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Edited Transcript of ARNC.N earnings conference call or presentation 2-Aug-19 2:00pm GMT

Q2 2019 Arconic Inc Earnings Call

Aug 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Arconic Inc earnings conference call or presentation Friday, August 2, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John C. Plant

Arconic Inc. - Chairman & CEO

* Kenneth J. Giacobbe

Arconic Inc. - Executive VP & CFO

* Paul Thomas Luther

Arconic Inc. - Director of IR

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Conference Call Participants

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* Carter Copeland

Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense

* Christopher David Olin

Longbow Research LLC - Analyst

* David Egon Strauss

Barclays Bank PLC, Research Division - Research Analyst

* Gautam J. Khanna

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* Joshua Ward Sullivan

Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst

* Matthew James Korn

Goldman Sachs Group Inc., Research Division - Senior Metals and Mining Analyst

* Seth Michael Seifman

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Arconic's Second Quarter 2019 Earnings Conference Call. My name is Jason, and I will be your operator today. (Operator Instructions)

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

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Paul Thomas Luther, Arconic Inc. - Director of IR [2]

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Thank you, Jason.

Good morning and welcome to Arconic's Second Quarter 2019 Earnings Conference Call. I'm joined by John Plant, Chairman and Chief Executive Officer; and Ken Giacobbe, Executive Vice President and Chief Financial Officer. After comments by John 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'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.

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John C. Plant, Arconic Inc. - Chairman & CEO [3]

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Good morning, everyone, and thank you for joining the call today. Let's move to Slide 4.

You can see that for the second quarter, revenue was up 3% year-on-year to $3.7 billion, which is a quarterly record since separation. Organic revenue, which adjusts for currency, aluminum and portfolio changes, was up 10% as we continued to grow in all of our key markets. Our adjusted operating income was up 27% year-on-year and operating margin was up 240 basis points.

I would like to comment on each segment's year-over-year margin expansion. Engineered Products and Solutions operating margin expanded by 310 basis points. Global Rolled Products margins expanded by 210 basis points. Transportation and Construction (Solutions) margins expanded by 220 basis points. Moreover, all segments had operating margin expansion sequentially.

In addition to revenue, operating income, operating margin and adjusted earnings were quarterly records. Adjusted free cash flow for the quarter was $227 million, and year-to-date cash flow has improved approximately $89 million from the prior year.

We continue to return money to shareholders with the completion of 900 million shares -- $900 million of shares repurchased year-to-date. The weighted average acquisition price was $19.80 per share for 45.4 million shares. Our return on net assets improved 450 basis points to 14.1%.

Later in the call, I will comment on the regular items that I stated in the February earnings call, namely operating performance, cost reduction, capital allocation and portfolio separation. I'm also going to talk to our 5-year planning process, asset impairments, union negotiations, divestitures and the recruitment and appointment of the 2 boards and 2 management teams before I review our updated annual guidance.

Adjusted earnings per share and free cash flow guidance will be raised for the second time in 2019. And we'll also provide EBITDA guidance for the first time.

Let me turn it over to Ken to give a deeper review of Q2 performance.

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Kenneth J. Giacobbe, Arconic Inc. - Executive VP & CFO [4]

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Great. Thank you, John. Now let's move to Slide 5 and the key financial results for the quarter.

Revenue for the second quarter came in at $3.7 billion, up 3% year-over-year. Revenue was at our highest level since separation.

Organic revenue, which adjusts for currency, aluminum prices and portfolio changes, was up $344 million or 10% for the quarter on a year-over-year basis. Revenue growth was driven by volume gains across all of our segments. The reconciliation for organic revenue can be found on Slide 22 in the Appendix.

All of our key markets continue to be healthy, and demand for our products continues to be strong. We've included our organic revenue growth rates by market on Slide 23 in the Appendix, and I'll touch on just a few.

Organically, year-over-year revenue for the total Aerospace business was up 11% with defense aerospace delivering growth of 25%. Additionally, industrial products was up 12%. Double-digit growth in these markets was supported by solid year-over-year organic revenue growth of 7% in commercial transportation and 5% in automotive.

Operating income, excluding special items, for the second quarter was at the highest level since separation at $484 million, up 27% year-over-year. Both EP&S and TCS delivered record segment operating profit. Higher pricing resulted in $41 million of favorable year-over-year impacts to operating income driven by EP&S and GRP. Year-to-date, prices increased $75 million over the prior year. As we mentioned on the first quarter earnings call, we expect favorable pricing to continue throughout the year as demand for our products continues to be strong. Higher volumes in the second quarter also favorably impacted operating income by $39 million mainly driven by aerospace but also in automotive and commercial transportation. Aluminum price was favorable to operating income $19 million in the quarter.

