There's a lot of work to do in 2014 in support of the higher production rates that are fueling the growth of the enterprise, as we also ensure our customers' success on their new programs.

Thirdly, our cost improvement actions and future plans continue to align our resources with where we bring competitive advantage and value-added design in manufacturing. And ultimately, our focus on free cash flow is beginning to bear fruit. Any true transformation, down to the shop floor, takes time, and you should expect to witness our full transformation over the course of the next few years. We are making progress, and the cash flow we produce in 2013 and this higher free cash flow guidance in '14 attest to our confidence.

My team is excited as we look to the future. We're focused on predictable results, we're committed to working to realize the opportunities, while delivering results to our customers, our shareholders and our employees. We are moving forward as a sharp company designing and producing high-quality, affordable aerostructures at record volumes.

I'll turn the call over to Sanjay, so he can walk you through the details. Sanjay?

Sanjay Kapoor

Thank you, Larry, and a very good morning to all. And as I finish my fourth month here and really, the first full quarter, I want to say I remain very excited about Spirit and also, our future.

I, too, also like to start by thanking our team for their efforts as we wrap up the strategic and financial review last year and now prepare for 2014. The cooperation and teamwork they displayed is a testament to the core value of this organization. And now, we are dedicated to ensure that we achieve our future commitments.

First, let's take a look at the results in the quarter with our segment highlights. I will then spend some time summarizing the company's full year financial results, including a more detailed discussion on the charges. Finally, I will wrap up with our outlook for 2014.

So now let's turn to Slide 4. In the fourth quarter, Fuselage segment revenues grew by 3% to $701 million. And year-over-year, the segment revenues grew by 10%, with strong, mature program operating performance. Operating loss was $227 million. Improvements on higher volumes in mature programs were offset by the forward loss charges in the 787 program, and model mix rate decreases and increased costs that impacted our low-volume 747-8 and 767 programs.

In the quarter, the Fuselage segment 737 and 777 production lines performed very well, and we realized $26 million in positive cumulative catch-up adjustments associated with continued productivity and efficiency improvements. Also, we remain on track to achieve production rates of 42 ship sets per month on the 737 program.

The 787 team also completed their transition to the 10 per month delivery rate in the quarter, and we are now producing at amongst the highest wide body production rates in our history.

Finally, the A350 fuselage team delivered 4 set of section 15 in the quarter, including 2 in 1 month for the first time. In terms of performance, we remained intently focused on quality and delivery on the production side, but as well, on the development of the A350-1000 derivative.

Let's turn to Slide 5. In the fourth quarter, Propulsion segment revenues grew by 8%. And year-over-year, the segment revenues grew by 11%, also driven by performance on our mature programs.

Operating income was $19 million on a revenue of $398 million, as improvements, driven by higher volumes in mature programs, were offset by the forward loss charges on the 787, increased cost estimates on the BR725 and model mix impacts on the 767.

The Propulsion segment's 737 and 777 production lines continues to perform well and contributed $15 million in positive, cumulative catch-up adjustments associated with productivity and efficiency improvements.

The 787 propulsion team also achieved their 10 per month delivery rate in the quarter. Let's turn to Slide 6. In the fourth quarter, Wing segment revenues grew 5% and year-over-year, the segment revenues grew 7%, with strong, mature program operating performance. Operating loss was $63 million on $393 million in revenue during the fourth quarter, as once again, higher volumes in mature programs were offset by the 787 forward loss and supplier performance, which impacted our Gulfstream product lines.

The Wing segment A320 production team continues to successfully support our customers' high-volume program, surpassing line unit 6,000 in the quarter. Spirit [indiscernible] 737 and 777 slats production lines showed solid performance in the quarter, contributing to the $10 million in positive, cumulative catch-up adjustments, again, associated with productivity and efficiency improvements. Lastly, we continue to make progress and work towards a win-win outcome with potential buyers for our Oklahoma operations.

Turning to the consolidated results for the company on Slide 7. Revenues for the full year of 2013 were up approximately 10% as compared to 2012. It's important to note that this growth is impressive because we achieved these higher production rates while, at the same time, resetting our cost structure.

Operating margins for the year of negative 6.1% reflect the full year charges, and losses per share for the year were negative $4.40, largely driven by the forward losses in the quarter.

