Q2 2019 Earnings Call
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797 for three to six.
Your first and last name.
Kevin Laflam K E V I and.
L.A.F.L.A. and M E.
And that was Michael Michael.
It was that.
Oh, yes.
Michael Okay.
In your firm name.
Era AI era.
Turning now.
We experienced a fire in our fastener plant and 10 home, France that resulted in a $4 million unfavorable impact in the quarter related to equipment in inventory damage as heavy as well as higher operating costs.
Fortunately there were no injuries.
We still continue to assess the impact of the fire.
Current estimates are that we will have approximately 5 million to 10 million unfavorable impact in the third quarter and it will take multiple quarters for us to recover from the fire.
We will update you on the situation in the third quarter.
We do have insurance, which is expected to cover the fire with the deductible of $10 million.
Finally, the impact of discrete and special tax items for the quarter was a credit of $61 million. It included a benefit related to prior year foreign taxes, and a benefit associated with a foreign tax rate change.
The second item I wanted to cover was on slide 21 in the appendix, where we've provided an update on our capital structure as we continue to manage our debt and reduced our liabilities.
Gross debt is 6.3 billion in net debt stands at 5 billion.
Net debt to EBITDA continues to improve year over year, despite the cash outflow associated with our $900 million of share repurchases year to date.
Net net debt to EBITDA stands at 2.35 times, which is an improvement of 6% compared to the second quarter of 2018.
With that.
Let me turn it back over to John .
Thanks, Ken.
Moving to slide eight.
I will now comment on the full focus areas that I discussed in the February earnings call, namely operating performance cost reduction.
Capital allocation and portfolio separation.
On slide nine.
Regarding operating performance, we continue to complete detailed quarterly operating reviews on most monthly focused reviews by segment as part of our profit improvement program.
The reviews are robust.
On the quarterly reviews cover 25 key areas to drive current on future profit improvement.
The review content continues to improve and underlying progress is being made.
However, there's still a long way to go regarding performance improvements.
On slide 10, and referred to cost reductions.
Actions are underway to reduce operating cost by $260 million on a run rate basis.
Commitments has increased by 30 million from the previous commitment of $230 million.
140 million of savings are expected to be captured now in 2019, which is an increase of $20 million from the previous 120 million commitment.
The increasing savings this quarter resulted in a severance charge of $27 million.
On slide 11, you can see that year to date, we have completed two share repurchases totaling $900 million.
The weighted average purchase price was $90.80.
Management has a total of $600 million that remaining share repurchase authority.
This is comprised of a 100 million of the repurchase authority from the prior 2018 authorization.
And then additional authority of 500 million, which is approved by the iconic board in May of this year.
Lastly on slide 12, we have an update on the separation.
We continue to track that our state Q2, 2020 implementation date with a targeted filing of the form 10 in the fourth quarter of this year.
You can see the critical closing additions as well as financial implications on the slide.
Moving to slide 13.
The names of the two companies will be how much aerospace and Arconic Corporation.
We plan to announce which company will be spin code at the next quarter's earnings call.
We also plan to provide 2019 year to date financial information for the two future companies at that time.
Consistent with the second quarter earnings call, we have identified non core businesses for sale with an estimated value of $100 million to $200 million in proceeds we had limited earnings impact.
We also expect corporate costs to be in line with industry leading peers.
And in aggregate for the two new companies they will be below the current accounting corporate costs.
I would now like to comment on five additional actions on slide 14.
Firstly in the second quarter, we completed the five year business plans for each of our units.
Let me clarify.
This is not a review of portfolio.
But more a granular level examination of market share.
Competitive position cost base and formulation of clear plans to execute within each business and to secure each business is future during the next year.
Three year and five year time periods.
This is consistent with the plans that we are now executing on.
The reviews focus on volume growth and price.
While building on a more competitive cost structure.
In terms of calibration for our shareholders.
See the benefits of these plans.
Regarding product.
Price and mix.
To exceed the aggregate of the current cost reduction commitments made earlier in my notes today.
Today I'll just call out one example of this.
Further clarity on other business units will be provided in our third quarter earnings call. When we outlined the two future segments for the new company going forward.
Back to BCS.
I referred to the 200 basis points of adjusted operating income margin improvement on the prior earnings call.
