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Edited Transcript of ARNC.N earnings conference call or presentation 30-Apr-19 2:00pm GMT

Q1 2019 Arconic Inc Earnings Call

May 8, 2019 (Thomson StreetEvents) -- Edited Transcript of Arconic Inc earnings conference call or presentation Tuesday, April 30, 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

* David Egon Strauss

Barclays Bank PLC, Research Division - Research Analyst

* Jeffrey Joseph Molinari

Cowen and Company, LLC, Research Division - Research Associate

* Joshua Ward Sullivan

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

* Martin John Englert

Jefferies LLC, Research Division - Equity Analyst

* Matthew James Korn

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

* Rajeev Lalwani

Morgan Stanley, Research Division - Executive Director

* 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 First Quarter 2019 Earnings Conference Call. My name is Christina, and I will be your operator for today. As a reminder, today's conference is being recorded for replay purposes. I would now like to turn the conference over to your host 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, Christina. Good morning and welcome to Arconic's First 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. I'd like to update you on a variety of topics commencing with the first quarter results.

If you please turn to Page 4. You will see that the revenue for the quarter was up 3% year-on-year and 9% organically, adjusting for the effects of FX, aluminum and disposals. Volume increased in each segment and all of our key end markets remained healthy. Demand for our products continues to be strong. Excluding special items, operating income was up 15% year-over-year and operating margin, excluding special items, was up 120 basis points.

Both adjusted income and adjusted earnings per share excluding special items were quarterly records since separation. Engineered Products and Solutions improved operating profit margins by 210 basis points driven by volume, price, operational performance and cost reductions.

We launched our first cost reduction program swiftly after taking the helm in February and initiated our first action on the 4th of March. And we expect to see savings of approximately $230 million on a run-rate basis and $120 million of savings in 2019.

Adjusted free cash flow improved by $151 million year-on-year with an 8-day improvement in working capital days. Pension and OPEB cash contributions were $76 million in the quarter, and we took actions regarding health plans and life insurance to reduce OPEB liabilities by $200 million year-on-year.

$700 million of shares were purchased at an average price of $19.21 to return money to shareholders. Our return on net assets improved 210 basis points to 10.7%, the highest quarterly level since separation.

Before we broaden the update, I wanted to state that we recognize the scale of the task at hand. We are trying to accomplish several things at the same time.

Firstly, a fundamental profit performance improvement program. This incorporates not only cost takeouts but top line increases as well; a separation of the company into an Aerospace-focused business and the Rolled Products business; the sale of certain businesses with revenues of approximately $400 million. These businesses either do not fit with the Arconic focus or are not material to its bottom line, and if accomplished will assist in driving the margin performance of the company. We plan to appoint 2 new CEOs and business teams later in 2019. We will create 2 boards as we move into 2020; and finally, improvement in the morale and confidence of the company's employees, starting with seeing success in the things that they're doing. Morale is always difficult to measure, and clearly, headcount reductions do not help. But I hope that getting these behind us swiftly and providing clear direction and purpose will build confidence commensurate with our achieving success in each quarter and execution of the plan.

Everyone can enjoy being part of something successful, and it's my role to enable this by doing the few things which are necessary, and most importantly, defining the things that we are not going to do to prevent wasting our time on these things.

Now let me turn it over to Ken to give more details on our quarterly results before I give you an update and more detail on the operational performance.

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

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Thank you, John. Now let's move to Slide 5 in the key financial results for the quarter. Revenue for the first quarter came in at $3.5 billion, up 3% year-over-year. Organic revenue, which adjusts for portfolio changes, currency and aluminum prices, was up 9% for the quarter on a year-over-year basis. A reconciliation for organic revenue can be found on Slide 21 in the appendix. Revenue growth was driven by volume gains across all segments. All of our key markets continue to be healthy. Organically, year-over-year revenue for Aerospace was up 13%, Commercial Transportation was up 15% and Packaging was up 15%. Double-digit growth in these markets was supported by solid organic growth year-over-year of 6% in both Automotive and Building and Construction. We've included our year-over-year growth rates by market on Slide 22 in the appendix.

Operating income excluding special items in the first quarter was the highest level since separation at $397 million, up 15% year-over-year. First quarter operating income was favorably impacted, $48 million, by higher volumes primarily in Aerospace, Commercial Transportation and Packaging. As John mentioned, demand for our products continues to be strong and we're driving higher prices where possible when we are fulfilling above our contractual share, we're doing contracts and selling noncontractual spot business. Higher pricing resulted in a $31 million favorable year-over-year operating income impact in the first quarter driven by Aerospace and Industrial Products. We expect favorable pricing year-over-year to continue throughout the remainder of the year.

Our incremental cost-out program was launched in the first quarter. This has mitigated the expected unfavorable mix impact of new product introductions. On the downside, the transition of our Tennessee plant from Packaging to Industrial Products negatively impacted operating income in the first quarter by $22 million on a year-over-year basis. Our toll processing agreement with Alcoa Corporation expired on December 31, 2018 and the Tennessee plant is transitioning from Packaging to more profitable industrial products. This was a one-time impact and we do not expect to see the same level of impact year-over-year in the second quarter. The cost and capital investment are part of the previously announced $100 million investment in Tennessee. The benefits of the transition in capital investment will begin in the second half, with full effects realized in 2020. Our confidence in the returns of this investment is backed by the recent common alloy duties enacted by the U.S. International Trade Commission. These duties, which range from 96% to 176%, are on common alloy imports from China. The duties are expected to be in place for at least the next 5 years.

