Howmet Aerospace Inc

NYSE:HWM

Earnings Call Transcript 2017-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2017 Arconic Earnings Conference Call. My name is Jennifer, and I'll 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 for today, Patricia Figueroa, Vice President, Investor Relations. Please proceed.

[Patricia Figueroa, executive]

Thank you. Good morning, and welcome to Arconic's Fourth Quarter 2017 Earnings Conference Call. I'm joined by Chip Blankenship, Chief Executive Officer; and Ken Giacobbe, Executive Vice President and Chief Financial Officer. After comments by Chip and Ken, we will take your questions.

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 have 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 to today's presentation. Any reference in our discussion today to historical EBITDA means adjusted EBITDA, for which we have provided calculations and reconciliations in the appendix.

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

[Charles Blankenship, executive]

Good morning. Thank you for joining the call. I'll begin with a brief introduction, then Ken will take you through our financial results, then we'll take your questions after that.

Let me begin by saying I'm very excited to be here. I'm here because I admire the work that Arconic does. I was an Arconic customer, so I arrived with some perspectives and a baseline knowledge about the company. I intend to use that insight for the benefit of our employees, our customers and our shareholders. I joined Arconic because I believe this company has foundational strengths and incredible potential, arising from a strong team, material science knowledge and deep customer relationships.

As mentioned, my experience aligns well with the work that Arconic does. Let me give you a little background on me. I completed undergraduate studies at Virginia Tech and earned a Ph.D. at the University of Virginia, both in the field of material science and engineering. I'm a metallurgist by training, so joining a company focused on making things out of high-performance metallic materials is a natural fit.

In addition to being a metallurgist, I spent 24 years at GE, primarily with the aviation division. I spent the past 5 years running the GE Appliances business, all the way through its sale, plus a year on the other side with Haier, a global appliance company.

As you all know, I'm 3 weeks into this job. I've spent most of that time on the road visiting 3 of our major customers and 7 of Arconic's operations, including Hampton, Cleveland, the Tech Center, Davenport, Whitehall, Savannah and Toulouse, to learn more about our businesses, technology and the capability of our team. My first impressions are that I see both great potential and great opportunity for improvement. While I saw some operations that I would consider world-class and as good as anything I've seen in my experience, I saw others that are below that benchmark. So the challenge for Arconic is to bring all our operations up to world class.

Now I'd like to discuss my priorities. First, customers. The most effective approach to winning more business is to understand customer requirements and deliver on current commitments. I have a relentless passion to win, so we will emphasize these 2 points going forward. As I said in my first 3 weeks as CEO, I visited 3 of our largest customers to hear their views on Arconic regarding what we do well and where we need to improve. Strengthening our customer connections will help us solve their biggest challenges and consistently deliver on our commitments.

Second, people. Teamwork wins over silo mentality every time in my experience. People make all the difference in any company, and having the right talent in the right place aligned and rewarded as a team is important to our success.

Third, operational excellence. Across the company, we will be focused on safety, quality, delivery and cost. If we do that right, strong financial performance will result. While the company has many strengths, there are clearly areas that need improvement. Free cash flow and the performance of the former Firth Rixson assets were disappointments for us in 2017. These are areas of increased focus for us in 2018. In the end, it comes down to execution. And I'm working with our team to improve here. Going forward, a robust, continuous improvement system across the company using lean principles will allow us to achieve better workforce engagement, new levels of problem-solving accuracy and velocity, process control and quality of delivered product. Our goal is to be the industry leader and sustain that leadership with continuous improvement.

Fourth, technology. The right technology investments help us win more business and achieve profitable growth. Creating relevant, differentiated technology that solves our customers' biggest problems or makes their products more valuable is one way to win with technology. Another way we win is developing technology that makes us more competitive on quality, delivery or cost in the marketplace. Our goal is to succeed on both fronts. By focusing on the 4 elements on this list, we will create value for our shareholders.

Additionally, we are initiating a comprehensive strategy and portfolio review to assess our capabilities and determine how best to unlock our potential. We will determine and clarify our strategic advantage or lack thereof in each business and examine the business models, including the prospects of the market served and the returns available with world-class performance. We will conduct this review with an eye on the purpose of the company as it relates to synergies available in technology, manufacturing and management focus. We expect to complete this review and develop our action plan by the end of the year.

Now I will address some important announcements. Last year, the team made meaningful progress reducing SG&A expenses at corporate and in the businesses worth a total of $111 million of annualized benefit. Consistent with our focus on reducing costs, today, we announced our decision to move our global headquarters out of New York City to a more cost-effective location. We intend to complete the move by year-end. We also made the decision to move retirement benefits from a defined benefit plan to a defined contribution plan for all U.S., non-bargain participants. This was a very difficult decision, which balanced the need to maintain a competitive benefits plan for our employees with the imperative to attain a more competitive cost structure and better manage company liabilities.

