Arconic Corp (PITTSBURGH) (ARNC) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Arconic Corporation Third Quarter 2020 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Shane Rourke, Director of Investor Relations. Thank you. Please go ahead, sir.

Thank you, Shannon. Good morning, and welcome to the Arconic Corporation's Third Quarter 2020 Results Conference Call. I'm joined today by Tim Myers, Chief Executive Officer; and Erick Asmussen, Executive Vice President and Chief Financial Officer. After comments by Tim and Erick, we will have a question-and-answer session.

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 earnings press release and in the appendix in today's presentation.

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

Thank you, Shane, and good morning, everyone. Welcome to our third quarter 2020 earnings call. For those of you who'd like to follow along with the presentation, the slides are posted under the Investors tab on our website.

Our third quarter performance supports an optimistic outlook for our future despite the current challenges of the pandemic. The fundamentals of our business remains strong. Our cash conservation efforts are continuing to offset macro headwinds and we are well positioned to take advantage of the demand recovery we are seeing in several of the markets we serve. Our highly variable cost structure provides us with the flexibility to adjust to the current demand volatility across the economy. And we are already seeing recovery in some of our most significant markets, which I will cover later in the call.

Let's begin on Slide 4, the financial highlights for the quarter. Revenue in the third quarter was $1.4 billion, up 19% from the prior quarter and down 22% or 16% organically year-over-year, reflecting an improving demand environment for some of our markets. The company recorded net income of $5 million or $0.05 per share compared to a net loss of $24 million or $0.22 per share in the third quarter of 2019.

Our adjusted EBITDA was $165 million, up 67% from the prior quarter. The sequential increase in EBITDA was largely driven by our cost-out actions and a resurgence in North American automotive production, particularly in pickups and SUVs, as well as recovery in the industrial market. Our adjusted EBITDA margin in the quarter was 11.7%, up 340 basis points sequentially. The increase is a testament to the proactive cost actions we took at the start of the pandemic and our highly variable cost structure, which we have rapidly flexed to adjust to available demand.

We generated free cash flow of $201 million, with cash from operations of $240 million and capital expenditures of $39 million in the quarter. While free cash flow did benefit from deferred pension contributions under the CARES Act, there was clearly strong cash generation in the quarter.

On October 31, our noncompete restrictions in the packaging market expired. We can now actively pursue additional opportunities in the can sheet market in North America, Europe and throughout Asia. The benefit of such expansion, particularly in North America, if projections on North American packaging demand come to fruition, is significant for our Tennessee operation.

Finally, we also decided to change accounting methodology for our inventory in the U.S. transitioning from last-in, first-out or LIFO cost accounting to average cost accounting. This methodology is more consistent with how we run our business as a converter of aluminum and how our peers report financial results. In addition, we believe this will provide greater shareholder visibility into the company's profitability.

Turning to Slide 5. I'd like to provide a little more detail on how we performed across the markets we serve. Ground transportation revenue surged 102% over the prior quarter as our automotive customers returned to full operations and increased their demand to keep up with strong consumer sales and backfill-depleted dealership inventories. Our automotive sales in the quarter were up 5% year-on-year. As a result, our ground transportation organic revenue in the quarter represented 37% of sales back to typical historical levels.

Within ground transportation, automotive sales increased 158% sequentially. However, demand for heavy-duty trucks continues to depress commercial transportation sales, which were down 37% year-over-year, resulting in ground transportation organic revenue being down 10% year-over-year in total.

Our aerospace organic sales decelerated in the quarter as previously communicated to a decline of 50% year-on-year. Depressed large commercial aircraft build rates continue to impact suppliers throughout our industry. The decline in the quarter was driven in large part by destocking through the supply chain and anemic build rates in large commercial aircraft.

Sales in the building and construction market were down 13% organically year-over-year, but increased 8% from the prior quarter. Sales in our packaging segment declined 3% year-over-year, largely driven by a decline in sales in our facility in China, but increased 2% from the prior quarter. As mentioned previously, our noncompete agreement, which limited our market reach expired last week, and we are looking forward to pursuing additional opportunities in this market moving forward.

