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spk02: Good day and welcome to the third quarter 2023 HowMet Aerospace Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Paul Luther, Vice President of Investor Relations. Please go ahead.
spk09: Thank you, Betsy. Good morning and welcome to the Hamad Aerospace Third Quarter 2023 Results Conference Call. I'm joined by John Plant, Executive Chairman and Chief Executive Officer, and Ken Giacobi, Executive Vice President and Chief Financial Officer. After comments by John 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 filings. In today's presentation, references to EBITDA, operating income, and EPS mean adjusted EBITDA excluding special items, adjusted operating income excluding special items, and adjusted EPS excluding special items. These measures are among the non-GAAP financial measures that we've included 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. And with that, I'd like to turn the call over to John.
spk07: Thanks, PT, and welcome, everybody, to the Q3 earnings call. The results for the third quarter were solid in all respects. and exceeded the guidance given in August, which itself was a further increase on that provided in May and February. Sales of 1.658 billion, increase of 16% year-over-year. EBITDA was 382 million, an increase of 18%. EBITDA margin increased to a headline rate of 23%. Margin rate improvements reflect the continuing good work in all segments. I would like to note fasteners with another sequential quarterly improvement of 230 basis points, and additionally the structure segment had a 320 basis points recovery from the Q2 rate. How much year-over-year revenue increase flowed through to incremental EBITDA margin at a rate of 28%, which was in line with guidance. Operating income increased by 22% year-over-year, and operating income margin was 19%. Continued top-line growth and healthy margins generated a earnings per share increase of 28%. Free cash flow was healthy at 132 million and helped drive shareholder-friendly actions, including gross debt retirement of 200 million, share buyback of 25 million. Lastly, we also announced a 25% increase in the dividend in Q4 on top of last year's 50% increase. Having provided this top level summary, I'll pass the call to Ken to provide further details of revenue by end market and the results by business segment.
spk13: Thank you, John. Let's move to slide five. All markets continue to be healthy with revenue in the third quarter up 16% year over year and 1% sequentially. As expected, Sequential revenue growth was impacted by normal third quarter seasonality. Commercial aerospace increased 23% year over year, driven by all three aerospace segments. Commercial aerospace has grown for 10 consecutive quarters and stands at 49% of total revenue. Commercial aerospace growth continues to be robust, supported by demand for new, more fuel-efficient aircraft, as well as increased spares demand. Defense aerospace was up 13% year-over-year, driven by the F-35 and legacy fighter programs. Commercial transportation, which impacts both forged wheels and the fasting system segment, was up 7% year-over-year, driven by higher volumes. Commercial transportation remains resilient despite normal seasonality. Finally, The industrial and other markets were up 10% year over year, driven by oil and gas up 29%, general industrial up 8%, and IGT up 4%. In summary, another very strong quarter across all of our end markets. Now let's move to slide six for more details on the third quarter results. Starting with the P&L and enhanced profitability, Revenue, EBITDA, EBITDA margin, and earnings per share all exceeded the high-end guidance. Revenue was $1.658 billion, up 16% year-over-year. EBITDA was $382 million, up 18% year-over-year, while absorbing near-term costs associated with net headcount additions of approximately 645 employees. The engine segment drove a majority of the increase by adding approximately 500 employees. Year-to-date, net headcount additions are just over 1,500 employees. We continue to increase headcount for the expected revenue ramp. EBITDA margin was strong at 23% despite absorbing the headcount additions. Adjusting for year-over-year inflationary costs passed through approximately $15 million EBITDA margin was 23.3%, and the flow-through of segment incremental revenue to EBITDA was approximately 28% year-over-year, which was right in line with our guidance. Earnings per share was strong at $0.46 per share, up 28% year-over-year. The third quarter represents the ninth consecutive quarter with growth in revenue, EBITDA, and earnings per share. Next is the balance sheet. Balance sheet continues to strengthen while returning cash to key stakeholders. The ending cash balance was $425 million after generating $132 million of free cash flow. In the quarter, $242 million of cash on hand was allocated to debt reduction, common stock repurchases, and dividends. Net