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

All right. Thanks, everyone, for joining us. Our next company is Arconic, and we're pleased to have John Plant, the Chairman and CEO; and Ken Giacobbe, the CFO. So thanks for joining us here in Miami this year.

John, wanted to start off and maybe ask you, what's different about the company today versus, I guess, a year ago when you stepped in to see what are the most significant changes you've implemented, both from a business process standpoint, operational perspective? And then maybe you could touch on -- you've had other CEOs kind of how John does things so differently.

By getting the performances...

[indiscernible] that's what separates you.

Yes. So maybe I'll start off with, let's say, the softer side first because we rarely talk about it because it's always in the -- more about specific granular numbers. So I think maybe sometimes it does help to talk about things like culture and motivation and clock speed. And what I think is different, first of all, is trying to narrow the conversation down in the company and focus on just a few things, which I think are really important to the business success rather than myriad of things, which many of them, I don't think really matter. And so I've used it before but I'll say it again, it's early on in the first week or 2, really listing out those things, which we were going to concentrate on in 2019. And those were no more than, let's say, 5 things. And then there was a very long list of these things that we're not going to do. And it comes from a belief that great companies and improving companies largely define their success by the things that they are clearly not going to do and to focus on those things that really matter. And I thought the company would benefit from that. Plus then speaking each quarter to, I'll say, let's pick the top 500-plus people in the company. And talking about the performance focus, talking about more than the results, but things like clock speed of the organization and trying to get the decisions framed and eliminating what I believe to be a lot of basically nonadded value, bureaucratic processes, which I felt, to some degree, had taken on a life maybe of their own and it was not necessarily serving the businesses well. And so I think trying to get people focused, motivated about the future and the future of their businesses and also changing the incentive plans, really focus it on their performance, try to bring several things together. But it's all about focus, motivation, clock speed and trying to get everybody to march together in step with one direction. Those things I'd say I've tried hard to make happen before I think, go into -- so what specific programs in terms of cost or price or anything like that, but it's trying to gain what I believe to be force multiplication because I don't believe that one person really can change very much at all. But if you think about it, I only actually introduced another couple of people into the company, which were necessary replacements, but then trying to gain the hearts, minds commitment of everybody else. And as I've said before, there's been some amazing -- there are some amazing people in the company. And with the force multiplication of focus and effort, I think that's really paid dividends because you need everybody to work with you and to march to that similar drumbeat. So maybe a long answer that...

I want to get Ken's perspective on that. How have things changed from your perspective? Maybe about how you measure things and the process you go through today versus pre-John?

Yes. So maybe I'll touch on what's the same first then what's different. So in terms of what's the same, I'd say, the assets that we have in the portfolio are truly differentiated. We've got scale surrounded by a tremendous amount of IP. So I think we have a very strong asset base. Second, we've got a very -- we're fortunate to have a very strong customer base as well in terms of who we do business with. And to give you a metric that goes along with that right now, we finished 2019 with around 95% current on AR, accounts receivable. So that just tells you we deliver product on -- in -- on time with the right level of quality. And then as John said, I think there's some exceptional talent in the company. So very resilient folks. If you look at the performance over the last couple of years, we haven't performed and we performed this year. And what John's brought to the table, it's been very refreshing. To sum it up, I think it all comes down to experience and focus and if you looked at more from a financial perspective, how we manage the business. John came in, and we've worked with John from the Board as well. So we know him from the past, but it's -- he told me, Ken, you first got to take care of your top line, the revenue, which we have. We've changed the philosophy on price throughout the company. Last year, we got over $150 million in price, clock speed around cost out programs, over $210 million of cost out, last year, with very strong benchmark information, especially on the corporate side, as we set up these 2 new companies. Going forward, the 2, what we call super corps, will be less than the cost of corporate Arconic Inc. today. But you can keep flowing that down. But when you have the revenue price cost out. We had a 55% increase in earnings per share, but it didn't stop there. The operational improvements in the business, again, John brought a suite of tools with him around manufacturing, productivity we're using the assets to the best of their ability. There is a very tight linkage there with the request for CapEx. So if you're not using your assets at the right level, you're really not going to come in and ask for more CapEx. You saw a decline in our CapEx spend last year despite doing 5 major growth initiatives on CapEx. But that's all interesting if it doesn't translate to cash, and we delivered about $970 million of cash last year, 90% free cash flow conversion, which is great. But then, John's been working with me for a while around the balance sheet as well from the Board perspective and as the CEO. I just admire how he's attacked for his views on pensions because we've got some legacy liabilities that we go after the gross side of the pension equation, not necessarily the net and how we've retooled our whole investment strategy around pension assets. We had a 20% return on our assets last year. So you roll all that together, it was a terrific year, but more importantly, I think John's brought a culture of winning to the team, and I think that's really important because we've struggled over the last several years.

