Howmet Aerospace Inc

NYSE:HWM

Earnings Call Transcript 2020-Q1

[Operator]

Good afternoon, ladies and gentlemen, and welcome to the Howmet Aerospace Preliminary First Quarter 2020 Results. My name is Shantel, I will be your operator for today. As a reminder, today's conference is being recorded for replay purposes.

I would now like to turn the conference over to your host today, Paul Luther, Vice President of Investor Relations. Please proceed.

[Paul Luther, executive]

Thank you, Shantel. Good afternoon, and welcome to the Howmet Aerospace Preliminary First Quarter 2020 Results Conference Call. I'm joined by John Plant, Executive Chairman and Co-Chief Executive Officer; and Ken Giacobbe, Executive Vice President and Chief Financial Officer. After comments by John, we will have a brief question-and-answer session.

I would like to remind you that today's discussion will contain forward-looking statements relating to future events and expectations. You can find factors that could cause the company's actual results to differ materially from these projections listed in today's presentation and earnings press release and in our most recent SEC filings. In addition, we've included some non-GAAP financial measures in our discussion. Reconciliations to the most directly comparable GAAP financial measures can be found in today's press release and in the appendix in today's presentation.

With that, I'd like to turn the call over to John.

[John Plant, executive]

Good afternoon, everyone, and thank you for joining the call today. A little bit of an unusual circumstance in that for the first time in probably 15 or 16 years of doing earnings call, I haven't been in the same room as the CFO. However, we'll get on with it. I recognize that this earnings call is a little earlier than normal, but we felt it both opportune and appropriate given the current economic environment and the separation event that occurred for the company on the 1st of April.

Let's move to Slide 4. As you know, on the 1st of April, we legally separated Arconic Inc., the reported entity today, into 2 companies: Howmet Aerospace, which is remainco, and that's companies primarily focused on the aerospace sector and contains 4 business units within the former Engineered Products and Forgings segment; Arconic Corporation, spinco, is primarily focused on rolled and extruded aluminum products to various end markets. Arconic Corporation contains the 3 business units within the former Global Rolled Products segment.

Let me cover the Q1 results before talking further about the current environment that we're currently managing against. Now let's move to Slide 5. Please note all the numbers relating to Q1 are what we currently expect. We will finalize results and discuss them in greater detail on the 5th of May. For Q1, revenues were approximately $3.2 billion, down 9% versus 2019 and down 6% organically, adjusting for the pass-through effect of the lower aluminum prices, currency and the disposal of certain businesses. We experienced declines in the commercial transportation, automotive and aerospace markets, partially offset by growth in the industrial market. Year-over-year market declines were driven by the disruptions from COVID-19 and the Boeing 737 MAX production reduction. Moving to the segments, EP&F revenues were down 4% organically and GRP revenues were down 7% organically.

Please move to Slide #6 for the operating profit. Operating profit, excluding special items, increased approximately $78 million year-on-year. And that was 20% resulting increase, resulting in a record margin of approximately 14.7%. We expect margin expansion of about 350 basis points year-over-year for Arconic Inc., with 300 basis points for EP&F and 310 basis points for GRP. Further profit performance progression was driven by the benefit of net cost reductions actioned last year as well as lower raw material costs and the price increases in the EP&F segment. Margin expansion is also expected to improve sequentially in both segments, having coming off the best ever fourth quarter results. When I look at each of the individual businesses in the 2 segments, every business increased its margins year-over-year despite being impacted by the disruptions I previously mentioned related to COVID and the MAX production cessation for the first quarter. I also note that the one troubled business in 2019, namely extrusions in the GRP segment, moved into profit and compared favorably to every quarter that we experienced in 2019, and this is a very significant turnaround.

Now let me move to Slide #7. Earnings per share, excluding special items, is expected to be in the range of $0.60 to $0.62, up approximately 42% from $0.43 per share in Q1 of 2019. Earnings per share increased primarily due to the operational improvements from corporate and segment productivity. Special charges totaled approximately $60 million after tax and were primarily driven by the separation costs of some $50 million and severance costs of $16 million. The severance costs are tied to our new $100 million cost reduction initiative to align the cost base as we move into a period of demand uncertainty.