Finally, sales in the industrial market increased 11% from prior quarter and declined 3% year-over-year in the midst of the broader economic slowdown. Our sales benefited from expanding volumes at our Tennessee facility as well as the early impact of the international trade actions that I will discuss on the next slide.

Slide 6 provides an update on the international trade case against common alloy products that have been dumped into our market unfairly. As I mentioned during our last call, the Aluminum Association filed a trade case in March, highlighting the unleveled playing field that 18 countries were exploiting unfairly against North American manufacturers of those same products. Both the International Trade Commission and the Department of Commerce have found that harm has in fact occurred.

Based on recent rulings from both of these bodies, most recently in August and October, preliminary antidumping and countervailing duties of up to 353% have been levied against these countries. For reference, imports from these countries represented 32% of domestic demand for these products in 2019, a total of 1.4 billion pounds or greater than $2 billion in sales of those products.

If we use the 2018 trade case against Chinese imports as a proxy, this represents an opportunity for North American manufacturers of approximately 1.1 billion pounds in 2021. In fact, we've already seen imports from these 18 countries decline by 45% year-on-year through the end of August in anticipation of the trade action. In addition to pursuing these new opportunities for our facilities in Davenport, Iowa and Lancaster, Pennsylvania, we are particularly excited for the opportunity to secure some of this demand to support the $100 million investment we are currently ramping up at our facility in Tennessee.

I'd like to now turn it over to Erick to talk about third quarter results in more detail.

Thanks, Tim. On Slide 7, you'll see a summary of our third quarter performance. Revenue in the third quarter was $1.4 billion, down 22% from the third quarter of 2019 or 16% organically, as the global pandemic continued to disrupt most of our end markets, except for automotive, which rebounded well. Of the 22% revenue decline, 14% was due to volume and mix, and the balance of the decline was primarily related to aluminum price, foreign exchange, price and divestitures.

As you'll note on the adjusted EBITDA walk, during the third quarter, we changed our inventory cost to average cost for all U.S. inventories previously carried at last-in, first-out or LIFO. The company's heritage on LIFO extends back to 1955 as an aluminum producer. As the company has changed as a result of the separations the use of LIFO does not fully align with our operations as aluminum converter. The impact of this change will not have a current tax effect on -- and the change in accounting methodology for the LIFO to average cost has been retrospectively applied to all periods presented in the company's financial statements.

We have provided reconciliations in the appendix of this presentation to highlight the impact of this change to our historical results. We believe the average cost method more closely reflects the physical flows of inventories. It also improves comparability to the company's operating results with its peers and it provides an increased level of consistency of measurement of inventories in the company's consolidated financial statements.

Accordingly, we have also changed the company's adjusted EBITDA measure to remove the impact of metal price lag. This change was made to enhance the transparency and visibility of underlying operating performance by removing the volatility associated with metal prices. The impact in the quarter of those 2 changes were $14 million benefit related to the conversion to moving average cost from LIFO and a $16 million benefit related to metal lag.

You'll also note in the appendix, that the carve-out accounting included non-service pension costs and adjusted EBITDA. And after the separation of the [business] from the former parent, these costs are in other income and expenses indicated in the reconciliation of nonservice cost to our historic financials that is provided in the appendix of this presentation.

Turning to the third quarter results. Adjusted EBITDA was $165 million, driven by a combination of pandemic-related demand reduction, partially offset by our cost actions. Our net savings programs are on track. Our cash conservation efforts delivered approximately $55 million of the $64 million of net savings in the quarter.

And turning to Slide 8, I'll provide more detail on our segment performance. As I mentioned in the previous slide, disruption from the pandemic impacted sales in every segment. Starting with our Rolled Products segment. Sales were $1.1 billion, reflecting disruptions in every market except automotive, and were down $305 million or 22% or 15% on an organic basis year-over-year, which is essentially all volume and mix-related.

Adjusted EBITDA was $138 million, down 14% year-over-year. And adjusted EBITDA margin was 12.6%, up 110 basis points from the same period last year, as our cost actions partially offset the adverse impact from lower volume and weaker mix.