One final comment on operating income. Operating income margin, excluding special items, was up 120 basis points year-over-year driven by EP&S and TCS. We've also included a reconciliation of operating income excluding special items on Slide 33 in the appendix.

Adjusted free cash flow in the first quarter was negative $266 million or $151 million improvement over the first quarter of 2018. The improved free cash flow generation was driven primarily by lower pension contributions and OPEB payments of $118 million year-over-year, also higher net income and lower interest payments. We continue to focus on days working capital with an improvement of 8 days year-over-year to 51 days. Capital expenditures increased $51 million on a year-over-year basis to $168 million. Approximately 3/4 of the capital spent in the quarter was for return-seeking projects as we expand our aerospace engine capacity in Whitehall, Michigan and Morristown, Tennessee, and we are also expanding our wheels capacity in Hungary. Capital expenditures are expected to reduce by approximately $120 million annually on a year-over-year basis to $650 million.

Diluted earnings per share excluding special items was the highest since separation at $0.43 per share. This was $0.09 per share or 26% higher than first quarter of 2018.

Now let's move to the segment results on Slide 6. Before reviewing the individual segments, I wanted to highlight that in the first quarter, we transferred our aluminum extrusions operations from the EP&S segment to the GRP segment. We are now leveraging operational expertise from our Global Rolled Products team and optimizing metal management, including scrap utilization across our Global Rolled Products and extrusion assets. It's important to note that the prior period financial information has been recast to conform to this new structure.

So EP&S. EP&S in the first quarter had record revenues of $1.5 billion, an increase of 5% year-over-year. Organic revenue was up 7% due to double-digit volume growth in aero engines and aero defense. Segment operating profit was up 21% year-over-year to $253 million, which is a record for the EP&S team. Resulting segment operating profit margin expanded 210 basis points year-over-year to 16.8%. The increase in segment operating profit was driven by volume growth in Aerospace engines and Aerospace defense markets, higher pricing in Aerospace and net cost savings. These favorable impacts were somewhat offset by the expected unfavorable impact of new product introductions in Aerospace engines and the continuing learning curve effect of new airfoil production.

In the first quarter, GRP's revenue was $1.5 billion, an increase of 1% year-over-year. However, organic revenue was up 10% due to double-digit volume growth in Packaging, Commercial Transportation and Aerospace aeroframes. Segment operating profit was down 14% or $17 million year-over-year to $107 million. Growth in our major markets as well as favorable pricing in the Industrial and Commercial Transportation markets was more than offset by the $22 million one-time unfavorable impact as we transitioned our Tennessee assets out of Packaging for the more profitable Industrial sales. We also had unfavorable performance in our aluminum extrusions business. Segment operating profit margin decreased 130 basis points to 7.1%, including an unfavorable 140 basis impact from the Tennessee transition. We've had 2 consecutive quarters of margin expansion in the GRP segment, and we expect continuing margin expansion in the second quarter as we transition to Industrial Products at Tennessee and realize additional cost-out savings.

In the first quarter, TCS delivered $535 million of revenue, which was flat year-over-year. Organic revenue was up 7% as we experienced solid growth in both Commercial Transportation and Building and Construction markets. Segment operating profit was up 30% year-over-year to $87 million, which was the team's best-ever first quarter. Segment operating profit margin increased by 380 basis points to 16.3%. The increase in segment operating profit was driven by higher volume in Commercial Transportation and Building and Construction as well as net cost savings.

Now let's move to the first quarter key achievements on Slide 7. EP&S had record quarterly revenue and segment operating profit. Aerospace Engines revenue was a quarterly record and up 12% year-over-year. EP&S' segment operating profit margin improved by 210 basis points as we started to see favorable Aerospace pricing improvement of $15 million year-over-year. Additional price negotiations are ongoing worth approximately $15 million on an annualized basis.

GRP. We continue to deliver strong growth in major markets on a year-over-year basis. Commercial Aeroframe revenue was up 23% organically and Commercial Transportation revenue was up 21% organically. GRP delivered pricing improvements in the Industrial and Commercial Transportation markets of $18 million.

TCS had a record first quarter segment operating profit. Organic growth in TCS continues to be strong, with 8% increase in Commercial Transportation and 6% increase in Building and Construction on a year-over-year basis. The TCS team also continued to consistently deliver improved net savings driven by Smart Manufacturing initiatives.

For Arconic in total, in addition to the highest adjusted operating income and earnings per share since separation, we achieved the highest quarterly return on net assets since separation of 10.7%. Return on net assets was up 210 basis points year-over-year and provides confidence as we look forward to further improve return on net assets. We continue to focus on our legacy liabilities as we reduce the net pension and OPEB liability by approximately $160 million sequentially due to payments in the quarter and reductions in OPEB benefits.