The incremental cost-out program that was launched in the first quarter was the main driver of our net cost reductions. On a year-to-date basis, the program has resulted in approximately $66 million of savings on a year-over-year basis. John will talk more about this program later in the presentation.

In terms of opportunity, we continue with the transition of our Tennessee plant out of the North American packaging business to more profitable industrial products. The transition negatively impacted operating income in the second quarter. However, this was an improvement from the first quarter, and we expect to be a positive operating income in the fourth quarter.

At a consolidated level, operating margin, excluding special items, was up 240 basis points year-over-year. As John mentioned in his opening comments, all 3 segments contributed to margin expansion both year-over-year and sequentially. We have included the reconciliation of operating income, excluding special items, on Slide 34 in the Appendix.

Adjusted free cash flow in the second quarter was $227 million or $62 million less than the second quarter of last year. For the second quarter, we continued to focus on days of working capital with an improvement of 2 days year-over-year to 52 days. Lower inventory of 4 days was the main driver of the improvement. The greatest improvement in days of inventory was in our EP&S segment with a 7-day improvement year-over-year.

Pension contributions and OPEB payments were $104 million, which was $21 million more than the second quarter of 2018.

Capital expenditures decreased $35 million year-over-year to $136 million. Approximately 70% of the capital spent in the quarter was for return-seeking projects as we expand aerospace airfoils, aerospace rings, industrial products and forged aluminum wheel capacity. We continue to expect capital expenditures to the year -- for the year to be approximately $650 million or 4% of revenue.

On a year-to-date basis, adjusted free cash flow is $89 million higher than the prior year. Year-to-date, the improved free cash flow was driven primarily by 3 favorable items: higher net income, lower pension contributions and lower interest payments. These favorable items were somewhat offset by working capital to support our revenue growth.

Diluted earnings per share, excluding special items, was at a new high of $0.58 per share. This is $0.21 or 57% higher than the comparable period. The diluted earnings per share was primarily driven by operational improvements of $0.13, aluminum prices of $0.03 and lower share count of $0.03.

One final comment on earnings per share. The second quarter is historically our highest-earning quarter with lower levels expected in the third and fourth quarters due to our typical seasonality. Although the third and fourth quarter earnings per share are expected to be lower than the second quarter, we expect to see robust year-over-year growth in the second half. If you use our midpoint of our Q3 earnings per share guidance, this forecast would be an increase of 56% year-over-year.

Now let's move to the segment results on Slide 6. In the second quarter, EP&S' revenue was a record $1.6 billion, an increase of 6% year-over-year. Organic revenue was up 8%. Segment operating profit was a record at $286 million, up 28%. The increase in segment operating profit was driven by double-digit growth in aerospace engines, aerospace defense, higher pricing and net cost reductions. The resulting segment operating margin expanded by 310 basis points to 18.3%.

In the second quarter, GRP's revenue was $1.6 billion, flat year-over-year, but organic revenue was up 11%. Segment operating profit was $145 million, up 31% year-over-year. The favorable year-over-year improvement in segment operating profit was driven by growth in our major markets, including aerospace, automotive and commercial transportation. Also, we had favorable pricing in industrial products and commercial transportation markets, lower aluminum prices and net cost reductions. The 31% growth in the segment operating profit included a $16 million unfavorable impact from transitioning our Tennessee assets out of North American packaging to more profitable industrial products. The impact in the second quarter was less than the first quarter, and we expect year-over-year impact to improve as we move forward. The second quarter also included challenges in our aluminum extrusions business, which is isolated to one plant. The team is making progress, and we expect to see improved performance in the third quarter.

Despite the Tennessee transition or -- transition and challenges in the aluminum extrusions business, the GRP segment operating margin increased 210 basis points to 9.2%. We've had 3 consecutive quarters of sequential margin expansion in the GRP segment.

In the second quarter, TCS delivered revenue of $548 million, which was down 2% year-over-year. But organically revenue was up 3%. Segment operating profit was a record since the separation at $107 million, up 10%. The increase in segment operating profit was driven by higher volumes in both commercial transportation and building and construction markets as well as net cost reductions. Segment operating profit increased 220 basis points to 19.5%.

Now let's move to the second quarter key achievements on Slide 7. Our EP&S business had record quarterly revenue and segment operating profit for the second consecutive quarter. On a year-over-year basis, aerospace engines organic revenue was up 10% and aerospace defense organic revenue was up 26%. Favorable pricing improvements in EP&S continued in the second quarter as we achieved $24 million of year-over-year price increases.

In GRP, commercial airframe revenue was up 19% organically year-over-year. Price improvements in the industrial products and commercial transportation markets resulted in $18 million of year-over-year price increases.

