Howmet Aerospace Inc.

Good morning, ladies and gentlemen, and welcome to the HowMet Aerospace First Quarter 2021 results. My name is Shelby and I'll 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, Vice President of Investor Relations. Please proceed.

Thank you, Shelby. Good morning and welcome to the HowMet Aerospace First Quarter 2021 results conference call. I'm joined by John Plant, Executive Chairman and Co-Chief Executive Officer, Tolga Ohl, Co-Chief Executive Officer, and Ken Giacobi, Executive Vice President and Chief Financial Officer. After comments by John, Tolga, and Ken, 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 filing. In addition, we've included some non-GAAP financial measures in our discussion. Reconciliation 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.

Thanks, BT. Good morning and welcome to the call. Similar to last quarter, I will give an overview of Hammett's first quarter performance, then pass to Tolga, who will talk to our markets, and then Ken will provide further financial detail. I'll return to the call to talk to guidance for the second quarter and the full year 2021. Please move to slide four. Let me start with some commentary on the first quarter. Revenue was $1.2 billion and in line with expectations. while EBITDA, EBITDA margin, and earnings per share exceeded expectations. Adjusted EBITDA was $275 million, and adjusted EBITDA margin was a healthy 22.7%, similar to the fourth quarter of 2020. Earnings per share, excluding special items, was 22 cents, which was ahead of expectations and ahead of Q4 2020. Historically, Q1 has been a significant cash outflow for the company. However, with improved margins and enhanced working capital control, the outcome has noticeably improved. This will be followed by cash generation in quarters two, three, and four. Lastly, in the first quarter, we focused on deleveraging, completing the early redemption of the 2021 notes at par for approximately $360 million of cash and reusing cash in hand. The resulting quarter in cash balance is 1.24 billion. Moreover, on May 3rd, we completed the early redemption of the $476 million of notes due in 2022 for approximately 500 million, inclusive of the accrued interest and fees. Both transactions were completed with cash on hand. Year to date, we have reduced debt by approximately 840 million, which reduces the 2021 interest expense by $38 million and $47 million on a run rate basis. In addition, in 2022, there'll be a carryover interest savings of $10 million. Now let's move to markets and performance on slide five. Q1 revenue was the same as the Q2 to Q4 2020 average and in line with our expectations. On a year-over-year basis, commercial aerospace was down 52%. driven by the lingering effects of customer interjections and fundamentally lower bills, starting with the Boeing MAX. Commercial aerospace continues to represent 40% of the total revenue of the company, compared to pre-COVID levels of 60%. The commercial aerospace decline is partially offset by continued strength in our other markets. Defense aerospace was up 12% year over year, driven by the Joint Strike Fighter, new builds and spares. The industrial gas turbine business continues to grow and was up 35% year over year, also driven by new builds and spares. Lastly, the commercial transportation business was up 15% year over year, despite customer supply chain constraints. Although truck demand is very strong, our customers manage through supply chain issues with several commodities, which are in short supply, including semiconductors, tires, and glass, to name just a few. We are working closely with our customers to meet demand, which is showing some interruptions. At the bottom of the slide, you can see the progress on price, cost reduction, and cash management. Price increases are up year over year and continue to be in line with expectations. Structural cost reductions are also in line with expectations with a $61 million year over year benefit. Segment decremental margins continue to be good at 27%, driven by price variable cost flexing and fixed cost management. CapEx was $55 million in the quarter and continues to be less than depreciation and amortization, resulting in a net source of cash. Adjusted EBITDA margin for the quarter was 22.7% and consistent with Q4 2020 on approximately $30 million of less revenue. Q1 revenue at $1.2 billion was consistent with the Q2 to Q4 2020 average. You can see the benefit of our actions since the start of the pandemic with a 300 basis point EBITDA margin expansion, while revenue was approximately $45 million less than the same period, so good year-on-year performance. Now let me turn it over to Tolga to give an overview of the markets.

Thank you, John. Please move to slide seven. Now to year-over-year revenue performance. Q1 revenue was down 26% driven by commercial aerospace, which continues to represent approximately 40% of total revenue in the quarter. Commercial aerospace was down 52% year-over-year, in line with our projections, as we continue to see customer inventory corrections as expected. Defense aerospace continues to grow and was up 12% in Q1, as we are on a diverse set of programs, with the Joint Strike Fighter being approximately 40% of the total defense business. Commercial transportation, which impacts both the porch wheels and fastening system segments, was up 15% year-over-year, with a very strong market demand. the industrial and other markets, which consist of IGT, oil and gas, and general industrial, was up 1%. IGT, which makes up approximately 45% of this market, continues to be strong and was up a healthy 35% year over year. I will now turn it over to Ken to give a more detailed view of the financials.

