Allegheny Technologies Inc

NYSE:ATI

Earnings Call Transcript 2022-Q1

[Operator]

Hello, everyone and welcome to the ATI's First Quarter 2022 Results Call. My name is Charlie, and I'll be the coordinator for today's call. You'll have the opportunity to ask a question at the end of the presentation. [Operator Instructions]

I will now hand over to your host Adam Pechart to begin. Adam, please go ahead.

[Adam Pechart, IR]

Thank you. Good morning, and welcome to ATI's first quarter 2022 earnings call. This is Adam Pechart filling in for Scott Minder, ATI's VP of Investor Relations and Treasurer, who is not with us today due to illness. Today's discussion is being broadcast on our website.

Participating in today's call are Bob Wetherbee, Board Chair, President and CEO; and Don Newman, Executive Vice President and CFO. Bob and Don will focus on our first quarter highlights and key messages. A supplemental presentation is available on our website. It provides additional color and details on our results and outlook. After our prepared remarks, we'll open the line for questions.

As a reminder, our forward-looking statements are subject to various assumptions and caveats. These are noted in the earnings release and in the slide presentation.

Now, I'll turn the call over to Bob.

[Robert Wetherbee, Chairman, President & CEO]

Thanks, Adam. Good morning and thanks for joining us. What we accomplished this quarter builds additional momentum for what we anticipate will be a very strong year for ATI. Our team is performing well, continuing to execute operationally and strategically. Our market conditions are improving. Customer demand accelerated in the latter part of the quarter. These all enhanced our topline growth rate and added to our earnings.

I'll use my time today to tell you about three things that really stand out for me about our performance. First, we delivered overall Q1 EBITDA margins of 15%. That's an increase of 430 basis points versus full year 2019. This margin level was achieved despite sales that were nearly 20% lower than 2019 on a run rate basis. Comparisons to 2020 and 2021 are even more favorable. We have fundamentally transformed our business over the past two years. Our results increasingly reflect the value of the actions we've taken.

Second, the value of our strategic actions is truly evident in the AA&S segment results. Q1 segment EBITDA margins were over 15%. No question there were a few beneficial tailwinds, but what's really driving this segment's results, structural improvements in our footprint, product mix, and customer profile. Continued operational discipline is also increasing the bottom line. We all know the tailwinds inevitably turn to headwinds. When they do, these structural changes will ensure a solidly profitable business through the cycle.

And third, our incremental margins were robust. While sales grew by 20% year-over-year, adjusted EBITDA doubled. That's truly impressive. It's a testament to our team's energy and focus to improve ATI. We all started 2022 with an optimism that the world return to corner on global volatility. What we recognize is that uncertainty remains the norm for all companies. Geopolitical issues in Europe and COVID-related lockdowns in China are the latest additions to the list. These events create short term raw material price volatility, supply chain disruptions and reduced consumer demand transparency. Yet every cloud has a silver lining. For us, it's our ability to nimbly react to ever changing conditions. And we are operating in an environment where underlying demand in our core markets continues to improve, particularly commercial aerospace.

Amidst the ongoing uncertainty, we continue to focus on the things that we can control, executing the strategy we shared at our Investor Day. We're well on our way to becoming an aerospace and defense powerhouse. We're serving growing markets with our material science expertise and unique process capabilities. We continue to progress on the final steps in our business transformation plan. We're no longer producing standard stainless sheet products. In the quarter, we recognized the benefit from the sale of a Stainless related facility and are nearing the mid-year closure of the remaining two sites.

We continue to take actions to ensure that we have a purpose-built portfolio aligned with our strategy. To that end, we recently announced the sale of our Sheffield UK facility. It's part of the HPMC segment and focuses primarily on oil and gas materials. This facility has struggled to be margin accretive and carries a legacy defined benefit pension liability that will stay with the business post sale. The UK government is conducting its customary review of the transaction and we expect it to close in the second quarter.