Moving to TCS. The TCS segment, as well as each business included in this segment, had record segment operating profit and record segment operating margin in the second quarter. The expansion of our Wheels facility in Hungary remains on track for completion by the end of the year. And finally, the Wheels team delivered record quality performance year-to-date.

For Arconic, in addition to the highest quarterly revenue, adjusted operating income, adjusted operating income margin and earnings per share, we achieved the highest quarterly return on net assets since separation at 14.1%. Return on net assets was up 450 basis points year-over-year. And excluding the impairment impact, return on net assets was up 410 basis points year-over-year.

Finally, we increased our cash balance sequentially by $38 million, including the use of $200 million for share repurchases. Our cash balance at the end of the second quarter is approximately $1.4 billion compared to $1.5 billion last year. However, this year, we completed $900 million of share repurchases as we continued to return cash for our shareholders.

Before turning it back to John, let me briefly cover 2 items that can be found in the Appendix. The first is on Slide 20 in the Appendix where we've summarized the special items for the quarter.

In the second quarter, our results included $565 million of pretax special items. More than 80% of the pretax special items, or $466 million, are related to noncash asset impairments and charges related to divestitures. Noncash asset impairments resulted in a charge of $444 million in the second quarter. The majority of the impairment, or $428 million, related to the Disks operation, an asset group in the engines business unit which is within the EP&S segment.

As John will discuss shortly, we have updated our 5-year plan in the second quarter. The updated 5-year plan and expected future cash flows at the Disks asset group resulted in an impairment. We also recorded a charge of $22 million in the quarter related to the divestiture of a small additive manufacturing facility that closed in the second quarter and a small energy business that is expected to close in the third quarter. Both of these entities were included in the Engineered Structures business within the EP&S segment.

There are a number of other pretax special items in the quarter that are detailed on Slide 20. We're planning to file the 10-Q later today, and these items will be discussed in more detail in that document.

For now, let me highlight 2 items. First, we recorded a pretax charge of $15 million in the quarter for lease termination and other costs. The majority of the costs related to exiting our corporate aircraft operations. Second, we experienced a fire at our fastener plant in St. Cosme, France that resulted in a $4 million unfavorable impact in the quarter related to equipment and inventory damage as well as higher operating cost. Fortunately, there were no injuries. We still continue to assess the impact of the fire. Current estimates are that we will have approximately $5 million to $10 million unfavorable impact in the third quarter, and it will take multiple quarters for us to recover from the fire. We will update you on the situation in the third quarter. We do have insurance which is expected to cover the fire with a deductible of $10 million.

Finally, the impact of discrete and special tax items for the quarter was a credit of $61 million. It included a benefit related to prior year foreign taxes and a benefit associated with a foreign tax rate change.

The second item I wanted to cover was on Slide 21 in the Appendix where we've provided an update on our capital structure as we continue to manage our debt and reduce our liabilities. Gross debt is $6.3 billion and net debt stands at $5 billion. Net debt-to-EBITDA continues to improve year-over-year despite the cash outflow associated with our $900 million of share repurchases year-to-date. Net debt-to-EBITDA stands at 2.35x, which is an improvement of 6% compared to the second quarter of 2018.

With that, let me turn it back over to John.

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John C. Plant, Arconic Inc. - Chairman & CEO [5]

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Thanks, Ken. Moving to Slide 8. I'll now comment on the 4 focus areas that I discussed in the February earnings call, namely: operating performance, cost reduction, capital allocation and portfolio separation.

On Slide 9 regarding operating performance, we continue to complete detailed quarterly operating reviews and monthly forecast reviews by segment as part of our profit improvement program. The reviews are robust, and the quarterly reviews cover 25 key areas to drive current and future profit improvement. The review content continues to improve and underlying progress is being made. However, there's still a long way to go regarding performance improvements.

On Slide 10 and referring to cost reductions, actions are under way to reduce operating costs by $260 million on a run rate basis. Our commitment has increased by $30 million from the previous commitment of $230 million. $140 million of savings are expected to be captured now in 2019, which is an increase of $20 million from the previous $120 million commitment. The increasing savings this quarter resulted in a severance charge of $27 million.

On Slide 11, you can see that year-to-date, we have completed 2 share repurchases totaling $900 million. The weighted average purchase price was $19.80. Management has a total of $600 million of remaining share repurchase authority. This is comprised of $100 million of repurchase authority from the prior 2018 authorization and an additional authority of $500 million which was approved by the Arconic board in May of this year.

Lastly on Slide 12, we have an update on the separation. We continue to track that our stated Q2 2020 implementation date with a targeted filing of the Form-10 in the fourth quarter of this year. You can see the critical closing conditions as well as financial implications on the slide.