Thank you, Tolga, and good morning, everyone. Now let's move to slide eight for the segment results. As expected, engine products year-over-year revenue was down 32 percent in the first quarter. Commercial aerospace was down 55 percent, driven by customer inventory corrections and reduced demand for spares. Commercial aerospace was partially offset by a year-over-year increase of 18 percent in defense aerospace and a 35 percent increase in IGT. IGT continues to be strong, and we will continue to make investments in this business as demand has been increasing for cleaner energy. Decremental margins for engines were 26 percent for the quarter, as segment operating profit margin was approximately 19 percent. In the appendix of the presentation, we have provided a schedule which shows each segment's decremental margins for Q3 2020 through Q1 2021. Now let's move to fastening systems on slide nine. Also as expected, fastening systems year over year revenue was down 29% in the first quarter. Commercial aerospace was down 42%. Like the engine segment, we continue to experience inventory corrections in the commercial aerospace market. The industrial and commercial transportation markets were down 2% year over year but up 19 percent sequentially. Decremental margins for fastening systems were 45 percent for the first quarter as furloughed workers returned to work. Please move to slide 10 to review engineered structures. For engineered structures, year-over-year revenue was down 36 percent in the first quarter. Commercial aerospace was down 57 percent, driven by customer inventory corrections, and production declines for the 787 and 737 MAX. Commercial aerospace was partially offset by a 10% year-over-year increase in defense aerospace. Decremental margins for engineered structures were 18% for the quarter compared to 24% in Q4. Lastly, please move to slide 11 for forged wheels. Forged wheels revenue increased 19% year-over-year despite customer supply chain constraints. Forged wheels revenue grew faster than the overall market in part due to how much new innovative 39 pound wheel. Segment operating profit margin was another record at almost 31% as year over year incremental margins were 56%. The improved margin was driven by continued cost management and maximizing production in low cost countries. Please move to slide 12. We continue to focus on improving our capital structure and liquidity. First, we completed two early redemptions of our bonds. The first transaction was on January 15th. We used cash on hand to complete the early redemption at par of the 2021 bonds due in April 2021. By paying down the bonds three months early at no additional cost, we saved $5 million of interest. The second transaction was earlier this week on May 3rd. We used cash on hand to complete the early redemption of the bonds that are due in February 2022. The bonds were redeemed at a cost of approximately 500 million. As a result, the interest costs have been reduced by approximately $47 million year over year. Moreover, as John has mentioned, in 2022, we'll get an incremental $10 million of carryover interest savings. Gross debt stands at $4.2 billion. All debt is unsecured, and the next maturity is in 2024. Finally, our $1 billion revolver remains undrawn. Before I turn it back to John to discuss the 2021 guidance, I would point out that there's a slide in the appendix that covers special items in the quarter. Special items for the quarter were charged for approximately $16 million after tax, and the charge was primarily related to three items. First, we had fire costs at two of our plants of $7 million. Second, we had an impairment of assets associated with an agreement to sell a small manufacturing business in France of $4 million. And third, we had a pension settlement charge in the U.S. of $3 million. Finally, we continue to work on reducing legacy liabilities and improving asset returns for the pension plan. I would highlight two significant items. First, we announced a planned administration change of certain prescription drug benefits that is expected to reduce costs and reduce our OPEB liability by approximately 20% or $39 million. Second, we are benefiting from pension asset investment returns of over 13% that we realized in 2020. The combination of the asset returns and the liability reduction have decreased annual pension and OPEB expense by 37% or $13 million annually. So now let me turn it back over to John.