Sales in our Building and Construction segment in the third quarter were $241 million, down $41 million or 15% year-over-year, primarily due to pandemic-related disruptions delaying construction projects. Adjusted EBITDA in the segment was $40 million, up $1 million or 3% year-over-year as volume declines were offset by cost actions in the quarter. Adjusted EBITDA margins were 16.6%, up 280 basis points year-over-year as a result of structural changes we have made to improve our mix in this segment and the cost actions we announced in the second quarter.

Sales in our Extrusions segment in the third quarter were $82 million, down $44 million or 35% year-over-year, and down 25% on an organic basis. The decline was driven primarily by aerospace weakness. Adjusted EBITDA in the segment was a loss of $6 million versus a loss of $8 million last year. And during the quarter, we continued to implement structural action. Improving financial performance of the Extrusions segment remains a priority.

Now turning to Slide 9. I'll provide an update on our balance sheet. As Tim mentioned, we had strong cash flow performance in the third quarter, and we ended the period with cash of $802 million and total debt of approximately $1.3 billion, resulting in total net debt of $480 million. Our ABL is undrawn, and we have total liquidity of approximately $1.5 billion.

It is worth noting we took advantage of the CARES Act. So our 2020 U.S. pension contributions have been deferred until the fourth quarter. We expect to make these contributions in the fourth quarter, and they are in the range of $220 million, putting pressure on our cash flow in the upcoming quarter.

With that, I'll now turn the call back over to Tim to talk about our expectations for the end markets we serve for the balance of the year.

Thank you, Erick. Now let's take a look at our expected fourth quarter market demand compared to the third quarter on Slide 10. While significant uncertainty remains in the macro environment because of the pandemic, we do have a good line of sight for the remainder of this year due to our lead times with our key customers.

First, on ground transportation, we expect automotive sales to be roughly flat sequentially in the fourth quarter, which would represent a decline of about 5% to 10% year-over-year. The modest year-on-year decrease is driven by the model year changeover of the Ford F-150 platform, which is a significant revenue generator for us. We expect the automotive decline to be offset by a modest recovery in the commercial transportation segment as heavy-duty truck production is anticipated to increase in the quarter.

We expect our aerospace sales to decline 10% to 15% from the third quarter or about 60% year-on-year. This decline is driven by continued destocking, particularly in the production of single-aisle aircraft. We expect destocking to continue pressuring our aerospace demand beyond the impact of lower build rates for several quarters to come.

Our building and construction sales are expected to be flat to modestly down on a sequential basis in the fourth quarter. Global macro uncertainty continues to pressure nonresidential construction, which makes up the vast majority of our sales in this segment.

We expect packaging sales to be roughly flat quarter-over-quarter. As mentioned earlier, the noncompete expired at the end of October, allowing us to reenter the packaging market in several regions previously unavailable to us. While there is a qualification period involved, we have idle packaging capacity that can be put into service with minimal capital expenditure. That said, we would not expect to see meaningful revenue contribution from new packaging production until the second half of next year or later.

Our industrial sales are anticipated to be a bright spot for the fourth quarter as we anticipate sequential sales growth of approximately 10% to 15% due to expanding volumes running on our newly installed capacity in Tennessee as well as continued tailwinds from the international trade case.

Let's move to Slide 11 for closing comments. First, and this should go without saying, we will continue to keep our employees safe and keep our operations running smoothly through this period of uncertainty. I couldn't be more proud or more appreciative of how all of our employees have stepped up to manage through the pandemic. We remain well positioned to produce the essential products that our customers need.

Second, the cost-out actions and productivity measures that we've put in place are on track and are expected to continue to improve margins and keep us nimble while the economy and our customers recover. As Erick mentioned previously, our cash conservation efforts delivered approximately $55 million of net savings in the quarter, and we will continue to deliver additional savings through a range of productivity initiatives, including increased scrap utilization, physical and digital automation and the debottlenecking of critical assets.

Next, we will continue to manage working capital and our capital expenditures to maximize free cash flow and to continue to delever our legacy liabilities.