Now there's a lot to digest here, so I want to spend some time and go into a bit more detail. What you see here is the result of our comprehensive strategic and financial review, which involves a thorough review on all of our programs.

So let me give you a little bit more color on these charges. First, on our Boeing programs, then our Gulfstream programs and finally, the deferred tax asset valuation allowance.

On the Boeing program, the 787 charges are based on updates with the current loss based on actual performance for labor and material, while also incorporating near-term, achievable cost reductions. This update resulted in the $385 million forward loss provision.

On the 747-8, the $31 million additional forward loss was driven by projected model mix changes of freighters to passengers, as well as rate reductions that impacted the current and also, the subsequent block.

On the 767, the $11 million forward loss reflects the impact of model mix changes and increased cost. On our Gulfstream products, the G650 $54 million and the G280 $42 million additional forward losses in the quarter resulted primarily from supplier performance issues that drove higher labor and delivery costs on both programs.

And the BR725 $22 million forward loss reflects increased labor and material estimates. Lastly, the deferred tax asset valuation allowance of $381 million was a noncash charge to earnings. After evaluation of both positive and negative evidence, including Q4 reported losses that result in a 3-year cumulative loss calculation, we determined this is appropriate based on accounting guidance to record a valuation allowance against our U.S. net deferred tax asset.

We have the potential to reverse these reserves as we recognize profits in the future. Now moving to the adjusted free cash flow. As Larry and I have shared, our focus is on cash. We have made a small step in the right direction. We generated positive adjusted free cash flow of $57 million from operating performance for the first time in Spirit's history.

We have reduced overhead costs, balanced capital spending, we are looking at make/buy strategies, we are putting a lot of thought to our investments. Comps and return on investment is the starting point for decisions in regard to how we utilize our cash.

As you will see in our guidance, this momentum continues into 2014. Let's move to Slide 9, that summarizes our cash and debt balances. Cash balance at the end the fourth quarter was $421 million as compared to the third quarter 2013 cash balance of $436 million.

At the end of the quarter, our total debt-to-capital ratio was 44%, and our net debt to total capital ratio was 34%. Our U.S. defined benefit pension plan remains fully funded.

Slide 10 summarizes net inventory balances at the end of the fourth quarter for 2013. Physical inventory balances are in line with the rate increases. Deferred inventory balances increased by $177 million, driven by the A350 program and the Gulfstream programs. $97 million of the deferred growth is on the A350 program, where once again, as I reminded you in the third quarter, while we are making really good progress, work completed at our customer sites on previously shipped units is included in this number.

The 787 program realized a net decrease of $16.4 million in deferred inventory on 19 deliveries, or approximately $860,000 per unit. Non-recurring inventory balances decreased, as we achieved milestones for development work on the A350-1000. And the recognition of forward losses in the quarter drove the increase in the forward loss provision balances.

Let's move to Slide 10. We are pleased to have completed our work in the strategic and financial review and are now ready to share with you our financial outlook for 2014.

In 2014, we are guiding revenues of $6.5 billion to $6.7 billion, reflecting an increase of approximately 10%. This is mainly driven by 787 increased production rates. Earnings per share rate of $2.50 and $2.65. And this is based on an effective tax rate of approximately 31% to 32%.

And finally, adjusted free cash flow of $150 million. Some important notes to our guidance. Consistent with 2013, it includes the Oklahoma operations for 2014. Two, it reflect the expected benefit of the U.S. Research Tax Credit for '14; and it excludes any potential adjustment to the valuation allowance recorded against the U.S. net deferred tax assets at the end of 2013. This outlook is the result of the detailed work of the team and it balances new opportunities present in a rate increasing environment with the challenges of early production on maturing programs. And while it's not risk free, we have a measurement system in place to monitor our performance and drive to deliver on our commitments.

In closing, I will echo Larry's comments in saying that the team is excited about the future. We are focused on predicable, consistent results and are working to realize the opportunities, while managing the risks that are inherent in our industry. We look forward to delivering superior results to our customers, our shareholders and our employees. At this stage, we will now be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Rob Spingarn from Credit Suisse.