We now see this opportunity is larger.
Moving from 2018 through 2019 and into 2020 margins will increase by approximately 300 basis points.
Cost is a feature but more importantly, we will rationalize product lines and re purpose assets to better markets, which allow us to increase revenues and profits, resulting from the benefits of this price and mix of products sold.
And I'll cover this in more detail in the next quarter.
For other businesses.
Second.
We took a charge for asset impairment.
As part of the five year planning activity, we reviewed the asset base to improve to assess future cash flows.
This review resulted in a noncash impairment charge of $444 million.
Of this charge 428 million relates to the dis business of what was formerly referred to as Firth Rixson.
Before moving on to other items I think that it's appropriate to update you on Firth rixson before eliminating the name for future use.
Firstly rings.
It's a business of approximately 700 million in annual revenue.
It is fundamentally a good business in which our chronic has the largest market share globally.
Profitability is now showing signs of improvement.
And from the 2018 base will show improvement in 2019.
Into 2020 and beyond.
Improvement is driven by a combination of differentiated products.
A more competitive cost structure, and bringing new more efficient capital online.
This business by comparison is fundamentally flawed.
In total it is just in excess of $300 million in annual revenue.
A portion of that this business will be disposed off.
On the smaller retain path has been right sized and the asset carrying value will be impaired.
To allow for future competitiveness and improved profitability in 2020.
The remaining portion of this this business will be a small part of our connect and the significant losses of 2018 and 2019 will be eliminated.
Third in the second quarter, we have come to a mutual agreement with the U.S. steel workers.
To successfully conclude negotiations of the U.S.W. Master agreement.
Additionally, we concluded negotiations with the steel workers as titanium structures business in Niles, Ohio.
We had been operating without a contract for the last 18 months.
Fourth.
Regarding divestitures, we've closed on a small transaction and signed the share purchase agreement for another transaction with the close currently pending.
We are making satisfactory progress on the remaining divestitures.
As you can see it's been a busy quarter.
Finally that process is underway to recruit and conclude appointments of the two boards and two management teams.
Search committees have been defined and recruitment firms appointed to help form the future leadership teams have rolled products and the aerospace companies.
Regarding the management team.
I want to announce the departure of L. modality.
Elmo decided not to participate in the future CEO selection process.
And to allow for a smooth transition.
Alma has agreed to step aside.
And we will continue to be a board member.
And I want to give a personal thank you.
Two Elmer for being my business partner in recent months.
In addition.
And to further solidify and clarify leadership I have agreed to extend my term beyond the straight to the February 2020 .
I will continue to serve as CEO through separation.
And beyond as required to ensure continuity and performance of our Kotick.
Finally, an update to our 2019 annual guidance.
In light of current performance coming off a healthy Q2, and considering our typical seasonality.
We are updating and raising our guidance for the year.
This reflects both our performance expectations in the second half.
And the fact that year to date, we've already earned and adjusted dollars earnings per share.
Annual revenue is unchanged at 14.3% to 14.6 billion. Despite the fall in assumed aluminum prices.
The adjusted earnings per share range forecast for Q3 is 47 cents to 53 cents earnings per share.
Adjusted earnings per share forecast for the year increases to $1.95 cents to $2.05 per share.
Free cash flow for the year increases to 700 million to $800 million.
EBITDA guidance is provided for the first time.
And is approximately $2.3 billion, plus or minus $50 million.
Our updated guidance assumes that the Boeing 737, Max will remain at 42 aircraft bills per month on airframes, and 48 barrels a month on an aircraft engines for the remainder of 2019.
One final item.
Before I turn it over to Q and a.
Regarding Grand fault.
There is an update this quarter, which is considered helpful.
In addition to funding replacement cladding for relevant high rise public sector housing the UK government has established a new fund.
To refurbish private high rise buildings, which have aluminum composite material trading systems.
And which are unlikely to meet UK building regulations.
This fund will cover buildings, which architects specified the aluminum cladding polyurethane from JP.
Fred subsidiary.
Which was then fabricated and 50 by contractors as one component at the cladding and insulation system.
This potential clotting remediation will be beneficial regarding the potential contribution of these systems to future fire risk in UK high rise buildings. The details of the refurbishment process on fund continues to be developed.