From a growth perspective, we are excited about reentering the packaging market in North America and other regions, capturing additional sales in the industrial market now that there is a level playing field and continuing to expand our ground transportation sales as those markets recover. We will also continue to position ourselves in the aerospace and building and construction segments as we adjust to and navigate through the challenges that both these markets face in the near term.

We are providing a full year outlook to help frame up our expectations for the remainder of the year. We expect full year 2020 revenue to be in the range of $5.6 billion to $5.7 billion, adjusted EBITDA for the year is expected to be in the range of $610 million to $630 million and cumulative free cash flow for the second quarter 2020 through fourth quarter 2020 is expected to be in the range of $150 million to $200 million.

In closing, Arconic was very productive in our second stand-alone quarter. Our swift action to conserve cash drove improved EBITDA margins, flexibility and liquidity within the quarter. Additionally, our prudent working capital management and low capital spending delivered positive free cash flow, improving our cash balance throughout the quarter.

Finally, we've identified several opportunities that will drive volume growth and increase market penetration, which will continue to improve our results, and we'll be actively pursuing those opportunities while our other markets recover.

I appreciate you joining us today. And at this time, we'll take questions. I'd like to turn it back over to Shannon.

(Operator Instructions) Our first question comes from Curt Woodworth with Crédit Suisse.

My first question is when you look at the Rolled Products division in terms of EBITDA per ton this quarter, it was -- my calculation above your full year number for '19, despite the fact that there's significant COVID-related headwinds and a lot of that is the $54 million of cost-out that you identified.

So I just wondered if you could give us kind of a view or a sense of how you think EBITDA per ton or margins are going to trend next year. I fully understand that aero remains a headwind, but I'm not sure it gets that much worse from where we sit today. And you do have some incremental cost down and auto recovery, et cetera. So any comments on that directionally in the next year would be appreciated.

Sure. I think you hit the nail on the head with your first comment. We're controlling the things we can control. And predominantly, that is executing on the cost-out program and making sure that we take advantage of what I think is a highly variable cost structure. So I would anticipate that we're going to be able to maintain this kind of, let's say, margin profile. And then as some of our other markets, particularly the aerospace market, where we have -- we enjoy some higher margins recover, we should benefit from that in the future.

Okay. And then with respect to optionality with the latent capacity, I think you identified roughly 270,000 tons of capacity you can get into the market with relatively little capital and sort of spread between packaging, industrial and auto. How do you think about how you want to allocate that capacity? And clearly, historically, packaging has been a much lower-margin business, but it's getting better. So just curious kind of how you think you would look to accelerate into any particular end market. And maybe the time line. I know you said packaging is more second half, but how you kind of think about allocation.

Sure. Well, I'd start by saying we've worked very hard to get our margins to where they are. I don't think we have a high interest on pursuing commercial opportunities that are going to diminish our margins. The good news is we do have a lot of optionality. We've got flexibility across the 3 primary plants that represent that 600 million pounds of incremental capacity that we can bring to bear. The 3 markets that you mentioned, they all kind of work in -- they move in different rhythms. So the gestation period for picking up automotive sales is a little bit longer than the qualification period for getting back into the packaging market. And then, of course, we've got the industrial segment, which, in many cases, has very, very short time to market.

And so as we move forward, Curt, I think the profile of what we do with that 600 million pounds is just going to develop based on how we secure those positions and qualify products with different customers. We're actively ramping up the $100 million investment that we had in industrial. So I think you're going to -- you should anticipate seeing growth in that segment first. And then we'll balance between the other 2 markets as opportunities present themselves.

Well, let me ask the question maybe another way. Of the 600 million pounds, what would be your hope or expectation for how much of that volume would be kind of into the market by the end of next year?

I would say -- my hope would be to unleash as much of it as we can. Everything starts with an order. And our noncompete in packaging just ended on Saturday. So we've had lots of expression of interest from that segment from current customers, former customers and customers we've never heard from. Certainly, we're seeing lots of good activity in the industrial segment. And we're still ramping up our sales in automotive based on the 8 platforms that we secured last year, the 8 new platforms.