Moving to Slide 13. The names of the 2 companies will be Howmet Aerospace and Arconic Corporation. We plan to announce which company will be SpinCo at the next quarter's earnings call. We also plan to provide 2019 year-to-date financial information for the 2 future companies at that time.

Consistent with the second quarter earnings call, we have identified noncore businesses for sale with an estimated value of $100 million to $200 million in proceeds with limited earnings impact. We also expect corporate costs to be in line with industry-leading peers. And in aggregate for the 2 new companies, they will be below the current Arconic corporate costs.

I would now like to comment on 5 additional actions on Slide 14. Firstly, in the second quarter, we completed the 5-year business plans for each of our units. Let me clarify. This is not a review of portfolio but more a granular-level examination of market share, competitive position, cost base and formulation of clear plans to execute within each business and to secure each business's future during the next year, 3-year and 5-year time periods. This is consistent with the plans that we are now executing on. The reviews focus on volume growth and price while building on a more competitive cost structure.

In terms of calibration for our shareholders, I see the benefit of these plans regarding product, price and mix to exceed the aggregate of the current cost reduction commitments made earlier in my notes today. Today, I'll just call out one example of this. Further clarity on other business units will be provided in our third quarter earnings call when we outline the 2 future segments for the new companies going forward.

Back to BCS. I referred to the 200 basis points of adjusted operating income margin improvement on the prior earnings call. We now see this opportunity as larger. Moving from 2018 through 2019 and into 2020, margins will increase by approximately 300 basis points. Cost is a feature. But more importantly, we will rationalize product lines and repurpose assets to better markets, which allow us to increase revenues and profits resulting from the benefits of this price and mix of products sold. And I'll cover this in more detail in the next quarter for other businesses.

Second, we took a charge for asset impairment. As part of the 5-year planning activity, we reviewed the asset base to assess future cash flows. This review resulted in a noncash impairment charge of $444 million. Of this charge, $428 million relates to the disk business of what was formerly referred to as Firth Rixson.

Before moving on to other items, I think that it is appropriate to update you on Firth Rixson before eliminating the name from future use.

Firstly, Rings. It's a business of approximately $700 million in annual revenue. It is fundamentally a good business in which Arconic has the largest market share globally. Profitability is now showing signs of improvement and, from the 2018 base, will show improvement in 2019, into 2020 and beyond. Improvement is driven by a combination of differentiated products; a more competitive cost structure; and bringing new, more efficient capital online.

The disk business by comparison is fundamentally flawed. In total, it is just in excess of $300 million in annual revenue. A portion of the disk business will be disposed of, and the smaller retained part has been rightsized and the asset carrying value will be impaired to allow for future competitiveness and improved profitability in 2020. The remaining portion of this disk business will be a small part of Arconic, and the significant losses of 2018 and 2019 will be eliminated.

Third, in the second quarter, we have come to a mutual agreement with the U.S. steelworkers to successfully conclude negotiations of the USW Master Agreement. Additionally, we concluded negotiations with the steelworkers at our titanium structures business in Niles, Ohio, which had been operating without a contract for the last 18 months.

Fourth, regarding divestitures. We've closed on a small transaction and signed a share purchase agreement for another transaction with a close currently pending.

We are making satisfactory progress on the remaining divestitures. As you can see, it's been a busy quarter.

Finally, the process is under way to recruit and conclude appointments of the 2 boards and 2 management teams. Search committees have been defined and recruitment firms appointed to help form the future leadership teams of rolled products and the aerospace companies.

Regarding the management team, I want to announce the departure of Elmer Doty. Elmer decided not to participate in the future CEO selection process. And to allow for a smooth transition, Elmer has agreed to step aside. Elmer will continue to be a Board member, and I want to give a personal thank you to Elmer for being my business partner in recent months.

In addition, and to further solidify and clarify leadership, I have agreed to extend my term beyond the 5th of February 2020. I will continue to serve as CEO through separation and beyond, as required, to ensure continuity and performance of Arconic.

Finally, an update to our 2019 annual guidance. In light of current performance, coming off a healthy Q2 and considering our typical seasonality, we are updating and raising our guidance for the year. This reflects both our performance expectations in the second half and the fact that year-to-date, we've already earned an adjusted dollar's earnings per share.

Annual revenue is unchanged at $14.3 billion to $14.6 billion despite a fall in assumed aluminum prices.

The adjusted earnings per share range forecast for Q3 is $0.47 to $0.53 earnings per share. Adjusted earnings per share forecast for the year increases to $1.95 to $2.05 per share.

Free cash flow for the year increases to $700 million to $800 million.

