Howmet Aerospace Inc. (HWM) Earnings Call Transcript & Summary

Okay. Terrific. Thank you. Afternoon, guys. I appreciate you coming in after lunch. I know it's always unpleasant to transition, but we're going to spice it up here. We are very fortunate to have with us Arconic Corporation, represented by CEO, John Plant; and Chief Financial Officer, Ken Giacobbe. We also have Head of Investor Relations, Paul -- PT Luther as well here. This is meant to be an interview format. Maybe in the last 5 minutes, we'll open it up for Q&A from the audience. My name is Gautam Khanna, I'm one of the research analysts at Cowen. I've covered Arconic for a couple of years now.

My first question, John, and I was just going back through press releases actually this morning, and I noticed some new board members were named to Howmet, and we do have the board named for Arconic, the ongoing Global Rolled Products business. And I didn't see your name on either list. And I was wondering if that was just a misreading by me or if that's, in fact, true, you're not on either board, and what we might infer from that, for your remaining tenure at the company?

Okay. Well, first of all, you shouldn't -- there's nothing to be inferred from it. What we did in the Form 10 was to set out the directors for the rolled products company. And name that slate, both the directors that would carry over to that company and for new incoming directors. And we've also taken the opportunity of announcing publicly the new directors recruited to Howmet, which I think you're seeing have 2 people of, I'm going to say, significant experience in the aerospace industry, one from Boeing and one from Pratt & Whitney. And then 2 other, I'll say, distinguished businesspeople in addition to that. So that was the purpose of making those announcements. It was not to name the ongoing directors of Howmet because everything in the last few weeks has really been aimed at, I will say, defining and accelerating the separation itself. And that's been something I've been highly focused on for a few months now, obviously, made it a bit more difficult by the issues at Boeing and having to redo all the financial models because of going back around the rating agencies loop. But I mean, getting that financing done to enable the separation done means we're essentially there. We now have to make the Form 10 effective, and that means being all hands to the pump to affect all of that, both at the board level, the management level for the new spun company. And now we'll begin to turn our attention back to resolving the remaining issues for Howmet and the future leadership and board of Howmet. So nothing to be inferred.

Okay. Well, maybe asked differently then...

Yes, I thought you could find a different way of asking the same question.

No, it's because literally the #1 question we got and is on the stand-alone prospects of each company, which, obviously, by definition, is very dependent on the capability of the management teams in place. That's going to be something that people are making a bet on. You have your Investor Day coming up for both entities on the 25th. Do you think it would be prudent to have new management or whatever the management is going to be in place for Howmet by then? Or is that not a realistic deadline? Or is that a deadline of any kind, in your view?

I don't think it has to be a deadline as a goal in itself. I think that would be the ideal condition because as you set out with investor days to try to define what these companies look like going forward, then it would be a good thing to do. And I recognize that whilst, inevitably, there'll be some churn between those people who want to own a materials business and those people who want to own an aerospace business at the time of separation, it's also, I think, particularly, I'll say, opportunity for new investors to consider, do they want to invest in those 2 future pure-play companies. And inevitably, just because of the different natures of them, where one aimed at the aerospace industry, one with a multi-product line, and what does that have in terms of the characteristics of that business. And then the one business, which is essentially aluminum-based, whether it's rolled product or extruded product, and with multiple different sectors. But as I try to explain at the Investor Day, what those businesses are about, clearly, future -- particularly, let's say, long-only shareholders rather than event-driven shareholders are going to be interested in the leadership of those companies going forward. So it will be prime time for Tim Myers to show on the rolled products side. And obviously, the ideal is to announce that future leadership of Howmet as well.

Okay. And to that point, what attributes are you looking for? And whoever ultimately leads Howmet, what are the...