Now let's turn to liquidity on Slide #8. Arconic Inc.'s pre-separation Q1 cash balance was approximately $2.65 billion. Adjusted free cash flow, excluding separation costs, improved $50 million year-over-year and was in the range of negative $200 million to $230 million, driven by the normal seasonal working capital build and significantly higher 2019 annual variable compensation payments. Q1 cash outflow associated with separation was approximately $110 million, and there is approximately $40 million of cash outflow expected in Q2, primarily associated with the early debt repayment that has already occurred on April 6. Howmet Aerospace post-separation cash balance is approximately $850 million after the $1.3 billion early redemption -- early debt repayment and allocation of $500 million of cash to the opening balance sheet of Arconic Corporation. The $850 million of cash is more than 2x the amount necessary to fund seasonal working capital changes. Howmet Aerospace's liquidity is strong, and also, we have an undrawn revolver of $1.5 billion. Lastly, in terms of notable impacts on Q1 trading and operations, the impacts worth noting are: COVID-19 disruptions; the Boeing 737 MAX production suspension; and the fire at one of our North American wheels plants.

Let's move to Slide #9. Turning now to COVID-19. We felt impacts from certain customer shutdowns or suspensions and disruption within certain shifts. Some of Arconic Inc.'s plants were closed for a period during March due to the virus. Plant closures averaged approximately 7 days in the month.

Now I'll turn to the outlook which I'll confine my comments solely to Howmet Aerospace. Currently, Howmet Aerospace has 8 manufacturing plants which are closed. Currently, we have limited visibility of future demand. Many of our customers are closed because of the coronavirus and the impacts on their employees. Information flow is limited. And hence, in the face of this uncertainty, we're reducing costs and preserving cash given the lack of clarity. We find ourselves unable to provide reliable guidance to you, and therefore, withdraw the guidance provided at the February 25 Investor Day. And as you know, we treat guidance as a very serious future tracking view. To mitigate the impact of the coronavirus disruptions, we have commenced plans to reduce by a further $100 million of cost on a run rate basis. This plan is incremental to the 2019 cost reductions, which carry over into 2020, and is primarily driven by incremental overhead and manufacturing reductions. Moreover, we're evaluating reducing capital expenditure due to the lower volumes. We have temporarily suspended the dividend to preserve cash to provide for additional flexibility. We'll continue to finalize the first quarter results and go into more detail on May 5. Additional slides have been provided in the appendix.

And with that, I'll now move to Q&A.

[Operator]

[Operator Instructions] Our first question comes from the line of Carter Copeland with Melius Research.

[Phillip Copeland, analyst]

John, I hope you're staying well. Just wondered if you could give -- of course, crazy times. I wondered if you could just help me understand a little bit, in the $100 million of further cost reduction, what that -- what you envision in terms of how to set a -- what you said in terms of a planning rate, I realize you have facilities that are closed, but you have to envision coming back up to some sort of rate. Could you give us some insight into how your -- how you plan around that, how you're thinking about that and whether that $100 million still leaves some stranded cost to protect for higher rates at some future period?

[John Plant, executive]

Yes. At the current time, we see no problem regarding coming up to future rates. In fact, what we had done, if you go back to earlier, the last earnings call in, I think, late January, one of the concerns I had then was trying to manage our way through the 737 situation, and indeed, protecting the, I'll say, vital skills to be able to do that, at the same time recognizing that we were going to face a potential for a further reduction in labor to stay soft a lot in the summer. I think it's a great credit to our team that we managed to actually plan our way through and level set what we're doing in our manufacturing against the former -- or the current Boeing plant. And so we're able to eliminate that labor concern of the summer. Obviously, in the current environment, we're now unsure because we don't know what will be the rate return for the 737. But as it stands at the moment, we are in -- I would say, in good shape to be able to meet customer demand. We will then, as we begin to know more about the shape of future aircraft builds, then take another view about what further cost reductions will be necessary to face after that. All the time, we are interested in protecting the bottom line as much as we are able to with the demand reduction, which is likely to occur, and also to stay in a cash-generative situation.

[Phillip Copeland, analyst]

And just to expand on that quickly, and I'm sorry for the follow-on question, but I just want to make sure we have this covered. The -- does your plan envisioning furloughs and reduced shifts and things of that nature to get that labor experience concern? Is that what you're envisioning as a kind of plan until you have to decide otherwise?