Today, we also announced $500 million in early debt reduction and a share repurchase program of up to $500 million. The timing of repurchases and the exact number of shares to be purchased will depend upon market conditions and other factors, including our seasonal cash needs. These plans demonstrate our commitment to return cash to shareholders, to reflect their confidence in our financial strength and the long-term outlook of our company. Returning cash to shareholders and investing in our future remain top priorities for us.

I know there are questions on my thoughts about the company's 2019 targets that were established in December of 2016. I joined Arconic because I'm convinced we have great potential. Having said that, I need time to understand our capabilities and the magnitude of our challenges and opportunities before addressing this question. I will be in a better position to comment on 2019 when we get to 2019. Meanwhile, this year, the focus is not execution.

Last but not least, I would like to thank David Hess for his leadership as interim CEO. He made huge contributions guiding the company in uncertain times. I will continue to count on his advice and counsel as a board member going forward.

Now I'll turn it over to Ken, who will take you through our results for 2017 and provide guidance for 2018.

[Ken Giacobbe, executive]

Good morning. Thank you, Chip. I'll move rather quickly through the financial slides. Please note that we have several slides in the appendix, which provide additional details if needed.

Starting on Slide 5. Revenue for the fourth quarter came in at $3.3 billion, up 10% year-over-year. Organic revenue, which adjusts for aluminum prices, currency and portfolio change, was up 6% for the quarter on a year-over-year basis and up 5% for the full year versus 2016. Organic revenue growth for both quarter and year was driven by volume gains across all segments. A reconciliation for organic revenue can be found in the appendix.

EBITDA for the fourth quarter came in at $436 million, up 54% year-over-year. EBITDA, excluding special items, was $446 million in the fourth quarter, up 24% year-over-year; and $1.854 billion for the full year, up 9% versus 2016. EBIT improvements were driven by volume growth in all 3 segments and net cost savings, which were partially offset by pricing pressures and unfavorable mix.

Higher aluminum prices were a headwind that unfavorably impacted EBITDA by $42 million in the fourth quarter and $84 million for the full year versus 2016. The reconciliation for EBITDA, excluding special items, can be found in the appendix.

EBITDA margin, excluding special items, was 13.6% for the fourth quarter, up 150 basis points year-over-year. For the year, EBITDA margin was 14.3%, up 60 basis points versus 2016. As I mentioned on the third quarter conference call, our EBITDA and EBITDA margins have been negatively impacted by higher aluminum prices this year as aluminum prices have increased approximately 30% in 2017. In the fourth quarter, higher aluminum prices unfavorably impacted EBITDA by $42 million year-over-year and EBITDA margins by 190 basis points. For the full year, higher aluminum prices unfavorably impacted EBITDA by $84 million versus 2016 and EBITDA margins by 110 basis points. On the third quarter conference call, we had estimated that the annual full year impact to be unfavorable approximately $90 million. Our actual impact was unfavorable around $84 million. The aluminum price impacts are detailed in the appendix for the fourth quarter and the full year. We will continue to brief you on aluminum prices impacts on future earnings calls.

Net cost savings were approximately 2% of revenue for the quarter and the year, including over $100 million of year-over-year reductions in corporate and segment SG&A expenses. We finished the year with $2.15 billion in cash, and our liquidity remains strong.

Now let's review our results versus guidance on Slide 6. Slide 6 shows Arconic's 2017 results versus our last guidance as well as the year-over-year aluminum price impact. As I mentioned on the previous slide, higher aluminum prices created a significant headwind, partially offsetting strong operational improvements across the business in 2017.

Overall, we delivered on or exceeded guidance for revenue growth, net cost savings and EBITDA performance as well as earnings per share growth. Two areas of disappointment were cost reduction progress in our rings and discs business, the former Firth Rixson; and free cash flow performance. For both of these areas, you can expect to see increased focus in 2018.

With respect to free cash flow, higher-than-planned working capital was a primary driving -- driver of the free cash flow variance. The days on hands reductions that we contemplated in our guidance were, in the end, not achieved in our efforts to support the delivery ramp and continued strong growth in many of our end markets.

The 3 main drivers of higher working capital were as follows. First, we continue to build inventory in our aerospace engines in advance of the engine ramp to ensure that we protect our customer delivery schedules and commitments. Our first priority in 2018 and going forward will be to continue to protect our customers' delivery schedules while optimizing working capital. The second driver was higher raw material prices, which have increased inventory values. And the third related to increased pressure from our customers on payment terms and shorter payment terms for our suppliers on expedite fees. Having said that, while we expect the continued strong end market growth in many of our segments in 2018, we are confident that we'll make progress on driving operational improvements in working capital efficiency, which will translate into better free cash flow performance.

Now let's review our results versus guidance for the segments on Slide 7. On this slide, you can see that GRP and TCS segments achieved or exceeded the latest guidance. Both GRP and TCS had record EBITDA margin years despite significant aluminum price headwinds.