Recent market dynamics created by the Russian invasion of Ukraine have created not only challenges, but also opportunities for ATI. Raw material flows to global industrial markets including commercial aerospace are being impacted by economic sanctions on Russia. Disruptions to material availability have led to higher material prices. As a case in point, extreme price volatility caused the London Metal Exchange to close for several days in the quarter. With disrupted availability and no primary financial market, nickel prices rose by more than 30% in March. We also saw significant increases in the first quarter for other key raw material inputs including cobalt, ferrochrome and molybdenum.

How did we respond is the question. We focused on what we could control. To ensure ATI's ability to meet increasing demand requirements we took decisive procurement actions to create a near-term price protected nickel safety stock. This will ensure an uninterrupted flow of materials to meet increasing customer demand. These actions increased our managed working capital balance in Q1, it's appropriate insurance, ultimately, benefiting our customers. We're focused on protecting a continuous flow of ATI products to meet our customers' expanding production rates, overcoming supply shortages, and adding new employees. We raised prices to offset the additional raw material, labor and supply chain costs we're experiencing. In product lines with fewer long-term customer agreements, we're able to fully offset inflation in the first quarter.

In our LTA oriented businesses prices are rising but the bottom line impact will lag higher cost by about a quarter. Current events also provide long-term opportunities. As customers rethink global supply chains there is a likely reallocation of demand to western suppliers. This is most evident in Aerospace Titanium where customers fear losing access to close to a third of the industry's capacity for Aerospace quality melt. As customers react to sudden changes and governmental policy and industry certifications, many are exploring long-term agreements to lock in future supply. We'll be disciplined as this process plays out over the coming quarters.

As we speak, it's abundantly clear that we're well positioned to grow this part of our business. We have the needed qualifications, capabilities and near-term capacity. Customers can and are making efficient and economical decisions to be more strategically aligned with ATI. As we move forward, we will diligently evaluate our opportunities. We're balancing the potential need for additional capital expenditures with our long-term return on capital expectations. Exciting times for sure, and exciting to be well positioned to take advantage of the opportunities ahead.

With that, let's move to a brief discussion of what we saw in our key end market in the first quarter and what we foresee in the coming quarters. I'll start with commercial aerospace. Demand for domestic travel is strong, specifically U.S. domestic travel statistics in January and February 2022 were nearly on par with 2019 as industry labor shortages and travel restrictions eased. International travel rates improved almost 100% year-over-year in January and February, but are still 60% below 2019 levels. These trends are encouraging. There is still significant upside to this market's full potential.

We're also encouraged with increasing demand for narrow body airframes as the 737 MAX received clearance to resume commercial flights in China. This is very helpful to releasing a significant portion of this model's order backlog. For ATI our jet engine business continues to gain momentum. Specialty Materials sales growth is accelerating and we continue to see steady progress in forgings where our recovery began in early 2021. This growth supports our jet engine customer's increasing narrow body production rates. Our 2021 share gains magnify the benefits for ATI.

Demand for wide-body engine materials and forgings also grew in the quarter primarily supporting MRO programs for engine overhauls as airlines prepare their fleets for increased international travel. One big milestone for us, for the first time since 2019 more than half of HPMC's quarterly jet engine sales were ATI's NextGen materials. That's a really positive sign for ATI. We expect these beneficial trends to continue in the coming quarters further propelling our bottom line.

When it comes to widebody airframes, sales also improved despite ongoing low widebody aircraft production rates. We're seeing the benefit of new business wins that began in late 2021 with Airbus and for an electric autonomous taxing vehicle. As I mentioned earlier, there are substantial new business opportunities in titanium over the next several years. Most significant potential impact will begin in 2023. Our current lead times for most titanium products are well into the fourth quarter of 2022.

Next up, our defense markets. Sales were down versus both prior periods. The year-over-year decline is heavily influenced by the divestiture of our Flowform business in mid-2021. Rotorcraft sales are affected by a timing issue. We're seeing the volume for the now completed programs decline faster than the CH-53K program grew. Looking ahead, our decades long partnership with Sikorsky to produce U.S. military helicopters continues. They recently announced ATI is a supplier on the newly proposed DEFIANT X program. This is a contender to replace the Apache and Black Hawk.