Thanks, Ken. Let me move to slide 13 for the Q2 and annual guidance. First, the good news is that we're another quarter along towards the recovery of the commercial aerospace market. This will go a long way in helping profitability and complementing the growth and solidity of the defense aerospace, IGT, and commercial transportation markets. There are a series of leading indicators that are showing very well for us. Numbers of flight inquiries, bookings of flights, hotels, and car rentals. And we also note the increase in USA TSA numbers, flight takeoffs, particularly in the US and China. Europe remains somewhat muted given the effects of the pandemic and slow implementation of COVID vaccines. All of this should begin to help airlines with aircraft production, particularly of narrow-body aircraft. We note that the demand for wide-body aircraft probably may not reappear until mid-2022 or even into 2023. We see at the end of the second quarter as to be an inflection point to the beginnings of production increases for Hamet in the second half of the year with the exact precise timing yet to be determined. We are planning to bring back from furlough or recruit several hundred workers during the next two quarters to train and retrain to be ready for this demand just in the same effective way that we did in the third quarter of 2020 for the commercial wheels business. My expectation is that these costs, plus costs of recommencing mothball plant and equipment, will hold EBITDA margins at around the 22% levels until further stabilization is reached. We also know that there is an effect on the commercial transportation market of part shortages, particularly semiconductors, which is reducing shifts and production work in the second quarter. As noted earlier today, the timing for cash generation has been a focus for us, and instead of the normal large Q1 outflow, which then has to be subsequently overcome, the first quarter was essentially breakeven, and all subsequent quarters are expected to be cash generative. Specifically, the guidance for Q2, sales at 1.2 billion plus or minus 30 million, EBITDA of 265 million plus or minus 5 million, EBITDA margin of 22.1% plus or minus 10 basis points and earnings per share of 20 cents plus or minus a cent. And for the year, sales at 5.1 billion plus 100 million minus 50. EBITDA baseline increases, the EBITDA baseline increases by 50 million to 1.15 billion with a range of plus 50 to minus 25. EBITDA margin baseline is now increased to 22.5%, plus 60 basis points and minus 20 basis points in terms of a range. The earnings per share baseline increases to 95 cents, a significant increase over prior guidance, and with a range of plus 7 cents to minus 4 cents. And the cash flow baseline increased to 425 million, plus or minus 30 million. Moving to the right-hand side of the slide, We note that the second half revenue is expected to be up 12% for the total company, driven by the increases in commercial aerospace, defense, and IGT. Price increases to be greater than 2020. Cost reduction carryover, approximately $100 million, and pension and OPA contributions of $160 million. We continue to evaluate the impacts of the American Rescue Plan Act upon pension contributions, and we'll determine those later in the year. CapEx is expected to be in the range of $200 to $220 million compared to depreciation and amortization of $270 million. And adjusted free cash flow conversion is about 100% of net income. We plan to reinstate the quarterly dividend of two cents per share of common stock in the third quarter of 2021, pending the final board approval. Now please move to slide 14. To summarize, Q1 was a healthy start to the year, and liquidity of the company continues to be strong. The guidance provided is raised from that given in early February and reflects our first quarter profitability strength, the redemption of bonds for cash, the institution of the dividend, all of which provide value to shareholders. More broadly, the focus is now turning to the beginning of the revenue recovery in the second half, commencing with commercial aerospace. and the run rate of both revenues and margins as we exit 2021 and move into 2022, where we see the prospect of further leading indicator improvements. Thank you, and now we'll take your questions.

Thank you. We will now begin the question and answer session. As a reminder, press star 1 to be placed in the Q&A queue. Press pound if you would like to be removed from the queue. We request that you limit yourself to one question. Our first question comes from Seth Seifman of JP Morgan.

Thanks very much and good morning. Good morning. Just looking at the different segments and sort of where Arrow came down, I guess if you think about where you are relative to the bottom, it sounds like obviously there's increases coming for the second half, but For fasteners, do you feel like you have visibility with regard to what the level of destocking is and what we've seen in Q1 is kind of close to the bottom? And then I guess similarly for structures as well.

Yes, the way I think about it is in terms of sequence of the transition. with the end of the second quarter being the transition from basically the current holding pattern and really as a result of the reduced demand and then the correction of the inventory to our customers. And already we know that commercial transportation is going well, subject to those, I'll say, interruptions because of supply shortages. The big turn comes in commercial aerospace, we believe, at the end of the second quarter. And I think that's going to be led by the engines business in terms of the first uptick in demand and supported by structures, with fasteners probably still being a little bit behind that by another quarter or so. So my picture... for the year is that commercial aerospace, I think year on year, we're gonna see that segment up 15 to 20% in the third quarter compared to second. Second quarter will be a reduced decrement compared to what we've seen, the 52% currently. And then as that increase that we see as the turn occurs, It will be led by engines, supported by structures, with fasteners following maybe fourth quarter or even at the end of the year, just as those inventories are absorbed with them with what we think will be a fairly significant snapback in the first part of 2022. So that gives the sequence that I expect, both for the commercial aerospace markets and how it affects each of our segments during the next three quarters.

Great. Thanks. That's very helpful. And then just as a quick follow-up, can you talk about your level of visibility on the 737 MAX versus, I guess, when we were on the call three months ago?

Yeah. I mean, we think that it's going to continue in line with Boeing's build rate, which is currently at 7, rising to 14 in the late summer. and then into the, I think, 22 per month range as we start 2022 and then up to 30 a month. So it seems set well at the moment. We're still, as I said on the previous call, have been supplying effectively below the seven rate per month in aggregate. Obviously, different levels go into different product lines, but we are expecting to see being in line with the ship set values to equal production and then the lift of production as we go forward. So that's all built into what we think will be that 20% increase in commercial aero commencing in the third quarter. And also supported by the increase in production in narrow body for the A320 for Airbus as well.