debt to EBITDA improved to a record low of 2.3 times. All bond debt is unsecured and at fixed rates, which will provide stability of interest rate expense in the future. Our next bond maturity of $705 million is due in October of 2024. How much improved financial leverage and strong cash generation were reflected in Fitch's August credit upgrade from BBB- to BBB, two notches into investment grade. Moreover, Moody's upgraded HOMET's outlook from stable to positive in September. The balance sheet continues to strengthen and is recognized with the rating agency upgrades. Finally, moving to capital allocation, we continue to be balanced in our approach. In the quarter, capital expenditures were $59 million, which continues to be less than depreciation and amortization. In the third quarter, we reduced debt by another $200 million, Year to date, we have reduced debt by approximately $376 million, which will lower annualized interest expense by approximately $19 million. We also repurchased $25 million of common stock in the third quarter at an average price of $49.32 per share. This was the 10th consecutive quarter of common stock repurchases. Share buyback authority from the board stands at $797 million. Since separation in 2020, we have repurchased more than $1 billion of common stock. We exited the third quarter with a diluted share count of 414 million shares. Finally, we continue to be confident in free cash flow. In the third quarter, the quarterly stock dividend was $0.04 per share. The quarterly stock dividend will be increased by 25% in the fourth quarter to $0.05 per share. Now let's move to slide seven to go through the segment results for the third quarter. The engine product segment continued its strong performance. Revenue was $798 million, an increase of 17% year over year. Commercial aerospace was up 15%, and defense aerospace was up 33%, with both markets driven by higher build rates and spares growth. Oil and gas was up 33%, and IGP was up 4%, as demand continues to be strong. As expected, Q3 sequential revenue was down 3%, driven by seasonal vacations. EBITDA increased 18% year-over-year to 219 million. EBITDA margin increased 20 basis points, both year-over-year and sequentially, to 27.4%, while absorbing approximately 500 net new employees. We are pleased with the continued strong performance of the engines team. Now let's move to slide eight. Fastening systems, year over year, revenue increased 20%. Commercial aerospace was up 34%, including the impact of the emerging wide-body recovery. Commercial transportation was up 6%, general industrial was up 7%, and defense aerospace was down 5%. Year over year, segment EBITDA increased 19%. EBITDA margin was 21.8%, and it's improved 320 basis points over the last two quarters. Please move to slide nine. Engineered structures year-over-year revenue was up 18%, with commercial aerospace up 33% driven by build rates and approximately $30 million of Russian titanium share gain. Defense aerospace was down 20% year-over-year. Sequentially, engineered structures improved production rates and revenue was up 14%, which was in line with our expectation of 10% to 15%. Segment EBITDA increased 7% year-over-year. Sequentially, EBITDA margin improved 320 basis points to 13.2%, despite absorbing approximately 145 net new employees in the third quarter. Q3 was good recovery by the structures team, and we continue to expect further improvement in margins. Let's move to slide 10. Forged wheels year-over-year revenue increased 7%. The $19 million increase in revenue year-over-year was driven by a 13% increase in volume, partially offset by lower aluminum prices. Segment EBITDA increased 20% year-over-year, driven by the higher volumes. EBITDA margin increased 290 basis points primarily due to the impact of higher volumes and lower aluminum prices. Finally, let's move to slide 11. Our balance sheet continues to be a source of strength with healthy cash flow supporting a $200 million debt reduction in Q3. The $1.25 billion October 2024 debt tower was inherited from Alcoa Inc. and has been reduced to $705 million with cash on hand. Since the separation in 2020, we have paid down gross debt by approximately $2.15 billion with cash on hand and have lowered annualized interest costs by more than $120 million. Gross debt now stands at $3.8 billion. All long-term debt continues to be unsecured and at fixed rates. We will continue to focus on improving our capital structure and liquidity. Lastly, before turning it back to John, let me highlight one item. In the appendix, slide 18 covers our operational tax rate, which was approximately 22.8% year-to-date. The midpoint of our guidance represents a 500 basis point improvement in the operational tax rate since the separation in 2020. Strong performance by the tax group and we continue to be focused on further improvements in our operational tax rate. Now let me turn it back to John for the outlook in summer.