Maybe just to finish off, there is a rigorous quarterly process we go through. Businesses have to talk to a prescribed format and an agenda of topics. We've, again, prescribed templates to be completed which centers the conversation about the things, which, again, I think, are important for the business and really touches on every aspect of the business. Not just in the year, but also things like how your revenue builds into the subsequent year and beyond and what your capital intensity will be. And I think that's helped, again, go from, let's say, the cultural side to then the harder edged specific measures, which I think are important. And that's not to say we don't talk about other topics as well [Technical Difficulty] once the formal business review has been completed.

So Ken touched on pricing. I wanted to talk about that. A whole bunch of different areas, I'll let you take it wherever you want to go. First of all, how have you been able to get it? How sustainable is it? What is the pricing opportunity? When do -- how much of your contracts are repriced every year? What the opportunity in '20 and '21 looks like as compared to the $150 million or so that you got in '19?

First of all, I think you have to separate, I say, the 2 future companies because it is the same for almost every subject for the company, it's difficult to talk to Arconic per se, where it becomes much easier to talk to what is the future? Howmet company? What is the future Arconic Rolled Products company? So if I start with the Rolled Products first, clearly, that business will have a different profile in terms of that, which is on long-term agreements, which may be relevant for the aerospace and the automotive sector, but really would not be relevant for much of the industrial markets where we are selling through distribution to many of the end markets, even though we also talked directly to those end market customers because distribution tends to be on an annual basis, and again, normally, with a maximum of probably 80% contracted in year. So you need to understand that as a backlog. And then -- and I'll come back to sort of what changes, and obviously, you have underlying market demand and capacity and scarcity, which influences pricing into distribution. But LTAs are a completely different matter, of course. And in the case of both of that, which is LTA in our client rolled and also in Howmet, then you really do know the sequence of contracts which are coming up for renewal, on average, roughly every 3 to 4 years. And so there's a book of business, which comes up for renegotiation each year. And obviously, the size of that book in each year can be quite different according to which programs inside which customers and albeit certain customers can be in sequential years because it's by product as well inside those customers. So the -- I think the discipline that I think is really important for every CEO is to, I'll say, take care of business first. And for me that means the revenue line, which price is an important component. And I think you need to take the time, and I think I have taken the time to try and understand the technological differentiation of our product. And I think actually as one analyst said in some of the meeting, Plant has become more nuanced in his conversation, which I guess that was true as I came to understand the different market share positions, the different technological moats that we have around in parts of the business. And the true uniqueness of some of the capabilities that we have. And so the willingness to not only understand that but also go through the discipline of separating our parts into high volume, let's call it, medium volume and lower volumes and those which go to maybe spares markets rather than original equipment markets. And having that level of discipline and engagement really from myself, so not to have it delegated into the business and willingness to discuss that every quarter with the business unit leader rather than have it left at a very low level in the organization with no fundamental direction. Because inevitably, our sales force is going to always spend more time with our customers than with the rest of the organization. That's what they're supposed to do. And I understand how difficult it is in particularly in B2B business selling because you like that -- these 2 big tectonic plates, which are grinding together and you're trying to establish the right value for your product. And so I've taken the time and effort to try to meet with many, if not all, of our salespeople to try to understand and get them to be convinced that I'll never ask them to do anything that I wouldn't be prepared to do myself, and indeed, have led any major positioning of those dialogues with the customers normally in advance. So that's trying to give them the air cover or umbrella regarding those things. So I think it's like everything else, it's a matter of focus, matter of understanding your product, understanding your position and obviously, to some degree, attitude and all. I think it's easy to get brainwashed into believing that anything which is an engineered product should be price deflationary, which I fundamentally reject that as a stance, and I was fairly focused on that in automotive. You know that would be a more price deflation in the industry. But I just can't see that the same characteristics apply for aerospace where the backlog, the underlying demand dynamics and the uniqueness of the product is very different.

So maybe touch on if you want to split out Howmet versus Rolled Products or just focus on Howmet, the pricing opportunities, you see it in '20 and '21 relative to '19?

Of course, it's always difficult to be definitive. It's always more -- you can be more clear-eyed where you have LTAs for renewal rather than what's the, let's say, the underlying market dynamic. But my thought is that the way we have planned our business is that probably 2020 on the Howmet side will be budgeted at a lower number than 2019. Of course, we have to see how that turns out, whether it's higher or lower than how we budgeted. And then our thoughts in stance is that 2021 would be a bigger year for us than 2020. And that's not commenting on, let's say, the degree of increase, but just sticking with the book of value, which we know is a larger book, and therefore, lends itself even if you apply the same percentage, which, of course, you don't have to. So that's why I believe that 2021 is a better year just because of the cadence of that revenue, which gets renegotiated in that year.