As with the previous slide, the last column shows the year-over-year impact of higher aluminum prices. For EP&S, we achieved our revenue growth guidance, including a record fourth quarter. However, we did not meet our expectations on cost reductions and operational performance, which was concentrated in the rings and discs business, and this resulted in an EBITDA margin miss. I will cover the segment performance in more detail in the segment slides that will follow.

Now let's take a closer look at the quarter, starting with the income statement on Slide 8. We've talked about revenue and EBITDA, so let me cover a couple of other key areas. Overhead reduction initiatives in 2017 were a success as we delivered $111 million of SG&A savings versus 2016. In the fourth quarter, SG&A was impacted by external, legal and other advisory costs related to Grenfell Tower of $7 million pretax and Delaware reincorporation costs of $3 million pretax. Excluding special items, our SG&A as a percentage of sales was 4.3% for the quarter, with SG&A being down $52 million year-over-year.

Restructuring and goodwill impairment charges were $766 million in the fourth quarter, which includes a noncash, nontax-deductible impairment of goodwill of $719 million, primarily associated with the disc portion of the Firth Rixson acquisition. We perform an annual goodwill impairment analysis in the fourth quarter of each year, and the estimated fair values of our goodwill reporting units are compared to their corresponding carrying values. The $719 million impairment is a result of unfavorable performance that impacted the fair value of the forgings and extrusion business, which included the disc business from Firth Rixson. The testings of our 6 remaining goodwill reporting units resulted in no additional impairment of goodwill.

The restructuring-related charges include a $41 million noncash, nontax-deductible asset impairment related to the sale of our Latin American extrusions business, which we expect to close in the first half of 2018. The remaining $6 million of restructuring charges related primarily to costs associated with decisions made in prior quarters to exit certain facilities in 2018. All restructuring charges this quarter were noncash.

The effective tax rate for the quarter was a negative 59.8% as a number of items, including the goodwill impairment charge, are not deductible. The operational tax rate was 29.6% for the quarter and 31.3% for the year.

Net loss for the quarter was $727 million or $1.51 per share. Excluding special items, net income was $152 million or $0.31 per share. This compares to $71 million and $0.12 per share on the fourth quarter of 2016. For the year, net income, including special items, was $618 million or $1.22 a share, up 24% year-on-year.

Moving to the right-hand side of the slide. You can see that special items for the quarter totaled $879 million after tax. I've already discussed the first 3 special items listed. As mentioned before, included in the fourth quarter is an item for the Delaware reincorporation, so it's $3 million of SG&A costs in the quarter associated with legal fees and transfer taxes. Moreover, the Delaware reincorporation required a $23 million tax reserve in the quarter related to certain NOLs in our foreign entities, which may be attributed and moved forward with future tax attributes.

Continuing down the list. As part of the Firth Rixson acquisition, Arconic entered in an earn-out agreement with the seller related to the Savannah, Georgia facility. Currently, we do not anticipate any -- making any payments under the agreements and have reversed the remaining $81 million liability associated with the potential earn-out payment. This item was recorded in other income line of the income statement and is noncash. We also reversed a guarantee liability of $25 million that was set up at separation related to an Alcoa corporation power contract that has been terminated. This item was recorded in the other income line of the income statement and is noncash.

Second to the last item on the list relates to U.S. tax reform legislation that was enacted on December 22 of 2017. As a result of the decrease in the U.S. corporate income tax rate from 35% to 21%, Arconic revalued its U.S. deferred tax assets resulting in a noncash charge of $272 million. Based on our estimates, we do not anticipate an impact to Arconic for the onetime transition tax on forward earnings included in the new U.S. tax legislation. Foreign tax credits will be utilized to negate this tax.

The last item associated with taxes includes not only the tax impact of the items listed above but also includes a favorable discrete tax item in the quarter. The majority of this relates to a release of U.S. tax valuation allowances. Following separation, Arconic now has a normalized U.S. taxable income profile that is anticipated to support realization of certain U.S. state-deferred tax asset and thus a portion of that state valuation allowance was released in the fourth quarter.

Now let's turn to the cash flow statement on Slide 9. Free cash flow was $376 million for the quarter. As you heard Chip comment in his introductory remarks, improving cash generation is a top priority for 2018.

We ended the quarter with $2.15 billion in cash on hand, which is well above our minimum operating cash level of $600 million to $700 million. CapEx spend for the year was $596 million, in line with our updated guidance and consistent with our efforts to rigorously manage capital expenditures. Net debt to adjusted EBITDA finished 2017 at 2.53x versus the end of 2016 when it was 3.66x. That's an improvement of approximately 30%.

Finally, as Chip discussed, the Board of Directors has authorized a $500 million early debt reduction program to further enhance our financial position. We will target the 5.72% bonds that are due in February of 2019.