spk07: Thanks, Ken. So let's move to slide 12 and talk about the outlook for the next quarter and year end. So first of all, regarding commercial aerospace, airline load factors continue to show improvement and resilience. Factory improvement for international travel, notably in Asia, also continues to increase. Domestic airline activity continues to be above 2019 levels in the Western countries. Given these low factors and the continued restriction of aircraft bills, the fleet of existing aircraft are having to work much harder. This is leading to robustness in the engine spares market, which is further increased by the fact that the deployment in recent years of new engine technologies, which are currently operating with increased replacement parts due to lower time on wing. You'll have read about this, and you can be assured that Hamad is playing its part in supporting both the technology upgrade in the high-pressure turbine and through providing additional service parts. This will continue for the next two to three years and probably beyond. Moving beyond commercial aerospace to the defense markets, this market is also showing strength with the start of the gradual buildup of engine spares over the next two to three years to support the F-35 program, for which the fleet now stands at 975 aircraft and growing. These increases more than offset the continued bulkhead inventory correction in our structures business. Other markets of IGT and oil and gas continue to be very healthy. In commercial truck and trailer, bills and order intake continue to be good, despite the lower freight rates and increased price of diesel fuel. We continue to be cautious, though, as we look forward, until we see several months of data for new 2024 orders, which the order box have only been open for a month. The initial month was good, but we also know that orders can be cancelled, depending upon how the broader economy moves in recent months. In aggregate, we see limited risk of aircraft demand from both the commercial aircraft market and defense markets. The two markets aggregate to approximately 65% of our revenue, and that moves up to 80%, excluding the commercial transportation business. Beyond the fundamental demand from airlines, clearly we rely upon aircraft manufacturers being able to produce and build up the stated and scheduled quantity of aircraft. particularly narrow-body aircraft. Looking forward into 2024, we envisage growth to be in the 7% range, plus or minus a percentage point. The headline sales number for 2024 is likely to be approximately $7 billion. This will be further refined when we see the achieved Q4 build rates from Boeing and Airbus with their confirmed plans going into 2024. All of this will be provided in further detail in February along with the assumed bill rates. Our stance is normally one of caution. Moving specifically to the fourth quarter of 2023, we see revenue about 1.635 billion plus or minus 15 million, EBITDA 375 million plus or minus 5 million, earnings per share at 45 cents plus or minus a penny. Regarding the full year 2023, Revenue has increased by about $100 million from $6.44 billion to $6.54 billion, plus or minus $15 million. EBITDA has increased by a further $40 million to $1.485 billion, plus or minus $5. Earnings per share has increased by $0.07 to $1.77, plus or minus a penny. Free cash flow is at $635 million, plus or minus $35 million. In summary, we see strong performance with health and liquidity and an increased guide for the remainder of the year. We consider the year-to-date progress to be very good, despite the continued choppy build conditions in commercial aerospace. We are comforted by the fact that any build misses by aircraft manufacturers will be moved into backlog, given the very strong underlying demand for travel, and in particular, the absolute requirements for fuel-efficient engines and fuel-efficient aircraft with an overarching mandate of reduced carbon emissions. Our four-year guide of $1.77 earnings per share is an increase of 26% year-over-year. This builds on the 2022 versus 2021 increase of 39%. Currently in 2023, we've purchased $376 million of debt and brought back $150 million of carbon stock. Our net leverage is further improving Q3 and is heading towards approximately two times net debt to EBITDA by year end. All of the debt actions help accomplish our goal of reducing interest rate burden in both 2023 and also going into 2024 with further improved cash flow yield despite the increase generally of interest rates. Thanks, everybody. And now let's move to your questions.
spk02: We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the key. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. In the interest of time, please limit yourself to one question. At this time, we will pause momentarily to assemble our roster. The first question today comes from Christine Lewag with Morgan Stanley. Please go ahead. Hey, good morning, everyone.
spk07: Hi, Christine.
spk04: You know, John, Ken, PT, I guess with a 7% revenue increase for your 2024 initial outlook, what does that imply for aircraft production rates for the Boeing 737, 787, and the Airbus A320 and A350? And also, you know, when you talk to your customers, how much visibility are you getting for the ramp?
spk07: Okay, I guess that's the big one, Christine. So let me just talk generally about the 7%, first of all. Within that assumption is a mid-teens assumed increase in commercial aero, and more like single-digit increases in industrial, things like IGT, oil and gas, and general and other, while an assumed high single-digit decrease in commercial transportation. So basically, in outline, solid defense, solid general industrial markets, a healthy increase in commercial aerospace, but reduced by a high single-digit assumption on commercial transportation. That's roughly now applying. I'm going to say, yeah, we see assumed build rates in, say, forecasting agencies. And for the most part, you know, we can see that they're going to increase both wide body and wide body fractional increase in mix next year at the moment specifically for Boeing 737 which is what you assumed you asked the question about our assumption is that it's somewhere between the mid 30s and 40 somewhere in that region we don't want to pit it specifically at this point you can assume that you know within the range plus or minus I gave And it's really important that we see Boeing achieve the rate 38, which we know is going to be, you know, prior to now, it hasn't really happened. It doesn't seem to be happening just yet, but we know it's going to be very soon. But we're not yet ready to believe and input into our guidance, even though we can supply that rate 42 should Boeing be in a position to build at that rate.
spk04: Great, thanks for the caller.
spk07: Thank you.
spk02: The next question comes from Robert Spingarn with Nellies Research. Please go ahead.
spk10: Hi, Scott for Rob Spingarn. John or Ken, I wanted to ask you a little bit about pension contributions for next year, and also just given the work you've done there, are you considering any sort of risk transfer to get rid of the pension liability and improve free cash conversion?