Robert Spingarn - Crédit Suisse AG, Research Division

Sanjay, in the past, we've talked about the concept at Spirit of forward-looking, forward losses and backward-looking forward losses. And I was hoping you could, within that context, talk about all of these charges, given that there are several of them and the numbers are large, and to what extent there's forward cash pressure from any of this, with particular respect to the 787? Or is it just simply reducing prior deferred and therefore, noncash? And then just as a follow-on to that, what kind of margins are you expecting by segment in '14?

Sanjay Kapoor

That's a good question. And let's start with the 787 because that, obviously, was the big driver in this quarter. And I will tell you that, like you based your question in terms of backward-looking or forward-looking, most of the impact of the 787 is forward-looking. And what we've done here is realize what we think we can achieve in terms of near-term cost reductions. And base our estimates on the actuals that we're currently achieving, which are pretty good. And so therefore, most of the 787 impact will be probably in the future. Now in terms of cash, there is a tranche carried in 2014, but that's baked into my guidance. And then there is a significant amount that will flow out in 2015 and '16. And of course, as we guide for both years, we incorporate those numbers as well. Now 787 is a big one. The remaining programs are balanced. In many cases, again, if I look at the Gulfstream programs, those outlooks are also in the future. And that's the next big charges that we took in the quarter. The others are rate decreases and model mix impacts that are a little bit more balanced between backward-looking and forward-looking. Hopefully, that answers your question.

Robert Spingarn - Crédit Suisse AG, Research Division

Is there a way to quantify the cash impact, the forward-cash impact associated with the charges?

Sanjay Kapoor

Like I said, the 787 charges, there is a chance this year, and then most of it is in '15 and '16. So -- and that is frankly the biggest number. The second one is the Gulfstream and that is, again, forward-looking. So I don't want to give you some precise numbers here, but again, like I said, when we guide for '15 and '16, we'll include those things in our guidance.

Robert Spingarn - Crédit Suisse AG, Research Division

Okay. And then only other thing was the segment performance in '14, the margins by segment.

Sanjay Kapoor

Again, we are focused -- listen, inside the business, we continue to be focused on driving our cost structure right, focus on the performance of our businesses and try and maintain these margins consistent with what we see as far as our customers are concerned and to obviously strive trying to get to best-in-class in our industry. So it's going to be consistent with what we have right now.

Robert Spingarn - Crédit Suisse AG, Research Division

Sanjay, I guess, the basis for the question is just you refer, throughout the release, you and Larry, to changing material and labor costs, and then also to these near-term achievable efficiencies. And I think that we would find useful some kind of measuring stick as we go through 2014 because it sounds like those figures are in flux.

Sanjay Kapoor

Again, so one of the biggest things, again, all of last year, and particularly, in the fourth quarter, Larry and I went through pretty much every program in a lot of detail, it's a very comprehensive review, so that we can have a balanced risks opportunity with our estimates and so on and so forth. One of the best measures you will see, as we deliver on these results that we committed to you, in order to give what we guided to you is a very balanced approach to what we think we can achieve and should achieve. And the team has obviously tried to focus on it. So in the second and the third and the fourth quarter, you will start to see, as we continue to perform and deliver on what we are committing to you in terms of the 2014 guidance.

Operator

And our question comes from Howard Rubel from Jefferies.

Howard A. Rubel - Jefferies LLC, Research Division

Sanjay, you said something that I want to understand a little bit more with granularity. If we take the numbers on 787, it would appear that the losses actually step up before they decline. Can you reconcile that with the fact that you'll probably be at a reasonable production rate? You're at 10 a month right now. So one would think that the cost should actually be coming down, not increasing.

Sanjay Kapoor

That's a good question. And you're right, the costs are coming down. But as you know, we have stepped down pricing in our contracts. And so what we have adjusted to is the current that we feel we can achieve. We will also include in there, like Larry mentioned, along with our customer, a number of cost reduction initiatives that we baked in. Now we plan to work on those. But again, these contracts do have step-down pricing, and that does matter as we go down these curves.