[John Plant, executive]

Yes. I mean we're looking at both structural costs, which is the main focus of the $100 million, and on top of that, furloughing various shifts in plants as necessary according to the demand that we see while protecting our ability to be able to meet future demand when we know what exactly that will be. So at this point in time, I don't think we should have any concerns about our ability to meet future rate. It's more about the flexing of our labor according to what we'll need to have to meet the demand pattern going forward.

[Operator]

Your next question comes from Seth Seifman with JPMorgan.

[Seth Seifman, analyst]

John, I wonder if you could talk a little bit about the visibility that you guys have to the level of inventory at your customers since the last downturn in 2008, 2009 was a very mild downturn for aircraft production, but the revenue declines for precision cast parts and for Alcoa EP&S were far more significant because there was inventory in the channel. And so I wonder if you guys have much visibility into that. And so how we can think about, sort of once we set our rate expectations, what kind of revenue impact Howmet might face given those rate expectations.

[John Plant, executive]

Yes. We actually don't have any great detail of what inventory our customers are carrying. I'm always very cognizant of the -- I'll say, the multiplier effect that inventory can have in a down market for the end product. I think the notable point for Howmet would be for our engine business. I think, as you know, we were in a position of excess demand for almost continuously for the last 2-plus year. And that's the reason why we built those 2 new plants in Whitehall and Morristown. That's Whitehall, Michigan and Morristown, Tennessee. Obviously, it's a little bit unfortunate that we now have the capacity and we have a more uncertain demand.

However, as you know, I think on a previous call, I did comment that we exited 2019 with actually a higher arrears position in aggregate across our engine business than we had when we entered the year and didn't make particular headway in the first quarter against that. So my thought is, I wouldn't be surprised to see some of those arrears vaporize in the case of falling demand. But at the same time, I feel there's a level of protection. So for some, it's $2.5 billion, $3 billion of revenue within the company. And my thought -- I would say it's knowledge. My thought is that the inventory multiplier effect may be fairly muted upon us, albeit it will be more significant in -- let's say, in the rings part of our business and also in our structural business and potentially fasteners. So it's -- there's no one single answer.

And then at the same time -- I mean the one thing which is a bright spot for us, so I think, as you know, out of approximately $7 billion of aerospace revenue -- or in Howmet revenue last year, fractionally under $1 billion related to defense. And so let's call it, for sake of argument, $900 million, $950 million. And that was a source of strength for us in the first quarter. We saw approximately -- I must say, it's around about 17%. I mean not exactly precise, but over 15% increase in that demand in Q1. And at the moment, we don't expect anything but further strength in that part of the business going forward. So again, you need to bifurcate that, which goes to the commercial sector, which is by segment, and then also consider the defense aspect of the business. And also part of our industrial business that we face off to, it actually had also very solid demand in the first quarter. So -- and that's probably $400 million to $500 million of revenue, which also increased double digits. So you need to bifurcate all of that when you come up with revenue estimates.

[Operator]

Your next question comes from David Strauss with Barclays.

[David Strauss, analyst]

I wanted to ask about the balance sheet and cash flows, so I don't know if Ken wants to jump in here. But in thinking about the Howmet business, how much cash do you need on the balance sheet you think to operate the business? And then I know you have access to the revolver, but how are you thinking about potentially taking advantage of markets that are open today and raising some money to shore up the balance sheet here? And I guess last part, do you think you can stay free cash flow positive over the course of the next -- looking out over the next 6 to 12 months?

[John Plant, executive]

Yes. Okay. That's a hell of a single question, David. But I recognize you knew what you were doing. Let's start off with the cash necessary to run the business. We've called that out publicly at $400 million. But that is a very, very conservative, I will say, number compared to what's actually necessary. And obviously, if the business was less than it was today, then that in itself would shrink the number as well. So I don't want to change the number which is out there, which is $400 million. But for my thought process, it's -- that's very conservative way of thinking about it.

You're right about the undrawn revolver, and that's there for us. We are studying the current debt markets to see whether there's something we should be doing with regard that but haven't settled on a final plan at this point in time. But we're cognizant that with the support of the Federal Reserve into the credit markets, they do seem to be falling a little bit. And we continue to watch those to see how things are progressing. I think that covered everything, David, is that right?

[David Strauss, analyst]

Free cash flow, free cash flow.