EBITDA guidance is provided for the first time and is approximately $2.3 billion, plus or minus $50 million.

Our updated guidance assumes that the Boeing 737 MAX will remain at 42 aircraft builds per month on airframes and 48 builds per month on aircraft engines for the remainder of 2019.

One final item before I turn it over to Q&A. Regarding Grenfell Tower, there is an update this quarter which is considered helpful.

In addition to funding replacement cladding for relevant high-rise public sector housing, the U.K. government has established a new fund to refurbish private high-rise buildings which have aluminum composite material cladding systems and which are unlikely to meet U.K. building regulations. This fund will cover buildings which architects specify the aluminum cladding, polyurethane from AAP, our French subsidiary, which was then fabricated and fitted by contractors as one component of the cladding and insulation system. This potential cladding remediation will be beneficial regarding the potential contribution of these systems to future fire risk in U.K. high-rise buildings. The details of the refurbishment process and fund continue to be developed. I plan to provide a further update on these topics noted today on our next earnings call.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Carter Copeland.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [2]

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Great progress. Congrats. Just a 2-parter, John. I noticed you guys made some comments around quality -- record quality in Wheels. But I wondered if you might speak to what sort of trends you've seen in EP&S in there on quality and yields. I know that was a particular point of focus. I wondered if you could just give us some insight on that. And to the extent that it impacts your CapEx -- longer-term CapEx planning, I wondered if you could touch on that as well.

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John C. Plant, Arconic Inc. - Chairman & CEO [3]

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Yes. First of all, quality within our EP&S business really across the board has continued to improve. In particular, I'd like to note the quality improvements as we've started to come down as an improved rates on the learning curves on some of the engine airfoils, and that's obviously very welcome.

Of course, we are bringing into commission 2 new manufacturing plants over the next really 5 months. That's the new plant for the molding process in Morristown, Tennessee for the insert to the airfoil business, and then a new plant in Whitehall, Michigan for the casting of the airfoils. Both of those are on track. In fact, if anything, a little bit ahead. And we're hopeful we may get some modest production out in the fourth quarter, which would be about a quarter earlier than previously anticipated. Everything appears to be on track. Obviously, we're monitoring that to make sure that our future quality is -- also continues to improve.

On the second part of the question on CapEx, we've maintained the guidance given. The critical investments that we need for the expansion, particularly in our engine business, has been -- again, everything's on track. Same for the Hungary, for the Wheels business and same for Tennessee, which allows that transition out of -- into the -- more into the industrial market which occurs in the second half of 2020.

So at the moment, I'll say everything is in order, and the -- I think the expectation is that we're planning to further trim our CapEx requirements going forward.

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Operator [4]

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Your next question comes from the line of Seth Seifman from JPMorgan.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [5]

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Wondering, if we think about how cash flow kind of, progresses from here and we think about some top line growth next year dropping through, the lack of severance costs, an incremental $120 million or so from the cost savings that didn't drop through this year, it would seem that there's a path to some nice cash flow growth next year with the one kind of question mark remaining there about pension. So I guess is it that -- can you speak a little bit to the potential for cash flow growth next year?

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John C. Plant, Arconic Inc. - Chairman & CEO [6]

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I think all the elements that you've highlighted, Seth, indeed are true. Next year, clearly we're not going to have the level of cash restructuring. I tried to provide a little bit of color of our future CapEx on -- in my response to the -- to Carter Copeland, and certainly the results of the cost reductions and some of those things I've talked about in terms of margin improvement really are all positive, I think, factors for future cash flow. Clearly, we shall conclude our negotiations at some point on separation with the PBGC on the pension matter. But outside of that, the underlying theme of what you said is correct.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [7]

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All right. And then apologize if I missed this, but you talked about staying on for kind of, I guess, an indeterminate period of time. Did you specify which company you plan to stay with?

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John C. Plant, Arconic Inc. - Chairman & CEO [8]

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No, I did not.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [9]

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Right. Okay. And I guess that perhaps when you give us more information next quarter about the split and who's RemainCo and stuff. But at that point, we'll learn that?

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John C. Plant, Arconic Inc. - Chairman & CEO [10]

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Well, I'm sure you're going to press me and ask me in the future about that very question. But the important thing is -- was to make sure we had continuity through to separation. And I think that's just -- that's fundamental to making sure that everything is really smooth and performance continues.

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Operator [11]

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Your next question comes from the line of Rajeev Lalwani from Morgan Stanley.

Your next question comes from the line of Gautam Khanna from Cowen Incorporation (sic) [Cowen and Company].

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [12]

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I heard you say your guidance implies 48 a month on the LEAP-1B. I just wondered, have you actually seen a step-down yet? Or is this just advance caution?