I plan to provide a further update on these topics notes today on our next earnings call.
And with Us I'd like to open the line for your questions.
Thank you.
And we will.
I will begin the question and answer session.
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Our first question comes from the line of Carter Copeland Your line is open.
Hey, good morning, gentlemen.
Great progress congrats.
Just.
A two parter John I notice you guys made some comments around quality record quality and wheels, but.
I wondered if you might speak to what sort of trends, you've seen and Ns and they're on quality and yields I know that was a particular point of focus I wondered if you could just give us some insight on that.
And to the extent that impacts your capex longer term capex.
Planning I wondered if you could touch on that as well. Thank you.
Yes first of all quality within our eight DNS business.
It's really across the board.
Has continued to improve.
In particular I'd like to note the quality improvements as we started to come down as an improved rate on the learning curves on some of the engine airfoils and that's that's obviously very welcome.
Of course, we are bringing into commission.
Two new manufacturing plants.
The next the BT five months that the the new plants.
For the the molding process.
In Morristown, Tennessee.
For the insert to the actual business and then a new plant in Whitehall, Michigan for the for the timing of the foils.
Both of those on track in fact, if anything a little bit ahead, and we're hopeful we may get some modest production out in the fourth quarter, which would be about a quarter earlier than previously anticipated.
Everything appears to be on track, obviously, we're monitoring that to make sure that our future quality is also continues to improve.
On the second part of the question on Capex.
We've maintained the guidance given.
The critical investments that we need for the expansion, particularly in our engine business has been.
Again everything's on track same for the hungry for the wheels business and same for for Tennessee, which allows that transition out of.
Into the more into the industrial market, which occurs in the second half of 2020.
So at the moment.
I would say everything is in order.
And the I think the expectation is that.
We are planning to further trim.
Capex requirements going forward.
Great. Thank you for the color.
Thank you.
Your next question comes from the line of Seth Seifman from JP Morgan Your line is open.
Hi, Thanks, very much good morning, and.
And good quarter Hum.
I Wonder if we if we think about how cash flow kind of progress from here and we think about some topline growth next year dropping through.
A lack of severance costs.
You know an incremental 120 million or so from the cost savings that tenant drop through this year.
It would seem that that there is a path to.
Some nice cash flow growth next year with the you know the one kind of question Mark.
Remaining about the pension so I guess is it can you speak a little bit to the potential for cash flow growth next year.
I think all the elements that you've highlighted this indeed true.
Next year, clearly, we're not going to have the the level of cash restructuring.
I tried to provide a little bit color on future Capex.
On.
In my response to the to Carter Copeland.
And.
Certainly the the results of the cost reductions and some of those things I've talked about in terms of margin improvement.
Really are all positive I think vectors for.
Full featured cash flow.
Clearly, we still have conclude negotiations at some points on separation with the PBGC on the pension manner.
But outside of that.
The underlying theme with what you said is correct.
Okay, and then I apologize if I missed this but you talked about staying on.
For kind of a I guess and then determine and period of time did you specify which company you plan to stay with.
No I did not.
Okay, and I guess.
Perhaps a when you give us more information next quarter about.
You know, the split and whose remainco and stuff, but at that point, well well well on that.
Well I'm sure you're going to press me and ask me in the future or about that very question, but the important thing is.
Was to make sure we had continuity through to separation.
And.
And I guess, just as fundamental to making sure that everything is really smooth and performance continues.
Excellent. Thank you very much.
Thank you.
Your next question comes from the line of Reggie is.
Low wanting from Morgan Stanley Your line is open.
Once again your next question comes from the line of regime Lavante from Morgan Stanley . Your line is open.
Your next question comes from the line of Gautam Khanna from Cowen Corporation. Your line is open.
Hey, Thank you good morning, guys.
Hi, guys.
Hey, <unk> I heard you say your your guidance implies 48, a month on the leap one b. I just wondered have you actually seen a step down yet or is this just.
Advance caution.
We still are on a modest step down of.
I think in the <unk>.
Two engines I think in the ER in the Bill lets the information I have let's see just let's be cautious as well.
Okay. Two engines from 52 just to clarify.
Yeah Okay.