Now let's move to our segment performance, starting with EP&S on Slide 10. As I mentioned earlier, EP&S exceeded expectations for revenue growth with a 6% increase in the fourth quarter on a year-over-year basis and a 4% increase for the full year versus 2016. Most of the aerospace markets as well as commercial transportation exhibited strong growth versus 2016, while industrial gas turbines declined more than expected. However, while the revenue exceeded expectations, we were short of EBITDA growth and margin expansion. EBITDA was up 12% in the fourth quarter on a year-over-year basis and up 2% for the full year versus 2016. EBITDA and EBITDA margins for EP&S legacy businesses were roughly in line with our expectations, but we did not make the cost reduction progress planned at our rings and discs businesses. For rings and discs, we have been able to deliver on the revenue projection as the full year revenue was $980 million or 6% higher than 2016, which is in line with our guidance. However, EBITDA was $120 million or $16 million lower than 2016 as EBITDA margin was 12% or 250 basis points lower than 2016. To address the ramp-up challenges with our rings and discs businesses, we've initiated the following. We've deployed targeted CapEx to increase velocity to our plants. We've deployed additional quality systems and technical experts from Arconic to these sites, and we've changed relevant segment business unit and location leadership personnel to bring about faster changes.

Lastly, in January, we consolidated the EP&S organizational structure, collapsing 4 business units into 3 and reducing layers in the process. These changes will save approximately $15 million in 2018, but equally important, have resulted in streamlined organization, which will accelerate progress, increase focus, speed up decision-making and improve delivery performance to our customers.

Now let's take a look at the GRP segment. Slide 11. As I've mentioned earlier, the GRP segment delivered revenue growth and improved EBITDA margins versus 2016. Organic revenue was up 7% compared to the fourth quarter of 2016 and up 5% for the full year. For the full year, double-digit growth in auto sheet and commercial transportation was somewhat offset by weaknesses in packaging and commercial airframe, which was driven by airframe supply chain optimization and lower wide-body build rates on selected platforms. In the fourth quarter, GRP's EBITDA was $124 million, up 7% versus prior year. Its EBITDA margin decreased 80 basis points to 10% as higher aluminum prices unfavorably impacted EBITDA margins by 160 basis points. For the year, GRP's EBITDA was $599 million, up 4% versus prior year, while its EBITDA margin increased by 10 basis points to 12% despite the unfavorable 140 basis point impact due to higher aluminum prices. Overall, a solid year for the GRP segment.

Finally, let's move to our performance in the TCS segment. Like GRP, the TCS segment delivered strong revenue growth and improved EBITDA margins versus 2016. Revenue was up 14% compared to the fourth quarter of '16 and up 10% for the full year. For the full year, TCS experienced solid organic growth in its 2 main markets of commercial transportation and building and construction. In the fourth quarter, TCS EBITDA was $84 million, up 12% versus prior year. Its EBITDA margin decreased by 20 basis points to 16.2% as higher aluminum prices unfavorably impacted EBITDA by 170 basis points. For the year, TCS' EBITDA was $321 million, up 10% versus prior year. Its EBITDA margin increased 10 basis points to 16.2% despite an unfavorable 120 basis point impact due to higher aluminum prices. A very strong performance by the TCS team.

Now let's look at our SG&A. On Slide 13, as I've mentioned previously, we've delivered on our overhead reduction initiatives for 2017. Excluding special items, our SG&A as a percentage of revenue was 4.9% for 2017, 120 basis point improvement or $111 million compared to 2016. Corporate overheads finished the year at less than 1% of revenue for 2017 versus our original guidance of 1.1%.

Now let's move to the end markets on Slide 14 and 15. Slide 14 provides a breakdown of our 2017 revenue by end market. As you can see, aerospace comprises approximately 40% of our revenue, while automotive and commercial transportation account for another 25% of the total revenue.

Slide 15 shows the growth in end markets. For aerospace and defense, we saw a 2% increase in 2017, and we expect to see higher growth in 2018.

As aluminization of the automobile continues, we expect to see strong growth again in 2018 for auto after seeing 22% growth in 2017. In commercial transportation, we expect to see continued strong growth with another 6% to 10% increase in the market. Building and construction will see moderate growth in 2018 of roughly 2% to 3%. Industrial gas turbines is more of a challenge. The market declined 7% in 2017, and we're expected to see continued reductions in that market by at least 40% in 2018. During the IGT downturn, we will address volume and redeploy capacity and talent to fully utilize our existing assets.

Let's turn to Slide 16 for our 2018 guidance. Supported by the growth in most of our markets, we're expecting to see organic growth of 2% to 4% in 2018. At current aluminum prices and currency rates, that will put revenue at approximately $13.4 billion to $13.7 billion. While we see strength in many of our main markets and overall see 2% to 4% organic growth, it's important to note that we are ramping down the North American packaging business. We also have other packaging businesses outside of North America, and we expect those markets to be flat. We also have a significant part of our revenue coming from industrial and other markets, and we expect that to be flat in 2018.