Great. Thanks very much.

Thank you.

Your next question is from Robert Spengarn of Credit Suisse.

Hi, good morning. John, just following up on Seth's question there on the MAX, maybe just to ask it slightly differently, but with Boeing or other suppliers talking about 160 aircraft being produced in 2021, can you tell us where you are relative to that number

given the inventories in this already in the supply chain and so on in other words how much production do you need to do to match to their 160. yeah i think we're closer to the uh to the 120 level so let's say 25 below that number for the year is how we see it with uh say that inflection point coming uh you know a significant inflection point coming uh as we start q3 for which If we didn't have confidence, we would not be going through the recruitment and bringing back people in our second quarter, starting the second quarter, and seeing significant employment increases during the next two quarters.

Okay. And just on that, I guess on the other question that Seth asked, and you talked about the second half improvement earlier led by engines, when will you actually know? How far in advance of the shop visits – Are they scheduled and are parts ordered? And what are the lead times for structures and fasteners as well? So in other words, when will you know what your second half looks like?

Okay. We have already begun to receive order intake now from our customers, particularly on the engine side. with letters and commitments and I'll say schedule releases and EDI transmission. So what we're seeing is all the things which have been stated appear to be materializing as we speak. So even in the last week, we received letters from, let's say, Safran or CFM and meetings with GE Aviation, et cetera. it's gone from what we think may happen to, I would say, a lot more confidence. And the question is one of just the final degree to be determined. So there's other stuff which has to fill in, but it's an increasing level of confidence compared to three months ago.

And is it different for fasteners? It's much more book and burn, so the lead times are shorter and you won't yet have a firm view on that?

Yeah, we operate with some of our customers on min-max systems, and so the averages take some time to re-average. So at the moment, as we were re-averaging down on those min-max systems, it takes time for it to feed through, and then it'll then snap back again more significantly to the upside. But with that, I'd say maybe a two-quarter delay for that segment is... is what I see as the most likely scenario. So that's why I said I think that FASTAs will be a quarter or two behind what we're seeing elsewhere.

Right, right. Well, thank you, John.

Thank you.

Your next question is from David Strauss of Barclays.

Good morning. Hey, David. Hey, John. John, can you touch on what an inflationary environment might mean for your business thinking about it from a pricing and raw material standpoint? As you net all of it, do you think an inflationary environment potentially going forward would be a net positive for the business?

To the next question.

few years I don't see it significant either way because material inflation will essentially be passed through to our customers by the escalator agreements that we have and therefore we're talking more about what would be the impacts of labor inflation labor for labor inflation for some significant parts of our businesses those are already set for the next I'll say two to four years depending upon the various labor agreements that we have in place. But obviously some of the workforce, it's an annual event. And then it's up for us to gain the productivity that we seek to gain each year to offset that labor inflation. So I'm in an inflationary environment. I don't expect that to be a problem for us. And indeed with our custom agreements that we have. Also, some of that we see is being taken care of within the bandwidth of the LTA negotiations that we've been undergoing.

Okay. As a follow-up on the capital deployment front, I know you've taken out a fair amount of debt, reinstituting the dividend, but it still looks like, you know, way you're tracking your, you know, your cash balance will be well over a billion dollars at year end without doing anything else. So, you know, now that you don't have much it looks like to do on the debt side of things, how are you thinking about, you know, share or purchase from here? Yeah.

So we described the potential for capital allocation strategies in some detail in the last call. In fact, I think I called it the smorgasbord of opportunity to do those things. What we considered as the first order of battle was to deal with the next couple of maturities of our bonds. We did that easily from cash on hand, and that obviously produces a lower interest burden for the company. a lower gross debt, and therefore it's also seen some improvement from the rating agencies. So that's been, I think, a good step for us. And now the next thing we have to address at some point, but I don't think just now, is the October 2024 at some point. So that's three and a half years away in terms of bonds. So I'd say that part of the balance sheet is dealt with. We felt confident. in the cash flows of the business to reinstate the dividend and that's an expression of our confidence and again part of our plan to return money to shareholders. And then the other two aspects that we have to consider is what about share repurchase and also to what degree, if anything, do we participate in any M&A activity which may materialize over the next, say, year or so as the commercial aerospace market solidifies into, let's say, skylines and a confidence level that we all can believe in. Clearly, that's beginning to happen, given what I said about the infection point that we see coming And I guess we're in that position, David, that you said, is that if all things work out as planned, is that we'll have a very significant cash balance at the end of the year and have the ability to make other decisions in capital deployment in the future. So I think all is well in terms of, let's say, the whole capital allocation strategy that we've set down for ourselves in the recent months.

