Allegheny Technologies Inc

NYSE:ATI

Earnings Call Transcript 2018-Q1

[Operator]

Good morning and welcome to the Allegheny Technologies Incorporated First Quarter 2018 Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator instructions] Please note this event is being recorded.

I would now like to turn the conference over to Scott Minder, Vice President of Investor Relations. Please go ahead.

[Scott Minder]

Thank you, Nichole. Good morning and welcome to the Allegheny Technologies first quarter 2018 conference call. This call is being broadcast on our website at atimetals.com. Participating in the call today are Rich Harshman, Chairman, President and Chief Executive Officer; Pat DeCourcy, Senior Vice President, Finance and Chief Financial Officer; John Sims, Executive Vice President, High Performance Materials & Components segment; Bob Wetherbee, Executive Vice President, Flat Rolled Products Group; and Kevin Kramer, Senior Vice President, Chief Commercial and Marketing Officer.

If you've connected to this call via the internet, you should see slides on your screen. For those who have dialed in, slides are available on our website, atimetals.com.

All references to net income, net loss, or earnings in this conference call, are mean net income, net loss or earnings attributable to ATI. If you've connected to this call via the Internet, you should see slides on your screen. For those who have dialed in, slides are available on our website, atimetals.com.

After our prepared remarks, we will open the line for questions. During the Q&A session, please limit yourself to two questions to allow time for others. We will make every attempt to reach everyone in the queue within the allotted call time.

Please note that all forward-looking statements are subject to various assumptions and caveats as noted in the earnings release and shown on this slide.

Now I’d like to turn the call over to Rich Harshman.

[Richard Harshman, Chief Executive Officer]

Thank you, Scott. Good morning to everyone on the call and to those listening on the Internet. The first quarter was a good start to 2018 and build upon our positive momentum from 2017. ATI’s first quarter revenue grew by 13% versus the prior year and approached $1 billion in total.

This solid top-line growth along with our continued and deliberate product mix enhancements in both segments drove year-over-year segment operating profit growth of 38% and margin expansion of 170 basis points.

We achieved quarterly earnings of $0.42 per share, which includes a $0.10 per share gain related to the formation of the A&T Stainless joint venture. Excluding this one-time gain, ATI earned $0.32 per share in the first quarter. This represents our best quarterly results since mid-2012 and builds on our solid fourth quarter 2017 performance.

Taking a quick look at our operational performance, both business segments contributed positively to our solid first quarter financial performance. Segment operating profit in our High Performance Materials and Components or HPMC segment climbed to 15.2% of sales representing a 520 basis point improvement versus the prior year first quarter.

This improvement was greater than expected and was driven by strong demand for our enhanced next-generation jet engine products, which resulted in a more favorable product mix. Aligned with our prior guidance, the Flat Rolled Products or FRP segment saw a decline in operating profit versus the prior year first quarter and sequentially versus the fourth quarter 2017.

This was primarily driven by an unfavorable one-time accounting impact related to retirement benefit expenses and by lower foreign currency hedge gains. The demand environment for our ATI’s Flat Rolled Products remains strong, particularly in the oil and gas markets and I am pleased to report that the segment is on track to achieve its near and mid-term financial goals despite some market uncertainty created by recent global trade actions.

The ATI team continues to focus on achieving sustainable long-term profitable growth and sustainable profitability throughout the business cycle. We strive to consistently create value for our shareholders and customers and opportunities for our employees and we are making good progress on these objectives.

Now I am going to turn the call over to John Sims to discuss our performance in the HPMC segment. John will be followed by Bob Wetherbee who will discuss the FRP segment and then by Pat DeCourcy who will comment in more detail on our first quarter financial results. I will then comment on our second quarter and make some concluding remarks before we open the call to your questions.

Here is John.

[John Sims]

Thanks, Rich. Turning to Slide 4, I am pleased to report that the HPMC segment’s first quarter financial results were better than expected. Year-over-year, segment revenues grew by 10% and earnings grew by nearly 70% resulting in margin expansion of 520 basis points. These results demonstrate the leverage of additional volume across our asset base and the accretive power of the next-generation jet engine product mix to drive incremental margin growth.

While these results were above our expectations, they continue the strong earnings growth trend and represented the seventh consecutive quarter of year-over-year margin expansion of at least 140 basis points. This pattern of improvement is primarily due to the ongoing production ramp of next-generation jet engines at all of our major engine OEM customers.

The industry is currently in the early phases of a multi-year production expansion and while we expect the pace of margin growth to vary by quarters, expected airplane build growth and our long-term customer agreements provide a solid foundation for achieving HPMC’s longer-term financial goals. We understand that our continued success is dependent on our customer success.

To support our customer’s long-term growth plans, we are keenly focused on operational excellence, superior product quality, on-time delivery, all across a wide range of potential industry build rates. Looking beyond commercial jet engines, we saw strength in several other end-use markets including construction and mining, which grew by more than 50% versus the prior year albeit from a relatively low base after several years of modest end-market demand.

I will cover performance across all of our end-use markets in more detail on the next slide. As a result of the elevated aerospace and defense and construction and mining market demand, we experienced strong year-over-year and sequential growth in sales of our forge products.