As Chip mentioned in his comments, we've taken a number of difficult actions to improve performance, including overhead reductions, relocating our global headquarters by the end of this year and freezing pension for non-U.S. bargained employees, just to name a few. We expect that these actions as well as improved operational performance will result in earnings per share in 2018 between $1.45 per share and $1.55 per share. That would represent a 19% to 27% improvement versus 2017. We expect to see continued pricing pressure in many of our markets, particularly aerospace, and higher raw material prices. Overall, we see a net favorable market and cost profile for Arconic in 2018.

For free cash flow, our target for 2018 is approximately $500 million. I will note that this is an annual target and reflects expected first quarter usage of cash based on anticipated timing of interest payments and pension contributions. We did not perform well in 2017 in terms of managing our working capital and delivering flat free cash flow. This will be a priority in 2018. The combination of improved earnings and working capital performance will accelerate our improvements in RONA, or return on net assets.

Slide 20 in the appendix provides some additional key assumptions that we used to build the guidance.

Now let's move to Slide 17, capital allocation. As you look at Slide 17, we're committed to returning cash to our shareholders. As announced today, the Board of Directors has authorized a repurchase of up to $500 million of Arconic stock. We will also continue to return cash to our shareholders in the form of quarterly dividends, which is targeted at $0.06 per share. As I've mentioned before, working capital efficiency and improved cash flow will be a priority for 2018.

Finally, we remain committed to delever the company. The announcement today that the Board of Directors has authorized the $500 million early debt reduction program is further evidence of our commitment.

In summary, for 2017, we had favorable performance in terms of revenue growth, net cost savings, EBITDA performance and earnings per share growth. Arconic's total shareholder return in 2017 was 48% compared to the S&P 500 return of 22%. However, it is clear that we have opportunity for improvement in delivering free cash flow as well as performance in our rings and discs business. As you can see, we will increase our focus in these areas and produce better results in 2018.

Now before turning it back to Chip, let me cover a couple other items that will help you understand our results as we move forward in 2018. First, on Slide 20, you will notice that our operational tax rate assumption, including the impact of the U.S. tax reform, is 27% to 29%. This range is based on the geography of our earnings and tax rates in each jurisdiction as well as our current understanding of the U.S. tax reform legislation. We will update guidance as necessary and as the details become more clear. I will also note that we do not currently pay U.S. cash taxes, so there is no immediate cash benefit from the U.S. corporate tax rate reduction. We do not anticipate incurring U.S. federal cash taxes in 2018. For 2018, we expect that our global cash income tax rate will be approximately 10% of pretax earnings.

On Slide 21, I'll also point out that you'll see details related to our pension and OPEB obligation. As mentioned previously, we froze the defined benefit plan for U.S. non-bargained employees effective April 1 of this year. Pension and OPEB-related expense in 2018 will be approximately $50 million less than 2017. Also, as a result of the new pension accounting standard that is effective for Arconic in 2018, pension and OPEB expense will be split between operating and nonoperating accounts. While historical expense data for 2017 will be restated and available for first quarter earnings release, Slide 21 shows the impact of the change between 2017 and '18. You can also see on Slide 21 that we expect our pension contributions to be higher in 2018 as a result of our lower pension asset returns in 2017, which were about 5%, and also the update to the IRS mortality tables for funding purposes. Finally, I will note that for 2018, we expect that 7% will be the expected long-term rate of return for our pension assets. The previous view was 7.75% return.

Finally, we'll be changing our segment profit measure to adjusted -- from adjusted EBITDA to operating income effective 2018. This change will allow a direct comparison of Arconic's income statement as the operating income is a separate line on the income statement. As part of this change, LIFO and metal lag will now be included in the operating income for each segment. Historical segment information will be restated for 2017 and will be available for release in our first quarter earnings release.

Now let me turn it back to Chip to wrap things up, and then we'll take your questions.

[Charles Blankenship, executive]

Thank you, Ken. Just to reiterate, I'm excited to be here leading the Arconic team and serving our customers. I see a good foundation in place in terms of people, process and technology. There are areas that are ripe for improvement where the next level of performance can be achieved. The kind of work that is ahead of us is not easy work nor is it quick work. Shortcuts won't get us there. It will take a refined execution mindset to deliver improved business performance. I have met many Arconic employees so far that I believe are up to this challenge. Our customers have declared their support for us. My attention and my leadership team's attention will be focused on supporting the factories and the team members on the front lines that will deliver on our customer and company commitments to maximize value for shareholders.

With that, I'd like to open the line for your questions.

[Operator]

[Operator Instructions] And our first question comes from the line of Sam Pearlstein with Wells Fargo.