Separately, maybe can I was wondering you know discount rates have moved down obviously pensions a bit of a.
You know a recurring theme, but I just curious given asset returns any preliminary color on where the plan what the.
Deficit with looked like if you snap the line today.
On the pension and OPEB.
Yes got them. So you know a couple of comments.
First when we look at pension and OPEB, we were down.
About or improved 322 million year over year and on top of that I would say that.
On the pension side, 90% of the gross liability is frozen to future surface accruals at about 75% on the open side.
We will re strike or re measured at the end of the year, but a couple of things that I can tell you.
Last year, we were the discount rate was it about four 4.35.
We're seeing a number.
More around 3.5 right now we do have for you in slide 19 of the appendix the sensitivities. So that's about an 85% it's moved on the liability side.
But also I would note that.
On the asset return side, we've been doing a lot of work over the last 12 months.
Last year, our asset returns were negative 3%.
If we look through June of this year, we're in the low double digits, we've moved our investment strategy more to the equity side.
So weve also benchmark those returns against our peer group Im worried about.
Better than about 85% of our peers.
So we will have an adverse impact to your point around the liability side driven by the discount rate there will be an offset on the asset side based on our returns most likely but we will restrict that at the end of the year.
In the sensitivities are on slide 19.
Thank you and one last one if I may I was just curious John if you could speak about.
The pricing in progress we've made on the pms side and sort of.
What opportunity still lie ahead is.
How receptive how difficult or those conversations.
Now what's your confidence on that.
On restrike contract buyer.
I think we have really tied to ensure that we have a few to line of sight.
Will all of these loans.
Contract renewals.
So I can see that.
Several years out.
On its very much being a process. We we spent more time during our five year plan reviews trying to understand the fundamental competitive advantage.
And where we had to excellence and so for example in the in the very end of the first and second third late in heart into the engine.
Well, we think we have some unique capabilities.
And so we think we should be paid appropriately for that level of skill set.
And value, we bring to the capabilities of those.
Aircraft engines.
And then just one example.
I mean, let me is I don't really want to spend a lot of time talking about apart from the discipline is as previously been.
Say very deep in the organization.
No, it's it's something that.
I expect each business unit had to be able to sit and talk to me about.
If I have the information and I expect them to.
And.
It's a healthy dialogue.
Trying to maintain booth.
Good relations with our customers, but same time trying to make sure that we do get paid appropriately for the level of value, we bring to the to the engine into the to the whole aircraft.
Yes.
Your next question comes from the line of Matt Corn from Goldman Sachs. Your line is open.
Hey, good morning, everyone. Just a couple from me.
First we heard from one of your competitors at a certain jet engine customers, becoming more aggressive with inventory management.
Are you seeing anything similar.
And then second having completed all these five year plans for each segment.
Could this turn into more clarity on medium term targets for all the segments into year end is that is that something we could see and understand a bit better.
For the split thanks.
Okay.
Okay. So let me deal with the second one first.
I'm I'm decided yet, but I'm thinking about possibly giving some 2020 revenue guidance.
The next earnings call and obviously, we will be giving 2020 guidance.
When we announced the fourth quarter in the in the early part of.
2020 .
Personally I'm not typically a fan of.
Giving future cost reduced the full acuity in terms of.
Giving gross and margin profiles.
It assumes a level of knowledge, which which inevitably in perfect.
I prefer to that achievement and.
I'd say that the directional vectors give give guidance to that.
I can't imagine me breaking out of pattern.
You Didnt want to do that in.
During.
Yeah, My leadership of the company.
So I think that deals with that one.
The first question Im just trying to remember what it was now inventory our inventory management no change I've seen.
Your next question.
Comes from the line of David Strauss from Barclays. Your line is open.
Thanks, Good morning.
I wanted to ask you about the EBITDA guidance that you gave.
The margin I think implied in that in the back half of the year is lower than obviously, what we saw in Q2 and I know you have normal.
Seasonality in the back half of the year, but what you are talking about with Tennessee, and BCS improvement can you just.
Can you just give a little bit more detail on the margin outlook in the second half.
I, just didnt know Dave's not impression so.
Rather than me.
Grappling numbers as we speak here David.