The resulting utilization increases across our isothermal and conventional forging assets generated significant incremental margin growth in the quarter including our recently announced fourth isothermal press, we believe that ATI is well positioned both in capability and capacity to continue to benefit from these trends well into the future.

Finally, I’d like to provide an update on the progress at our titanium investment castings business. We continue to work diligently with our customers and with our employees to further develop as a sustainably profitable industry-leading supplier of titanium investment castings.

We’ve made substantial progress and while we are not yet satisfied with the results, we continue to believe that we will generate near break-even financial results in 2018 and be profitable in 2019. Much progress has been achieved, but more is required.

Turning to Slide 5, the pie chart and table show HPMC’s first quarter 2018 sales by market and provide detailed comparison versus the prior year. In total, segment revenues grew by 10% with more than half of the markets expanding led by a double-digit increase in aerospace and defense. As I mentioned earlier, we saw a significant growth in construction and mining led by demand of our forgings.

Two of HPMC’s smaller markets saw year-over-year sales declines. Continuing a trend from 2017, ATI’s medical market sales declined in aggregate with biomedical specialty material sales growth more than offset by declines in the Magnetic Resonance Imaging or MRI end-use market due to increased competitive activity globally.

Additionally, sales of the oil and gas market were lower by 8% or about $1 million in the first quarter primarily due to the absence of customer inventory restocking activity that we experienced throughout 2017. Sales to this market represent approximately 3% of HPMC segment’s total sales.

Further analyzing our performance in the aerospace and defense market, year-over-year growth was mixed in the major submarkets. Commercial jet engine revenue expanded by 23% in the first quarter, primarily due to a 65% increase in next-generation product sales versus the prior year. Sales of next-generation products reached 48% of total jet engine product sales in the quarter marking a significant increase versus 2017 levels.

While we expect the production of these new jet engine models to steadily increase our next-generation product sales over time, the ratio of these sales to legacy product sales likely will vary by quarter. Commercial airframe sales declined in the first quarter by 8%. Sales to our major OEM customers improved year-over-year at a modest rate but were more than offset by declines in sales to our distribution customers.

Distribution-related sales are generally not covered by long-term contracts. Overall demand and inventory levels as well as our customers’ fluctuating order patterns can cause our airframe submarket sales to vary by quarters. Sales to the government and defense market increased moderately in the first quarter primarily due to naval nuclear and military jet engine demand for our specialty materials.

In addition, we saw modest sales increases for rotorcraft-related products led by sales of our forgings. In summary, the High Performance Materials and Components segment posted solid operating results exceeding our first quarter expectations. Next-generation engine product sales increased by 65% year-over-year and accounted for nearly 50% of total HPMC’s segment jet engine sales.

These sales are accretive to our operating margins and will likely continue to expand over prior year levels throughout 2018.

I will now turn the call over to Bob Wetherbee to talk about our performance in the Flat Rolled Products segment.

[Robert Wetherbee]

Thanks, John. Turning to Slide 6. The FRP segment generated solid first quarter financial results due to continued strong market demand and despite several headwinds experienced in the quarter. Revenues increased 7% sequentially even as compared to a strong fourth quarter 2017 period. The segment experienced 20% sequential growth in oil and gas market sales expanding on 2017’s favorable growth trends.

This was due in part to the production of a nickel sheet product to supply a previously announced pipeline repair project outside of the United States. This project, along with other nickel product demand helped to set a quarterly sales record for nickel sheet products building on the previous record set in fourth quarter 2017.

We expect a sequential decline in nickel sheet product sales in the second quarter due to a completion of the previously mentioned pipeline repair projects. Aligned with our prior guidance, segment operating profit was negatively impacted by approximately $8 million due to the required accounting changes on retirement benefit cost capitalization as well as the negative effect of lower foreign currency hedging gains.

Additionally, our STAL joint venture saw a decreased demand in production level sequentially due to the weak long Chinese New Year holiday. We previously anticipated a negative impact from lower raw material surcharges due to ferrochrome price declines. However, the lower ferrochrome surcharges were largely offset by a significant increase in March’s nickel surcharge level.

Looking forward, we see higher ferrochrome prices and anticipate higher nickel price-driven surcharges in the second quarter based on current market conditions. The segment’s first quarter results reflect our greatly improved operations and streamlined cost structure.

Despite the negative accounting-related and foreign currency impacts that I previously discussed, the absence of any raw material-related tailwinds and lower STAL results, the segment was profitable in the first quarter. We continue to progress toward our long-term goal of generating consistently profitable results across the business cycle regardless of trade policies.

Turning to Slide 7. I want to take a few minutes to provide updates on some of the segment’s most significant strategic initiatives. Despite global trade-related actions recently announced and the ensuing market uncertainty, we continue to make progress on our goals. First, we announced the official formation of the A&T Stainless joint venture on March 1, after receiving all required regulatory approvals.

As a reminder, this joint venture was created to produce 60-inch wide stainless sheet products for sale in North America from Indonesian made semi-finished stainless slabs. The joint venture now owns and operates ATI’s previously idled Direct Roll Anneal and Pickle line or DRAP located in Midland, Pennsylvania and utilizes conversion services at ATI’s Hot Rolling and Processing Facilities or HRPF in Brackenridge Pennsylvania.