Larry A. Lawson

Howard, if I can interject. This is Larry. If we were actually -- if we compare 787 performance, it's actually the best we've ever seen of any of our comparable products. I mean, I think we've got a great track record and it's pretty well recognized in the industry in terms of what we've done with the 737 cost-reduction and what those curves have looked like. And truthfully, and I don't know if we've spoken about this a lot, but the truth was 777 was really the best performing program we had. The truth is, the 787 is actually outperforming both of those programs in terms of total cost reduction. The curves are really quite impressive. And what we had to -- what we're doing is we're taking -- we're ship set 167 or so in terms of deliveries. And so -- at the end of 4Q. So we're pretty well into this -- 164 units, I'm sorry. And so we have a pretty good handle on where we're going. The labor numbers look great, support ratios are coming down. We'll continue to press on that. And we have to continue to work down material cost. So as we projected from unit 164, out to the end of the block, we just said, all right, look, given the kind of the term of this execution, there is no model cost reduction we think we're going to achieve and then put that forward. And so it's not bad performance, it's actually exceptional performance. But it's a challenge to be able to recover all of the deferred inventory as we go forward against the step-down pricing.

Howard A. Rubel - Jefferies LLC, Research Division

So then, a chunk of this is actually not cash because you've already invested it and...

Larry A. Lawson

Well, so the deferred inventory is, of course, prior cash. But in front of us, what we're talking about is, getting enough cash to recover this deferred inventory. So we aren't talking about future cash flows, we're just talking about the magnitude of the future cash flows.

Howard A. Rubel - Jefferies LLC, Research Division

Just to conclude. Where are you with the rest of the negotiations with Boeing in terms of, what I'll call, your master agreement with them?

Larry A. Lawson

We continue to meet with Boeing, and we continue to work on trying to reach an equitable agreement for both parties. I mean, there's -- the conversations become -- have become more refined and, I think, more data-driven. And we're going to continue to work with them and try to figure out where the -- to bring this to an equitable conclusion.

Operator

Our next question comes from Carter Copeland with Barclays Capital.

Carter Copeland - Barclays Capital, Research Division

Just a quick one, a couple of quick ones. Sanjay, can you clarify with, respect to the 787, when you

think about GAAP -- your GAAP earnings versus sort of underlying unit earnings or something closer to cash, how does that look, positive or negative? If we think '14, '15, '16 under the new profile. Is '14 negative, but then '15 and '16 are positive to recover what's left of the deferred balance?

Sanjay Kapoor

Thank you. Here's what I'll tell you. I mean, clearly, '15 and '16 are more challenged. And again, in '14, we've made some pretty impressive rate increases, like Larry talked about. We've gone down some pretty excellent learning curves and so on. But again, based on step-down pricing, the out years are more challenged from a cash perspective than current years.

Carter Copeland - Barclays Capital, Research Division

So the out years are presumably use of cash instead of a source of cash?

Sanjay Kapoor

Yes. Again, based on -- I'm sorry, based on -- go ahead, go ahead.

Carter Copeland - Barclays Capital, Research Division

All right. I had a different question. Please, go ahead.

Sanjay Kapoor

Well, I just want to remind you that, again, exactly what I just said in terms of the deferred loss that we've established, there's some chunk within this year but that's included in our guidance. And then the rest is in '15 and '16 in terms of cash flow.

Carter Copeland - Barclays Capital, Research Division

Okay. And then with respect to the margins. I mean, when you look at what sort of implied in the segment level margins to get to the EPS number, it looks like a reasonable step down, probably 200 somewhat basis points from what you did in 2013, X the various catches and charges. Now some of that will be mix, I would assume, maybe 75 bps, something like that. But the rest is sort of unexplained at this point. Have you left some room in that? I know you made a comment with respect to development program [indiscernible]. Have you left room in that guidance to absorb the kind of hiccups we've seen in cost estimating on something like the A350 for this year or not?

Sanjay Kapoor

Well, again, what I tried to give you in terms of guidance, what Larry and I gave you, you're absolutely right firstly, in terms of the mix impact. And we can look at Spirit's portfolio, clearly, at this stage, we've got a number of programs, the A350 and even the 787 and the Gulfstream program that are in the early stages of maturation. So that clearly has an impact. It's inherent in this industry and so the mix obviously plays a role. Listen, what we gave you in terms of guidance is what we believe is a balanced view of all of our -- of the entire portfolio. Now our goal inside the company clearly is to try and perform to the higher end of the ranges that we've given you. But I have to make sure that what we commit to you is something that we deliver.