spk07: We've been working at pension liabilities for several years now, and we've indeed taken over the last five years from where we started several billion out of that net liability, or gross liability rather, and we've always been focused on taking gross and net out together. Otherwise, you just leave yourself open to interest rate risk and mortality risk, and we've Managed it down now to, I think, about three quarters of a billion for pension and healthcare, something in that region. And so it's now, let's say, a tiny fraction of our market cap and therefore essentially is not relevant. At the same time, while I've noted that one other company, maybe a couple have continued annuitizing, there's I'm not yet at that point willing to consider that. It's not that it's off the table because I think it would be something which would be useful to do. But at the same time, I think at this current time, there's other better uses of our cash and also I'm not willing to leverage to enable that to occur. So essentially, we're aware of it. We continue to work at our plans I can see us potentially picking off one or two and do partial annuitization either within a plan or in a total of a plan. But you shouldn't expect to see that liability extinguished and us pay the premiums to insurance companies to enable that at this point in time. I think that may come over the next, you know, let's say three to five years at some point, but not yet. And the assumption we have for next year is that the cash contributions will be a little higher than this year, but at this point, not material.
spk10: Thanks. I'll stick with one question. Thank you.
spk02: The next question comes from David Strauss with Barclays. Please go ahead.
spk08: Good morning. Hi, David. John, you mentioned your work on upgraded blades. I wanted to see if you could give a little bit more color there around the timing of when you, you know, when you think you'll be producing, upgrading, producing and delivering upgraded blades to both GE and Pratt.
spk07: Okay. So, both for the GTF Advantage and engine upgrade, and for the LEAP 1A, 1B upgrades. Those have been something that we've been working on for several years now. And if anything, let's say a little bit later into production than originally envisaged, although those pushbacks in timing have not been a result of Hermet not being ready. So we're in good shape. I've commented in the past that increased performance in the high pressure turbine leads to increased complexity. And with that is value. And we certainly have been intimate with the engine manufacturers to improve the performance as the engine temperatures have seemed to be higher than originally envisaged, and therefore to help improve time on wing. I feel as though specific timing for both what was originally called lean burners now has a different code name for GE, and I think for the advantage for Pratt & Whitney, you're best asking them for timeline disclosure. rather than myself. Because we have an agreed plan, but that can and has been varied according to the specific needs of those engine manufacturers at this point in time.
spk08: Okay. Fair enough. I'll ask them. Thank you. It's far better, David. And then, Ken, I guess a two-parter for you. Just Quick comments on working capital through the end of this year. It looks like you're kind of a pretty big, you know, reversal benefit in Q4 and thoughts on that into 24. And then pension expense, you know, you brought it down a little bit for 23, but what are you looking at for 24? Thanks.
spk07: I'm going to comment on the working capital first and then let Ken amplify. and then that can totally deal with the the pension side and the reason why I want to talk about the working capital because it's also tied up with the specific operations and status of where they have met different business units are so first of all in terms of working capital I mean AR or accounts receivable and accounts payable, they just move on the day's assumption. So if revenue goes up, David, as it has, then clearly we have more dollars tied up in receivables than we had. But that's a good answer because whatever days it is, and I don't know if we've ever disclosed it, but you can back engineer it. But our days are pretty constant. And so because revenue went up, a few more dollars went on, but the days in receivables are exactly the same. payment payables. The big wild card on what Gap is always inventory. And so far, inventory is still elevated, more elevated than I would like. But just because I don't like it doesn't mean it's not where it should be at this point in time. So moves with the, I will say, status within each business of where we are operationally. and in terms of start from, let's say, volume recovery. So if you take our wheel segment, which was the first division to show volume increase, manning, and then moving through towards stability and now smoothness of production, our days of inventory are in really good shape, and indeed I believe we're at close to world-class levels. If I look at our engine business, which is our second division out of the gate in terms of building of revenue, increasing running, and that's continuing to increase. We have gradually been smoothing out production, albeit we're not in the same level yet as we are in wheels. What we see is gradual improvements in efficiency of our inventory holding and days on hand. I think that will continue to improve again in the fourth quarter and into next year. I'm pleased with the trajectory, but we're not yet at where we need to be on our engine business. In terms of fasteners and structures, those are very different points. Fasteners It's been later in the cycle in terms of volume pickup. As you know, we've been recruiting this year, building it up, and you've seen, first of all, the margin begin to respond to that and also mix and production efficiency. And also you've seen a little bit of a calming of recruitment in that business in the last few months. We're still in that recruitment mode and replacement mode for employees, but trying to improve efficiency. The moment, the days on hand is well out of order in terms of where it needs to be and is not yet improving at all, but will begin to improve, I believe, as we go through 2024. In the case of structures, that's probably our worst business in terms of days on hand. And if you remember, last quarter wasn't particularly a great quarter in terms of the throughput of the business. And so I allowed that business not to focus on inventory, but just to use inventory as the buffer to help stabilize the manufacturing operations and therefore improve the margin, which is what you saw occur in the 300 basis points improvement in the structures business. At this point, I don't think it goes anywhere at all in the fourth quarter. And that's a combination of it still needs to stabilize its operations. But also at the moment, I see customers laying in additional demand, particularly laying in additional urgent demand on the titanium side. I'm not yet prepared to add heads nor working capital in inventory or nor input materials until I'm satisfied with the economics to pay those premium costs. And so, if anything, I'm going to hold back on that because I've got better places to deploy capital, which is what I told you last quarter and generally in the business of analysts is that I'm very disciplined of where we allocate capital And so at the moment, I'm not trying to drive working capital, particularly in that business, but that will come next year as that business begins to smooth out and improve its production and gain more responsiveness in terms of, I'll say, people paying for the premiums if they want the demand and drop in, then they pay for it. Otherwise, they don't get it. It's that simple. So that deals with working capital, be comprehensively, David, and now past the can.