The joint venture will directly create approximately 100 high-paying jobs in Midland and indirectly create several hundred additional jobs along its U.S. supply chain. Additionally conversion of joint venture semi-finished slabs will substantially increase utilization of ATI’s world-class HRPF to approximately 50%. This increased volume provides a healthy product base load to support ATI’s entire Flat Rolled Products business including products critical for U.S. defense.

I am particularly proud of the team that has executed a safe and highly effective joint venture start-up, commercially, legally, operationally, and financially. Their efforts are much appreciated and recognized by their colleagues and the customers they have ramped up to serve.

After the A&T Stainless joint venture formation, the U.S. Commerce Department imposed a 25% tariff on all imported steel products including the stainless steel semi-finished slabs imported from Indonesia. ATI officially filed a Section 232 tariff exclusion request on behalf of the joint venture on March 26.

Based on our interactions with a wide range of government constituents and the facts that first, there is currently nor has there ever been a merchant market for stainless slabs in the United States.

And second, the joint venture improves the cost efficiencies of ATI’s HRPF which is used to produce Flat Rolled Products for various U.S. defense applications. And third, the joint venture creates jobs in a Western Pennsylvania community that’s going to hard hit by unfairly traded stainless and carbon steel imports.

We are confident that our request presents a strong case for tariff exclusion and is grounded in relevant facts. The review process takes approximately 90-days to complete and we anticipate receiving a response in the second quarter.

Secondly, an update on STAL. As we discussed on the fourth quarter 2017 conference call, our STAL joint venture currently operates two facilities in the Shanghai China area to produce Precision Rolled Strip Products.

We are nearly complete with an expansion that will add approximately 50% additional capacity and expect to begin production on the new line in the second quarter continuing to ramp during the second half of 2018 and throughout 2019.

Chinese domestic end-market demand for STAL products remains strong across several markets. This expansion will be fully funded from joint ventures cash flows, demonstrating the long-term strength of the entity.

And finally, an update on our potential third-party HRPF conversion agreements. We continue to run large-scale trials for multiple carbon steel producers who see tremendous value in the mill’s expansive products with capabilities, its ability to maintain product gauge control throughout the slab conversion process and its flexibility to create multiple end-customer products from a single unit of input material.

To-date, these extensive trials have successfully demonstrated the mill’s capability to our potential conversion partners and in many cases to their end-customers.

We continue to expect that we will sign at least one conversion agreement in 2018, but recognize that the recent tariffs levied by the U.S. Commerce Department on all steel imports cast significant uncertainty across the entire carbon steel supply chain, particularly while country and company exclusion requests are temporarily granted or still under consideration.

The A&T Stainless joint venture and the potential for carbon steel conversion agreements represent capital-efficient actions to increase asset utilization and to drive improved financial results. Each of these initiatives will contribute to our long-term goal of sustainable profitability for the FRP segment.

Now I will hand the call over to Pat DeCourcy to talk about our first quarter financial performance.

[Patrick DeCourcy, Chief Financial Officer]

Thanks Bob. Turning to Slide 8, I would like to take a few minutes to update you on our first quarter financial performance and to provide you with initial guidance for our expected 2018 full year free cash flow.

Cash generation and importantly prudent deployment of our cash resources remains a key focus areas for ATI. At the end of the first quarter, we had $110 million of cash on hand and approximately $305 million of borrowing capacity available on our asset-based lending agreement or ABL net of $50 million of outstanding temporary borrowings on our ABL’s revolver.

These short-term borrowings were largely used to fund our first quarter investment and manage working capital to support business growth previously outlined by John and Bob and to provide funding to the A&T Stainless joint venture during the initial production ramp up process. We did not expect to have any borrowings under our ABL facility at year-end 2018.

First quarter, capital expenditures were $42 million reflecting the increased outflows for two significant projects. First, we made the initial downpayments for our fourth isothermal press and heat treat expansion to be located at our isothermal forging center of excellence in Cudahy Wisconsin.

Second, we had a substantial payments due for the capacity expansion of the STAL joint venture facility in China, which we anticipate will begin production in the second quarter 2018.

Both of these investments are expected to generate substantial cash flows and return on capital results over the next five years and beyond. Looking ahead, we continue to work with our aerospace and defense customers to understand the potential impact of production rate increases on the timing of our capital expenditures over the next several years to ensure that we are able to meet the desired industry production rate.

As a result of our ongoing operational improvements, disciplined spending and a structural reduction in our debt profile, we expect a significant improvement in free cash flow results for 2018. Excluding roughly $40 million in contributions to the ATI pension plan, we expect to generate over $150 million of free cash flow in 2018. This represents an improvement of approximately 400% or more versus 2017 and reverses a trend of negative free cash flow in the three year prior to 2017.

We intend to build cash on our balance sheet throughout 2018 and along with our expected improvement in segment operating profit, we anticipate continued improvements in our financial leverage metrics. This will bolster our case to return to the investment-grade credit ratings over time. We recently took a small step in this direction with a ratings outlook step-up at one of our major credit ratings agencies.