Lastly, as expected, titanium armor sales increased in support of U.S. and British armored vehicle production. Our defense sales should increase in 2022 with growth in some categories, partially offset by declines in programs at or near their lifecycle ends. Longer term, we expect ongoing growth that's supported by replenishment of vehicles and weapon systems consumed by the conflict in Ukraine, increased U.S. and allied defense spending, and new programs like Hypersonics.

Shifting to Energy Markets. Sales to our oil and gas customers expanded versus both prior year periods despite the completion of a large pipeline project in the fourth quarter and our exit from production of standard stainless sheet products. Market demand remains elevated as oil prices have steadily risen in 2022. As a result, offshore investments have recovered to pre-pandemic levels. We expect this trend to continue as offshore activity increases including for nickel clad pipeline projects in Latin America, the Middle East and Asia. In our specialty energy markets, revenues were in line sequentially but down year-over-year. The latter is largely due to the timing of shipments for civilian nuclear applications and pandemic reduced pollution control project work in Asia. Shipments for land-based gas turbines remains strong in the quarter.

Looking ahead, we anticipate specialty energy demand will increase as the transition to greener Energy accelerates. We see two drivers, one, the need for more secure energy supplies in the wake of the Russian invasion of Ukraine; and two, increasing momentum to decarbonize. Additionally, advancements like modern nuclear power reactors, hydrogen as a fuel, and efficient gas turbines were all likely play a larger role in future energy policies. We will require extraordinary material science expertise and advanced process technologies, the core of ATI's differentiated capabilities.

Finally, in our smaller medical and electronics markets, first quarter sales performance was mixed. Sales to medical markets were in line sequentially and increased significantly year-over-year. This was led by materials for MRI machines as hospitals upgraded equipment to support elevated demand for elective surgeries. In our electronics markets, sales declined versus both prior periods. Sequential declines were largely due to the Lunar New Year holiday shutdowns in Asia. Year-over-year decreases were more modest and compared to record Q1 sales in 2021.

In the near term, we see lower sequential revenues as the COVID driven Chinese lockdowns continue. That said, we expect strong underlying market demand for electronic devices and chips to lead the market recovery later in the year. From my perspective, that's where we stand. In the past, I spoke of pivoting to growth. Now the markets have pivoted and we're fully accelerating. The path forward is clear. Our largest and most profitable end markets are strong and accelerating, fueled by underlying market demand and our team's ability to execute for our customers.

We have significant growth opportunities ahead driven by four things. First, commercial jet engine demand expansion. Second, airframe demand growth acceleration in 2023 aligned with international travel growth. Third, potential reallocation of aerospace titanium market shares. And fourth, defense market growth as global spending increases. We've made tremendous progress thus far. The ATI team is committed to improving every aspect of our operations and it shows. Concurrently, we've put ourselves in a great position to win. I'm confident in our team and our future.

Now I will turn it over to Don to give you some additional detail on our Q1 and financial results, and forward outlook. Don?

[Don Newman, EVP, Finance & CFO]

Thanks, Bob for a great overview. Here are my headlines for the quarter. Q1 revenue was up 20% year-over-year and 9% sequentially. Our bottom line is growing and our margins are expanding. This reflects the strong underlying demand in our end markets and benefits from our transformation. As a result, we are raising our full year EPS guidance by nearly 60%. I'll explain how these results position ATI for a great 2022 and are creating momentum for 2023.

Let's start with our first quarter performance. Sales of $834 million were up 20% year-over-year and 9% sequentially. Earnings growth was even more impressive. We earned adjusted EBITDA of $125 million, up 100% versus prior year, that's 32% growth over Q4 2021. This translated to an adjusted first quarter EPS of $0.40.

These adjusted results exclude a few things, a $25 million non-cash charge related to the pending sale of the Sheffield UK operation, a $7 million dollar gain on sale of our Pico Rivera facility, and an $8 million dollar net increase to our reserves, primarily due to a proposed settlement made on a pending litigation matter. On a reported basis, we earned $0.23 per share.

Before I cover the segment details, I want to provide some color on an ATI specific tailwind. Bob noted that we recognized some federal employment related subsidies in the first quarter. If you recall, we recognized these same subsidies in smaller amounts in the second half of 2021. First, we received a benefit under the Aviation Manufacturing Jobs Protection program or AMJP to maintain employment levels as the aerospace industry recovers.