spk13: Yeah. Hi, David. So as John articulated, their days are really the key on working capital. And then also depending on where we are in the cycle by business segment. So as we exit this year, I think we've given everybody the walk and the assumptions tab of the deck to kind of walk through it. But that would indicate a working capital burn this year, roughly about $190 million plus or minus. And it's really driven by, you know, we've increased the revenue guide. Once again, so you have more AR that goes with that. Plus, we're keeping inventory in the business to make sure that we're not the bottleneck for our customers, right? Delivering on time in full at the right spec is really important for us. So we've got a little bit more inventory. Next year, we've got another growth projection here. So I anticipate there'll be working capital burn again next year in 2024. probably be better than this year as we work down inventory in the business. But it's, again, going to be dependent on where we are in the cycle. So I believe it's in really good order here, driven by the growth of the business. On the pension expense side, as John mentioned, I'll start at the top of the house. We've taken gross liabilities down by 45% since separation. That's a pretty big decline. A big significant part of that is the actions that we've taken to reduce gross liabilities. You also get a bit of a help from the increase in discount rates, but there's a lot of action around that gross liability. John mentioned cash, right? It will be up next year. We remeasure at the end of the year, so that's pretty much of a volatile line, so we'll give you more guidance on the next call in terms of what the cash contributions would be. The expense side, That's a little bit more visible right now. Again, we strike it at the end of the year. If you look at our pension and OPEP expense right now, it's $35 million on an annual basis. So next year, based on asset returns, the market's been a little tough here. I'd say probably another $15 million, plus or minus $5 million on either side of that. So really not material. But I think that's all in good order as well.
spk08: Great. Thanks for all the detail.
spk02: The next question comes from Scott Dutroux with Deutsche Bank. Please go ahead.
spk12: Hey, good morning.
spk02: Hey, Scott.
spk12: Two very quick questions, both for John. First, did price realizations accelerate again in the third quarter? I think they had accelerated the last quarter. And then on fasteners, can you say whether you're shipping at five a month on 8-7 at this point, or are you still tracking a bit below that? Thank you.
spk07: Okay, I don't think we've given the third quarter detail on the commercial side. I think that will be in our 10Q later where we file it.
spk13: That's correct.
spk07: I'll say that it's in good order. and in line with what we previously said, both for the quarter and for the year. And I stand behind my comments regarding 2024, which I made on the last call. 787 at the moment. We're a little bit below rate 5. But fully expecting that to move up to rate seven next year. And I commented before, we see very strong underlying demand for that aircraft, and I can see the need to go above rate seven as well. It's only a question of when.
spk12: Okay, great. Thank you.
spk07: Thank you.
spk02: The next question comes from Miles Walton with Wolf Research. Please go ahead.
spk01: Thanks. John, I was hoping you could dig a little bit deeper into the fastening margin performance and obviously sort of troughed at the beginning of the year and has been showing some signs of resiliency and improvement. I think at the beginning of the year you told me to not expect much for a couple of years. Are we at a point where new management plus the rate increases on the wide bodies, we should start to think about getting back to 2018, 2019 fastener performance?