Operator

Our next question comes from Doug Harned from Sanford Bernstein.

Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division

Continuing on the 787. In the Fuselage Systems area there had never been a charge before. And I appreciate you've been coming in the learning curve very rapidly. And as you said, it continues to be quite good relative to other programs. But the step down in pricing has been known for some time. So can you talk about, with respect to the fuselage, and actually, the other 2 components as well, where you've run into problems here? Is it the -9? Is it taking rate up? What has made this turn out worse than it was thought to be before?

Larry A. Lawson

Doug, we -- first of all, let me just say, we really took a lot of time on this particular subject. This is not -- this is really based on a very in-depth analysis of, really, all the moving parts as it relates to our cost. And I don't really want to get into kind of, I'll say, the long history of what assumptions were made in terms of commodity pricing, material, loan, all of that, what kind of leverage people thought that they could get. But there were a number of very large assumptions made early on as it related to expectations in terms of, I'll say, material cost, et cetera. And as we've kind of gone through all these items and really assess both labor, support, quality of the product, quality-related costs. And then on the material side, both, what I'll say, fabricated material, things, supply that we buy, as well as commodity material, we really got down to pay 164 ship sets in. And we're going to have to predict what the next 336 are going to cost. So in this window, what is our expectation? And we have another expectation further out in time. But in this -- through next 3-year window, '14, '15, '16, we have to make adjustment, and we did. And it doesn't -- by the way, we didn't flatten the curve. The curve continues to follow the performance we've seen. And then it really leverages some of the initiatives that Boeing's put in place to see further additional material cost downs. But when you balance that all out and you bring it all up to the top, after looking at this very hard for the last 9 months, this was the conclusion we came to. And all I can tell you is this has been incredibly exhausted, not only with us, but quite frankly, with other partner, spending a lot of time looking at all this.

Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division

Well, 2 things on that then. If -- I first take it that material cost has been a large part of this. And then second, when you're working with Boeing, in the context of the broader agreement you're trying to complete with them, are you getting any relief from them on pricing here?

Larry A. Lawson

Well, what I would say, Doug, is we're continuing to work. The data is the most important part of having an intelligent conversation. And we still have -9 and -10 in front of us, as well as future cost-reduction initiatives. And frankly, a look at what the ultimate build rates will and the configuration of the final product. So there's still some variability out in front of us and room to work. So I'll just tell you, we're not doing this in the vacuum.

Operator

Our next question comes from David Strauss with UBS.

David E. Strauss - UBS Investment Bank, Research Division

Following up along the same lines. In terms of these step downs that you're now citing, I think you also went through a step down at unit 100. Where do these next pricing step downs take place? And are they of actually bigger magnitude than what you saw in terms of the step down at unit 100?

Sanjay Kapoor

So, David, again, I don't want to get into when the step downs are, how big the step downs are. I mean, clearly, you know that our contracts are doing well with step downs in the current block. And I'm even working really hard to make sure that our cost line and our curves are the best that they can be. So have we been aware of a step down? Yes, we have. But Larry just explained in quite detail, over the last 9 months, we had an exhaustive look at our curves, which have been pretty good, on labor, on material. But at this date, we have delivered a significant portion of the current block. And when we look at what we can achieve in the near term, and by the way, there is a lot that we signed up to do, that's the result of that exercise. So a balanced view in terms of what we feel we can deliver. And that's the basis of the charge.

David E. Strauss - UBS Investment Bank, Research Division

Okay. And how are you estimating price on -9? Because I think last we knew, you still haven't set a price from Boeing on the -9.

Sanjay Kapoor

Again, like Larry said, we are working with our partner, our customer at Boeing Corporation. And there are number of factors, as we discussed the -9 and in future, the -10 pricing. So we continue to work with them on the configuration, on the pricing, on the quantity and so on and so forth. So that's still out there. And we are working that hard with them.

Operator

Our next question comes from Ron Epstein from Bank of America Merrill Lynch.

Ronald J. Epstein - BofA Merrill Lynch, Research Division

Maybe a very big picture question for you and then a follow-on. Larry and Sanjay, when you look -- you brought in a whole new team into the company. You did this comprehensive review. What are you guys doing different than the previous team to make investors feel confident that -- okay, this is it. We don't have more of these kind of charges coming down the road. This is probably the most common question I get asked and probably my peers do, too, wow, I mean, when does Spirit stop taking charges? What are you guys doing different than the previous team? Because clearly, under the previous management, Spirit went way off the rails.