All right. Thanks very much, John. Thank you.

As a reminder, we do ask that you limit yourself to one question. To ask a question, press star one. Your next question is from Carter Copeland of Malleus Research.

One question. David's in trouble. I guess I got to stick to one, right, John?

Well, you'd never do anyway, Carter. It's one of these aspiration things, but you go for the multiple five-part question.

That's fine. I'll do one one-parter. Obviously, the shift in focus is moving to going back up in production and then bringing people back from furlough training and the like, but one of the things that we used to talk about before this all went down was Whether that's, you know, first pass yields or roll throughput yields in some of those key spots in your facilities. When you look at yields in production facilities today versus where those were, you know, when we were talking about shortages and engine OEM factories, you know, two years ago or so. How does that stand today, and how does that play into your confidence and conviction around going up without hiccups? Okay.

When I look at the last couple of years in our aerospace business, I think one of the untold stories is the improvement in delivery performance and our quality levels, where it's been reducing arrears, whether it's been parts per million defects or even internal scrap in our manufacturing plants. And yields have clearly and definitely improved both for our defense aerospace and commercial aerospace segments. And so it's all good. I really want to protect reputation and ability with our customers and really seek to do that by bringing labor back and training it. So I think the things we did last year in the third quarter for our wheels business have paid off handsomely in terms of our ability to increase production with excellent quality and deliver these very significant incremental margins that we've seen in that wheels business. And so rather than, I think, stumble through this We're trying to be ahead of it, being planful on labor and recognizing that there is a training time or retraining for people to be able to deliver at the yields that we currently have and hopefully continue to improve them. So that's why I want to plan carefully through the next couple of quarters because we are talking, you know, very significant increase in labor. Obviously, we'll be tailoring it to and trimming it exactly as we see to go through it. But I really want to be ahead of this thing and not chasing it and having yield issues and arrears bill and all the consequences that that puts upon the business. So, you know, if it costs us... let's say a couple of 200 or 300 basis points or whatever margin for a quarter or so, I think that's money really well spent because it's going to be what's the margin as we exit this year and how do we perform into 2022. So really trying to be planful about the next phase of our business and not just react to it after the event and that you seem to be scrambling. So that's all part of the value we bring to, I think, to the industry and to our customers. Great. Thank you, John. Thank you.

Your next question is from Gotham Common of Cowan.

Hey, guys.

Hey, Gotham.

Forgive a two-question ask, but first I was curious about lead time discussions with customers. Are you having those? I imagine it's chicken or egg if the lead times are short, they don't have the urgency to place orders. But then we have, you know, as the order books pick up, the lead times extend and there's a cueing effect. I mean, do you think that plays out over the next year and a half where we see kind of a bullwhip effect? I know you just talked about the second half being above the first half, but I mean, could we see kind of outsized growth as we move in? Or do you think it will be just feathered in gradually? in terms of the recovery? May I have a follow-up?

Yeah. The way I see it at the moment is everybody's aware there's plenty of metal in the system, and that gives people, I'll say, the ability to drop in a little bit later than would have been normal. If you looked at the demand levels of 2019, where lead times were, let's say, to get metal for some of our products was... was over 12 months. And so we need to recognize the situation we're all in with carrying some trapped inventory, and we still have trapped inventory, which we plan to liquidate during the balance of 2021. And it's really interesting because when we look at our inventory levels, it's been the most of the year. One of the recent discussions in our quarterly review has been To what degree do we hold on to some of those in the latter part of the year? Just so again, we're in a really strong position as we enter 2022 with what we think will be a fairly strong year for us in terms of demand. So where we find ourselves at the moment is our customers know that there's metal in the system and know the strapped inventory. and so we're more on that three to six months of lead times and people have been holding off and we've been seeing that fill in very significantly in the last few weeks and then obviously it's like everything's going to depend but i do see if we look at six months from now then those lead times are going to be significantly increased and therefore orders are going to have to be placed otherwise some of the production increases on narrow bodies in particular that the airbus and boeing are looking at for 2022 and certainly later in 2022 i mean they won't occur unless orders are placed uh because uh the the availability of that inventory and uh and the current uh excess of metals has been in our system for the last year just won't be there that is helpful and then

I just wanted to ask, you know, last quarter we talked about how the Boeing schedule was a little bit more in flux than the Airbus production schedule, but we heard Spirit yesterday talk about nine to 10 A350s coming out of the plan this year and next. I was curious, how stable is it now on the Airbus side? Did you see much in the way of changes over the past three months?