In the appendix on Slide 18, we provide more details on our pension and OPEB obligations.

Finally, we improved our first quarter free cash flow on a year-over-year basis by $151 million.

So before turning it back to John, let me briefly cover 4 items that can be found in the appendix. The first item is on Slide 19 where we have summarized the special items for the quarter. Restructuring-related special items resulted in a charge of $12 million pretax, which consist primarily of 2 items. The first is a charge of $68 million -- $67 million related to headcount reductions that are linked to our cost-out program. Also, a noncash credit of $58 million associated with the elimination of retiree life insurance benefits. In the first quarter, we incurred $2 million of external legal and other advisory cost related to the Grenfell Tower which were reported in SG&A. The level of spending is lower than prior quarters, and John will comment further on Grenfell Tower in his closing remarks.

In the first quarter, we incurred $6 million of external costs related to the conclusion of the strategic review. Additionally, there was $3 million of cost related to the planned separation, both items were recorded in SG&A.

The second item that I wanted to touch on is on Slide 20 in the appendix, where we've provided an update on our capital structures. We continue to manage our debt and reduce our liabilities. We finished the first quarter approximately $1.3 billion of cash after executing the $700 million share repurchase program. 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 the $700 million share repurchase. Net debt-to-EBITDA stands at 2.48x, which is an improvement of 5% compared to the first quarter of 2018.

The third item is on Slide 25, where we provided a reconciliation of segment reporting changes. As I mentioned earlier, the aluminum extrusions business has moved this quarter from the EP&S segment to the GRP segment. And all prior period financial information has been recast to conform to the new structure.

The fourth and last item is related to aluminum prices. Aluminum prices have stabilized over the last few months. The year-over-year impacts are unfavorable to revenue by $59 million and favorable to operating income by $7 million. Details on Slides 23 and 24 in the appendix outline the changes.

At the current aluminum prices, we're expecting continued segment operation profit favorability in the second quarter on a year-over-year basis. Furthermore, on the last earnings call, we mentioned that in 2019, we now qualify for hedge accounting for almost all of our aluminum hedges. As we look forward to new accounting treatment and the continued stability of aluminum prices are expected to reduce the volatility of our operating profits related to aluminum prices.

With that, I will turn it back to John.

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

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Thanks, Ken. And you can see that the results in the first quarter were an improvement. Revenues increased, margins were expanded and the team delivered record adjusted operating income, earnings per share and return on capital since separation.

When I take you through the earnings guidance, you will see that I expect the improvement trend to continue into the second quarter. Slide 8 lists key focus areas of operating performance, cost reduction, capital allocation and portfolio separation. I will provide an update on these each quarter.

Turning to Slide 9. Operating reviews have been instituted, which touched all aspects of the business, that I held by each division and focused on financial performance, revenues, costs, headcount tracking, price, product launch status with economics and OEE which is plant and equipment efficiency and, finally, employee productivity. Monthly and quarterly forecast reviews are conducted with myself in a detailed format.

Let's move to Slide 10. The cost reduction program that I spoke to you about in February on the earnings call had an annual run rate of $200 million. That plan is set, solidified and already partially accomplished starting with our employment reduction in March. The current state of the program is that the annualized plan now stands at approximately $230 million, of which we expect $120 million will be realized in 2019. Naturally, the part-year effect of this program going into 2020 will provide further earnings lift next year. Updates will be provided next quarter.

Now moving onto Slide 11. The share buyback announced in February on the 19th is now complete. 31.9 million shares were delivered to Arconic on February 21 and a further 4.5 million shares were delivered on April 29 at an average price of approximately $19.21. $300 million remains available under the prior repurchase authorization through the end of 2020. The quarterly common stock dividend was reduced from $0.06 per share to $0.02 per share.

Slide 12 outlines our progress on separation. The project team is set, work is underway and the business perimeters are concluded. The intention is to hold these business perimeters frozen such that the separation is accomplished in the fastest possible time. We plan to file our initial Form 10 in the fourth quarter 2019 and complete the separation during Q2 2020.

Critical closing conditions are clearly identified. Timelines for each individual step are set out. And of the major tasks to be done, none are currently coded as red. The one-time costs of the separation will be in the range of $130 million to $160 million excluding debt breakage.

On Slide 13, it sets out the perimeter of the 2 public companies. They will be headquartered in Pittsburgh. The search for 2 CEOs will be conducted, looking at both internal and external candidates. Our wheels business currently inside TCS will be part of the Engineered Products & Forgings business Operational synergies including shared facilities and complementary forged process technologies will benefit our Aerospace wheels business. Aluminum extrusions has already been moved to the Rolled Products business.

Moving on to Rolled products. The Building and Construction Systems business will be retained as part of Rolled Products. We did not believe that the manner in which the sale was conducted nor likely net cash outcome would generate most value for Arconic shareholders, and that will always be my focus. Instead, I expect that we will expand the margins of this business and plan to achieve a 200 basis point improvement in margin as we move through 2019 into 2020 by providing clarity of direction, cost reductions, revenue enhancements and improved focus.

The leadership of this business is firmly engaged in the execution of the plan. We are focused on profit and cash generation.