We will continue to refine our cash flow guidance as the year progresses and we’ll update you accordingly. I will now hand the call back over to Rich.

[Richard Harshman, Chief Executive Officer]

Okay, thanks, Pat, Bob, and John. Turning to Slide 9, our first quarter results represent a good start to 2018 reflecting the full year view that we laid out on our 2017 year-end earnings call back in January. As you heard from John Sims, the HPMC segment’s first quarter results exceeded our expectations and were driven in large part by a significant expansion of our next-generation jet engine product sales.

In general, we expect this trend to continue as our aerospace and defense customers deliver on their multi-year order backlog for new aircraft and engines. Although the HPMC segment’s margins expansion outpaced our expectations for the first quarter, our results support our confidence to achieve our stated HPMC segment goals of a minimum 200 basis points of year-over-year margin as a percentage of sales improvement in 2018 while achieving a year-over-year sales growth rate in the high single-digits.

In the Flat Rolled Products segment, Bob Wetherbee detailed our good first quarter results despite the negative impact from a change in accounting and foreign currency fluctuations. These results were based on the foundation of strong market demand that carried over from the fourth quarter 2017. We expect these favorable market conditions to continue in the second quarter.

Additionally, we believe that raw material surcharges will be favorable versus the first quarter for both ferrochrome and nickel based on current market conditions. With regard to our joint ventures, we will continue to support production ramp up of the A&T Stainless joint venture through our HRPF conversion agreement and expect production volumes to grow ratably across the second quarter and for the balance of 2018.

Separately, we anticipate a response on the Section 232 tariff exclusion request sometime in the second quarter. We anticipate the completion of the STAL expansion in China during the second quarter with initial production starting on the new manufacturing line. We do not anticipate financial benefits from this expansion during the second, third quarter start-up phase.

Beginning in the fourth quarter, we anticipate ratable growth across the ensuing four to six quarters as the additional capacity is used to satisfy anticipated customer demand growth in China. On a full year basis, we expect results from our FRP segment to improve year-over-year and reiterate our guidance for a high single-digit revenue – percentage revenue growth and operating margin expansion of 100 to 300 basis points.

Finally, as you heard from Pat, ATI is projecting a significant improvement in 2018 free cash flow laying the foundation for ongoing growth in this area as we continue to expand our business, and remain disciplined on our spending.

We will continue to refine this guidance as we progress throughout the year. As I stated earlier, the first quarter marked a good start to 2018 and reinforces our confidence in achieving our full year 2018 goals as well as our longer-term financial targets.

Operator, may we have the first question please?

[Operator]

[Operator Instructions] Our first question comes from Richard Safran of Buckingham Research Group. Please go ahead.

[Richard Safran, Buckingham Research Group]

Good morning, everybody. How are you?

[Richard Harshman, Chief Executive Officer]

Good morning, Rich. How are you?

[Richard Safran, Buckingham Research Group]

Very good. Thanks. First, a bit of a multi-part question here on titanium, for some time we’ve been talking about Boeing and Airbus derisking from Russia, we see recent geopolitical events appear not only just support that but maybe cause that trend to accelerate.

What I wanted to know is Boeing or Airbus discussed increasing the amount of titanium they buy from you, on the comments you made about forgings on the few moments ago, has Boeing or Airbus discussed how you make some forgings that the VSMPO was making? Did that impact you in the quarter? And finally, is there any thoughts you can give in potentially do we starting Raleigh?

[Richard Harshman, Chief Executive Officer]

Okay. Yes, that is a multiple part question. I’ll see if I can remember each part here, Rich. I think, Boeing and Airbus has, for the last year plus done a very good job of assessing the risk from any geopolitical actions as it pertains to Russia or any other parts of the world. So they have exercised their supply chain including ATI to make sure they understand what options they may have if those risks are encountered. I think and we’ve commented on this in the past that part of our emergent demand on the mill products side was probably a result of those kind of actions.

And I think some of the opportunities on some of the forging side that we saw in 2017 and continue to see today was mostly likely a result of that. So, I think, in the more recent actions that the U.S. government has taken or threatened on Russia, I think that the supply chain, the cost of the OEMs understand what options that they have, they have taken appropriate actions in terms of inventory builds in the last year plus and I think the supply chain and certainly ATI stands ready to support them and whatever our customers in whatever way they may need us to support them. But I don’t think it had any significant impact on Q1 at all.

[Richard Safran, Buckingham Research Group]

And any thoughts on Raleigh?

[Richard Harshman, Chief Executive Officer]

Yes, that includes both in mill products and forgings. Regarding Raleigh, I think if there was a need for us to deliver more titanium products into the supply chain either for risk mitigation or for just growth, we don’t see any current needs for restart in Raleigh.

For titanium sponge, we have very good competitive long-term supply agreement in place with multiple suppliers for titanium sponge including rotating quality or premium grade sponge that extend many – several years into the future and have the ability to flex up in volume. So, I don’t see a need for us to restart Raleigh at this point in time.