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John C. Plant, Arconic Inc. - Chairman & CEO [13]

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We saw a modest step-down of, I think, of 2 engines. I think in the build, that's the information I have. But it's just being cautious as well.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [14]

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Okay, 2 engines from 52, just to clarify?

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John C. Plant, Arconic Inc. - Chairman & CEO [15]

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Yes. Yes.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [16]

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Okay. Secondly, maybe, Ken, I was wondering, discount rates have moved down. Obviously, pension is a bit of a recurring theme. But I was just curious, given asset returns, any preliminary color on where the plan, what the deficit would look like if you snap the line today on the pension and OPEB?

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Kenneth J. Giacobbe, Arconic Inc. - Executive VP & CFO [17]

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Yes. Yes, Gautam. So a couple of comments. First, when we look at pension and OPEB, we were down about -- or improved $322 million year-over-year. And on top of that, I would say that on the pension side, 90% of the gross liability is frozen into future service accruals and about 75% on the OPEB side. We will restrike or remeasure at the end of the year, but a couple of things that I can tell you. Last year where the discount rate was at about 4%, 4.35%, we're seeing a number more around 3.5%. Right now, we do have for you in Slide 19 of the Appendix the sensitivities. So that's about an 85 bps move on the liability side. But also, I would note that on the asset returns side, we've been doing a lot of work over the last 12 months. Last year, our asset returns were negative 3%. If we look through June of this year, we're in the low double digits. We've moved our investment strategy more to the equity side. So we've also benchmarked those returns against our peer group, and we're at about -- better than about 85% of our peers. So we will have an adverse impact, to your point, around the liability side driven by the discount rate. There will be an offset on the asset side based on our returns most likely, but we will restrike that at the end of the year. And the sensitivities are on Slide 19.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [18]

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And one last one, if I may. I was just curious, John, if you could speak about the pricing progress you've made on the EP&S side and sort of what opportunities still lie ahead. Is -- how receptive, how difficult are those conversations? And kind of how -- what's your confidence on restriking versus contract buyer?

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John C. Plant, Arconic Inc. - Chairman & CEO [19]

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I think we have really tried to ensure that we have a future line of sight for all of these long-term contract renewals. So I can now see that several years out. And it's very much been a process. We spent even more time at -- during our 5-year plan reviews trying to understand the fundamental competitive advantage and where we had true excellence. And so, for example, in the very -- or the first and second and third blade of the hot end of the engine, there we think we have some unique capabilities. And so we think we should be paid appropriately for that level of skill set and value we bring to the capabilities of those aircraft engines. That's just one example.

I mean some of these I don't really want to spend a lot of time talking about apart from the discipline has previously been, I think, very deep in the organization. And now it's something that I expect each business unit head to be able to sit and talk to me about because if I have the information, then I expect them to. And, I mean, it's a healthy dialogue, trying to maintain both good relations with our customers but, at the same time, trying to make sure that we do get paid appropriately for the level of value we bring to the engine and to the whole aircraft.

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Operator [20]

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Your next question comes from the line of Matt Korn from Goldman Sachs.

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Matthew James Korn, Goldman Sachs Group Inc., Research Division - Senior Metals and Mining Analyst [21]

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Just a couple from me. First, we heard from one of your competitors that a certain jet engine customer is becoming more aggressive with inventory management. Are you seeing anything similar? And then second, having completed all these 5-year plans for each segment, could this turn into more clarity on medium-term targets for all the segments into year-end? Is that something we could see and understand a bit better before the split?

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John C. Plant, Arconic Inc. - Chairman & CEO [22]

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Okay. So let me deal with the second one first. I haven't decided yet, but I'm thinking about possibly giving some 2020 revenue guidance at the next earnings call. And obviously, we'll be giving 2020 guidance when we announce the fourth quarter in the early part of 2020.

Personally, I'm not particularly a fan of giving out future hostages to fortune in terms of giving growth and margin profiles. It assumes a level of knowledge, which inevitably is imperfect. I prefer to let achievement, and the directional vectors give guidance to that. And I can't imagine me breaking out of pattern to do that in -- during my leadership of the company.

So I think that deals with that one. The first question, I'm trying remember what it was now.

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Matthew James Korn, Goldman Sachs Group Inc., Research Division - Senior Metals and Mining Analyst [23]

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Inventory.

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John C. Plant, Arconic Inc. - Chairman & CEO [24]

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Oh, inventory management. No change I've seen.

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Operator [25]

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Your next question comes from the line of David Strauss from Barclays.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [26]

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Want to ask you about the EBITDA guidance that you gave. The margin, I think, implied in that in the back half of the year is lower than obviously what we saw in Q2. And I know you have normal seasonality in the back half of the year, but what you're talking about with Tennessee and the BCS improvement, can you just give a little bit more detail on the margin outlook in the second half?