I'll say I don't recognize it so maybe ill get usage, we check your math, so we'll do it and we'll have a separate conversation with you, but that's not something that's.
It was in tune with my thinking.
Okay.
All right.
And then I think in Q4, you have this convert that's coming due how do you how do you what's the what's the plan for that at this point.
So.
I'm going to pass that across the can but essentially will be my expectation is we'll we'll bill pay that off.
And redeem them.
Yeah, the only thing I'd add to that.
David is on slide 18 in the appendix you can see the share count.
By quarter and to John's point included in that is for us to settle the RT using cash.
Okay. So I thought I just wanted to confirm thanks, a lot and let's say, it's going to take both gross and net gross debt down.
Right.
Right.
Got it thank you.
Thank you.
Your next question comes from the line.
Of.
Josh Seaport.
From.
Josh Sullivan from Seaport Global your line is open.
Hi, good morning nice quarter.
Thanks, Jonathan.
Just wondering GRP on the automotive body in white vertical Arconic was a pioneer in that market I know you've been able to sweat the assets now you've got the five year review.
Curious on what your capacity needs in the auto sheet are at this point and then just as a follow up can you talk about growth expectations for our sheet over the next 12 months or so.
Yeah, I think the underlying.
Secular trend of Lightweighting is certainly going to be a feature in the automotive markets. The for the next decade.
And if I look as if I could on average.
For the last few years is somewhere between six and 9% conversion on an annual basis.
And.
Obviously on the normal auto cycle that should be enough to to overcome a I'll say auto cyclicality.
Obviously quarter to quarter, you can't say that roughly he can.
We intend to say grounded GRP segment, I mean, if we falls into three in the future, which is ER aerospace, where we added just over 20%.
Of our revenues.
Which is very solid and healthy.
Automotive, which is obviously a contracted as well in terms of volumes with the vehicle manufacturers. There we are.
We have good margins.
And I'd expect that to continue and in fact, one of the features of our plan has been diversification of our customer base and indeed, well, we have not announced which vehicle manufacturer.
We have succeeded in.
In a in signing up another very major us platform in the second quarter.
Which obviously is going to be good for the future order book.
We'll see some of that materialize in 2020 .
And then obviously if the full year effective 2021 and beyond so we're pretty pleased about that not only for the after the inherent profitability, but also the security of the.
Of supply.
And trust and actually need to achieve more throughput.
And on more volume out of our Rolling Mills analyses. So it gives us a very good base load.
And then finally, the industrial segment.
Where we've seen obviously significant.
Healthy price improvements.
Putting with the.
Comments like trade case, which has given us that protection the probably the next few years it could be five years and beyond.
And.
And obviously with the.
Well I'll say.
Publicized investment in Tennessee that we've talked about that additional capacity and additional finishing and melt capacity is planned to come on.
In the second half 2020 again, we see that as a healthy future margins of the business and us being totally out of packaging in the U.S., albeit we'll still be in production for packaging in Russia and China.
So I tried to give you a bit of a sweep through GRP.
And obviously, we'd be making progress and you've seen the sequential margin improvement that can talk to you from really Q3 of last year through Q4, which is about 5% quarters to seven to nine and obviously, we're pleased with that progress.
Great. Thank you.
Okay.
Your next question comes from the line of Chris on from Longbow Research. Your line is open.
Hey, good morning.
Chris.
Just you might have touched on it a bit on an earlier question, but I would I just want to maybe be zeroed in on going a bit here.
On maybe your confidence level and keeping the market share.
On the next Airbus titanium contract seems like all four companies are are submitting bids.
In the past there had been some reliability issues with the old Archie I am just wondering if you're going to keep it and what pricing holding anything there would help.
Well of course, I mean, nobody knows at this point, whether we keep that so that contract is one specific course, there are multiple contracts for titanium and with the increased use of titanium if future aircraft, we're confident about the future.
Revenues and an order book for our business.
I have been paying particular attention.
Titanium business.
And indeed, it was actually the very first.
Major site, which is Niles in Ohio is the very first site.
As I visited in a.
No panic and.
During the last few months have tried hard.
To to dedicate resources.
To that plan to to have fundamental improvements in terms of.
Quality in terms of.
Only in throughput and in terms of customer compliance.