[Richard Safran, Buckingham Research Group]

Okay. Thanks for that. And next, last year you were impacted by a bit of an influx in legacy CFM 56 works which was a bit dilutive relative to the work you are doing on the LEAP, certainly, it doesn’t appear to showing up this quarter, but we are starting to see a pick-up in aftermarket demand and I wanted to ask if that’s something that could reoccur given the pick-up in the aftermarket.

Are you obligated to do the work on the legacy platforms and basically, what I am looking for here is that the mix is going to continue to improve?

[Richard Harshman, Chief Executive Officer]

Yes, I think that 2018 continues to be a transition year from a demand standpoint away from the legacy-oriented products and not only the alloy side, but also on the parts and components side into the next-generation demand. But I think, as a transition year, it will continue to be a little volatile on the product mix side.

And I think, as you get into 2019 and 2020, our understanding of the build rate especially on the engine side would suggest that the richer product mix begins to take a more consistent larger portion of our capacity. You are always going to have some legacy demand there or if not always, but certainly for a number of years because of aftermarket, there is still building CFM-56 engines, right.

So that demand – not at the rate that they were being built in 2017, but the demand is there not only on the alloy or mill product side, but also on the parts and components side. So I think 2018 is more of a transition year to a stronger product mix in 2019 and beyond.

[Richard Safran, Buckingham Research Group]

Okay, well, thanks very much for that.

[Richard Harshman, Chief Executive Officer]

Okay, Rich. Thank you.

[Operator]

Our next question comes from Gautam Khanna of Cowen and Company. Please go ahead.

[Gautam Khanna, Cowen and Company]

Yes, thanks, good morning.

[Richard Harshman, Chief Executive Officer]

Good morning, Gautam.

[Patrick DeCourcy, Chief Financial Officer]

Good morning, Gautam.

[Gautam Khanna, Cowen and Company]

So, maybe to expand on some of the things Rich asked and you answered, it seems like the Russian sanction threat sort of intensifies in recent weeks subsequent to the quarter end. I just wondered, have you seen – do you anticipate seeing kind of a desire by Boeing and perhaps anyone else to start to order – ask for you guys to ship more – to kind of buffer and expand on the safety stock that could be a pick-up in Q2 and Q3 on the airframe side would sort of lagged in this quarter, even Q1?

[Richard Harshman, Chief Executive Officer]

Yes, I mean, we are – as you know on the mill product side, I mean, the order entry rate does tend to look ahead by one or two quarters. I mean, we are filling up at a rate that is consistent with what our expectation would be on the order entry side for mill products from Boeing which were much larger with than we are with Airbus at this point.

So, I think that some of that has emergent demand in it and we are seeing that just as we did in 2017, I think that there were some actions taken in 2017 to build buffer stock in anticipation of potential sanctions, additional sanctions. So, I think that whatever we are seeing is consistent with a prudent approach by the OEMs to make sure that they manage that risk.

I think on the forging side, especially the large forgings, were there is some unique capabilities that VSMPO has that we don’t have quite frankly. I mean, we don’t have those – that large 50,000 ton plus press to make those large forgings. Others in the U.S. do, so they probably are seeing something there, but we wouldn’t be seeing that on those very large forgings where there were some smaller forgings that fit our capability.

We saw some actions taken by our customers in 2007 – in 2017 in awarding those – some of those parts to us that we are producing today. And we would expect to continue to produce those and perhaps see other opportunities as we move through 2018.

[Gautam Khanna, Cowen and Company]

Okay. That’s a very helpful answer. Just to follow-up on the forgings piece, so you are seeing fairly expansive growth. When we think about the LEAP engine ramp, not everyone is – there are constraints in the supply chain.

I don’t think you guys are one of them, which is fantastic. But have you seen emergent demands because of perhaps one of the other suppliers, a second source being unable to produce with the same rate. Are you seeing that outside of the VSMPO dynamic, which is sort of underlying …?

[Richard Harshman, Chief Executive Officer]

Yes, we’ve commented on this in the past, Gautam. I think that, first of all, we worked very hard to not be the impediments of the production rate ramps. So there is a lot of great work by John and Bob and the teams throughout ATI to do that and some of it has – has happened by sheer muscle and others just by continuous improvement efforts.

So, we will continue to do that. I think that, certainly on the forging side, we have seen emergent demand above the contractual share that we have won on certain parts. We saw that in 2017. We are seeing that in 2018. I think we’ll continue to see that in 2018 and possibly beyond. And as long as we have the capacity available to help our customers, we will do that.

And that’s part of the reason for the fourth isoforging press that we announced here a short while ago that will be coming on stream in a couple of years and that is based on not only the business that we have currently and the rate ramps that are there but also discussions that are ongoing for other opportunities that our customers are talking to us about.

[Gautam Khanna, Cowen and Company]

Okay. And one last one, if you could just level set us on – because Q1 clearly was very strong at both segments, but at HPM in particular. Historically, there has been the seasonal pattern where Q2 tends to be a better – even the highest margin period of the year and then Q3 level dropped a bit of seasonal outages and what have you and then Q4 has the shorter days due to the holidays – but fewer days.