Second, we recognized employee retention subsidies for maintaining appropriate recovery ready employment levels during the pandemic. In aggregate, these benefits totaled $29 million in Q1. These are meant to offset prior year expenses and current cost inefficiencies relating to sustaining employment levels. In reality, these benefits allowed us to retain the employees needed to be ramped ready for our customers. We expect a roughly $6 million AMJP benefit in Q2.

As a company, we generated robust year-over-year incremental margins up 50% in the first quarter. Our business transformation is reducing cost and eliminating less profitable businesses and product lines. We are also capturing benefits of employment subsidies, tailwinds from higher raw material prices and strong demand. We have consistently maintained incremental margins above 30% since our recovery began in mid-2021. Our employees have worked hard to get us into this position.

Now, let's dive into segment performance starting with High Performance Materials & Components or HPMC. First quarter segment revenues were $342 million, up 40% year-over-year and nearly 10% sequentially. The segment continues to benefit from the expanding commercial aerospace recovery. We see that particularly in jet engines where sales increased almost 90% versus prior year as a result of increasing material sales and steady forgings growth. Defense sales were lower while medical sales increased versus the prior year.

Segment EBITDA was $68 million resulting in a nearly 20% margin. This included $22 million of employment subsidies partially offset by labor and other costs related to ramp readiness. Results also reflected higher material input costs from increased commodity prices and temporary global scrap shortages. Segment EBITDA grew 12% sequentially compared to the Q4 2021 that also included AMGC benefits as well as a large customer credit. Excluding those benefits from Q1 2022, margins increased year-over-year.

When the subsidies are removed from both periods, we saw sequential declines for two reasons. First, we experienced temporary margin compression when raw material cost drive higher surcharges in revenue while EBITDA dollars remained constant. Second, a high percentage of the HPMC revenues are generated under long-term agreements, many have price recovery mechanisms that tend to lag actual input cost by approximately one quarter. This causes a drag on margins when prices increase rapidly, but will unwind when prices fall, benefiting margins.

In Advanced Alloys & Solutions or AA&S, the benefits from our ongoing transformation are clear in our results. Revenues increased by 9% versus both prior periods due to broad-based expansion in several core markets. Growth was led by aerospace and defense sales which increased by 47% year-over-year and by 29% sequentially. These gains were largely in airframe applications which benefited from new business that began in mid-2021.

Sales to markets focused on standard stainless products declined as we entered production in those materials. Segment EBITDA of $75 million grew by over 50% year-over-year and sequentially. This included $7 million of employment subsidies and benefits from higher raw material prices. Margins increased by over 500 basis points versus both prior periods. We were able to overcome the impact of higher costs in the quarter through improved product mix and brace pricing along with volume related benefits. The Specialty Rolled Products team is doing a fantastic job at quickly changing the business mindset from a producer of commodity products to a true high value specialty materials provider. The numbers tell the story.

Let's turn to the balance sheet, where cash and available liquidity totaled nearly $700 million at the end of the first quarter. For normal seasonal patterns, cash from operations declined versus year end 2021 levels, as we work to build inventories in support of the ongoing market recovery. In addition, as Bob shared, Russia's invasion of Ukraine has negatively impacted the price and availability of many industrial commodities. We took proactive steps to procure additional raw materials required in order to ensure on time customer deliveries throughout 2022.

Managed working capital as a percent of sales increased versus year end 2021. This was a result of increased volume demand particularly late in the quarter as well as higher raw material costs. As a partial offset, gross inventory turns improved by nearly 10% in the first quarter as the work of our dedicated inventory flow teams gained traction. We intend to closely manage inventory as the year progresses continually assessing the need to maintain additional strategic quantities.

At our Investor Day, in February, we laid out our capital deployment plans in detail. To summarize, we will focus on one, funding organic and inorganic growth as opportunities arise. Two, reducing debt and pension obligations. And three, opportunistically returning capital to shareholders. In support of these objectives, we spent $26 million on capital expenditures in Q1. We expect this pace to accelerate as we plan to hit our 2022 CapEx range of $210 million to $225 million.