[Sam Pearlstein, analyst]

I was wondering if you could talk how you're thinking about the buyback activity. I know you're assuming none in the guidance with the 505 million shares. But just what's the criteria for deploying it? How should we think about how you're going to deploy that buyback?

[Ken Giacobbe, executive]

Yes, you're correct. Our guidance does not contemplate any change in share count, so the buyback would be incremental to that. We will be opportunistic based on where we see the value of the stock as well as we will have to take a look at our cash -- seasonal cash needs, as you know, in the first quarter. We normally have pay-down of debt, interest payments and also our pension funding, which causes a drain in the first quarter. So we're going to look at opportunistic plays here as well as what our cash balances are.

[Sam Pearlstein, analyst]

Okay. And then, Chip, if you can talk a little bit about the portfolio review. I mean, what does the review entail? And what do you see in terms of how we'll hear about it? Is it a series of individual announcements? Or is there going to be one big kind of release in terms of the completion of the review?

[Charles Blankenship, executive]

So we're initiating a comprehensive review. It's going to be a thoughtful approach regarding our strengths and weaknesses, and really, like I said in the script, to determine the best way to unlock our potential. Primarily, it's a tool to refine our commercial and go-to-market strategies and really look at capital allocation. It's a very important exercise, but I don't view it as an urgent exercise. So we're going to take the year to do that in a really thoughtful way, Sam. And we'll reveal the outcome of that as well as the action plan going forward at the end of the year, early 2019.

[Operator]

Your next question is from Rajeev Lalwani with Morgan Stanley.

[Rajeev Lalwani, analyst]

Just a follow-up on the last question there. When you're looking at your portfolio review, will you take a look at potentially exiting certain businesses or selling certain assets, whether it's GRP, TCS, maybe the company as a whole? And then just related to that, what are your thoughts on the synergies between the various segments that you have and essentially the benefits of having the 3 under 1 umbrella?

[Charles Blankenship, executive]

Well, it's a little bit early to offer my opinion on the synergies. I think that's really, as I highlighted, one of the things we really need to look at across the board, how do these segments perform together and what are the advantages for having them together. As far as more radical actions like you suggested, we will look at everything. But like I said, primarily, this is a tool for us to understand how do we compete, where are we strategically advantaged, where are we not, so that we know whether we're investing in the right technologies to further our strategic advantage, or if we're less advantaged, can we utilize our assets better by really targeted and opportunistic sales and operations connections to improve our utilization and productivity and lowest cost per pound to produce. Does that help you?

[Rajeev Lalwani, analyst]

And Ken -- yes, it is. And then, Ken, a quick one for you. Can you just maybe provide a bridge between the 2017 and 2018 free cash flow figures, I mean, going from $100 million to $500 million is a pretty big shift, especially given what we're seeing on the CapEx side? Would just love some color there.

[Ken Giacobbe, executive]

The biggest change, Rajeev, in '17 was the working capital, right? We carried too much inventory in our EP&S business that was related to our engine business. We hit a milestone in our engine business where our revenue went up to $2 billion. We did carry a little bit of extra inventory there, more than expected. But that was the main drivers. In terms of 2018, earnings is going to drive our free cash flow. We're also going to invest opportunistically some more CapEx in the business. CapEx guidance is in the $700 million range for 2018. Now a lot of that incremental CapEx on a year-over-year basis, Rajeev, will be for productivity, CapEx and growth CapEx. Our sustaining CapEx will probably be still around 45% of our depreciation. The actual raw number is coming down on a year-over-year basis. So all of these investments will be to improve our flow through the plants, improve our working capital performance that will help cash. Now on the other side, we are growing revenue in 2018 by roughly $600 million, right? So although we'll get days improvement in our days of working capital, you won't see a cash contribution in terms of working capital dollars because you got a lot of incremental revenue. But the drivers will be still improvements in our earnings in the business. We'll fund that extra capital through the business, and cash would be around $500 million for 2018.

[Operator]

Your next question comes from Seth Seifman with JPMorgan.

[Seth Seifman, analyst]

So I guess my question about the portfolio review is where is it taking place? Who's going to be involved in conducting it, Chip, maybe besides you and how often? And intimately, is the board going to be involved?

[Charles Blankenship, executive]

So we're going to use our team to do this portfolio analysis. And that's one of the reasons why the length of time is as we specified because our urgent activities really are to get on PO with customers, support them with the right quality and at the right cost. So the same folks that are leading our businesses and supporting that activity will also be involved in the portfolio review. So really, that's the answer to that question. We'll reach out to external consultants if we think they can add value on very targeted, specific items. But I think we have a good view internally on our business, and we can step back and take that neutral view that we need to look at everything.

[Seth Seifman, analyst]

Great. And then as a follow-up, maybe given your experience at GE and the aviation business, looking at this engine ramp, I think we all know and management has made a point before and I think it's a valid one that there's a very steep ramp in engine production going on. And just sort of how you view the challenges ahead on that front? And maybe talking about little bit more broadly than the Firth Rixson and Savannah, where are the opportunities that you see for improvement?