I just want to make sure, like, if Q1 sort of the proper mark from which we should think about Q2, I know, I am just curious about is there is a mix or is there something going to be – something different in Q2 at HPM that may bring it down and at Flat Rolled, I think Bob made a comment about one of the nickel sheet pipeline projects not seen in the quarter – are being delivered. So, I just want to get a sense that we don’t overshoot on Q2, if you could just help calibrate us on what we should be thinking about?

[Richard Harshman, Chief Executive Officer]

Yes, I think, as we see it, we are early in Q2, obviously and some of the emergent demand that we typically see interestingly happens in the second half of the quarter. So, what we are really going off or what we see in the marketplace and what the order book looks like today and what the production schedules look like today.

So on the HPMC side, I do think that we are currently expecting the mix to be not as rich with new products in the second quarter as we saw in the first quarter and that’s our current expectation. We’ll see how it plays out, but that’s what it looks like the base of the business is at this point in time.

You are looking at the rest of the year, you commented appropriately on the third quarter it’s a little noisy, because lot of our customers in Europe and there is extensive plant shutdowns and vacations that happen throughout the month of August, just not the whole month of August. So, it has a tendency to be a little noisy. However, this is an interesting year, right, because you have a lot of rate ramp happening, especially on the engine programs as we continue to move throughout 2018.

So, we’ll have to see how that plays out in the third and the fourth quarter. I would hesitate to say that that history is a good indicator in the second half of the year because of the extent of the rate ramp on new engine programs.

As it pertains to Flat Rolled, where we have a little bit less visibility in the Flat Rolled business in terms of looking out into the second half of the year, I think one of the things that we are pretty – we are very confident of as it pertains to Flat Rolled in the second quarter is we won’t have the non-recurring charge, right.

And I don’t think that we are going to have the kind of comparative issue on the foreign currency side and as Bob indicated, we expect to see some favorable movement in the two critical raw materials on the surcharge side in terms of ferrochrome and nickel. So, I would expect to see an improved performance in the second quarter compared to the first quarter in Flat Rolled Products.

Despite the fact that we won’t see the level of nickel sheet or plate deliveries because of the large projects in the oil and gas side in the second quarter. As you look at the second half of the year, the one thing we are seeing and do believe is that, there are additional projects out there in the oil and gas side for nickel sheet and plate for projects, in particular that we would expect to certainly positively impact the fourth quarter and possibly a little bit in the third quarter.

[Operator]

Our next question comes from Phil Gibbs of KeyBanc. Please go ahead.

[Phil Gibbs, KeyBanc Capital Markets]

Hey, good morning.

[Richard Harshman, Chief Executive Officer]

Good morning.

[Phil Gibbs, KeyBanc Capital Markets]

I had a question on the margin guidance. So the – call it, the 200 basis point growth in Flat Rolled margins at the midpoint, are you anticipating tariff impact in those numbers, Rich?

[Richard Harshman, Chief Executive Officer]

I think at the low-end, we are anticipating less of a favorable impact from the JV than we are at the upper-end. So, when we gave that guidance at the beginning of the year, we weren’t aware of – I mean, we knew that there was a 232 investigation going on, but we didn’t know what the end-result would be. So it would be disingenuous of me to say that that was directly related to the 232 case.

But I think as it plays out, I think it is. The lower end of that range is less of a value-add from the JV and the upper-end is what we would expect that the JV to deliver to Flat Rolled. Bob, would you agree with that?

[Robert Wetherbee]

I would.

[Phil Gibbs, KeyBanc Capital Markets]

So you need – I guess, in other words, you need – do you think you need an exclusion to be at the high-end of that range or above that range?

[Richard Harshman, Chief Executive Officer]

Yes, I think it depends on all the other markets, right, in the second half of the year. As I said, I don’t – we don’t have the clear visibility longer-term, because of the more short-term oriented nature of the Flat Rolled Products business compared to the High Performance business. So, yes, I would say, at this point in time, as we look at the markets, that to hit that higher end or I mean, ideally, right our objective is to exceed the higher end and this is our objective is to exceed the guidance we gave on High Performance. But we’re giving you a read in both of those segments in terms of what we see the market is playing out in 2018 and where we are positioned.

[Phil Gibbs, KeyBanc Capital Markets]

Excellent. And Bob, are you seeing price increases on the commodity, stainless side start to flow through as that market tightens up a little bit?

[Robert Wetherbee]

Hey, good morning, Phil.

[Phil Gibbs, KeyBanc Capital Markets]

Good morning, Bob.

[Robert Wetherbee]

The answer to your question is we are seeing the increases – I think the market is somewhat unsettled in terms of supply and that people are making the decisions they need to make now to fill their supply chains through the balance of Q2. So the price increases that we’ve announced – I guess, I’d say are sticky and we are certainly invoicing, collecting.

So, as I talk to various customers, they are not seeing the serious spikes in stainless as they’ve seen at other commodities like aluminum or carbon. But they are trying to keep their demand close – or their purchases close to the demand levels, not to get overstocked, especially with the price issues that are going out in those segments. But for stainless, we are getting the increases.

[Operator]

Our next question comes from David Strauss of Barclays. Please go ahead.