We also acted on our recent Board authorization to repurchase up to $150 million of ATI stock. In the first quarter, we bought back approximately 3.5 million shares at an average price of $25.57, that's 6% below Monday's closing price. These repurchases will go a long way toward offsetting the expected dilution when our convertible notes mature on July 1 of this year. We expect to issue 5.8 million shares at that time since settlement in shares is required above the $14.45 conversion price. We're excited to be in the position to return cash to shareholders while still funding our business priorities. To date, we've spent about $90 million and $60 million remains on our $150 million authorization. We'll continue to provide quarterly updates on our progress.

Now, let's spend a few minutes pulling it all together. What do these results mean for our second quarter and full year 2022 outlook? We expect underlying market conditions in our core aerospace business and our strong execution to drive increased sales and earnings across 2022. Demand expansion in other key markets should also support our growth. In the second quarter, tailwinds from governmental subsidies and raw material benefits will likely be significantly smaller than in Q1. COVID related logistical challenges in China [indiscernible] production output at our Asian Precision Rolled Strip business.

Finally, we expect a non-cash charge of about $110 million related to the expected Sheffield sale, which will be excluded from adjusted earnings. On the positive side of the ledger, we anticipate a $9 million benefit from our portion of the Section 232 tariff recovery made by our A&TS joint venture. We anticipate second quarter earnings in the range of $0.32 to $0.40 per share. Despite the strong market conditions, net unfavorable sequential headwinds will likely cause second quarter earnings and margins to contract somewhat compared to first quarter. Year-over-year earnings and margins are expected to continue to expand.

Looking a little further out, the picture becomes a bit hazier. There is raw material volatility, the impact from ongoing geopolitical events, supply chain disruptions, and COVID resurgence in China, however, the team is managing challenges and driving results. Given Q1 performance, Q2 outlook and anticipated growth in the second half of the year, we're increasing our full year guidance. Our revised full year 2022 EPS guidance is a range of $1.40 to $1.60 per share. This represents a midpoint increase of $0.55 per share versus the prior guidance range that's nearly 60% higher.

We are confident underlying market fundamentals support growth, and we have sufficient levers to meet this increased EPS outlook. Due to the uncertainty of raw material pricing and the potential need for higher strategic inventory levels, we're keeping our full year free cash flow guidance in place. We'll reevaluate as events unfold across the second quarter and provide an update on our next earnings call.

With that, I'll turn the call back over to Bob.

[Robert Wetherbee, Chairman, President & CEO]

Thanks, John. I'm sure today's audience can sense just how excited and encouraged we and our leadership team are by our start to 2022. We've got a strong set up heading into the second quarter. Our growing end markets, solid execution, and the team's proactive and creative efforts to address challenges as they arise are driving results and beyond the second quarter, we have great long-term opportunities to profitably expand our business. As excited as we are about our first quarter performance, we also want to keep our long-term goals for ATI in the forefront. We outlined them at our Investor Day in February. They're straightforward, impactful and worth recapping. We intend to grow faster than the market, 9% to 11% annually through 2025.

With that growth, we expect ATI's EBITDA margins to increase steadily to 18% to 20% over that same time period. When we hit our profitable growth milestones, we anticipate converting 90% of our net income to cash to further propel growth and returns to shareholders. With our first quarter results and strong second quarter guidance, we're on the path to hit these targets. If you haven't had a chance to go through our Investor Day materials, I encourage you to look -- take a look, listen at what's driving us to a better company than ever before. The video replay and slides are available on our website.

Operator, we're ready for the first question.

[Operator]

[Operator Instructions] Our first question comes from Seth Seifman of JP Morgan. Seth, your line is now open.

[Seth Seifman, JPMorgan]

Hey. Thanks very much and good morning everyone.

[Robert Wetherbee, Chairman, President & CEO]

Good morning, Seth.

[Seth Seifman, JPMorgan]

Just wanted to make sure -- good morning. Just wanted to make sure I understand the dynamic kind of pass-throughs in HPMC and what kind of drove the margin, if we took out the subsidy, I hadn't really expected the margin to remain at the Q4 level, but the step down was significant. And so just understanding the pass-throughs there, especially on some of the mill products it sounds like, and how to think about the trajectory of the HPMC margins from here given the different drivers.