No, we've seen no changes on Airbus. It's been solid. Um, solid all the way through, meeting what they've said, reinforcing what they've said, issuing of both skyline and production schedules. So no changes from Airbus at all. And in fact, in the more recent past, we have not seen changes from Boeing either, which in the last year or so tend to be towards the downside. Again, none of that's been occurring.

Terrific. Thank you, guys.

Thank you.

Your next question is from Robert Stallard of Vertical Research.

Thanks so much. Good morning. Hey, Rob. John, you were saying some pretty positive things about what we could be seeing in 2022 and beyond. But I was wondering, as we feed this volume through the system, what your thoughts might be on incremental margins as volumes recover? Can we say, for example, take your experience in wheels and apply that to aerospace?

I think obviously we also have a different profile to our energy business, to our structures business, so it's got to be segment by segment. But essentially, I am on record having said that we expect fairly strong incrementals as we go forward because in the way that we managed through this crisis, you can see that compared to our normal decrementals of let's call it 40%, We've been getting those into the 20s and have been quite pleased with both the way we've managed our structural cost takeouts and the variable costs. It's our job not to allow those more fixed costs to creep back into the system and also indeed try to be sticky on those variable costs as we go back up the production volume curve. So we are expecting healthy incremental margins and part of it is also getting that labor in place at the right time in the in you know trained and ready uh as i tried to describe on a couple of questions ago so we don't stumble our way through this it's uh you know planfully uh you know uh set out um and and accepting it as if it cost us uh you know 200, 300 basis points of margin, not 200 basis points, 20 or 30 basis points of margin. So I think I just calmed it to like just over 22% for second quarter, just to take out, I'd rather bring the labour in and then look forward to those healthy incrementals going forward.

That's helpful. And just a quick follow-up, that margin impact from extra labour, that's baked into your 2021 guidance? Yes, it is. Yeah, that's great. Thank you very much.

Your next question is from Noah Pompano of Goldman Sachs.

Hi. Good morning, everyone. John, having 2Q revenue be down year over year a little bit, despite that lapping, you know, a largely pandemic-impacted quarter, the low end of the 2Q guide being down a little sequentially, That's pretty surprising given your mix. I kind of expect that in aerospace original equipment as that's a longer cycle, but aerospace aftermarket, defense, truck, industrial would think would all be up year over year and sequentially. Is there just more destocking in aerospace original equipment or a longer time for you to link up to Boeing and Airbus than maybe I had appreciated and So if you could help me understand that and maybe just get specific on how much inventory destock left and anywhere where you're not yet linked up to Boeing and Airbus would be really helpful.

So Q2 of 2020, our customers were not rapid to change some of the production requirements and that became more of a feature in the third quarter as you know from last year. So when we look at Q2 this year, because some of the schedules had not been reduced that significantly, although they were reduced and plants were closed down, it's a very, I'll call, turbulent quarter to comp against. And so the way I look at it is more on a sequential basis where I'm thinking that, well, commercial area was down 52%. It's going to be down a lot less than that. in terms of bill comparisons. And then the only other muted effect I'm thinking about at the moment is we are careful in terms of the commercial truck bill plans of our customers just because of those part shortages. So we are seeing shifts go down and customers take weeks out in the second quarter, and that's part of what we're guiding to as well. including that in our numbers as best as we can estimate it at this point in time. So it's a fairly, I'm going to say, careful assumption around the commercial transportation and business for the second quarter. At the same time, I'm going to say to you now the flip side of that is that order intake for us pretty much globally has been very healthy. And you've seen Class 8 truck and trailer sales orders at levels now which essentially secure the backlog for the balance of 2021 and most of the way through 2022 at the moment and so whereas before we were thinking we had a fairly good trajectory but it wasn't filled in totally now we just see that demand so strong so for example if you wanted to buy a new trailer to go with your truck at the moment If you ordered today, you wouldn't be thinking about taking delivery for 12 months that you're looking at into the second quarter of 2022. Now, that's how long lead times are in the commercial transportation industry. So that's really very healthy for us and really puts a very solid platform on the 2022, never mind the balance of this year. So I just want to give you the full picture around that. And so if we're cautious on delivery, I'll call supply-based interruptions of the truck build in the very short term, give the strength of the economy what we see by way of transportation and shipping of things. It's producing a very solid picture for backlog for the next, let's say, 18 months.

Okay, that's really helpful. Could you just put a little more detail around where, if anywhere, you're not yet linked up to Boeing and Airbus, or where in the business there's more inventory destock yet to occur?