[David Strauss, Barclays Bank]

Good morning guys.

[Richard Harshman, Chief Executive Officer]

Good morning, David. How are you?

[David Strauss, Barclays Bank]

Good, good. Following up on that line of question, I guess, just to confirm if you don’t get this 232 exclusion that the plan is still to go forward with the JV and then following on that, I think you’ve talked about that what contributed $25 million to $35 million in operating income on your side. If you don’t get the 232 exclusion, what do you think that number looks like?

[Robert Wetherbee]

Good morning, this is Bob. I think, we are confident that we have the case to get the exclusion. So we continue to drive for that result. I think if we don’t get the exclusion, what we expect to see is a pretty tight standard stainless market in the United States. We would most likely see additional price increases coming to offset any of the short-term operating costs related to the JV. We have definitely invested in the JV for the long-term.

We see Section 232 as a short-term issue that we are going to have to work through and that our original estimates of that $20 million to $35 million through the JV are still very realistic. If they don’t occur in 2019, it’s probably a six, nine, twelve month slide based on the extent of Section 232.

Can’t say that the customer base has responded very favorably to the reintroduction of the 60-inch wide stainless sheet from Midland from a quality and service perspective and all minor actions with customers remain positive. Again, they see 232 as a short-term issue that we are going to work through.

[David Strauss, Barclays Bank]

Okay. Thanks, Bob. Appreciate that. Pat, the free cash flow forecast this year, can you talk about assumptions around working capital within that and then, also your bullet on Slide 8 around NOIs and the impact of potential aerospace rate increases on capital spending. Could you give a little bit more color on that? What you are thinking about there? What that might mean for the capital spending plan beyond 2018?

[Patrick DeCourcy, Chief Financial Officer]

Sure. For the full year, we anticipate, I’ll call it a modest working capital investment. Not as significant as we’ve obviously seen in the first half related to several different things. You’ve got the initial ramp in sales in both segments plus the investments for the A&TS joint venture. In addition to that, we have some – probably some inventory related to the pipeline projects that would be cleared normally as they ship and then we collect the receivables on those sales.

So, we do anticipate for the full year, I’d say it a modest, based on our full year guidance in revenue increases in the probably the $40 million to $45 million range growth. So that would be the full year commitment. And then the second question, can you repeat the second question?

[David Strauss, Barclays Bank]

Yes, it was just around the capital spending plan beyond 2019 given potential rating, beyond 2018, given potential rate increases?

[Patrick DeCourcy, Chief Financial Officer]

So, we are continuously evaluating our CapEx commitments over the next several years and we would adjust if there are significant changes in those build rate schedules. So, as those build rate schedules are adjusted to real, we have to take a look at the timing of our capital expenditures.

So we have a full five year outlook of what we anticipate and then if the rate increases are real, the ramp changes a little bit, we might have to pull forward some of those commitments. So we are continuously evaluating that. You saw the announcement in the last quarter with the new isothermal press and the heat treat expansion project. That was a reaction to anticipated build rate increases within this next three to five year period.

[Richard Harshman, Chief Executive Officer]

Yes, Dave, this is Rich. I think that, there is obviously a lot of dialogue going on with some of our strategic customers in terms of their – on the aerospace side in terms of their demand profile going forward and how they would like ATI to participate in that rate ramp and in that growth. And so, as we get into the next couple of years, we start bouncing up against some capacity constraints that would limit the potential upside of ATI’s participation in long-term growth, which obviously is not in the long-term best interest of our shareholders.

So, to the extent that we have that demand is there, it’s strong, it’s contractual that supports a prudent manageable investment in capital and has a strong business case, we would look at that. So, we don’t want to limit our upside, longer-term growth opportunities by being foolish in terms of ignoring potential investment to specially in producing products that are absolutely differentiated that has significant technical barriers to entry that ATI is a recognized leader in.

So, we will always look for those kind of opportunities. That’s why generating strong earnings and strong cash flow growth going forward is critically important. So that, we have the balance sheet and the cash flow to support those kind of investments that are in the best interest of our shareholders.

[Operator]

Our next question comes from Timna Tanners of Bank of America Merrill Lynch. Please go ahead.

[Timna Tanners, Bank of America Merrill Lynch]

Yes, hey, good morning everyone.

[Richard Harshman, Chief Executive Officer]

Good morning, Timna. How are you?

[Timna Tanners, Bank of America Merrill Lynch]

Okay, thanks. Just on the last question, I think it’s a really important point and I appreciate the discipline in the balancing act there. But, just reading between the lines, you are saying that, should the demand is required, ATI has the capability. So, under what contractual terms, you try to make the decisions to whether or not add any capacity? Can you give us a little bit more color about how those agreements would have to play out? Just to understand how your thought process works?

[Richard Harshman, Chief Executive Officer]

Yes, we – the – our thought process is probably best sums by a reference to a movie, right. We are not big believers in the line, if you build it, they will come, right. We are believers on the line that, if we have a contractual commitment that supports the utilization of that investment and generates a good return on capital employed for our shareholders, we will make that investment. So- and that’s the dialogue that we have ongoing with our customers, right now, right.