Although we will not sell BCS, we are targeting to sell certain businesses with revenues approximately $400 million. These businesses either do not fit with our focus nor are material to its bottom line, and if accomplished will assist in driving enhanced margin performance for the company. We expect aggregate proceeds from these asset sales to be in the range of $100 million to $200 million. None of these disposals will be detract from the company's mission and will provide the margins of the -- I'm sorry, and will improve the margins of the 2 new companies. We expect to sell these assets prior to separation. We also expect corporate costs to be in line with industry-leading peers and below current Arconic costs. There will be minimal or 0 stranded costs.

Lastly, we have clear ideas on which business will be SpinCo to optimize shareholder returns, and we'll communicate further on this topic during our next earnings call.

I would now like to take you through our financial guidance on Slide 14 for the balance of 2019. For the year, we continued to envisage sales to be consistent with our previous guidance of $14.3 billion to $14.6 billion. We now envisage that earnings per share will increase to a range of $1.75 to $1.90. This has increased from the prior guidance range of $1.55 to $1.65. For reference, this updated guidance, depending upon which point in the range is selected, is approximately 40% to 50% higher than either of 2 prior years since separation.

Capital expenditures will be further reduced to approximately $650 million from the prior guidance of $700 million given in February. Adjusted free cash flow for the year is seen to be in the range of $650 million to $750 million, an improvement from the prior range of $400 million to $500 million. The guidance we gave last quarter did not include the benefit of these cost reductions. Today, we've updated the guidance reflecting the operating performance as well as the approximately $120 million of expected cost reductions.

As you can see, or at least reverse engineer from the guidance numbers given, there will be further margin enhancements as we proceed with the execution of our plans in the coming quarters. More specifically, we're also providing earnings per share guidance for the second quarter, $0.46 to $0.51 per share as we continue with the implementation of the plan.

Before taking your questions, I'd like to provide a brief update on Grenfell as it pertains to Arconic. This is appropriate since it's been some time since the company made any reference on this matter. And secondly, there were leaks to the media during the second half of 2018, which in my personal view were essentially done to put the company and board under duress during the potential transaction discussions.

Firstly, let me say that Grenfell Tower, with its attendant loss of life, was a terrible tragedy. Our French subsidiary Arconic Architectural Products or AAP is participating in the U.K. public inquiries as core participant. Phase 1 of the public inquiries has been aimed at examinations of the circumstances leading up to and surrounding the fire. This phase of inquiry finished in the second half of 2018, and we expect a report will be forthcoming. There are approximately 500 entities participating in the inquiries as core participants. There's a second phase of the public inquiry, commencing later in 2019, which is expected to examine why the fire spread. AAP will participate in the second phase as well. The police investigation, also assisted by AAP, is not expected to be complete until late 2021, and only after the second phase the public inquiry has completed its work. We remain committed to offering our full support to the authorities and to the public inquiry as they continue to investigate the complex issues surrounding the Grenfell fire. Currently, there's no litigation against Arconic in the U.K. In the U.S., there are 2 federal securities lawsuits. Arconic believes that these claims have 0 merits and will be vigorously defended to the fullest extent.

And with that, I'd like to now open the call 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 David Strauss from Barclays.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [2]

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John, can you just give us a little bit more detail exactly what you're doing in terms of a cost reduction plan? Is this just a headcount reduction plan? I know you also touched on plant productivity, any sort of metrics you can give there? And were there any actual cost savings that came through in Q1?

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

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First of all, yes, there were cost savings in Q1. We've taken action on a variety of fronts well beyond employee headcount reduction. We have addressed legacy liabilities, as I mentioned. In those costs, we've addressed the issuance of shares in the company in the extent of those. We've looked at all of our variable expenses and have done the initial phase of that program. And there will be further work coming in the latter half of this year on those, I'll say, variable expenses. But I think if you went down the, I'd say, the P&L, you will find action pretty much in every dimension on the cost side. [Now we see, it's just not] -- in commenting on the bright side of the business. So I would say, if you pick one, we've probably touched it and those programs are continuing from March. We've already taken another step in April, and we'll do so, and hopefully conclude the majority of the things we're looking at by the end of the second quarter with some, I think, small carryover into Q3. And essentially, those are down to just taking a little bit longer in Europe as we go through the correct processes through the headcount reduction there. But again, all aspects of, I'll say, costs have been addressed. I guess, I'll probably leave it at that, unless you have any follow-up on that side.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [4]

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No, that's great. I wanted to ask a follow-up on the free cash flow forecast. If -- when I look at it, it would appear that you're forecasting relatively flat working capital for the full year, is that correct? And also on pension, based on what's in your 10-K disclosure, it looks like pension funding, while down this year, is going to actually increase from here?

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

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Okay, on the pension side, certainly, we restricted the funding in the first quarter and we will make an assessment of what appropriately goes through the year. We're also -- I'm also very cognizant as we go through the separation, we'll make a fundamental assessment of how the pension split and what's the appropriate funding level as we go into the future companies. But I'd say everything is, I think, is in good order regarding those pension contributions. We've noted the significant improvement in working capital in the first quarter. I'll ask Ken to give a little bit more on the year. But I think we're expecting to show year-on-year improvement, albeit maybe not on that level.