[Don Newman, EVP, Finance & CFO]

Sure. So, this is Don. Let me take a run at that. First of all, in terms of the pass-throughs, the way that you want to think about it for HPMC, we have long-term agreements that allow for the pass through of a good portion of metal price movements. We also have CPI types of adjustments that we're able to get through those same agreements. In addition to that, those are the LTAs. Under the non- LTA transactions or transactional sales, we're able to typically get good recovery in terms of our underlying cost increases through price increases.

Now, one thing to keep in mind when you do you think about the pass-through mechanisms under the LTAs is there -- does tend to be a bit of a time lag where there is about a one quarter lag between when the inflation is seen in our cost structures and when the adjustment mechanisms within the LTA allow for the recovery in the prices, so that as you're thinking about the incremental margins in quarter-to-quarter margins, that's one way that you're going to want to think about it.

The other thing to keep in mind as you kind of consider the employment incentives that we raised this quarter is the headline numbers $29 million of credits that -- or exempts rather that were recorded in the quarter '22, I believe was related to HPMC. But that's not the whole story. The whole story is those credits are really about helping to make businesses ramp ready. And how is that happening? Well, companies like us are adding new employees all the time. This quarter we added about 500 employees. As you can imagine, when we hire those employees there is training required multiple months ahead of those employees being able to be a key part of our meeting ongoing demand. So there is real cost involved that you need to consider as you think about those credits.

So you don't want to just strip out the $29 million or $22 million of credits as you think about Q1 because there are offsetting expenses to think about as well. For Q1, to give you some sense south (ph) in terms of what those offsetting expenses are as you're doing your math, I think in terms of probably $8 million to $10 million of inefficiencies tied to those new heads or other ramp related inefficiencies within our cost structures. So I would add that.

Now, how do you think about the real -- the margins going forward? The way to think about the margins going forward in terms of the overall business, or we've done a really good job I think in terms of our incremental margin performance, and what we shared is think in terms of 30% to 40% incremental margins as the business continues to progress through the ramp. It's going to be the same story with HPMC specifically in the broader sense. So I would expect that as the year continues, we will continue to see expanding margins, top line growth and growing bottom line, and of course all of that I think is reflected in the guidance that we gave for the full year.

So a lot of good news, a little bit of noise in the current quarter, but the noise I think as you consider the things I shared, the noise will be -- once you adjust for that, I think it's clear that this underlying performance -- the underlying performance of the business is quite strong.

[Operator]

Perfect. Our next question comes from Richard Safran of Seaport Research Partners. Richard, your line is now open.

[Richard Safran, Seaport Global]

Bob, Don, Adam, good morning. Scott, hope you get better. So I wanted to follow up on your titanium comments. Boeing said two things on its call, it has a lot of inventory and it suspended imports from Russia. Clearly, there's a lot of share to be gained here. It's also true I think that Boeing isn't unique here de-risking from Russian titanium, this impacts Airbus and the engine manufacturers. So I thought you might expand a bit on your opening remarks and talk about share gains, what your incremental capacity is, the timing of those gains, when we might see it, and if you're already in those discussions with the customers right now and to pick up share? Thanks.

[Robert Wetherbee, Chairman, President & CEO]

All right. This is a great way -- good morning, Richard -- a great way to get four questions in one here, so I'll try to work out in reverse order. So I would say that the major OEMs are very energetic and focused, making sure they have their titanium supplies in line for the long term. So we do see a lot of activity, expect the second quarter to be a really busy time working with the customers to try to sort that out.

And the second piece of your question I think from an industry perspective, I think the titanium aero quality melt will be the primary stress point that people are going to work through. So I think you'll see people in the industry today that they're looking at some of the, I'd call it bottleneck management 101 techniques, or you look at the product mix that you have, are you optimizing through the bottleneck, and for us, I think it will be -- and the industry, it's going to be the melt side. It's probably about 30% of the world's titanium aero quality melt that's kind of at-risk here. So I think what you're going to see through the course of 2022 is positioning for 2023 and beyond. Our lead times are out into the fourth quarter today. That's really -- our order book is really driven by current demand, no real share shifts.

