Spirit AeroSystems is Boeing's Biggest Problem

Set over a sprawling 1200 acres, Spirit Aerosystems Wichita, Kansas airframe manufacturing facility is the heart of the Boeing 737 production line. Without Spirit, Boeing wouldn’t have airframes for its bestselling midsize commercial plane, but it also may not have the problems that keep coming with it. 

Boeing and Spirit AeroSystems have a long and intertwined history, dating back to the establishment of Boeing in the 1920s. Spirit AeroSystems (SA), initially part of Boeing, became an independent company in 2005 when management spun out Boeing’s facilities in Wichita, Kansas and Tulsa and McAlester, Oklahoma. The complete line of thought on the divestiture has never been clear. 

In a way, Spirit AeroSystems is Boeing’s “nepo baby,” a child (or in this case, a company) which has succeeded almost entirely thanks to its parents' success. 

The relationship between Boeing and SA has evolved into a strategic alliance. SA has played a key role in manufacturing components for the 787 Dreamliner, airframes for the entire 737 lineup, and collaborated on defense contracts and military programs. 

Late last year, Boeing and Spirit renegotiated a long term deal for 737 and 787 airframes, revising terms on the work the supplier is doing that is slated to net Spirit about $190 million in additional sales through 2033.

SA has historically benefited from the credibility and reputation associated with being a key supplier to Boeing, attracting lucrative defense contracts for navy helicopters, drones, B-52 bomber engine retrofits, and the B-2 Spirit Bomber. 

While Spirit has worked on Boeing programs like the KC-46 tanker and the P-8 antisubmarine aircraft, those projects involved building the forward fuselages on the commercial 767 and 737-800 that serve as the platform aircraft for those programs. 

The B-52 work, which Spirit openly pursued for several years, also came as the company pushed on a goal of boosting defense to 40% of its overall business. 

And in the case of the B-52H, all of which were made in Wichita, it comes with the added bonus of bringing the vaunted bomber back home to give it new life through at least 2050. 

“We’re going to come full circle and really help this aircraft finish its lifecycle,” Hein says.

But while Spirit has done a great job fulfilling their new military contracts, they haven’t done a good job keeping up with Boeing’s backlog of 4,420 737 MAX orders, which includes 962 orders for the yet-to-be-FAA-certified 737-10.

Airframe problems

Last weekend, every air traveler's worst nightmare happened, (I have a frequent recurring dream of sitting alone in an airplane when the floor blows out from under me) when part of the cabin of an Alaska Airlines 737-Max blew off at 16,000 feet, depressurising the cabin and sending phones, laptops, and t-shirt flying. 

Over 1,200 Alaska Airlines and United Airlines flights have been canceled in the U.S. following an incident with a Renton-made 737 Max 9 jet that lost a piece of its fuselage mid-flight. The Federal Aviation Administration (FAA) has grounded approximately 170 Max 9 aircraft with similar door plugs, initiating inspections to verify their airworthiness.

Although the cause of the recent failure is still unclear, some aviation experts say the allegations against Spirit are emblematic of how brand-name manufacturers’ practice of outsourcing aerospace construction and eschewing vertical integration has led to worrisome safety issues.

The faulty emergency exit door panels, known as plugs, are fully installed in two steps, in two factories. First by SA in Kansas, and later by Boeing in Washington State.

Boeing has not yet specified whether the problem originated in its own assembly, fuselage supplier Spirit AeroSystems, or elsewhere in its supply chain.

The latest incident raised questions about the quality-control processes across Boeing and its suppliers particularly as a wave of retirements has left them with more inexperienced workers, Bank of America analyst Ronald Epstein wrote in a note to investors. The company extended its required retirement age of 65 to 70 to allow Mr Calhoun, who is now 66, to stay in the top job.

A federal securities lawsuit filed a month before the accident accused Spirit AeroSystems of deliberately covering-up systematic quality-control problems, encouraging workers to undercount defects, and retaliating against those raising safety concerns. 