Any a combined also with the significant inventory reduction, which I think is a fundamental part of quality improvement as well.
So.
I think very positively about our titanium business.
It's an area, which I think we need to continue to focus on I was really pleased that we were able to just to conclude agreements with the steel workers on that contract.
And really trying to reset.
The I think have to luxury reset.
All these tempted to reset the relationship between management and the steelworkers enough size.
So I think it's a really important site for us.
And I see plans and expect plans and achievements to improve the future profitability of it.
Having said that rich I'd say with a very positive backlog of the business.
On the Airbus contract were all in a bid situation.
We're incumbents, we are hopeful to retain our share, but I'm sure that I've read the same stuff that you read about other people think that they got to where that I'm never so bold as to make those predictions when we're looking at bidding and so the people.
I don't see why that I need to beat my chest, and say that sort of stuff.
Okay helpful and then.
I just want to make sure I understand.
Your comments about Boeing and the Max I think you said 42.
On the on the frame and 40 in any engine I had always been under the impression that Arconic lead times on some of these products are pretty far out there.
Are you shipping at those levels are you shipping yet where Boeing is going to be in like the fourth quarter in 2020.
And we'll ship whatever Boeing spirit sung ji want us to ship out.
I'm just trying to give you guidance to what we've assumed in our plans financially going forward.
So if.
If people were to build fuselage at a higher rate than obviously, that's good for us.
Or end he has a high right. That's good for US clearly if the engine rate was lower than we'd be a moving some of that capacity to clear some of the other areas and meets the demands on other engines that we have.
And in particular for the for the military requirements of.
Of the those engines as well and so where we sort of try to balance everything out at the moment, but I was just trying to give.
You.
The best guidance I could in terms of.
Financial assumptions, Okay that makes sense. Thanks, a lot and congrats on the success you had.
Thank you.
Your next question comes from the line of Rajeev Lalwani from Morgan Stanley . Your line is open.
Once again your next question comes from the line of Reggie of low money from Morgan Stanley .
Yeah.
[laughter] tanks I can move on.
So I think we're just coming through.
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Your next question comes from the line of Seth Seifman from Jpmorgan. Your line is open.
Thanks.
Guys just one one follow up here in terms of understanding the cost cutting plan and it was sort of.
My understanding that it was directed kind of primarily at overhead and if I look back at like the run rate corporate cost in the back half of last year. It looks like annualize that was.
About $200 million, so when we think about where the cost cutting is directed clearly.
You know that the corporate costs are now going to zero, obviously so.
Do you consider that there was a fair amount of overhead in the segments that that's also.
You know where the cost cutting is kind of a directed or.
Maybe I was sort of overestimating the degree to which overhead was was playing a role here.
I'm going to pass the majority of that question gross the can.
Essentially.
That was significant cost cutting at the corporate level, but we also.
Planned to reduce percentage cost cutting at the businesses and in particular, something which we did which.
I guess, maybe we haven't publicized enough is the.
Between corporate on the six individual businesses they were three sub HQ levels wonderful.
Each of those reporting segments. They once were the real products one for the EPA in AF and ER.
Lps are live and one for Tcs those have been eliminated.
Altogether, so that has been cost cutting at every level one of the reasons why you may not see a full effect of any future mark.
As DNA is that we've also had a good problem to deal with is as the share price has improved is the needing to remark on put through the personnel additional charge for a for the year for share compensation.
I just wanted to make sure we got that fact out there as well, it's all taken care off in the results year to date.
Ken I'll Pascoe, Steve just a couple of other things.
To build on John's comments, you'll see in the Q that we file later on today that.
There's multiple pieces that come out of this cost restructuring program biggest part is labor and you'll see in there that about 40% of the labor reduction is coming at corporate.
But it's not just limited to labor, we're looking at other items like indirect cost savings.
Which relate to energy maintenance transportation. We've also exited the aircraft that I talked about earlier on there, but weve also looked at the balance sheet.
So on the.
Retiree side retiree life, we eliminated we reduce some of the Medicare subsidy programs as well so it's an all encompassing.
Program and you'll see some more detail of that in the Q.
Excellent. Thank you very much.
And Keith.
Thank you everyone for joining todays call.
We are now.
Concluding the call.
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