Wanted to touch on MAX. So you had given the sensitivity that you've assumed a $400 million headwind. I guess I miscalculated kind of what baseline that was off of. Maybe just talk about what you've roughly assumed in terms of shipset numbers for MAX? Where you are today? And how quickly you could ramp back up the other way?

Yes. As I think everybody knows, we were in this maybe, I'll say, slightly difficult position of having to, for good reason, announce our earnings and stance before Boeing, [ Jay ]. Normally, we wouldn't want to do. But essentially, there was a 3-day window to commence the financing and not have to delay separation from what I believe is the earliest possible date that we could have reflected this. But we made the decision that a, separation is beneficial, although we wouldn't be doing it. There's a time value to money as well. And so that should be guiding that decision. And so we did go out before Boeing. Clearly, we were party to conversations with them starting in the, I'll say, maybe a day or so before Christmas, and then afterwards between that and the New Year and every week in January. So we had a fairly good idea that which Boeing were contemplating in the 2 or 3 variants that we received from them early from scenario planning through to what they think is the plan. Of course, I was never going to be willing to discuss that because that's really for Boeing to say what their plans are not ever for Arconic to comment on them. All I know is that -- because I know that you say, we're slightly higher than...

Yes, just another baseline, which you can comment on.

Which we can, maybe, it's a lesson in obfuscation as well to try to keep everything. But try and give you the best position we could, which is, we saw revenue is $400 million as we previously expected. We thought that there were certain things which might help mitigate some of that. But I came up with a net $400 million. And that assumes -- and I -- again, I've not called out the number of planes but given that I know you were up in the $400s million. If I tell you it's clearly sub-$300 million, that gives you a much better feel for our planning basis internally in the company. And tried to give a set of guidance, which I felt was appropriate to the circumstances. And also, I think I called out a wider bandwidth of normal just because I think we should all recognize there is this uncertainty. None of us are certain when the FAA will grant recertification of the plane. And that is most likely to influence the trajectory of commensurate of build and the rate of build, even though there is a plan. Of course, that plan can be changed up or down, I mean, accordingly, which then leads us to the next decision, which I think is important to mention here is, so how do we think about the year? Clearly, we've been trying to curtail costs in the light of the production cessation. But also being very clear-eyed about the decision, which really -- doesn't really occur until the middle of the year, which is when do we take our next set of labor actions with more permanency than, I'll say, the thrifting that we've already done and the cutting of things like overtime and using a vacation and shift patterns and all of this. So it's now very clear that we don't take that decision until the summer. And hopefully, by then, we'll have much better information in terms of the build plans and the recertification of the aircraft. But more importantly, what's the build rate as we go into 2021? Because if we were to delete permanent, some of that what I call, critical skills, then obviously, that would impair our ability later. And I think it's important to protect that.

And I wanted to ask you about free cash flow. Maybe take at a high level and then as we think about the 2 individual businesses. So I think this year, you forecast free cash flow roughly in a similar range as last year. You've got a pension headwind. You've got a CapEx tailwind. But how do we think about the moving pieces on free cash flow, working capital, that opportunity, both at a high level and Howmet and Rolled Products going forward?

Yes. So the details of the 2 businesses, we'll be giving at Investor Day on Tuesday of next week. But as you mentioned, the pension cash contributions in 2020 for Arconic Inc., the full company today, is about $200 million higher, driven primarily by discount rate came down significantly, about 105 bps. Asset returns were up 20%, but the net was a cash unfavorable. So that's a bit of a headwind as we go in CapEx. So around the 4% range for the total company. We'll give more detail on the 2. But 1 of the 2 should be sub-4%, maybe sub-3% as we move forward, and the other one more in the 4% range. Income will drive it and then constantly managing the working capital. I've talked about the AR portion of the business team is -- we have some opportunity on the inventory side as well as we move forward in payables. As John mentioned earlier, this is all a part of the quarterly ops deck. There's a full working capital component. So there could be some opportunity there as well.

And I wanted to ask you like maybe I think you focused on this, Ken, the comparable set for Howmet and new Arconic. How you view that? And where the comparables are trading today?

Yes. So on the Howmet Aero side, we believe that peer set, we've got roughly heat peers that we look at. We think the multiple is more in the 13% range. On the Arconic Corp. side, it's a little bit more straightforward. I think you've got more Constellium and Kaiser. They are our direct competitors there. They are more in the 6 to 7 multiple range. Although I think we did a lot of really good work in 2019, probably one thing that we didn't do well is with the increase in stock price and EBITDA, our multiple actually went down. So probably some opportunity, but I think we're trading at a discount compared to the peer sets.

Ken gave me a fail. He said you deserve an F on that criteria. So I felt to be humble at the end of the year by that. And then if you just look at these guys over on the aerospace side, so he's calling out likes of Woodward and Safran and Rolls-Royce and Meggitt and so on. And they like these guys much better than you, John. My card in a very severe way.