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John C. Plant, Arconic Inc. - Chairman & CEO [27]

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I have to say I didn't know as it gave that impression. So rather than me grapple for numbers as we speak, here, David, I'll say, I don't recognize it. So maybe I'll get you to recheck your math or we'll do it, and we'll have a separate conversation with you. But that's not something that's in tune with my thinking.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [28]

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Okay. All right. And then I think in Q4, you have this convert that's coming due. How do you -- what's the plan for that at this point?

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John C. Plant, Arconic Inc. - Chairman & CEO [29]

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So I'm going to pass that across to Ken, but essentially will be -- my expectation is we'll pay that off and redeem them.

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Kenneth J. Giacobbe, Arconic Inc. - Executive VP & CFO [30]

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Yes. The only thing I'd add to that, David, is on Slide 18 in the Appendix you can see the share count by quarter. And to John's point, included in that is for us to settle the RTIs in cash.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [31]

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Okay. It's what I thought. I just want to confirm.

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John C. Plant, Arconic Inc. - Chairman & CEO [32]

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And so it's going to take both our gross and net debt -- our gross debt down.

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Operator [33]

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Your next question comes from the line of Josh Seaport from -- or Josh Sullivan from Seaport Global.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [34]

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Just within GRP on the automotive body-in-white vertical, Arconic was a pioneer in that market. I know you've been able to sweat the assets, and now you've got the 5-year review. Curious on what your capacity needs in the auto sheet are at this point. And then just as a follow-up, can you talk about growth expectations for auto sheet over the next 12 months or so?

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John C. Plant, Arconic Inc. - Chairman & CEO [35]

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Okay. I think the underlying secular trend of lightweighting is certainly going to be a feature in the automotive market for the next decade. And if I look at it like an average for last year, it's somewhere between 6% and 9% conversion on an annual basis. And I'm going to say on a normal auto cycle, that should be enough to overcome, I'll say, auto cyclicality. Obviously, quarter to quarter, you can't say that. But roughly, year-to-year, you can.

We intend that -- so if I look at the GRP segment, I mean, it really falls into 3 in the future, which is: aerospace, where we're just over 20% of our revenues, which is very solid and healthy; automotive, which is obviously contracted as well in terms of volumes with the vehicle manufacturers. There we're -- we have good margins and expect that to continue. And in fact, one of the features of our plan has been diversification of our customer base. And indeed, while, we have not announced which vehicle manufacturer we have succeeded in signing up another very major U.S. platform in the second quarter, which obviously is going to be good for the future order book and we'll see some of that materialize in 2020, and then obviously a full year effect in 2021 and beyond. So we are pretty pleased about that not only for the inherent profitability but also the security of the -- of supply and -- for us to actually need to achieve more throughput and more volume in our rolling mills. And obviously, that's -- it gives us a very good baseload.

And then finally, the industrial segment, where we've seen, obviously, significant and healthy price improvements, putting with the common alloy trade case, which has given us that protection for the probably next few years. It could be 5 years and beyond. And obviously, with the well, I'll say, publicized investment in Tennessee that we've talked about, that's additional capacity and additional finishing and melt capacity is planned to come on in the second half of 2020. Again, we see that as a healthy future margin for the business and us being totally out of packaging in the U.S., albeit we'll still be in production for packaging in Russia and China.

So I tried to give you a bit of a sweep through GRP And obviously, we've been making progress and you've seen the sequential margin improvement that Ken talked to, if I'm -- really Q3 of last year through Q4. So it's about 5% quarters to 7% to 9%. And obviously, we're pleased with that progress.

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Operator [36]

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Your next question comes from the line of Chris Olin from Longbow Research.

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Christopher David Olin, Longbow Research LLC - Analyst [37]

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Just I -- you might have touched on it a bit on an earlier question, but I just want to maybe zero in a little bit here on maybe your confidence level in keeping the market share on the next Airbus titanium contract. Seems like all 4 companies are submitting bids. In the past, there had been some reliability issues with the old RTI. Just wondering if you're going to keep it and would pricing hold. Anything there would help.

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John C. Plant, Arconic Inc. - Chairman & CEO [38]

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Of course, I mean, nobody knows at this point whether we keep that contract. There's one specific. Of course, there are multiple contracts for titanium and with the increased use of titanium in future aircraft, we're confident of the future revenues and order book for our business. I have been paying particular attention to our titanium business. And indeed, it's actually a very -- the major site, which is Niles in Ohio, is the very first site that I visited in Arconic. And during the last few months, I've tried hard to dedicate resources to that plant to have fundamental improvements in terms of quality, in terms of OEE and throughput and in terms of customer compliance and combined also with the significant inventory reduction, which I think is a fundamental part of quality improvement as well.