So at this point, we're not providing guidance for 2021. The market does seem to be showing some stability now, but there's still a lot of uncertainty associated with the pandemic. And as our crystal ball becomes a little clearer, we'll give you a better view of that.

Okay. And then just one final one from me. When you look at, I guess, the outlook and things clearly -- you have greater visibility than you did 3 months ago. And pre-COVID, the company kind of articulated a view to have a dividend policy. Can you update your thoughts on that, on when or what you would kind of need to see within your business? I mean, obviously, the free cash flow this year is pretty proof positive that the business could support some level of dividend. So just curious to get your thoughts on that. And congrats on a good quarter.

Well, first of all, thank you very much for the congrats on the quarter. In regards to cash allocation, here in the short term, we did take advantage of the CARES Act. So we have a fairly significant obligation to the pension this quarter. And then right behind that, there are really 2 things on our radar stream.

One, as the markets recover, that is going to require working capital, right? So working capital has been a source of cash here in recent months. It may become a consumer of cash going into next year. And we still have some uncertainty with what's going to happen with the pandemic and the recovery of our various end markets. So I think it's a little -- maybe a little premature for us to think about capital allocation beyond that. But it's certainly a discussion that we have as a management team along with our Board.

Our next question comes from Chris Terry with Deutsche Bank.

Tim and Erick, and well done on a solid quarter. I had a few questions I wanted to run through. Maybe starting on Slide 10, just on the end markets, if I can. Just running through some of the segments. Maybe with aerospace, you touched on it on the previous -- with the previous questions. But I wondered if you could give indications of when you think the bottom might form in that market, sort of hearing late 1Q '21 from some other companies. Just some views there, if you could, please?

Well, I would -- my opinion is we're kind of at the bottom now. The build rates are pretty low. Different suppliers have different spots in the supply chain. And so whether it's going to be at this level for another 3 quarters -- 2 quarters, 3 quarters, 4 quarters, it's a little hard to ascertain at this point. Because our customers are still waiting to see when passengers are going to get back into airplanes, which will allow some of the airlines to start taking aircraft. And of course, the certification of the 737 MAX is showing promise, but it's not done yet.

So I think that we're probably at the bottom of the cycle as we come out of the second half of this year. I don't expect to see much change in the first half. And we'll see how that market recovers going into the second half of next year.

Okay. And then just for the ground transportation business, can you remind us what the mix is there with commercial transportation? How much of the mix that is, just thinking about your comments on how the 4Q shapes up?

Yes. I would say, typically, about 70% of our sales in ground transportation are automotive, 30% commercial transportation. We see those markets evolving well. I mean the projection for automotive, and then were predominantly North American, going into 2021 is continuing to improve.

If you follow what IHS Markit and [wards] are saying, and also the commercial transportation segment, Class 8 trucks, they declined. I think the projection is just over 40% year-on-year in 2019. And the projection -- the external projections right now are for a 40% recovery going into 2021. So hopefully, those projections hold true.

Okay. And the last one, just on Slide 10. So you used the word tepid relating to building and construction. That's you said non-res construction that's European, is that correct?

So in the building and construction segment, when you think about us, about 70% of our sales are in North America, the balance are in Europe. So we're more impacted by what's happening in North America. Again, if you look at firms like IHS Markit and the order activity that we've seen in nonresidential, we've seen an 8% to 10% kind of a decline in the market in 2019. And it's projected to have a similar profile going from 2020 into 2021.

Okay. And just a couple of final ones from me. Just coming back to the Tennessee questioning. I appreciate there's a mix and there's a qualification period, and you've got to work out exactly which end markets you're going to sell that into. But when do you think it might be roughly that you get your first sales? Is that second quarter '21? Or is it just too early to tell?

So are you being specific to the packaging opportunity? Because we're [ramping our] orders in automotive and industrial against that capacity.

No, I'm just talking about the whole picture, any of the end markets.

Yes. Well, we saw 2019 types of volumes in the third quarter of -- in these results already and we've picked up share there. So I think you would start to see the incremental growth in automotive flowing through in 2021. The capacity that we're bringing online in Tennessee is ramping up through this quarter and we're securing orders against it into 2021. So if we don't see a pandemic-related disruption, I think we should see some growth there.