spk07: Well, I think it's a bit premature to go back there because, I mean, I think the conditions there and the wide-body market in particular were quite different to what they are now. Basically, in the first quarter, which is probably our low point in fastener margins, reflected essentially just a total metallic build of aircraft. You can call it zero in terms of any real volume on the composite side. So that's one factor. Of course, that's begun to change. The business itself has also begun to improve, and I see very much improved signs of operating efficiency improvements, but with a ways to go. I see additional discipline in the business commercially, and there's still a ways to go. And going forward into next year, what I see is a volume increase for commercial aircraft production, and also a fractional improvement in mix, because of the wide-body going to next year, and you can pick your own assumptions on what the final wide-body production will be in composite aircraft, but essentially even on wide-body transitioning from metallic to composite aircraft during the course of the year, hopefully with some deliveries of 777X parts as well, which has got a composite wing, and so I'll say general improvement in conditions for the business but still with a big thrust on improving its productivity and throughput efficiency, which needs to occur. So basically, some ways to go yet. I have optimism we'll continue the good trend of the last couple of quarters, but too soon to call out any specifics on it, and I don't think we have a guide by segment anyway. And I haven't guided how I met margins for the next year, just giving you the fact that revenue increases. So that gives you a picture for that business.
spk01: Thanks, John.
spk07: Thank you.
spk02: The next question comes from Ronald Epstein with Bank of America. Please go ahead.
spk06: Hey, John. How are you? The topic that doesn't tend to come up much is the forged wheels issue. and it appears that it's been running ahead of expectations. I mean, how should we think about that? And, you know, what are your expectations around it? And when we think about modeling it, what would be a prudent way to do so?
spk07: Well, essentially, the play on forged wheels for aluminum is that you start off with what's the big picture in terms of truck and trailer production essentially in North America and Europe, albeit we do play in some of the Asian markets at a significant share position as well. And then you factor in basically some, whatever percentage change that is, and then you factor in as a positive against what I think would be a worst macro position next year. There'll be some Penetration achieved against steel wheels, particularly as fuel efficiency requirements step up. A fractional contribution, but nothing of great note in terms of adoption of the different, I'll say, powertrains. I think they're hinting at their moves towards electrification or whatever, but no big moves next year. But that's a positive vector as well. And then a fractional share improvement. on top of that. Basically, we see secular growth in the segment offsetting some macro decline in the assumed markets. That's why Guy commented as I did about high single-digit reduction for the business is our assumption. trying to be fairly cautious at this point in time until we've got a better read on what's the general economy going to do. Although I do see freight rates beginning to stabilize and improve recently. So there's a lot of factors yet to bring to bear in terms of what the final outlook for next year is. But I want to take a fairly cautious assumption. This year, I'd already commented, I saw a more difficult second half As it is, we've still been able to burn off backlog. And let's say even despite today, we know we have the Mack truck, which is subject to the UAW strike. Our arrears are such that that's not going to affect us in the fourth quarter. and our assumption is that by Q1 next year, by another couple of months, that UAW dispute at the macro could be resolved and therefore they'll be back. Um, so that's about it really. It's, you know, it's been pretty strong this year. And, uh, I do give you the general in years. Yeah.
spk06: And then, and then maybe just one, one follow on, if I may just a little change of subject, the, um, when we think about the Pratt Whitney situation, um, with the GTF and all the disks that need to be reworked. Is that good, bad, neutral for you guys? I mean, how should we think about the impact on you, I mean, the company, vis-a-vis the GTF situation?
spk07: Yeah. I start off with having to separate two issues, I think, on the GTF. Because I think while it gets all enmeshed together, I see them as quite separate. and then the cavities are intertwining for convenience. So the disc contamination issue, clearly that requires inspection and that might take, I don't know, so many days, let's call it 20, 30, 40 days on and off wing to achieve that inspection and then I guess longer if those risks turn out they require to be replaced or not. I guess it's a small fraction of those that are required to be replaced. That's one separate item. Over, let's say, previously in center field, but I'll call it left field, there is the discussion about the time on wing issues that have been publicized by everybody regarding the DTF, particularly in harsh climate countries or pollution countries that the time on the wing is a fraction of the predecessor engine and also what was originally thought for the GTF. So the question then becomes for the problems around the combustor, the filling of holes, the higher temperatures and then those temperatures and pollutants hitting the few blades in the high pressure turbine, those clearly require replacements And the question is, what is the replacement interval for them? And so that stands alone as an issue. And Pratt and Whitney will determine what frequency they want to replace those blades at. Again, more of a question for Pratt than for myself. We're able to stand behind them and supply what needs to be supplied you know, within degrees, the question is, you know, what's the requirement? Then, of course, you can entwine them together. So maybe when those engines are off-wing for the powder metal contamination issue, maybe the opportunity will be taken to replace some of those high-pressure turbine blades and other components on the engine. Or maybe it won't. That's a practice issue. And the question I have in my mind is, do they go for full replacements for them as they really look at inspect and take the engines off the wing for the first time? Or do they stick them back on just because the airlines will want the engines back on wing and only seek to replace those in harsh climates at that time? And so maybe that's the more I read from MTU of the 300 days turnaround time. So I just don't know, Ron, what it will finally turn out to be. It's a choice by Raytheon or Pratt & Whitney to determine to what extent do they make improvements for the time on wing issue, including the high-pressure turbine parts, as they take those in. So what it's written about is almost one issue of powder metal, actually there's two distinct issues, which may come together, but just depending upon the pressure to get those engines back on wing. And we are still in discussions with Pratt & Whitney regarding all of that. And they determine how many of our parts go to OE production and how many go to the spares market. And that's up to them and the aircraft manufacturers to decide that.