So I think very positively about our titanium business. It's an area which I think we need to continue to focus on. I was really pleased that we were able to conclude agreements with the steelworkers on that contract and really trying to reset the -- and I think have to logically reset or at least attempted to reset the relationship between management and the steelworkers in that site. Because I think it's a really important site for us, and I see plans and expect plans and achievements to improve the future profitability of it. But having said that, which I say has a very positive backlot to the business, on the Airbus contract, we're all in a bid situation. We're an incumbent. We are hopeful to retain our share. But I'm sure that, and I've read the same stuff that you've read about, other people think that they're going to win it. I'm never so bold as to make those predictions when we're looking at bidding against other people. I don't see why I need to beat my chest and say that sort of stuff.

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Christopher David Olin, Longbow Research LLC - Analyst [39]

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Okay. Helpful. And then I just want to make sure I understand your comments about Boeing and the MAX. I think you said 42 on the frame and [48] (corrected by company after the call) in the engine. I had always been under the impression that Arconic's lead times on finished products are pretty far out there. Are you shipping at those levels? Are you shipping at where Boeing is going to be in like the fourth quarter and 2020?

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John C. Plant, Arconic Inc. - Chairman & CEO [40]

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We'll ship whatever Boeing, Spirit and GE want us to ship out. I'm just trying to give you guidance to what we've assumed in our plans financially going forward. So if people were to build fuselage at a higher rate, then obviously that's good for us -- or engine at a higher rate, that's good for us. Clearly, if the engine rate was lower, then we'd be moving some of that capacity to clear some of the other arrears and meet demand on other engines that we have and in particular for the military requirements of the -- of those engines as well. And so we're sort of trying to balance everything out at the moment, but I was just trying to give you the best guidance I could in terms of our financial assumptions.

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Christopher David Olin, Longbow Research LLC - Analyst [41]

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That makes sense. And congrats on the success that you had.

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John C. Plant, Arconic Inc. - Chairman & CEO [42]

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Thank you.

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Operator [43]

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Your next question comes from the line of Rajeev Lalwani from Morgan Stanley.

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John C. Plant, Arconic Inc. - Chairman & CEO [44]

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I don't think Rajeev is coming through.

(Operator Instructions) Your next question comes from the line of Seth Seifman from JPMorgan.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [45]

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Guys, just one follow-up here in terms of understanding the cost cutting plan. Sort of my understanding that it was directed kind of primarily at overhead. Now if I look back at like the run rate corporate cost in the back half of last year, it looks like annualized that was about $200 million. So when we think about where the cost cutting is directed, clearly the corporate costs are not going to 0, obviously. So do you consider that there was a fair amount of overhead in the segments that that's also where the cost cutting is kind of directed? Or maybe I was sort of overestimating the degree to which overhead was playing a role here.

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John C. Plant, Arconic Inc. - Chairman & CEO [46]

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I'm going to pass the majority of that question across to Ken. Essentially, there was significant cost cutting at the corporate level. But we also planned at the reduced percentage cost cutting at the businesses. In particular, something which we did which, I guess, maybe we haven't publicized enough is that between corporate and the 6 individual businesses, there were 3 sub-HQ levels, 1 for each of those reporting segments. So 1 for the rolled products, 1 for EP&F and or EP&S rather and 1 for TCS. Those have been eliminated altogether. So there has been cost cutting at every level.

One of the reasons why you may not see a full effect of, if you do the math, SG&A is that we've also had a good problem to deal with as the share price has improved, is that we've needed to re-mark and put through the P&L additional charge for that, for share compensation. So I just wanted to make sure we got that fact out, there as well it's all taken care of in the results year-to-date. And Ken, I'll pass it across to you.

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Kenneth J. Giacobbe, Arconic Inc. - Executive VP & CFO [47]

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Yes. Just a couple of other things, Seth, to build on John's comments. You'll see in the Q that we'll file later on today that there's multiple pieces that come out of this cost restructured program. The biggest part is labor, and you'll see in there that about 40% of the labor reduction is coming out of corporate. But it's not just limited to labor. We're looking at other items like indirect cost savings, which relate to energy, maintenance, transportation. We've also exited the aircraft that I talked about earlier on there, but we've also looked at the balance sheet. So on the retiree side, retiree life, we eliminated. We reduced some of the Medicare subsidy programs as well. So it's an all-encompassing program, and you'll see some more detail of that in the Q.

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Operator [48]

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Thank you, everyone, for joining today's call. We are now concluding the call. You may now disconnect.