Basically, we're still having inventory taken out in the second quarter. And then we think, and it's a best judgment, that basically that just essentially stops at the end of the second quarter. So we begin to see our structures business in the second half where we're planning for increased production We're seeing it's clearly I've already mentioned the the engine based business and the only business which is going to lag for again a couple of quarters behind that is going to be our Faster business where I think we're going to be close on I've balanced all inventories out by the maybe by the end of the third quarter It could strain to q4, but that's how we see to the moment so, you know different flavors for those different segments according to basically lead times and and trying to get ahead of it because I think one thing our customers don't want to have is some of the supply constraints, particularly around engine parts, which are really long lead time items ultimately. They're on the same constraints as we saw a couple of years ago.

Okay, thanks so much. Thank you.

Your next question is from Paritosh Misra of Barenburg.

Thank you, good morning. I'm guessing structures have the highest wide-body exposure and probably engines have the highest narrow-body exposure. Is that correct? And if any way you could further quantify it as to what's the wide-body versus narrow-body split in engine versus structures?

Certainly you're right in terms of basically our structures and our fastener business because of the composite content of wide-body aircraft. So if you're thinking Airbus A350s, as an example, or Boeing 787s, then with those composite structures, more titanium, a whole different suite of fasteners, then you can see that impact in the way we've laid out our revenue expectations. We're then, as we said, in an improving situation, somewhat behind the engine business. If you look at the traditional split going back to, you're going to have to go back to 2019 because it's been moving around and I'm struggling to keep all of these numbers in my head, but it's like a 60-40 narrow, maybe 55-45 narrow to wide body split that has shifted the same as Boeing and Airbus has shifted over the last 12 months. So to give you a picture on that, I think traditionally Boeing would have been 60 plus 40. It's flipped the other way and then it'll rebalance again in 2021 to some degree as the max gets back up and going. For engines, I actually don't keep the numbers in my head in terms of what the exact split is. Certainly in terms of what we see over the next 12, 18 months is that the narrow body engines So think LEAP 1As, LEAP 1Bs, and then obviously some of the aftermarket service business coming back, particularly for the CFM engines. What we see beginning to fill in at the back end of the year, then it's 2022. But I think that's the best I can do at this point. I can't exactly remember the split between wide and narrow for engine, and maybe we haven't given it.

This is great, John. I really appreciate all the details. And maybe as a follow-up, with regard to the industrial and other end market, and sorry if I missed this, but have you given out what sort of full-year growth rate is baked in your revenue guidance for the year?

For the growth rate for industrial markets, we haven't called that out, but just to give you a picture on that, the way we see us going through IGT, part of that the business is strong and getting stronger in fact and so at the moment we could sell everything we could make and so again we're working on raising production for that so that's I'll say fairly exciting. Oil and gas has been really very muted for the last year and the first half of this year but our thought process is that maybe the fourth quarter or certainly by the first quarter of next year We're thinking the oil and gas begins to show an improvement for us. We see Texas crude now at $66 plus or minus, and natural gas has moved up. Rig count has moved up significantly for the Gulf, and so all that's talking well to us in terms of the demand pattern as we work through inventories in oil and gas. And then general industrial is also strengthening, as we see, through the balance of... of 2021 again in the second half. So basically snapshot is IGT strong, oil and gas, you know, another quarter or two of weakness followed by some strength and then general industrial progressively getting better as well.

Great. Thank you very much. Thank you.

Your next question is from Phil Gibbs of KeyBank Capital.

Hey, good morning. It's Mike on for Phil. I wanted to get an update on price increases here. You're, you're getting good traction there and you expect to be greater than what you saw in, in 2020. But do you have visibility into when you expect the lion's share of those price increases to be seen in the year? Or should we expect fairly steady benefits quarter over quarter?

Um, I think we're going to see a fairly steady pattern throughout the year. Um, Most of our agreements have now been, in fact, I think all of our agreements have been renewed in terms of LTA for 21. We don't expect much by way of spot business unless something occurs in the back end of the year where demand is mismatched to a previous schedule. So that's the picture there. And I guess we'll be giving enhanced detail on that in our 10Q, which we plan to issue later today. But basically, everything's in order on that side compared to previous statements.

Okay, great. Thank you.

Thank you.

Your next question is from George Shapiro of Shapiro Research.

Yeah, John, it looks like sequentially commercial error was maybe down about 2%, if you could validate that. And if you could also break out what you think the mix is now between OEP and aftermarket, and then the improvement you're looking for in the second half, is that primarily OE or aftermarket? Thanks. Okay.