Larry A. Lawson

Well, what I would say is, kind of maybe I was too oblique in my comments. But we're trying to make smart decisions as it relates to going forward in terms of the type of work that we get involved in and then our ability to estimate that work. And make sure that the jobs that we take on are aligned with our core competencies. And where they don't, then we look at frankly, divesting those things from the portfolio. The -- so that's -- I'd say, that's absolutely the first step of really working this thing. What I would say is some of this is just timing in the industry. It is very difficult to, and this is kind of a -- part of the commercial market space. It's very difficult early on to kind of make -- a clean sheet of paper is more challenging, when we say it this way, for a major redesign or new product, I should say, than, let's say, a derivative product. So the good news going forward is that there aren't a lot of clean sheet paper products out in front of us. They're mostly derivatives. And so that provides us less risk as we go forward and we're -- with more rigor and discipline. We are trying to figure out, at the same time, when we're taking on these new things, we're obviously trying to figure out how to run the business as efficiently as possible. And so that provides us some headroom. And we're very fortunate to be in a growing industry. And so the kind of the growth side of the industry, and especially the fact that it's in our core, provides us a little bit of opportunity, especially as we work efficiencies to try and absorb some of these other challenges. So it's been an interesting set of timing. I have to admit, when I came here, I think you all asked me what was the biggest surprise. And the biggest surprise for me the, I'll say, balance of new programs versus mature programs. I mean, in most companies I have worked for and enterprises that I've run, the balance is a little different. You probably would have one major development, and then maybe a couple of derivatives, and then your mature product line. In our case, we've had a number of new developments. And it's created a bit of, I'll say, imbalance in the portfolio. And to some degree, it's reflected in our guidance. I think the question earlier was kind of your guidance looks a little conservative. Well, it reflects a little bit of that in terms of the overall balance. So the only confidence I can give you is, the good news is we're in a growing industry as opposed to declining. And we've got the right folks here. And frankly, we're not finished to try to figure out how to execute on the tough things and optimize our performance and the things that are more mature for us. I wish we were a lot more sophisticated than that, I'd be really proud of myself. But the truth is, this is blocking and tackling.

Ronald J. Epstein - BofA Merrill Lynch, Research Division

Okay, okay. And just as a follow-on would be now that you've done the review and you've written down a lot of the programs that are problematic, why divest to Tulsa now? Why not just keep it in the portfolio, be it that everything is kind of marked down now, right?

Larry A. Lawson

Yes. Well, it may turn out that way but I -- Ron, it may turn out that way. But I will tell you, I don't think we've changed. We're not -- we took our time to make the decision to do that. It was, I think, as I've said previously, it was fundamentally tied to -- I think we view that site as more of a build-for-it business. And we think that, frankly, to be perfectly candid, there's -- we're kind of -- at least, at this point, it's kind of a bring back and focus on our value proposition. And it gives us a little bit of balance, a little more balance in our portfolio. In some cases, frankly, there's folks who have more leverage in the execution of the products built there. And in some of -- again, in some of the business areas that are there are not as long a cycle, or maybe -- we tend to be focused on, I'll say, the commercial side of the business as other segments of business. And so that really was our motive as it relates to Tulsa. And we kind of moved away from that. I mean, we think -- look, back to your point, it's a really good business, especially in this long cycle of the commercial aviation business. If things don't work out, we'll be the proud owners.

Operator

Our next question is from George Shapiro from Shapiro Research.

George Shapiro

Sanjay or Larry, I wanted to look at your earnings guidance from a different perspective. Each of the past several quarters, you've shown underlying earnings of $0.70 a share or better. And next year, the 737 deliveries are going to go up. So why shouldn't the guidance be at least 2 80 unless you're are assuming lower margins on the mature 737, the 777 programs or you're just being conservative?