The lawsuit also includes statements from a former employee at Spirit AeroSystems who allegedly warned company officials about safety problems and expressed concerns about an "excessive amount of defects," suggesting that a major defect could escape to a customer. 

An amended version of the complaint, filed on December 19, provides more expansive charges against the company, citing detailed accounts by former employees alleging extensive quality-control problems at Spirit.

Company executives “concealed from investors that Spirit suffered from widespread and sustained quality failures,” the complaint alleges. “These failures included defects such as the routine presence of foreign object debris (‘FOD’) in Spirit products, missing fasteners, peeling paint, and poor skin quality. Such constant quality failures resulted in part from Spirit’s culture which prioritized production numbers and short-term financial outcomes over product quality, and Spirit’s related failure to hire sufficient personnel to deliver quality products at the rates demanded by Spirit and its customers including Boeing.”

Other analysts have argued that the Federal Aviation Administration (FAA) has failed to properly regulate companies like Spirit, which was given a $75 million public subsidy from Pete Buttigieg’s Transportation Department in 2021, reported more than $5 billion in revenues in 2022, and bills itself as “one of the world’s largest manufacturers of aerostructures for commercial airplanes.”

“The FAA’s chronic, systemic, and longtime funding gap is a key problem in having the staffing, resources, and travel budgets to provide proper oversight,” said William McGee, a senior fellow for aviation and travel at the American Economic Liberties Project, who has served on a panel advising the US Transportation Department. “Ultimately, the FAA has failed to provide adequate policing of outsourced work, both at aircraft manufacturing facilities and at airline maintenance facilities.”

McDonnell Douglas

But blaming the FAA doesn’t cut it. A widely held belief that Boeing’s approach to quality and engineering changed for the worse after the 1997 merger with rival McDonnell Douglas, which was passed down to Spirit, may be a better explanation. “McDonnell Douglas bought Boeing with Boeing’s money,” went the joke around Seattle. 

The merger resulted in internal conflicts, including a major strike, and had lasting impacts on the company's culture.

Boeing's identity as an "association of engineers" during the early decades of the jet age contributed to the company's success. The focus on engineering excellence and innovation, regardless of expenses, and the company's philosophy prioritized design and quality. Engineers had a significant influence on decision-making.

Boeing's white-collar engineering union protested the merger with a 40-day strike in 2000, with union members expressing concerns about the future competitiveness of the company and the need to preserve Boeing's engineering-centric identity.  “A passion for affordability” became one of the company’s new, unloved slogans, as did “Less family, more team.”

During the 1960s and 1970s, Boeing and the U.S. aviation industry benefited from what was considered a "golden age." However, the 1980s brought about changes in the airline industry with deregulation under Presidents Jimmy Carter and Ronald Reagan. Increased competition forced airlines to become more cost-conscious, putting pressure on aircraft manufacturers like Boeing to adapt. 

Boeing, led by CEO Phil Condit, had already initiated a program of cost-cutting, outsourcing, and digitalization. Acquiring McDonnell Douglas offered several advantages to Boeing. Firstly, it allowed Boeing to assert dominance over its oldest rival, marking a victory for the company. Secondly, the acquisition provided an opportunity to gain McDonnell Douglas' valuable military expertise, enabling Boeing to diversify its offerings beyond the volatile commercial aircraft market. The military sector was seen as a more stable source of revenue.

By the 2000’s, the FAA’s regulation of Boeing lapsed as both were under pressure to cut costs. At Boeing, pressure from Wall Street eroded the corporate culture that had defined the company for about 80 years. 

Investigative reporter Peter Robison highlighted the impact of the merger on Boeing's leadership and operational decisions. The company's culture shifted to prioritize schedule, cost, and shareholder value, with a focus on cost containment. The leadership, influenced by executives from McDonnell Douglas, emphasized reducing costs, leading to a culture where ideas were evaluated in terms of dollars, and employees faced performance and time requirements tied to cost reduction. 