[Charles Blankenship, executive]

So on the engine ramp, this is one of the biggest challenges, I think, industrially that the aviation community has faced, whether its engines or otherwise, getting on rate for the narrowbody build rates that from -- in my experience are higher than ever imagined. We are performing well. We are behind in a couple of areas. We're ahead in a few areas, and we're right on time in -- with some other part numbers. So we're doing everything we know how to meet the customer demand. I would say that the challenge is really to get the capital that was approved last year in play so we can increase velocity through the plants, reduce our costs, limit the amount of outsourcing that we need to support the customer. And it's really about achieving both at the same time on PO with the customer as well as our reduced cost to achieve that.

[Seth Seifman, analyst]

Great. And then maybe as a final one, if you could just give an example, maybe 1 or 2, the types of capital projects here that are going to allow you to work faster in the plants and I guess keep inventory at a reduced level.

[Charles Blankenship, executive]

Yes. Just briefly, I would say that it expands the realm from just rate tooling to support additional lines and additional loads into furnaces as well as it involves major equipment in terms of bringing online a press to reduce the number of operations and reheat cycles to support our customer.

[Operator]

Your next question is from Curt Woodworth with Crédit Suisse.

[Curtis Woodworth, analyst]

First question is on the EP&S segment and the performance in the fourth quarter. You noted about a $50 million annualized headwind from product mix. But then you also noted that the jet engine revenue ramp was 9%, and you were flat on airframe. So I would assume mix would've been a tailwind on the jet engine side this quarter. Can you just elaborate on sort of the mix dynamic this quarter and how you see mix evolving into '18?

[Ken Giacobbe, executive]

Yes. To your point, jet engines, as I mentioned earlier, hit the milestone of $2 billion of revenue. It was about 8.5% growth year-over-year. It's interesting, too, as you dissect that engine build, if you look at the next-generation platforms, they were up about 60% year-over-year, and our legacy engines, which were a smaller -- a much bigger dollar amount, declined about 7%. So we had a mix within the engines. As you do that, we've got to learn out our costs on those next-generation engines. They're not as profitable as the legacy engines. So you've got mix within the engine component. So that's the first major driver. And then the second one is IGT, right? That's an attractive margin business for us, and it just pretty much dried up a lot of the orders that we received. So it's a combination of the mix within engines in terms of the profitability side and then IGT.

[Curtis Woodworth, analyst]

Okay. Great. And then with respect to the $81 million contingent earn-out at Firth, does that imply that you see less -- I think it was related mainly to the isothermal development. Does that imply that you see significantly less EBITDA contribution from isothermal? And can you just give us an update on sort of commercialization of isothermal?

[Ken Giacobbe, executive]

Right. So in terms of the earn-out, that relates specifically to the Savannah, Georgia facility that does house the isothermal press. Although we wrote down the earn-out, we're still driving performance in that business. We're investing a lot of capital down there, not only in 2017, but we'll continue that in 2018 to improve the throughput of the plant. As Chip mentioned, bring some of the outsourcing expense in-house and getting rid of those expedite fees. So we're continuing to drive the Savannah operation. In terms of the isothermal technology, we'll continue to invest, and we're making progress. However, we're behind. In 2018, our revenue for isothermal will be probably in the $10 million to $15 million range. There'll be a greater contribution in '19 and '20, but I wouldn't expect a lot of revenue out of isothermal in 2018.

[Operator]

Your next question comes from Gautam Khanna with Cowen and Company.

[Gautam Khanna, analyst]

On Slide 16, you mentioned some of the headwind in the bag this year. One of them was Airbus destocking. What specifically is going on there?

[Ken Giacobbe, executive]

Yes. So there's 2 items with Airbus. First, on the fastener side, we are seeing that there's some drawdown on some of the inventory with Airbus. That is impacting our fasteners business that primarily relates to the A350 platform. However, we have a bit of an offset in terms of now we're seeing Boeing is actually behind us. So those 2 are kind of offsetting. But we do see in the sheet and plate business for GRP that there's some inventory corrections going on. And that, combined with the wide-body build rate reductions, is impacting the performance.

[Gautam Khanna, analyst]

Okay. So last quarter, when we asked, the 350 was not an issue, so it just started to actually pick up in Q4 for the first time?

[Ken Giacobbe, executive]

Yes, we're starting to see it now, Gautam.

[Charles Blankenship, executive]

Yes, now, this quarter.

[Gautam Khanna, analyst]

Okay. I know, Chip, you don't want to comment on 2019's standing guidance. But just looking at the math, $100 million of free cash in '17 to $500 million in '18, and you have a very steep ramp, as you described, on the new engines, which brings with it a need for whip inventory. And the guide is $750 million for free cash in 2019. I just wonder, can you say anything over, under on that number from where you sit and how much work needs to be done to get there? Can you give us any more comfort that that's actually a number you're going to hit or exceed? Or is there something that we're just going to have to wait and see?