Well, I don't think you refer to -- I -- because I think it has to be the paragon of all virtue that does that. But I mean, if there's one essential characteristic, I think, someone who is not only clear-eyed about what business sort of levers are, but also has the intellectual curiosity that goes along with it to try to say, are there better ways of doing things and -- to achieve the goal, which essentially comes down to can it, in the case of Howmet, achieve what I think the 3 tenets of the business are, which is to outgrow the aircraft industry, and can it do that with top quartile margins and with a free cash flow conversion, which I've called out so far in what I said in the fall of last year, in excess of 80% of the net income. And I just try to give like those like guideposts, and ultimately, as those things are refined for everybody on February 25, is I think those would be -- beyond all the additional detail, I'll give you that segment's products, et cetera, et cetera, in that presentation. I think those are the 3 things that I'd like investors to walk away with, which is top quartile performance with that level of free cash flow and outgrowing the market. And I'd say -- and what more do you need to know?

Right. Fair enough.

Yes. Well, because I can tell you a lot more about the business, but that would be 3 points I'd like you to remember. Maybe that's why I'm saying them to you today.

That's good. So John, you've been there just over a year in the CEO suite, and in that role. And huge transition in the margin structure of the company. It's been fairly urgent. It's been fairly dramatic. I was wondering if you could maybe give us a peek into what you've actually done on the factory floor to kind of drive this clarity to drive kind of -- to leverage the company to scale the -- what you're actually doing. Can you give us examples?

I mean I'd like to think about initially standing back -- well, stay standing back trying to get a complete view of the company. Obviously, I had some perspective from the board. But the real truth is, as a board member, you don't really know that much and maybe you only get to know that which management tell you. But it was, I will say, quite revealing to me in, I'll say -- because you asked specifically about the factory floor rather than the business as a whole, where I'd like to talk about price/cost, all the other levels. But in terms of the operations on the factory floor, first of all, I don't think there's any consistent theme within the company of any form of truly driven manufacturing excellence. I think there've been a complete lack of focus on throughput and machine uptime and the necessity to operate at a leaner levels of working capital, not just for the financial objective themselves. But if you focus on those 2 things to do with, let's say, just inventory management, it drives you to do a lot of other things well. So in other words, your quality has to improve, your machine uptime has to improve. Otherwise, you can't possibly achieve the inventory levels that you should be. And so having those few metrics and focusing on them religiously then helped a lot. And it's been really interesting to me as we've begun to look at the OEE levels of each of the major manufacturing assets, and so I could reel off what our extrusion pressures are running at in Cleveland or I could talk to you about what our ring rolling is in, say, in our Rochester facilities. And as I say, when we got to the late fall, the one thing, which I think was really telling amongst all the other things that have been done, when one of the operations said, yes. And you know what, as we've been able to improve these machine throughput times and uptimes and have machine availability because they weren't broken down. We did have the spares. We are doing preventative maintenance. It's enabling us to deman. So in that singular plant, we looked at over 150 people that we no longer needed because the machines were working when they were there, they weren't standing and waiting. And so suddenly, the level of efficiency and labor productivity at the plants also began to improve. And so I think all of that thing -- those things have begun to really improve our manufacturing operations, which I think there's still a long way to go. I mean there's no way I'd say that, that journey is complete. I mean there's lots of other things we've done in the business to address things that really mattered. But on the shop floor, I'd say it's all to do with that relative productivity of both people and machinery, but using just a few metrics to focus on.

Can you talk...

I always believe in focusing on the few and not the many.

Yes, speak to that, actually. It's a -- you've brought a lot of clarity. Can you talk about some of the higher level things you've done to drive this?

Well, I think, I spoke a little bit about this at dinner last night. And I remember one of the early meetings, and Ken remembers it well, I only have a view dealing with, let's say, 3 to 5 fundamental things and focusing on those. And reiterating, in fact, our internal management call just after the turn of the year as we announced our end of year results and trying to see if any personal objectives that you might have written for yourselves. If they don't meet these defined priorities, then I'm not really interested in them. And what's more, you shouldn't be listing out long reams on things you're going to do because you can't remember them, you're not going to do them, so just focus on the few. And it was rather more important that as we did earlier last February, I've taken over the business, I listed out, and this is the list of things we're not going to do, and that list was probably 5x longer from the things that we are going to do. Because I think truly successful companies are also very clear on the things that they're not going to do. And I think that really defines the difference between, I'm going to call it, mediocre performance and excellent performance because many organizations do get, I think, lost in its miasma of all the things that are there to be talked about and all the latest management fads and all the things that you could talk about, which actually make no difference at all. So I really am, I will say, an evangelist or believer in just focusing on the few in it and not the many.