Sanjay Kapoor

George, I understand your -- both the question and possibly, your calculation. But like I said in my comments, a significant portion of the growth that we are seeing between this year and next, I mean, we're doubling the rate at which we will produce the 787 program. And as you're well aware, that forward loss provision is a low margin business for us. So that, unfortunately, does have a dilutive effect in terms of our overall operating margins. Listen, we are going to continue to drive our improvements in our mature programs. We need that to offset some of the risks that, like I've said, are inherent in this industry, in our program and in our portfolio. Larry talked about it a lot. So what we try to do here is to give you a very balanced view of what we think. On the mature side, we're going to drive and do better at and some of the challenges that we continue to face on the new programs, on the development that's going on inside our businesses. So that's what you're seeing at a very macro level in terms of our guidance.

George Shapiro

If I push back a little bit, the $0.70 plus the share each quarter that you've shown includes the 0 margin business. So I'm not -- operating margin is certainly going to go down. But the $0.70 a share is just coming from mature programs and the mature programs, if anything, are going up. That's the gist of my question.

Sanjay Kapoor

No, I understand, I understand. Again, you're right. The $0.70 per share is the number. And I kind of answered to you the impact of the growth in the 787, which is a large part. But again, the $0.70, I mean, we still have a lot of work to do to achieve what we have committed to ourselves on all of the other programs. You've seen a variety of charges. There are model mix impacts, there are rate delta's that happen, and so on and so forth. The delivery and the supplier things that we have to do deal with on the Gulfstream program. So we baked that into our balanced view and gave you the best guidance we think we can achieve at this point.

George Shapiro

And just a question on the free cash guidance issues given. Can you just provide how much deferred production increase that assumes? I'm thinking maybe it's $300 million or $350 million?

Sanjay Kapoor

Listen, again, I can't give you a specific number here. But again, that is baked into the guidance of $150 million free cash flow. There are a variety of numbers that go in, as we can imagine. Larry talked about and I talked about also not just for cash from operations, but also managing the cost side of the cash, whether it be in CapEx or others. But it's -- we have growing businesses that will have an impact, whether it be the 350 or the Gulfstream. That's incorporated into the $150 million number that we gave you. And again, I say this on the earnings per share, as well as on the cash flow, we will strive to do better.

Operator

Our next question comes from Sam Pearlstein from Wells Fargo.

Samuel J. Pearlstein - Wells Fargo Securities, LLC, Research Division

Just a follow-up on that. Can you talk a little bit about incentive compensation and any changes that you're implementing? Just because if I look at the magnitude of these charges, it would certainly seem to say that your EBIT as a percentage of revenues would miss whatever targets you had for the year, maybe free cash flow is a little bit better. But what changes are you making to help drive this performance into 2014?

Larry A. Lawson

Yes. So, we -- I'm gathering your question is about 2014 incentive comp as opposed to 2013. We have made, well, very, very significant changes in the incentives. I referenced that in my opening comments to make sure that they're frankly -- what we did, obviously, even more detail. What we really did, we visited the bottoms up build, right? This is not a tops down answer. And when we did this bottoms up build, and Sanjay referenced kind of the comprehensive look at the opportunities and risks and then where we set the targets for every one of the programs. Every owner in every program and every product now has a very definitive set of performance measures that they have to meet. And so I mean, I think that level of detail didn't exist previously. And then, of course, at the macro level, the integrated results are equally aligned and very much different than, I'll say, prior incentives. So there's very clear accountability. That's why I kind of made the point this is my team's plan. There's very, very clear and measurable accountability for the performance to the execution plan for 2014.

Samuel J. Pearlstein - Wells Fargo Securities, LLC, Research Division

Okay. And then if I can follow up, one of the things you had said you were going to talk about in your strategic plan was about capital allocation. And so how should we think about, I guess, capital structure in general, because you have a big hit to the equity with the charges. And then using the free cash or any proceeds from Tulsa, how do you think about that?

Larry A. Lawson

Well, yes. Look, I wouldn't want to tie -- any conversation about how we might deploy capital, I probably wouldn't tie it to any singular event. We hope to accumulate capital again. That was kind of my point when I think about the near term. And I kind of, I'll say, the simplest way to say this is really kind of stabilize the operations so that we can accumulate cash and then grow the enterprise. And the question, how we might deploy capital, I can just tell you, we will consider all the options ranging from share repurchase to the normal things that you would talk about, dividends and then M&A. We'll be really thoughtful, though. I will tell you, we're going to be -- again, when I stay stabilize and grow, I mean, we're going to really, really focus on the challenges we have in front of us in terms of performance and in cash accumulation. We're performing, frankly, where we need to perform as a business. So you should expect, year-over-year, significant improvements.