Later on, the outsourcing of software-development tasks, including those related to navigation and autopilot, to recent college grads earning low wages raised concerns among experienced Boeing engineers. The engineers earned as little as $9 an hour, and were employed by an Indian subcontractor set up across from Seattle’s Boeing Field.

Stuck culture

The merger gave just enough time for the toxic culture from McDonnell Douglas to seep into the divisions that would later become Spirit Aerosystems. Today, Spirit’s top managers, quality control directors, and executives came either directly from Boeing, or reported directly to those McDonnell Douglas executives before 2005.

Terry George, Senior Vice President Wichita and Tulsa Operations, was a senior manager at Boeing for 22 years before joining the newly spun-out Spirit AeroSystems in 2005, and previously served as Boeing’s manager on the 737 program. Jose Sanchez, Executive Director of Operations, was a Composite Manufacturing Manager at Boeing for seven years before joining Spirit in 2006. 

CFO Mark J. Suchinski also joined Spirit in 2006 as an Aerostructures Controller, and later became the Vice President and General Manager of the disastrous 787 program. His Director of Quality for the 787 program, Brad Davies, joined Spirit in 2007. And Richard Cassube, Director of Quality for the 737 program, joined Spirit in 2006. You get the idea. 

The 737 MAX would become a dark mark on Boeing’s history after it was grounded worldwide between March 2019 and December 2020 following two crashes that resulted in 346 fatalities due to a malfunctioning computer system and poor engine layout. The extended grounding incurred substantial financial losses, estimated at $20 billion in fines, compensation, legal fees, and over $60 billion in indirect losses from canceled orders. 

The plane's original design, meant for a time before machine-aided cargo loading, positioned the aircraft low to the ground to facilitate ground crews hauling baggage. However, as the planes grew larger, their engines also increased in size. Unlike earlier models where engines were hung under the wing, the 737 Max had engines moved forward and upward. The repositioning of the engines caused the fatal crashes of 2018 and 2019.

To address this issue, Boeing implemented the Maneuvering Characteristics Augmentation System (MCAS), a software fix for the underlying hardware problem. However, this software solution was flawed. 

Internal exchanges revealed instances where Boeing's vice president, Mike Sinnett, misunderstood the term "single-point failure" in the context of the MCAS software system implicated in the 737 Max crashes. The assertion that pilots themselves constituted a second point of backup showed a departure from Boeing's traditional practice of having multiple backups for every flight system.

According to pilot and software developer Gregory Travis, the MCAS relied on the wrong systems and sensors, lacking cross-checks with easily accessible information from the plane's sensors. Travis emphasizes that such a flawed system should not have passed scrutiny, stating that none of these issues should have received approval from even the most junior engineering staff. 

The 2023 third quarter included the revelation and fallout of mistakes made in assembling bulkheads on the narrowbody. It followed the second quarter's quality control issue on the tail fin assembly. There also was a week-long strike in early July by Wichita workers who eventually negotiated a guaranteed annual wage increase up to 34% combined over four years.

Spirit still does not know what the ultimate cost of the tail fin issue will be. The company estimates that it will cost $31 million to perform the work on 737s yet to be delivered to Boeing, at roughly $100-150,000 per airplane.

The 787 program seemed to face a new problem every year too. While the first 787 was originally scheduled to be delivered back in 2008, a string of delays and cost overruns meant that deliveries didn’t start until 2011. Fuel leaks, smoking cabins, and fires damaged the plane's early reputation.

Then Suchinski led the 787 program between 2017 and 2019, when improperly manufactured outsourced components led to the aircrafts worst quality control issues. By August of 2020 the FAA had launched an investigation into the aircraft and grounded dozens of airplanes.  

"Boeing has identified two distinct manufacturing issues in the join of certain 787 fuselage sections, which, in combination, result in a condition that does not meet our design standards," a Boeing spokesperson said in a statement.

One problem is that the shims used for filling empty spaces installed on some aircraft weren't of a correct size while a separate issue involved "skin flatness specifications" not being met in certain parts of assembled aircraft.