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Kenneth J. Giacobbe, Arconic Inc. - Executive VP & CFO [6]

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Yes. So we do have a big revenue uptick year-over-year. So although the days will improve, you'll see modest improvement in dollars, which will flow to cash. We -- the team has continued to do a very nice work on the inventory side. We continue to see reductions on inventory in the first quarter alone, they were 3-day improvements. So I would say the days will continue to improve. But as we ramp up the revenue on a dollar basis, it will be a modest contribution to that cash number.

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John C. Plant, Arconic Inc. - Chairman & CEO [7]

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And then finally, if I come back in and say our quarterly operating reviews are increasingly being focused on efficiency in the plants, not just the OEE level of equipment efficiency, the dimension in the corp, but also added value per employee, and those type of efficiencies, our days of inventory. And with the firm belief that if we can improve inventory days, that drives along many of the benefits with it in terms of quality and efficiency within the business, including the uptime of machines, which have to perform at a higher order than they have in the past.

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Operator [8]

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Our next question comes from Seth Seifman from JPMorgan.

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

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I wanted to start off by asking about pricing. You touched on the improvement in the quarter. And I think the idea that a lot of people have had about this business, particularly EP&S, is that this is a deflationary business. And every year, your pricing is down, let's say, 1% to 2%, and then there has to be a cost reduction that's in excess of that to yield margin expansion. Do you think of this business that way? Do you see that business in that kind of paradigm? And then to the extent that there's pricing goodness now, what do you attribute that to? And is it kind of a one-time thing that will be done this year?

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

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First of all, let me say, I do understand the principle of being in a deflationary industry from a price perspective, as you know, having spent some years in the automotive industry. But I actually fundamentally reject that as a stance within -- for the markets that Arconic faces into and into the aerospace business in particular. So price, I think, is very important. Not only just setting price at the start of a contract, but we're also looking at price upon LTA renewal and a feature of the aerospace market is those LTA renewals and looking at that. So yes, in the first quarter, we did push over the line, the approximately $30 million of improved pricing which will occur in 2019. And it will be a continuing focus as we move through the balance of the year. And also a discipline I've put in place regarding the LTAs, which are coming up for 2020 and 2021, are already being subjected to a scrutiny and, indeed, what are our stances is regarding those. So I'd say, it's a little bit different to maybe the way you perceived it in the past.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [11]

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Great, great. And then as a quick follow-up, I noticed on the slide, you talked a prudent capital structure for both companies after the split. Does that mean investment-grade rating for both companies?

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John C. Plant, Arconic Inc. - Chairman & CEO [12]

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Not necessarily. I was pleased by the way that our meetings with S&P went and their reaffirmation of continuing investment grade for 2019. And of course, you prefer to have a higher rating rather than a lower rating. I think there's possibly some merit to the investment grade in the aerospace market. That's essentially yet to be proven to me. But assuming that it is, I don't necessarily believe that both companies have to be investment grade. So it will be, what I believe at least to be the most efficient capital structure including underlying cost of capital for those companies as we go forward. And I've spent many years being in that noninvestment group's space. And so it's all fundamentally no concern for me at all. But again, we will make those detailed assessments as we do all of the financing around the separated companies.

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Operator [13]

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Our next question comes from Rajeev Lalwani from Morgan Stanley.

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Rajeev Lalwani, Morgan Stanley, Research Division - Executive Director [14]

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John, I wanted to come back to some of the comments that you made around the spin, so just some questions, clarifications. As far as the financing needs and tax matters, can you talk a bit more about what they are? I think you're implying that those numbers wouldn't be too material relative to that $100-plus million one-time cost that you talked about. And then as far as recurring cost, I think you're alluding to this, we shouldn't think of there being any incremental recurring cost around headquarters and back office and that sort of things?

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

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Yes. Basically, let me deal with a lot of points first. In terms of corporate costs, clearly, we've already made some reduction in those. And let me just give you a little bit more detail. So if I look at the percentage reductions of employment that we've gone through, then the highest percentage actually has been in the corporate area, and I hope that's been appropriate. And when I look at what I believe to be benchmark, world-class for super corp cost then my intention is that the 2 new separate companies will be at that benchmark. And most importantly, we -- by the time we finish the program, as we go through 2019, there will be no stranded costs. I said the headquarters will be in Pittsburgh, and that obviously improves the situation regarding stranded costs fundamentally. And the headquarters have moved here already. And so there is no drag, no friction at all from today to tomorrow's future state regarding that. I did comment on the cost of separation for the operating expenses, and I gave you that number between $130 million to $160 million, and haven't commented any further yet in terms of more detail on tax, which I don't think is a big issue and on the financing. But more to come as we go through that in the balance of the year. But I think importantly, you've got the dimensions around all of that, and you can see that, basically, if we're successful on the proceeds, from the disposals we're talking about, then that will more than pay for those separating costs.

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Rajeev Lalwani, Morgan Stanley, Research Division - Executive Director [16]

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And if I may, for a follow-up. John, this will be useful particularly given your background. As far as the Auto and Commercial Transportation markets, I think there's a view out there that there's going to be some pressures there, a lack of growth, maybe even some contraction within commercial transport. How does that relate to the growth within Arconic, i.e. your ability to not be hit by any pressures that we see there and your ability to outgrow those markets?