Operator

Our last question comes from John Godyn from Morgan Stanley.

John D. Godyn - Morgan Stanley, Research Division

Larry, in the prepared remarks, you sort of acknowledged volatility in the short term, but a focus on a long-term, multi-year plan. And I was hoping that you could maybe elaborate on some of the metrics that the organization is focused on in the long term. Are there kind of margin targets, free cash flow growth targets, ROIC targets? You also mentioned Defense as an opportunity. If you could just help us sort of plug into the vision that you have for the organization 3 to 5 years down the line.

Larry A. Lawson

Well, I'll tell you in the near term, and it's, again, for my team, I try to keep this really simple. Let's focus on the cash flow. It's been a -- obviously, you have to have earnings to generate cash. So you can't give up your earnings and expect to generate cash. So for us, the emphasis, really, in the near-term has been on free cash flow. And to get that free cash flow in line to where you would expect a $6 billion plus enterprise to be throwing cash, and then, then have the conversation around how you might deploy that capital. Mostly, today, the focus really needs to be on why we have so much difficulty in getting that to the bottom line. Now again, I would say, some of this is timing, right, the good news, bad news. The good news is that you're in a market that's growing. And the good news is you're a participant in programs that have very long cycles. The challenging part is there's investments that go with that. And then the question is, how do you balance those investments against your overall needs to take care of your shareholders? And so really, that kind of rigor and discipline. So we look at every component of the cost that we have in the enterprise. And whether it's overhead or whether it's CapEx, or whatever, all of those elements, that was a point I was really trying to really make about being an integrated enterprise. And this isn't just a program-related conversation. I mean, the functions have to perform as well. So for example, I made the comment, the centralization of a lot of functions, I think actually, it will improve our performance and not just reduce our cost. I think we'll actually end up performing better as an enterprise. So that's really -- I'll be very, very candid, that's where the drive today is. And so most of the metrics that the team are working to, they're pretty detailed. I mean, I have a -- I brought a lot of tools with me. I felt I had good fortune of being involved in a lot of production programs, development programs. And so today, we have a very by-program, by-product, week-to-week, did you earn your hours, did you hit your productivity? Did you -- all those kind of metrics, both in production as well as development in terms of learning how to manage the business. And then kind of an integrated approach to making decisions. I made the comment earlier about being very responsible about the decisions we make because when you take on these decisions, then they just define your future. So that's really, I'll just say, with the most intensity, where the metrics are. In the long-term -- yes, we have long-term objectives, but I would say, and I think I was asked this question in the prior 2 calls, where do you ultimately see your margins? And my answer always is, well, my expectation of margins are going to line up to our customers. And today, we may be a little about there, a little suppressed from there just because of the mix. As we move along, we would hope to see some margin expansion. We will be out of line with our customers, would be what I would say as it relates to the ultimate objective, which brings you back again to let's focus in on cash.

Coleen Tabor

Thank you. Now I'd like to turn the call back over to our President and Chief Executive Officer, Larry Lawson, for some closing comments.

Larry A. Lawson

Thank you. Well, in summary. As we enter 2014, we are absolutely more a financially metrics driven enterprise. We're absolutely committed to generating predictable and consistent results through process, focus and discipline. We're stepping up our game of what we do best. We're far more disciplined about our decision-making and we're stabilizing the enterprise through performance and cost improvement. I believe these actions, coupled with the ramp up of the commercial aerospace up cycle, positions Spirit to deliver results to our customers and shareholders and our employees. And so I will just end -- I'll end the call with thanking you and certainly, thanking our employees. And actually, I hope to see many of you in the month ahead. I'm going to be on the road. I'll be in Toronto, New York and Boston, talking to a lot of our shareholders, as well as many of you. I will be presenting at several conferences in the near term. And I hope we cross paths. But if we don't, then I'll -- we'll have a chance to talk again in our next call in early May. Thank you.

Operator

Thank you, ladies and gentlemen. This includes today's conference. Thank you for participating. You may now disconnect.

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