On the packaging opportunity, there is a qualification period. So first, we have to line up commercial commitments. And then typically, you're looking at about a 6-month kind of a period to go through the qualification cycles to get to, what I would call, ramp-up volumes. So that's why I alluded to probably second half revenue next year, but not full up.

Okay. And then the last one from me, just thinking about the business and having gone through the worst of 2Q and shaping up, you've obviously given 2020 guidance. Would you expect with your full year 2020 numbers early next year to then provide -- go back to regular sort of annual guidance? Or how are you thinking about the sort of shorter-term and medium-term estimates you provide to the market?

We're not going to commit in this call to providing 2021 guidance. But I think there's still some uncertainty, in particular with the pandemic and cases rising. But if we have a good line of sight as to what's happening with the economy, then our intention certainly would be to provide guidance as soon as we feel confident that we can provide solid guidance.

Our next question comes from Josh Sullivan with The Benchmark Company.

Just with regard to your approach to the can sheet market and the interest you're seeing, do you feel you're going to go after market share? Do you plan to be disruptive to get a presence? Or just what are you thinking about how you guys are going to go-to-market there?

Got it. I mean, first of all, I think we've had a lot of interest from the market. So I think the market is going to welcome us back. But certainly, as I stated earlier, we've worked very hard to improve the margin profile of this business. And that market is growing. So I think that we're going to make sure that we find the right opportunities. It's not that we have a tremendous amount of capacity vis-à-vis the size of that market. So I don't know why us entering back into it would be disruptive.

Got it. And then, I mean, just along that same line. I mean I know you're not giving guidance on the working capital for next year, but as far as loading those lines, is that going to be material? Or do you think versus the automotive opportunity or as you expand capacity there? What do you think about working capital as it relates to the can sheet opportunity?

Well, I think it will be a ramp-up. We're coming from a standing start. And we do have to go through that qualification phase. And at this point, it's hard to say how many different customers we'll be balancing through that because we haven't really gotten that far into the conversation. So I think it will be a balance between the ramp-up and the terms that we have with our customers and the terms that we secure with suppliers, which is all kind of a white sheet of paper at the moment.

Got it. And then from the interest that you've seen, has there been any indication, there's demand for -- there's a lot of talk about water converting to aluminum cans. Are you seeing interest from the customers at that level at this point?

Yes, absolutely. Absolutely. I mean it appears to us to be a buoyant market.

Okay. And then just one on the trucking market. How should we think about the Arconic's exposure, the difference between kind of cab and trailer? And any dynamics in either one of those markets that you think is interesting.

I think I might want to do a little bit of research on that. I have an impression that we're relatively balanced between the 2. But let us do a little homework on that and we'll -- I'll have Shane get back to you on it.

Got it. And then just one last one. Any updates on Grenfell at this point? And is there anything to say along those lines?

I guess the big news last quarter was the fact that the Behrens case in the U.S. got dismissed. The court here rule that the proper venue was back in the U.K. So from a litigation point of view, I would say that was of relevance. On the other side of it, the inquiry is continuing to move forward. I think as we listen to the testimony and assess what's happening there, it validates a lot of the things that we've communicated in the past, which are, first of all, we are very deep in a relatively complicated supply chain.

I think a lot of what's happened in the inquiry shows that we don't really control the specifications, the regulatory regime or the testing of those products. And that some of the players that have been involved in Grenfell may have lacked the qualifications or the expertise to make the decisions that were made. So we're continuing to support the inquiry. Again, would mention the fact that we do feel that we're adequately insured for a company of our scope and size. And we're going to continue on the processes working through the second phase of the inquiry, which at this point looks like it could stretch out into 2022.

I would now like to turn the call back over to Tim Myers for any closing remarks.

Okay. Well, again, I would like to thank everybody for joining us for our second quarterly analyst call. We're very excited about our journey as a new company and the bright future in front of us. So we look forward to providing you an update next quarter. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.