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John C. Plant, Arconic Inc. - Chairman & CEO [17]

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Well, let me deal with the commercial business first. I mean, we have a strong business there. As you know, we have chosen to invest further in that, in particular, in Hungary, in Europe, and which gives us the ability to serve a greater portion, not only of the European market, but also acts as a low-cost source for those wheels compared to some of our existing sites around the world. The investment is on track. The financials for that look healthy. And even with the potential slowdown, I'd say, in classic truck should one occur, then I don't think that's going to provide any interruption to the earnings momentum of that business. So I think that deals with that. In terms of the Rolled Products business and its interface into the automotive market, a couple of things there. We're particularly faced off to the light truck, pickup truck, SUV part of the market which as you know is getting a higher percentage market share. So that's good. Secondly, the amount of aluminum and -- because of lightweight images going on is increasing the plate with each fresh model that comes out. And so unless there is an absolute collapse in the industry in terms of volume, secular trend of that lightweighting and aluminization will actually cause us to actually supply more products than today. And we're also -- have been hard at work, expanding our customer base and indeed have also achieved a significant new position with a new customer in the first quarter of this year. And so again, when I look at it, diversification of the customer base, the fundamental lightweighting trends and our technology position within the alloy constructions, I'm actually really enthused by having that as a backdrop to this business this.

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Operator [18]

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Our next question comes from Gautam Khanna from Cowen and Company.

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Jeffrey Joseph Molinari, Cowen and Company, LLC, Research Division - Research Associate [19]

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This is Jeff Molinari on for Gautam. I wanted to ask you about the historical free cash flow of each entity, either on a percent of total free cash flow basis or on a free cash flow conversion basis. I kind of wanted to get an understanding of how these entities, once they're spun, will be converting, and what the free cash flow profile will look like for the 2 of them? And relatedly, a capital need for those two?

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John C. Plant, Arconic Inc. - Chairman & CEO [20]

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Okay. Well, let me deal with it on an as-is basis first, and then try and attempt to provide you somewhat sort of an answer on the split entities. I think you can assume that if we were to achieve the guidance given, that the free cash flow yield of the company is increasing and will increase at that level that historically we have not achieved. So I guess that's the first good point. And within that, the free cash flow yield will improve in each of the segment levels. So it's not confined to one segment. So that gives you a broad statement of not only what is but also what I intend will be. And as we go forward into the future, first of all, our plan is to provide pro forma financials for those 2 new companies, possibly as soon as next quarter, if not the quarter after, so you'll be able to see that. And again, the free cash flow yield of those will be -- you could anticipate will be more than adequate to cope with the debt structures of those. But inevitably, the company that I see focused on Aerospace will have fundamentally -- truly fundamentally higher margins, and therefore, fundamentally higher free cash flows. And I also see that for a lot of the required investments. So for example, in the new, I'd say, range of, I'd say, Aerospace engines or aerostructures, a lot of that has been done. Of course, we will continue to invest healthily but appropriately going forward. And similarly for the Rolled Products business, we've made a major investment in Tennessee. That gets up off its knees in terms of the industrial business during Q2 and, firmly, by Q3 and into Q4. And I expect that to continue with, again, an improved free cash flow yield going forward. But I'm not giving you any granular detail at this point. I'm giving you directional. But you can see the free cash flow yield on an average basis, using the guidance numbers.

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Jeffrey Joseph Molinari, Cowen and Company, LLC, Research Division - Research Associate [21]

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That's very helpful. And if I may, just one follow-up. How should we think about the allocation of the pension liability between the entities? Is there any way to frame it?

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

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Clearly, I mean, one part is very easy in the -- that which pertains to the Aerospace business or the Rolled Products business, flows naturally into those, that's very easy. The judgment which has yet to be made is indeed for the current corporate pension costs as those are allocated. And that cannot be made in isolation without also looking at the debt structure of those 2 separate companies going forward. So the allocation of debt to that which is SpinCo, any dividend back and also providing the degree of what I'll call hard liability, which is the cash or the debt part of the equation compared to what I call the softer type of liability, which is the pension deficit, which as you know moves around with the yield curve, the asset returns and also mortality. So I'd say all of that is up for play, and it's essentially around the corporate pension cost, which -- for which the judgment has to be made beyond the fundamental allocation of the liability structure of the company.

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Operator [23]

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Our next question is from Matthew Korn from Goldman Sachs.

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Matthew James Korn, Goldman Sachs Group Inc., Research Division - Senior Metals and Mining Analyst [24]

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A question on EP&S. John, operationally, where is EP&S overall versus what you see is its potential? Are you seeing progress made year-over-year, quarter-on-quarter in yields and sustainable cost performance, whether at the Firth Rixson assets or overall? And do you have a division -- do you have a vision of what kind of margin should be achievable at the new EP&S segment upon reaching that potential?