[John Plant, executive]

The last part was about cash flow. Obviously, cash flow also depends upon the degree of downdraft that we may see in the face of this as we currently understand it. And so if I use at the moment the only thing that I feel as though, I say I know, and that's -- you always -- you say -- when you say you know something, maybe it's difficult these days. But I have seen the announced plans of Airbus producing, for example, the narrow-body production from 60 a month down to 40 a month. And if you use that as a proxy for everything else at the moment, then my current feeling is that we will remain cash positive through the year as we go through it. And so when I look at the cash profile of what was Arconic Inc. and then I look at cash profile of Howmet, at the moment, assuming that's a sort of revenue type of adjustment, then I'm feeling and sensing -- it's not quite the same as saying I know because I'm not sure enough yet about all the promise of demand reduction, how the -- everything else will phase in. But I expect that 2020 will be a cash flow positive year after payment of interest, after payment of pension contributions. So that's net after everything that we currently envisage.

[Ken Giacobbe, executive]

And David, this is Ken. Let me just add one thing to that. So John walked through the slides, we were trying to give you a view of what the cash balance would look like on April 1, and that was $850 million. So if you go back to your question, minimum cash to require -- to run the business, we've said $400 million. And to John's point, that's a pretty conservative number. We usually don't need that much. But why $400 million? It's because we normally have our biggest working capital burn or cash burn in the first quarter. As you're bringing up revenue, you're bringing up inventory and all that. The first quarter is now behind us, right? So we've done the working capital build. We're comfortable. So as you move through Q2 to Q4, you're in much better shape because you've already done your working capital burn.

[Operator]

Your next question comes from Gautam Khanna with Cowen.

[Gautam Khanna, analyst]

So John, I was wondering if you could opine on asset utilization and the -- and maybe just what percentage of the cost structure is fixed, at least fixed in the next 1 or 2 years, because a large part of the margin enhancement that we saw was kind of getting utilization up. And to the extent that we're now going to see OE rates pressured, I'm just kind of trying to frame what kind -- you mentioned the $100 million, you mentioned last year, $300 million, of which you realized $213 million. I'm just curious, what do you view the fixed cost structure of the business to be? And then how should we think about the decrementals and your ability to kind of continue to chase out costs so that we don't get kind of whacked on the way down?

[John Plant, executive]

Yes. Clearly, when revenue is under pressure, you're always fighting -- let's say, fighting the -- let's say, you're fighting, let's say, as you go through this sort of thing. What I'd like to comment, first of all, my philosophical stance then bring it to practicality. So my philosophical stance is that I really don't treat anything as fixed, with the exception of depreciation, because that really is a decision of the past and we cannot change that. Everything else is changeable. Main question is the time line on which you change it. And so that's how I will say my stance relative to those type of discussions. And because I think it's the duty of every good business to challenge everything that you do. So that's how I start off. Then I'm going to reach back into history just to try and give you a view.

So in, let's say, a prior life, and going back to the business I was involved with in 2008, 2009, which I think, as you know, is in the automotive business, which has margins far less than Howmet's. So let's think of margins about 1/3 of Howmet's, and in recognizing what we faced off to, there, we moved quickly and we moved often. And so first of all, you must not assume that the $100 million is done and gone, and that's it. So we moved successively at that time, and we only experienced the 2 quarters of operating loss. And of course, I'm not indicating for one second at the moment that we have operating loss. I'm just trying to say to you, that was pretty good and pretty unique for that industry. So in terms of what we will do and what we're doing is that you saw in Q1 that we actually have already taken a reserve. We're already implementing those cost reductions. And by no means that we called out that what we've done is it. And so once we are clearer on what is the shape of the business going forward as we move through 2020 and also into '21, because we also need to also think we're managing for and [ package predict ] that -- which is vital for the future, is that we'll have a better view over what shape will be our next action that we'll undertake to -- I'll say, to preserve as best we can the performance of the company.

So it's a long way of saying, I can't give you the exact number because I don't know at this point. We should assume that we will be -- have a very keen eye to the cost base of the business and move accordingly. Then we'll focus on the cash flow of the business. We would also examine capital expenditure. And then the final part of your question, which was what are the decremental margins, I don't want to call that out at the moment. We will see whether we're able to say anything further in that regard in the more detailed call that we'll hold in early May, once we may have a better handle on the demand pattern going forward.