Can you talk about the few that you've narrowed the focus to and where we are in that journey?

Well, it all comes down to -- I mean, the few being, I've always been, I'd say, vocal about focusing on our commercial arrangements, and with that goes price. Also all the aspects of cost management from whether it's been our corporate costs. And I think there's still a little bit of amazement that we can operate 2 future public companies with a lower corporate costs than has been the current Arconic ink cost. And that's been a result of what I believe willingness to benchmark and achieve what I believe to be a world-class headquarters operations, so we shouldn't be burdening the businesses. And the business is -- the headquarters is not there just to talk and control but also to support. So again, very focused, I'll say, level of corporate support that which needs to be to get the, I'd say, the job done. But then to give -- I'll say cost in all its forms, whether it's been not just our input materials cost for direct materials but also indirect as well. And so programs that are don't -- not difficult to do, but just having that singular purpose. And this is what we're going to achieve. And the way I think about it, business really is pretty simple. We don't need to make it too complicated. If you can take care of your revenue line first, both in terms of underlying growth and price with the right commercial arrangements, and you turn your mind to the fundamental cost lever, so basically, if you can raise price, reduce cost, life is going to be good. Not to worry about too much else. No, I'm trying to make it simple to make the point. But if you think about all the things that corporations get tied up in, many lose their way.

Yes. And speaking of which, so you had a repricing exercise over the past year that's generated quite a bit of -- you've quantified the number in 2019. How did you -- did you actually take those negotiations out of your sales force's hands? Or how did the -- how did you personally kind of manage that process?

I think as I said, I think, taking care of the revenue line would behoove all CEOs to do. And it's the first order of business, in my view, and that's no different when I was in the automotive industry to now with different dynamics and -- around it for sure. But it also goes along with, I'd say, the intellectual curiosity to know your product and your competitive position for each data. I don't mean the competitive dynamic around, say, fasteners or maybe you get -- need to be a little bit more nuanced and say, what's the type of fastener that goes into an aluminum-based aircraft compared to composite. Are they the same? And of course, you suddenly realize or come to the conclusion there, they're fundamentally different with different levels of materials, technologies and, of course, different levels of price points altogether and so on into our engine business. And so when you think about, in our case, where are you on the turbine in the jet engine, it really matters in terms of your, I'll say, spares volume, whether you're at the front end of the engine, or the hot end or the colder end and knowing those characteristics. And so many of the things that Howmet has going forward, I mean, it really -- many think the themes of what I think the modern world, which is in terms of being environmentally sensitive, sensitive to emissions. Then as we enable, let's say, composite aircraft to fly and the benefits that, that has for, let's say, both fuel consumption and for the environment, then we're at the center of that with our titanium structures and with the, let's say, the fastening capabilities if you look at the need for additional fuel efficiency, and again, for emissions control to enable that with both higher temperatures and higher pressures. Again, part of the Howmet technology in aerospace is to enable that to happen as well. And so I think we can also say, to have this improved world around emissions and being responsible, then I think Howmet has a good story to play in that whole ESG space, not just from our own emissions from our own plants, but in all of that as well. So I think it talks to many of the themes in the modern world. And if you emphasize those and you resource allocate to those areas of clearly defined market need rather than treat everything as equal, then you can really change the DNA inside the company.

So just to put a finer point on it, though, when you went about assessing your own product portfolio where you had a competitive advantage where you may have been one of the few that could provide a product, was the pricing that we saw last year effectively a mark-to-market, i.e., legacy Arconic-Howmet wasn't doing this? Was just sort of pricing to continue the business. And so there was this opportunity. So we saw a big gap that was filled. And as we move forward, that's going to attenuate because we largely marked everything in the market?