spk06: Got it. Thank you very much. Thank you.
spk02: The next question comes from Noah Popanek with Goldman Sachs. Please go ahead.
spk00: Hey, good morning, everyone. Hey, Noah. John, I was hoping to get a little more color from you on your perspective on the broader aerospace new build ramp up. You've had good perspective, and as you mentioned, you've been cautious, and that's been correct. It felt like in the middle of the year and kind of around the air show and into the summer, you sounded more optimistic and sounded like the supply chain was kind of finally ready to go. And then we've had these incremental engine and aero structures issues. Did Boeing especially, and I guess Boeing and Airbus, keep the underlying broader supply chain going towards the planned higher rates? And is everything kind of ready to ramp once aft fuselage and the like are fixed. And you mentioned them giving you plans for next year. Are they incrementally more firm on that now with the master schedule than they've been recovery to date? Are things firmer or is that wishful thinking?
spk07: I think Boeing in particular have had firm plans throughout the year. It's been the realization of those plans, which has been more of the issue. And I guess it's from a combination of reasons. There's always going to be somewhere in the supply chain amongst all the parts and difficulties. There's always going to be the degree of experience in Boeing's own plants with all of the change of people in and out or out and in post-COVID. And then, of course, we read in the press about the difficulties of, say, was it strike at Spirit Aerospace? And then some other production issues of some failed parts and holes and all the rest of it. And yet there seems to have been some management change there, which may prove to be positive. That's a TBD. and hopefully there, and I guess you listened carefully to the commentary from Spirit yesterday. We're optimistic that those fuselage and other component problems do get resolved. It's not something in our control, but should those begin to improve, I think that's a major step forward in Boeing realizing its own plans for production rate increases and also getting behind it the retrofit of those uh tail tails which were you know subject to fasteners fitted wrongly or then the holes built too big and bigger fasteners put in so i think the coping you know with herculean efforts to try to achieve all of that um but you know as you know just Herculean efforts by themselves that sort of produced the output, and we've still got to see that improve. So hopefully during October, November, December, we will begin to see rate pick up at Spirit, other suppliers, and then obviously Boeing itself to get to their required or stated rate 42 next year. In terms of then on the engine side, you've read commentary. I think anyone I've seen was the GE commentary instead of, let's say, 1,700 engines, 1,600 engines. That isn't really impactful for us at this point in time because for us, it's just us meeting their rate requirements and And then there's a choice, as I said on the previous question, what goes to OE compared to what goes to service requirements. We're dealing with very robust demand on both sides, and we see that demand increasing again next year, plus some blended-in changes potentially for the technology change yet to come.
spk00: Okay. I appreciate it. Thank you.
spk07: Thank you.
spk02: The next question comes from Sheila Kayawu with Jefferies. Please go ahead. Hi, John.
spk03: Hi, Ken. Thank you, guys. So, hey, I have two questions, if that's okay. So, John, don't strip the second one.
spk07: Well, I've been pretty lenient today in answering, you know, two parts, three parts. So, yeah, sure. Go for it.
spk03: You are. You are. But I want some good nuggets here. So, you know, the OEs are calling out. castings and forgings in terms of supply chain, you know, kind of slowing down the supply chain. I know you've been clear that Homet isn't a bottleneck and you aren't in the large structural casting business anyway. So maybe could you characterize your output today and what you're capable of in terms of demand? And then this is more of like a larger opportunity in terms of pricing and volume. How do you think about that trade-off going forward?