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John C. Plant, Arconic Inc. - Chairman & CEO [25]

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Well, I'm certainly not going to give you future margin guidance at this stage and I'm still going to claim that I don't know enough. I think on the last earnings call, I've told you that didn't know anything about aerospace. Well, first of all, that wasn't actually quite true. So I do know something. But in terms of, let's say, just speaking of the businesses, I think we have -- some really strong positions are -- I'll say, the response and focus continue to build momentum to the, I'll say, the new challenge that I've put up on the businesses. I think our engines business has been coming through strongly and I think that will continue to be the case. In fact, I was so relaxed about the earnings. We actually went to one of the engine facilities yesterday to take a, I'll call it, day trip to go look a bit more and see those assets being put into place as we need to make more in the future as I think you know. I'm pretty encouraged by the stability of that discipline and the dedication of the management there. So improvement in that business. On the fastener side, similarly strong business with -- I think improvement is going to be shown in the fastener business. And then on the structures side, we are taking -- I've taken some steps to reorganize that. I think that was a fundamental disappointment in that business, and there has been already some management change, and in fact, someone joins us next week to take on the responsibility of the revised structures business. But again, I'm seeing good responses to the focus that's been given. Commenting on the Rings and Disks. I see that the rings business is improving. I've actually taken time to visit about 3 or 4 plants, one of those is a rings plant. And I'm convinced, and it's always good enough you can pinch yourself that there's going to be margin improvement as we go through 2019 on that and further significant improvement in that rings business as we go into 2020. They know exactly what they've got to do. They know the expectations. We have the benefit, in addition of a new extrusion press coming online during the next -- I'll say, gradually during the next couple of quarters and it should be up and running by the fourth quarter this year, and it's a reasonable level of efficiency. And so all of that's good. The business which is more perplexing to me currently is the Disks business. But as you know, I think that disks business, fairly small, and they call it a $200 million to $300 million revenue business. So that's not going to be the biggest issue in terms of materiality to driving EP&S forward. So I think that's a great first step in EP&S. I think 210 basis points of margin improvement is not shabby by anybody's standards. It marks a reversal from the trend of what EP&S has been doing, which has been some declines, maybe sequential declines over the last couple of years, and I expect that to continue. And clearly, I wouldn't have given the guidance that I gave without feeling confident that's going to be the case. But don't expect me to give you an earnings guidance in terms of margins for the business at this point

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Matthew James Korn, Goldman Sachs Group Inc., Research Division - Senior Metals and Mining Analyst [26]

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No. What you gave me was actually much more useful than that. It's good to hear, and I'll pass it on from here.

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Operator [27]

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Our next question comes from Martin Englert from Jefferies.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [28]

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So for the potential noncore asset sales that you've identified thus far, can you provide any incremental details there, what segments they might be associated with?

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

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Actually, the sum from each of the 2 futures companies, clearly, in keeping the perimeter pristine, I shall be pulling those at disposal then what will become SpinCos. We'll finalize that in the coming couple of months. So yes, there'll be some in Aerospace. And what's been interesting to me is that we have some sites which -- -- and some businesses which are producing what I call really high-quality levels of return. And there are some sites, which in my vernacular, is either going to fix them, close them or sell them. And so these disposals fit firmly into that category. And I'm hopeful that we will find our first shared purchase agreement with a potential buyer this month. Actually, I should say May because this the last day of the month. So it's -- the first day is imminent, and that really is focusing the company on things it needs to do and, more importantly, identifying things which are completely irrelevant to achieve the mission and clean those up.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [30]

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Any detail that you can provide within GRP as well?

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John C. Plant, Arconic Inc. - Chairman & CEO [31]

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Yes. I mean, this one, I'll say a small country based business which, in my view, can't really develop into anything which is significant. I'm not planning that I would ever put fundamental new capital in it. And if you choose that you're not going to put future capital for growth into a business, then it's probably better off in somebody else's hands. So that's the plan there.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [32]

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Okay. If I could, one last quick one. What was the LIFO impact on the quarter? And then why stop providing the detail?

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John C. Plant, Arconic Inc. - Chairman & CEO [33]

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I'll ask Ken for that level of detail. The most important thing is the whole volatility to aluminum is at a much reduced state going forward. Given what Ken has always said to you about the implementation of hedge accounting. And so I think this -- the whole month, the aluminum effect -- the whole quarter, I'm sorry, was about $7 million at the profit level. LIFO, I'm giving Ken plenty of time to be able to pull that up if it's irrelevant. Then if not, he'll get back to you.

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Kenneth J. Giacobbe, Arconic Inc. - Executive VP & CFO [34]

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Yes. The LIFO -- and we've pushed metal lag. Of those 2 together, it was pretty much flat for the quarter on a year-over-year basis. To John's point, the total impact was a $7 million favorable item for aluminum because we had some operational improvements. And as we said earlier, we're going to see a tailwind as we go into the second quarter as well on aluminum prices.

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Operator [35]

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Our next question comes from Carter Copeland from Melius Research.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [36]

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Just a couple of quick clarifications and a question. The -- it sounds like the pricing in EP&S was an LTA renewal. I wondered if you could just tell us if that was aeroframe or engine related? And then on the pension, I can appreciate that there is some variability there in the middle on the corporate pension costs. But how much of a range of a split should we assume there is, given that 2 pieces of that will sort of go naturally with GRP and EP&S?