I don't think it's a one-off thing by any means, if that's what you're trying to get at. It's part of a journey because our contracts refresh every, let's say -- speaking on the aerospace side now, talk more than the rolled product because they have different dynamics, and I'm happy to talk about that as well, but they come up for renewal every 3 to 4 years. And I don't think they're the same and they're not equal in each bundle that comes forward. But again, commensurate with where they play competitively and when I think about an industry with a multiyear backlog with technologies, which are really at the forefront of the industry, and when you have, I think, a uniqueness to some of those performance characteristics. And so I look at where do we stand on, for example, the Joint Strike Fighter and the uniqueness of that air flow management and coatings technologies, then those products should be -- command a good value, and so on as those go through generations of aircraft engine. And so I do think the positioning and knowledge and listing of visibility of price in the organization because if I'm willing to focus on it, then assure the business unit head is because he has to sit opposite me and he's always opposite me in the quarterly business review. And I do expect that person to know. And he's in a bit of a cultural shock, the first one we did because when I -- I would call for the information and got it. And it's a bit embarrassing the business team themselves may not have known, the granularity of each of those contracts which are up for renewal. And so -- and also the willingness to it, as I have done and engage directly with the sales team, to let them know that I'm not only knowledgeable enough to be able to debate the product with them, but a freedom -- to give them freedom around a parameter of pricing. But there's an expectation. And I think it's like everything, if there's an expectation and which you're willing to engage with and support and directing myself at the customer, then I feel as though that everybody balances to try to address that. So I mean there are some -- have been some absolutely outstanding people in Arconic. And I think, again, coming back to focusing on the things that truly make a difference and identifying what those are, not just for 2019, but for 2020 and 2021, and eventually put the position in the company that you're really -- you're living in a secure space where you know the outcome of tomorrow and the next year before you actually got there. And I can't say we're there yet in every aspect, but clearly on a path where we've seen both -- some margins have improved last year. And they have been improving sequentially. So -- and as we all know, the only difficulty we're having at the moment is really truly understanding the -- I'll say, the production rate of the 737, and because that's a very significant program for us as it is for many aero suppliers.

Speaking of that, on the 737, you gave a ballpark number of $400 million of bottom line pressure in 2020 from it. Is it still a very low contribution margin in terms of the OE sales? Are you guys making money on the OE sales?

Yes. Yes. I mean we make money. And I didn't know it was low contribution. That's news to me.

I believe that it were. I thought the new engine -- well, you guys used to call it out as new programs or negative...

Well, margins went up. So it's a bit better now. And moving down the learning curve on engine and driving some of the structured products to be the fundamentally high level efficiency. So Boeing, the 737 is an important product for us, not just for revenue, but also margin. And so yes, we -- I did call out the $400 million. Very clear that -- and just -- because I did read a report saying that maybe Arconic is a little bit optimistic on its assumptions. Of course, I don't know what -- how they would know what our assumptions are that we've taken a fairly conservative view of what I think the aircraft build will be in 2020. But the truth is none of us really know. None of us are certain about the date of FAA certification or EASA, and none of us know exactly what the build schedules will be because they can change. We do have, obviously, and have been recipient of the information from Boeing. So I think I described in the call, every week of the January month, we were highly engaged with them. But as we understand more as we go through the years, we understand what would be the ramp -- the exit ramp of production and 2021 that will further inform us on the next set of decisions to make regarding labor management as we get into the summer of this year. But I don't want to kid anybody that we absolutely have certainty around this situation because we don't. And if anybody can tell me, I'd appreciate it.

All right. Well, can you maybe describe how many different customers you actually sell to on the 737? And if, at this point, you -- they're all sort of relatively well aligned in terms of their expected...

Well, we only sell to Boeing or GE for the most part. But I mean, there are lots of other suppliers, and I suspect that there's going to be -- throughout this process, those which are fairly well aligned. And I mean, and also I have to say I'm a little bit concerned about the financial stress this will be on certain suppliers because we've been -- again, that's pretty opaque to us. I'm sure it's clearer to Boeing. But that's nothing that I can manage at all. I'm just cognizant of the wider issues in the industry.

But at this point, do you think that like GE has given you guys a rate for x number of months? Obviously, subject to change. But you at least have some direction on Q1, Q2, Q3?