spk07: Generally, You know, forging and castings have been a bit of a whipping boy for a couple of years, with commentary, I think, made even before there was any basis for it. Albeit, you know, subsequently, I think there has been a basis for commentary where to replace the skill levels to produce some of these, in particular the castings, is really at a very high order. So the recruitment and then training time to produce effective production workers in some of this certainly strained, I think, all of the companies in that regard, including Hammett. We did choose to start recruitment a bit earlier. I know that I've cost the company at 20 basis points of margin by being slightly ahead of the curve on recruitment. But at the same time, I think it's paid dividends for us in the fact that we've been able to produce generally on time, at rate, and with generally good quality. So I think it's been a good trade-off for us. I want to correct you on the structural casting side. We're probably the number two in the market behind precision cast parts, but they're still the big dog on the block in terms of production of structural castings. You know, we do produce them and we're at a good rate for, let's say, 98% of all our structural castings. I mean, early on we had a few moments, but things like fairings are now just like shelling peas and coming off at good rates and no problems whatsoever. And so, you know, should there be increased demand for structural castings, obviously where we're tooled, and if not, you know, the availability to tool us for the next few years should engine manufacturers want to, is that, you know, we're in a position to supply because we still have some available capacity and indeed are willing to invest their commensurate with its being a good return of capital. And generally, I've been quite positive about investing in our engine business and contrasting that to our structures business based upon returns. So it's one way of saying we're in a good state We're in structural casting. We are the significant supplier to the industry on turbine blades. And I hope I've given you enough nuggets.
spk03: How do you think about pricing and your contract structures going forward given the constraints in the supply chain and you're hiring ahead of the curve?
spk07: Pricing has been positive for us and I think it reflects the value that we bring. When I look at Some of the requirements for the increased temperature performance in the narrow body engines, we are bringing to bear some of the technologies that we've deployed for the F-35 engine in terms of the ability to manage both pressure and thermal performance in the high pressure turbine. and we're able to produce parts. We obviously work with the customers to engine into specification, but if they're specified at 2,500 degrees and operate higher, we can take it higher because, as you know, for the F35, we're up at 3,500 degrees and, indeed, the only company in the world that can provide the turbine parts with that thermal performance in that environment. um you know we've already commented previously that we are working on the improvements uh for the currently 2028 upgrade to that engine to improve its uh its thrust and time in air and so again we are able to take the temperature performance of those parts and elevate it further and we've talked a little bit but only a little bit in our technology day about some of the technologies that we would be able to deploy for that. And so we're in position to bring a degree of performance and capability at scale, which I think needs to reflect in value because in truth, the turbine blade is a pretty small part of the value of the engine. And to achieve the requirements for, let's say, lower carbon footprint, continually taking up the pressure inside the engine to improve the atomization of the jet fuel, and then for its burn characteristics, the lower pollution, and the whole fuel efficiency and carbon footprint presents great value to the industry.
spk02: Great. Thank you.
spk07: Thank you.
spk02: The last question today comes from Seth Seifman with J.P. Morgan. Please go ahead.
spk11: Hey, thanks very much. Good morning, everyone. So, John, I know you said you wouldn't say this or haven't said this, and so I'm not necessarily expecting a number in terms of the margin outlook for next year. But if we think about that sort of baseline incremental of, you know, 30%, plus or minus 5%, you know, how do we think about the puts and takes for where next year can come in relative to that? Does the addition of headcount and the need for, you know, the learning to develop among your employees, you know, does that keep things sort of below that 30% range as it's been in recent years? Or are there other opportunities to be above it? What's the best way to think about that at this point?
spk07: Yeah, I mean, we were able to step up last quarter to that. 19% operating profit, 23% EBITDA rate. I don't have any commentary regarding margin rates for next year. What I still see at the moment is potentially, I don't know this, but potentially a few more months of choppy production, particularly on the airframe manufacturing side. It's just an assumption. Maybe we get lucky towards the second half of next year or the back end of next year and we see things get to smooth out you know we have seen some things begin to move in our favor and smooth out as i commented when on the imagery side when i was talking about our engine business um but in terms of you know what at what point do we reach what i call what i previously referred to a state of grace where things smooth out and you know, margins, you know, become stable and better and cash just oozes out of the industry and hopefully out of Hamas. You know, I've always said that's a year away and I still think it's a year away. It could be the back end of 24, but more likely going to 25. And that hopefully combines with if the 25 external markets I'll say views of what the aircraft production will be, including its wide body mix, then that begins to get, I say, you know, into a good state. So, you know, I have generally medium to long-term optimism and feel as though we're in a really great place with great backlog and good things to come, albeit, still having to face up to shorter-term challenges of all the things we've talked about in terms of build rate changes and assumptions change in many parts of the market, in particular the commercial aerospace part of the market. I think that's the best picture I can give. Excellent.
spk11: Thanks very much, Topol. Thank you very much.
spk02: This concludes our question and answer session and concludes the conference call. Thank you for attending today's presentation. You may now disconnect.
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