[Charles Blankenship, executive]

Gautam, nice to meet you over the phone, at least. Sorry to say that that's just something we're going to have to all wait on. I'm not prepared to comment on the 2019 number. We are focused, however, on delivering on 2018. These numbers are something that we're taking to heart and the teams deployed on and we're prepared to deliver on.

[Gautam Khanna, analyst]

Okay. And last thing, I just want to make sure I understand. On Slide 16, the negatives that you cited, are those in order of increasing impact -- I'm sorry, descending order? IGT/Power is the biggest absolute impact on guide. Aerospace pricing is the second-largest headwind, et cetera, as we move down that slide.

[Ken Giacobbe, executive]

No, we didn't stack it that way, Gautam, by order of magnitude. But I think the bigger impacts will be the IGT. That business has just dried up for us, unfortunately. And then the wide-body will impact the GRP business as we're seeing some reductions in selected platforms. And raw material costs, we don't think it will be as significant as it was in 2017 as we just had a significant ramp, especially the aluminum prices going up about 30%. At least some raw material costs but not of the magnitude that we had in 2017.

[Operator]

Your next question is from Josh Sullivan with Seaport Global.

[Joshua Sullivan, analyst]

On the automotive side, what's driving that growth? Any share gains you can point to? And then how do you serve that market going forward? Can you continue to sweat the assets here for additional capacity? Or did you then make some incremental investments at some point?

[Ken Giacobbe, executive]

I think I can handle that one, Josh. Automotive, it's just we're seeing the continued aluminization in the market. Fortunately, we're on Ford programs, as we've mentioned in the past, but we're on about 58 other platforms in the portfolio right now. So just the market, in general, how we're positioned bodes well. We've given a commitment of $1.3 billion of revenue in 2018, which is about an 18% increase year-over-year. We still feel comfortable in that number, and that's our internal view. But we look at Ducker a lot as well, and they're just saying this is unprecedented growth in terms of automotive. I think it's, since they have been tracking it. It's the biggest increase that they've had. So the market is good. Our product is differentiated. We're on 58 different platforms, and we feel comfortable that we can hit on our commitment.

[Joshua Sullivan, analyst]

Okay. Great. And then kind of just a similar question on aerospace, Boeing exploring higher narrowbody rates. Would you need to step outside of your footprint to get above 57 on the sub-737?

[Charles Blankenship, executive]

No. We're not above the footprint. We have a pretty good network on engines, and we have the right level of assets for sheet and plate to support that.

[Operator]

Your next question comes from Jeff Kramer with Morgan Stanley.

[Jeff Kramer, analyst]

Just curious how your view of the balance sheet fits in to the overall strategy. I mean, obviously, previously in your career, it wasn't an issue for you but different situation at Arconic. Is being investment-grade a priority? How does the share repurchase program fit into that strategy? And are you interested in accelerating the transition to investment-grade?

[Charles Blankenship, executive]

So just based on my background of being part of General Electric and then actually being a part of a standup U.S. entity for Haier where we did worry about all things balance sheet, I do have as a priority investment-grade for a variety of reasons. Risk-averse and security and liquidity being among them. So those are my comments. I'll transfer the rest over to Ken.

[Ken Giacobbe, executive]

Yes. Chip and I are in violent agreement on that. If you look at your performance to ensure that we are investment-grade, as we've mentioned, our net debt to EBITDA has decreased about 30% in 2017 to 16%. We're rated about 2.5x right now, which I think is healthy. We've also made a concerted effort around the paydown of debt. We've -- in the last 2 years, we've taken our interest expense down around 25%. That had nothing to do with U.S. tax reform. That's just part of our capital allocation strategy. And we -- our liquidity remains strong in the portfolio. We've got about $6 billion of liquidity, and we're comfortable within our covenants for the business. So the answer, investment-grade is very important to us. We think our balance sheet is strong, and our liquidity is good.

[Jeff Kramer, analyst]

Great. Okay. And just as a follow-up, you have little north of $2 billion of cash right now. You guided to about $500 million of free cash flow in '18. About $1 billion of that is accounted for between the debt reduction and the share repurchase program. So suggest you have about another $500 million to $1 billion of excess cash for allocation, how would you think about deploying that?

[Ken Giacobbe, executive]

We're going to look at a bunch of different options for that residual. You are correct. We normally need about $600 million to $700 million of operating cash to run the business. So we're working with Chip in terms of alternative uses for that excess cash.

[Operator]

We have no further questions in queue at this time. And I would like to turn the conference back over to our presenters.

[Patricia Figueroa, executive]

Thank you, everyone, for joining. We will look forward to talking to you in our next call.

[Operator]

Thank you for your participation. This does conclude today's conference call, you may now disconnect.