So benefits in the second half essentially is OE. There will be some modest improvement, I think, in commercial aero, but fairly modest. To give you a picture, if you go back 2019 at the reference point, 800 million of spares, which essentially is engine per service, bit on top of that in our fastener and structure business. It was 400 million of defense and industrial that grew, let's say, let's call it 20% over the last year or so. So healthy growth there. But for the most part, the spares or parts we sell through to the MRO shops through our customers It just dropped off a cliff in the second half of last year. So basically you see limited demand, but still a demand like commercial business jet and some very modest levels of business. And that picture through that is first half of this year is pretty much the same as the back half of last year. Compared to $100 million a quarter, I think more like $20 million a quarter. It can be below that, it can be just above it. It just depends on the quarter. It's just bouncing around with small numbers. In the second half of this year, I think we're expecting a modest lift, but not planning for anything significant in that shares business in the second half at this point. But let's say a little bit higher than that. Let's compare to the 20 million a quarter, thinking more like that 25 to 30 million a quarter. It doesn't move the needle for us at this point in time. I think it will in 22. So all the guidance I've given you is essentially in a balance of being the commercial aerospace part of our business is coming off the OE demand.

Okay, thank you very much. Thank you.

Your final question is from Noah Pompinac of Goldman Sachs.

I know you're back. I'm back. I swear to get more than one question in. I totally never violate the stick to one question rule, so I came back. Just kidding. John, the last time commercial aerospace was in a similar point in its cycle, sort of looking at the early part of the recovery, the fastener's market was just volatile. And it turned out that it was because of a lot of use of distributors and just kind of maybe a long path from the part OEM to the airplane OEM. It ended up just taking a long time to recover and was just kind of messy. And hearing you talk about the inventory D-stock maybe lasting a little longer there, maybe you could just help us get comfortable that the issues that drove that last time around are in the system again. And I guess, how worried are you about that in that business?

Well, I don't know as I can give you any more comfort takes. I wasn't thinking around when the last cycle really occurred. So I don't know. We've done a lot of efforts in our business to try to grow it, not just in OED demand, but also through distribution. And at the moment, I think it's good and clear that we've called it out, being probably a couple of quarters behind where we think some of the other parts of our commercial aerospace business are beginning to respond. And so I think that's a fairly thought-through and quality view of the market at this point. I recognize that we do have extended chains, so for example, part of our, if you just take the North American business, and so I'll just confine my comments to that. Yes, we'll supply directly to Boeing, so that's part of the demand. We'll also supply into, if they come into spirit, and therefore it's another step in the supply chain. What we're clear on is that we've been supplying at the low rate for some time. We've not trying to be optimistic in saying we're going to see that recovery in Q3 or Q4. We've been saying it's a couple of quarters behind and do think that it will begin to recover or maybe even maybe it's the Bulwark comment that Gotham used or is it Snapback? I think we're going to see significant demand increases for our fastener business in 2022. That's the best I can guide you at this point in time without the perfect visibility that I guess we'd all like but we don't have.

Yeah. Okay. That's helpful. And just one more while I'm on here. The cost you've referred to to sort of prepare to have growth come back, hiring, et cetera, is there any range of an absolute dollar number you could put on that just so we could then compare that to the cost out number you've had?

Um, well, it's of course it's the cost out number is essentially, uh, more of a structural cost takeout rather than the variable cost side. The cost of the employment that I'm talking about bringing into the business is essentially in our variable cost structure. So you need to understand it's completely different parts of bucketing in the P and L. Uh, and I just consider the like direct labor. We flex in accordance with the production requirements. To give you a picture for our second quarter, then we're thinking of, let's say, around 400 people, could be 500 people to bring into the business during April, May, and June to prepare ourselves for what we've talked about and recognizing that many of those hours won't be necessarily that productive as we go through. So you can begin to work out if you just apply an average direct labor cost per employee for that sort of numbers and average them through a quarter, you can see the sort of costs that we're talking about that's been there. But I believe that that's essential for us to be able to then achieve the yields, the incremental margins that we've talked about, which is really what this business is all about and the way we should think about it.

So I should just think of it as your structural cost outnumber you've spoken to, then obviously variable cost tethered to revenue, but that you're going to have some variable cost lead the revenue recovery as you anticipate it.

Exactly. So production works will be taken on. We're preparing to go through waxing and I'll say prep for slurry tanks and then de-moss balling our casting machines and lines so that all of that occurs so we can take the production as we go into Q3 and Q4. Okay.

Thanks for taking my questions.

Okay. Thank you very much, and I think that concludes today, but if I'll leave the operator to conclude it for us.

We have no further questions in queue. Ladies and gentlemen, thank you all for your participation. This concludes today's conference call. You may now disconnect.