We are not – it wouldn’t be a speculative investment and it’s also not something, I don’t want everybody to get all worried and scared. I mean, we are not talking about a $500 million project or something like that. These are potential projects that range from $50 million to $100 million of spend over a two or three year period. So, it would be roughly within the kind of guidance that Pat has given in the past, but would add a marginal amount to that additional capital investment every year.

So, but it’s something that the business case has to be there to support it. The contractual arrangement has to be there to support it in terms of it being a long-term agreement, not something that’s two or three years, but something that’s seven to ten years or longer. And when that’s there, and that supports the business case then, it looks like a good project to us.

[Timna Tanners, Bank of America Merrill Lynch]

Okay. That’s helpful content. Thank you. My only other question was on the energy and on the comments on the construction and mining demand. If you could just characterize that a little bit more if you think that’s sustainable energy if it’s offshore, onshore? And is it rebuilding inventory? Or is this underlying demand? Thanks a lot.

[Richard Harshman, Chief Executive Officer]

Yes, I’ll talk about the energy side and John can comment on the construction and mining side. I think the energy side, energy is a broad market. We are not seeing any significant demand at all in the large frame gas turbines, right, for energy generation and that’s pretty much consistent with what companies like GE has said right?

We are seeing some demand in some of the smaller gas turbines – industrial gas turbines that utilize, maybe lower grades of some of the specialty materials that we make, but also have forging opportunities right? So, we are seeing that. We think that that demand is real. We think it’s supportive only by the U.S. demand, but also the global demand.

So, we would expect that to have a nice growth rate here over the next two to three years. Some of the other energy markets that are strong, that kind of fall within the energy category, at least in our Lexicon is marine scrubbers, right.

You’ve probably read and heard with the passage of some new global - the Paris Accord, I guess is the source of this, is a lot of the diesel fuel and fueled ships are installing scrubber systems in their – on the ships themselves.

So in cargo ships, large structural ships and that market is a very strong market, especially in Asia. And that takes in some of our Flat Rolled Product alloy systems that Bob produces and we are selling that product today and we see strong demand not only in 2018, but really over the next two to three plus years. And that – so that energy market is a strong market.

And then, even on the nuclear side, I mean, there are opportunities on the nuclear side, not that there is a nuclear renaissance going on, but more of a refueling. When you look at the refueling cycles for the commercial nuclear reactors that are in the U.S., there is good demand that is supportive of our Specialty Alloys and Components business and the High Performance segment. John, do you want to comment on the construction and mining?

[John Sims]

Sure, Rich. Hi, Timna. On the construction and mining side, these are largely large forgings for heavy mining vehicles for mining activity outside the United States. And so the leveling of increase we have seen beginning probably second half 2017 and into 2018, we project strong for 2018 and looks good into 2019. They are not at the levels that we saw back at the peak of 2012, but they are certainly higher than anything we’ve seen in the last five years.

[Operator]

Our next question comes from Chris Olin of Longbow Research. Please go ahead.

[Chris Olin, Longbow Research]

Hey, good morning.

[Richard Harshman, Chief Executive Officer]

Good morning, Chris. How are you?

[Chris Olin, Longbow Research]

Good, good. Thanks. Rich, you spoke about emergent demand on the jet engine side and you talked a little bit about long-term contracts tied to any investment decisions. I guess, I was just wondering about the formal decision on the forge press. There was no contract announced with that. And I was just curious if you have won new business to actually justify that and maybe is there any type of update in terms that GE 9X contact, is that been awarded yet? That’s all I had.

[Richard Harshman, Chief Executive Officer]

Yes, well, we actually did – part of the support for the fourth isoforge press is, is the long-term agreement that we announced with UTC Pratt Whitney that involves not only isoforgings, but also powder production. So it’s the full integrated supply chain from producing their powder into using our TSAF assets in the Carolinas to forge it into a billet and then produce the isoforging from that process for them.

So, when you combine that plus the demand from the rate ramp for the other engine programs that we are on, that supports in the timeframe of when that forging ramps for Pratt would work in, that supports the timing of that announcement and when that isoforge press will come on stream. I think as you look further, are there opportunities for us on other new programs as well as growing our share on the existing platforms, the answer to that is, yes.

That would look at continued to utilize our precious capacity on the 10,000 ton open die press forge in North Carolina that is the asset that is critical to producing the billet from powder. So that becomes a precious capacity issue that we are very much focused on and then how that flows into iso capacity demands going forward really beyond 2020 into 2021, 2022, 2023.

So those kind of become including despite the fact that we have the fourth iso coming on stream in the next couple of years. Those two assets become really critical capacity constraint points for us in looking at emergent demand and what the customers are asking us to do.

[Chris Olin, Longbow Research]

Excellent. Thank you.

[Richard Harshman, Chief Executive Officer]

Thank you.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to Rich Harshman for any closing remarks.

[Richard Harshman, Chief Executive Officer]

Okay. Thank you and thank you for joining us on the call today and as always thank you for your continuing interest in ATI.

[Scott Minder]

Thank you, Rich. And thank you for all the listeners for joining us today. That concludes our first quarter 2018 conference call.

[Operator]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.