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John C. Plant, Arconic Inc. - Chairman & CEO [37]

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Okay. Let me deal with the price environment first. It's affected -- the pricing affected 2 parts Aerospace business. There were some in engine and some pricing benefit in fasteners. And I'm not going to categorize the degree on those at this point. And also regarding pension, the allocation of corporate pension, I'm not prepared to say anything further that I've already done in terms of that allocation because there's too much work which remains to be complete. And I think that's one of the last bouncing items as we set these companies up.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [38]

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Okay. And then just a question on the 737 MAX production. Any potential impacts there, if it's either providing opportunity for your manufacturing processes, if it's having any impact on expedited shipping or less of that or if you continue a pace with no real change? Any perspective you can give us on that?

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John C. Plant, Arconic Inc. - Chairman & CEO [39]

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Yes. If I look at this month and maybe Q2, I really don't see anything in terms of our revenues and profit impacting upon the second quarter guidance that has been provided to you. And if the plan to go forward, as publicly stated by both Boeing and also by the other, I'll say, suppliers that we sub-supply into, then that's clearly taken account of in the guidance that's been provided to you. What you should note is that I actually broadened the guidance range, so you had previously a $0.10 guidance range. I've given you a $0.15 guidance range in the call today. And I've also tried to work out, so what if Boeing didn't go back up to 52 and back up then our plan to go to 57 build, and how much impact would that be on 2019? So basically, I said if we put the flat line in this at 42 build a month for the balance of the year and, obviously, it's going back up, then my feeling is that around about $0.03 plus or minus $0.01 or $0.02 in terms of the impact. But given the range that I've given you for, I'll say, $0.02 to $0.04, it's not going to change the guidance I've given you. It's the way I see it. But again, it's probably too many factors yet that are unknown and can't be commented upon what the real build and the 737 MAX will be. But if you assume $0.02 to $0.04 subsequent guide for now and you can assume that it's covered.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [40]

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Okay, that's great. And if I can sneak one last one in, can you just give us some color on the considerations that went into the SpinCo determination, and as you mentioned in the release, the value maximization there? Just the thought process in broad strokes?

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John C. Plant, Arconic Inc. - Chairman & CEO [41]

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Yes, I mean, the first principle is pretty easy, like an aerospace business and a rolled business. And then beyond that, looking for, I'll say, any like technology or shared facilities which makes it easier. And so I like to clean up anything I didn't feel was appropriate, going forward, for the Aerospace segment. And again, some of those are disposed. We've moved the extrusions business across to -- it's all aluminum and belongs much more clearly with the Rolled Products segment. And you've seen it have aligned, the Building and Construction business with the Rolled Products segment. I think that's again more appropriate there. It's aluminum, it's extrusions, and it just fits better. But I think the most important thing is, whether I look at the sequential improvement in margins on the Rolled Products business as you've gone from Q3 last year, Q4 into Q1, you've been going from about the 5%, 5.5% level to the 7% level. And Ken has commented on the hopefully improving prospects of that, as we go to the Industrial business. And then I also commented about the clear mission that our Building and Construction business has. I told you it made no sense to sell it. It was not appropriate in terms of what the value the shareholders would get. And then I look at the things we can do with that business and putting 200 basis points on its margin, similar to the 200 basis points that's fully on the EP&S margin. I mean, all of that's good.

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Operator [42]

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Our next question comes from Josh Sullivan from Seaport Global.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [43]

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Just the separations outlined here. Does it preclude any scenario where GRP finds a partner, public and private? I mean, do you feel the sale of partner avenues for GRP had been examined at this point or, I guess, exhausted?

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

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First of all, I haven't tried to sell GRP and don't intend to sell GRP. And certainly, I'm not willing to entertain any discussions from anybody about GRP, not now and not in the future during my tenure at the company. Since that would fundamentally jeopardize the tax-free nature of the transaction, or the spin of assets for the company, and that would be fundamentally a degradation to the value to shareholders. And so I think I've told you like once, twice, and now thrice on the call, that's my focus. And putting huge tax leakage into a transaction, the premium required to overcome that leakage would be so enormous. It's just fundamentally no interest to me whatsoever.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [45]

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Okay. Got it. Just wanted to.

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

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That's pretty categoric I think, if it lacks certainty for you.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [47]

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I think we got it. One more, just on more of on the RTI asset side. How are those assets performing? There's been some discussion, some titanium mill market share shift here.

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John C. Plant, Arconic Inc. - Chairman & CEO [48]

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Okay. Well, you got me there. I don't know about a share shift in the titanium markets. What I can see is that the titanium business has increased in terms of its revenue. I am currently not satisfied with its fundamental performance, and that's, in my view, one of the areas we need to make further improvements, both in its underlying operations, its profitability and its earnings growth. I think there's a lot of potential there. And I'm looking to work with managements, employees, unions to achieve all of that. But fundamental share shift or drift of market share, not aware of it.

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Operator [49]

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Thank you. That is all the time we have for today. This concludes today's conference call. You may now disconnect. Thank you, have a great day.

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John C. Plant, Arconic Inc. - Chairman & CEO [50]

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Thank you.