The plane was grounded again a year later when another outsourced component from Leonardo SpA in Italy was manufactured improperly but installed anyway. Boeing was able to resume deliveries of the 787s after a five-month hiatus - only to halt them again after the FAA raised concerns about its proposed inspection method. 

If Boeing, why not Airbus?

Spirit AeroSystems is also a leading supplier of airframes for the Airbus A350, a direct competitor to Boeing’s 747. And for all Boeing’s faults with the 737 and 787 programs, one would think Airbus would have the same problems. But that is far from reality.

While Spirit AeroSystems did spin out of the Boeing Wichita plant, they also manufacture airframes for Airbus out of the former BAE Systems aerostructures factories in Scotland and France which were major suppliers to Airbus and Boeing, with 80% and 15% of output respectively.

And while Boeing has faced grounded airplanes and countless problems with suppliers, the only major problem with the Airbus A350 was a paint issue found by Qatar Airways and Lufthansa in 2021. Although the “surface degradation” was a major flaw for the A350 program, it was nowhere near as disastrous as the 737 MAX program with its hundreds of fatalities. Importantly, Spirit AeroSystems does not paint fuselages.

Boeing's CEO wants to make changes,

Boeing's CEO David Calhoun has taken steps to shift the company's practices back toward a product-focused approach. Weekly reports from the engineering team and the establishment of a safety committee on the board reflect an effort to prioritize safety and engineering concerns.

The list of to-do tasks for the surprising new chief executive of leading aerostructures supplier Spirit AeroSystems is clear and daunting: stabilize and increase ship sets for Boeing 737 MAXs, fix other commercial programs, repair investor relations, and figure how to make a major debt repayment looming in 2025.

Calhoun has made changes such as merging the 50,000-strong engineering department into a single, integrated global organization—previously, engineers reported to managers inside individual business units—while stressing transparency. The changes have yielded results, which included the disclosure of a quality problem Boeing found and disclosed, in August: incorrectly drilled holes in 737 aft bulkheads made by supplier Spirit AeroSystems.

That change isn’t happening quickly enough for some observers, who would like to do more and do it faster. AeroDynamic Advisory managing director Richard Aboulafia says he isn’t “seeing the progress on culture,” and believes adding more engineers in senior leadership roles would be a beneficial change.

And Spirit’s does too

Despite bad management and a broken culture, Spirit’s new CEO and Boeing veteran Patrick Shanahan wants to change the company dramatically. 

Shanahan was a Trump administration Pentagon official who previously worked at Boeing for more than thirty years, serving as the company’s vice president of various programs, including supply chain and operations, all while the company reported lobbying federal officials on airline safety issues. 

“We are uncertain on the ability of the interim CEO to change the near-term execution challenges facing Spirit, but we do believe [former CEO Tom] Gentile had lost substantial credibility with investors and even within the company and industry,” RBC Capital Markets analyst Ken Herbert said in a note. “The focus for Spirit will remain production execution, potential customer contract renegotiations, and then debt refinance.”

Tom Gentile, former CEO and president of Spirit AeroSystems, faced significant challenges during his tenure, including the Boeing 737 MAX crisis, the impact of the coronavirus pandemic, and ongoing manufacturing issues. Despite efforts to raise Spirit's investment profile and diversify revenue, the company struggled amid industry challenges. 

By last summer, analysts characterized Spirit AeroSystems as the "sick man of industry" and noted its challenges in relation to original equipment manufacturers (OEMs). 

Beyond MAX production issues, the company’s work on Airbus A220 and A350 are in forward loss positions. Corporate debt reached almost $4 billion, including $1.2 billion due in 2025 in what is still a high or rising interest rate environment.

“The path forward is focused on executing on rate ramps, dealing with forward loss contracts, and cleaning up the balance sheet,” Jefferies analysts said.

According to analysts, Shanahan has indicated his key priorities include: 1) boosting Spirit’s production rates; 2) improving supply chain execution; and 3) meeting its customer commitments. “But we assume reaching agreement with Boeing regarding price relief also is a key objective,” Cowen analysts added.