[Ken Giacobbe, executive]

Gautam, this is Ken. Just one thing I'd add. You mentioned the cost reductions that we executed and delivered in 2019 of $213 million. So this time last year, when we get our first quarter earnings, we committed to a target of $120 million in a year and we delivered the $213 million, so substantially overdelivered. But it's now we're talking about Howmet in moving forward. If you took that $213 million and said how much of that was Howmet last year, it's about $110 million, roughly half that. And we said that you're going to get some benefit in 2020 of another $50 million in 2020, just the carry-through of that cost-out action that we took last year. So $50 million incremental this year. We'll go into more detail on the May 5 call. But if you look at the first quarter alone for Howmet of that $50 million annually, we've got a little bit more than $20 million. So we're seeing the benefit of that plan, then you've got this incremental plan that we just launched as well, and that will help as we move forward.

[John Plant, executive]

And maybe worth mentioning, you can witness that benefit because our EBITDA margin moved to be over 23% in the quarter despite the disruptions that we talked about.

[Operator]

Your next question comes from Curt Woodworth with Crédit Suisse.

[Curtis Woodworth, analyst]

So given your expertise in automotives and the complexity of the supply chains and the fact that they're not really functioning today, can you just speak to, on the rolled product side specifically, kind of the plan to ramp back into that market? Can you kind of talk to expectations around automotive restarts in general, sort of what the overall utilization rate of your rolled products business looks like today?

[John Plant, executive]

Well, thanks for the question, Curt. I really don't want to answer, I'm sorry, your question for rolled products. I don't really want to answer rolled products questions. I feel as though that is the [ preserver ] of Tim Myers. What I can tell you is that when I was involved and I had laid out as best I could, but laid out for Tim both in -- actually, in December, what I call the [ Work 2 ] program of, I think, it was some 20 to 25 line items of things to do in 2020. And obviously, we refined that and further looked at and examined it in March. Well, first of all, in -- I'll say in January, first of all, and then again in March. And it left, I think, that business in good shape in terms of the things to be done. And I know that -- well, I haven't had subsequent conversations because I really don't want to interfere except that I've said my telephone line is always open because -- metaphorically, my door isn't at the moment because we are in different places.

But I very much, first of all, want that business to be a success, set it up with a good balance sheet and with the [ Work 2 ] a really good program. And I know that they've already moved on many fronts to address cost and flexing in the light of demand. Again, I read that even there the demand pattern is changing, for example, for both companies. It was going to restart in the middle of April. I think it's now put us off towards the end of the month. So I'm not up to speed any longer and unable to comment any further. But I do know that there were a lot of work going on to reflect future improvements in the business and stepping up to -- into the challenges going forward.

[Curtis Woodworth, analyst]

Well, let me maybe reframe the question more than -- I guess on the Howmet Aero side. Can you comment at all about what your utilization rates are today in some of your businesses, fasteners, structures, just to give us a sense of plant-level utilization, where we stand today, if possible? I understand it's very fluid and you may want to wait...

[John Plant, executive]

Yes. I think I really do want to wait until May for that. I mean we had a reasonable, as you can imagine, a reasonable utilization rate in the first quarter that began to be impacted just because -- as we have had instances of both suspected virus contamination and people self-quarantining and us quarantining departments and shifts. So that began to cause us quite some problems as we went through for the last 3 weeks of March. And so to come up with anything that's meaningful in terms of it was this utilization, it's now though -- is really difficult. And we're facing the same position at the moment. As I commented, we did have 9 plants or 8 plants which are currently closed because of -- and they tend to be the smaller plants, but they are closed. For most of our important plants, they're open, functioning and are deemed essential, as you'd expect for those -- the top products we do, plus also serving the defense industry.

And so at the moment, we are functioning, I would say, well but clearly not at the level we were in the first 2 months of the year. And it's pretty difficult. So if you'll give us another few weeks to talk to the subject more, then I think we'll be able to better address it in May or, if not, subsequent to that. So that's the best I can do, Curt, to answer the question. So thank you very much.

[Operator]

Ladies and gentlemen, we have reached the end of the allotted time for the question-and-answer session. This concludes today's conference call. You may now disconnect.

[John Plant, executive]

Thanks, everybody. Bye-bye.