Shanahan “is well regarded and very well-qualified for the job,” the Cowen analysts further said, echoing other analysts. In the Trump administration, Shanahan served as deputy defense secretary, along with a six-month stint as acting defense secretary during Cabinet turnover in the first half of 2019. 

Analysts have said that OEMs, and namely Boeing, cannot allow Spirit to fail as a business. “So, Boeing is apt to be there for additional advances, if needed,” the Cowen analysts said. “But we don’t see Boeing wanting to buy Spirit. Doing so could put upward pressure on wage rates in Wichita, which are lower than in Seattle; and as a large Spirit customer, Airbus could object to a Boeing takeover bid.”

Would Boeing buy Spirit back?

“We’re a public company,” former Spirit CEO and President Tom Gentile said. “People can make offers for public companies, and we would respond to those things. I have no idea what Boeing’s plans are related to something like that.”

Gentile answered the question posed by a Bank of America analyst during the company's first-quarter 2023 earnings call. The question came after Spirit reported disappointing results for the first three months of the year. 

While seemingly farfetched, executives and investors previously had thought Spirit would be rising above the aftermath of Boeing’s MAX crisis and the pandemic’s commercial downturn by now. Instead, the company admittedly is facing another bad year, says Aviation Week.

“While the OEMs are never going to let Spirit fail, it is now in a form of indentured servitude that will severely impact its future cash flow,” analysts at Vertical Research Partners said. “For many investors, Spirit continues to be seen as a geared way of playing a potential recovery at Boeing Commercial Aircraft, and for us that is a risky call.”

Spirit managers acknowledged the difficulty. “Looking ahead, the rework and disruption from the vertical fin attach fitting issue, as well as the risk of lower 737 deliveries, will have a negative impact on free cash flow this year,” Gentile said. “The forward losses taken during the quarter will also result in additional pressure in our cash flows.”

Spirit previously had guided that its free cash flow should be “better than break even” in 2023, but now it is forecasting a $100-150 million cash burn in total by end of year.

But Spirit leaders acknowledged Boeing could seek compensation for its own rework on MAXs already delivered to airline and lessor customers, and Boeing’s rework will be more expensive because more is involved with reworking a finished aircraft.

A host of operating issues

While Spirit acknowledges additional costs, it is relying on increased 737 production to mitigate debt and cash burn. The company aims to raise monthly fuselage production to 38 in August and 42 in October. Despite the challenges, Spirit plans to deliver 390-420 fuselages in 2023. The potential financial impact of Boeing seeking compensation remains uncertain at this time.

On its November earnings call, and prior to the latest incident, the company reported unprecedented demand in the aerospace sector and strong delivery and revenue growth. This demand surge is particularly notable in Spirit AeroSystems' core segment, where they currently have a substantial $42 billion backlog.

The company tightened its relationship with Boeing with a memorandum of agreement ("MOA"), bringing an immediate higher price on the 787 program, resulting in a $350-370 million reversal of forward loss and material right obligations.

The MOA also includes a release of claims and liabilities, funding for tooling and capital, and extended repayment dates on customer financing. It also benefited from higher deliveries, as revenues in 3Q23 were $1.4 billion, up 13%, driven by higher production on various programs.

“We think investors had expected a poor quarter from Spirit given the well-known 737 fin issue, but the expected cost of fixing that has been dwarfed by yet more charges on existing OEM programs, most notably $81 million on the Airbus A220 program,” Vertical analysts noted. “With charges on the 787 and A350 also being called out, Spirit is clearly struggling with a host of operating issues at the moment.”

CEO Patrick Shanahan wisely declined to provide guidance for 2024. 

Although it’s hard to speculate what will happen to Boeing’s existing aircraft, Spirit’s fuselages aren’t going anywhere. But if Spirit AeroSystems and Boeing can’t address their mutual challenges, the 737 may stay grounded far longer than anticipated.