And as we look to 2023, we'll do the usual incremental small projects to debottleneck some of our downstream and worry about the melt, but I think what you'll see is an opportunity for reallocation of shares 2023 and beyond. It's too early to speculate as to what that is. But from our standpoint, if you go back to Investor Day, we were clear that we feel we have the capacity to support the build rate projections through 2026 which was -- financially we built in about 100 narrow bodies and 20 wide bodies per month.

So if you think about where we are in the widebody production today we have plenty of upside. And as we've said before, we don't produce to build rates, we produce to firm orders. And when we do that, we don't really invest capital without firm customer commitment. So at this point, I think we're probably about 90 days away from giving you a good answer on share shifts, but I think I would just leave you with the thought that there is a lot of activity and we expect to be in a good position to gain from that going forward, but too premature to really make any commitments.

[Operator]

Perfect. [Operator Instructions] Our next question is Phil Gibbs from KeyBanc Capital. Phil, your line is now open.

[Phil Gibbs, KeyBanc Capital]

Yeah. Thanks very much. Don, on the side of high Performance Materials and Composites in the first quarter. If we were to assume that you effectively had proper timing of raw materials and pricing, you noted the one quarter lag, and I think in your adjusted result excluding subsidies it was something like 13.5% margin. Now, if those things were aligned, what would that margin -- what would have looked like? Is it a drag of 300 bps or 200 bps or what type of number should we be thinking that you're going to recover?

[Don Newman, EVP, Finance & CFO]

Well, so it's hard for me to give you a solid number on that lag effect. What I would say is if you just start with the margins for the quarter and adjust for -- directionally for credits to kind of pull out those credits and the offset -- offsetting expenses related to it, you'd be approaching about 16% EBITDA margins. Generally, yeah, I could see where that one quarter lag could push you up into probably the upper teens. At the present time, but it's just a swaying estimate off top of my head.

[Phil Gibbs, KeyBanc Capital]

That makes sense. And then on the side of net working capital, clearly, a big increase there. I guess within that, how much of that was volume metric versus inflation related because obviously, everything that you consume has gone up materially in the last three months to six months. And then what's the path as we should think about beyond potential net working capital release or stabilization moving ahead?

[Don Newman, EVP, Finance & CFO]

Sure. So the first answer is if you look at what happened with managed working capital in, in the quarter, the inventory was up about $140 million, about two-thirds of that increase was tied to commodity price increases. The remainder is, I would say volume related. It has to do with us ensuring that we've got adequate materials in place for the ramp to satisfy our customers' needs. It's also addressing some of the underlying risks that came up with Russia's invasion of Ukraine. We took some proactive steps to make sure that we had inventory for things for example like nickel that were on the ground and it's a disruption of supply which there hasn't been at this present time, but if there was a disruption then we are in a good position to continue to produce for our customers.

And I think, as you look further out what you should expect is, number one, we absolutely have not [indiscernible] side of our target of getting our managed working capital back down into that 30% range. We certainly expect that we'll be there by the end of the year, all other things being equal. And I think also I mentioned in the prepared remarks, some of the headway that our teams are making around managing our inventory in a more efficient way. And we saw a 10% improvement in inventory turns management. I think that's early indicator that what we're focused on as a team is working.

[Operator]

Our next question comes from Gautam Khanna of Cowen. Gautam, your line is now open.

[Gautam Khanna, Cowen]

Hey, thank you. I was curious if you could talk about on the titanium share opportunity, are you guys engaged with not just the air-framers but the engine manufacturers like specifically Safran, which you talked about sourcing about half of its titanium needs from VSMPO. I'm just wondering -- you guys used to be a big supplier there, I don't know if you still are and if those conversations are happening now.

[Robert Wetherbee, Chairman, President & CEO]

Yeah. Good morning, Adam. In terms of titanium, we break our business down into the industrial side, which we're actually taking a break in the short term with our joint venture and kind of moving away from that in the short term, but then you get into this standard quality for structures and then the rotating quality for engines. And I would just be really clear that everyone who is in the rotating quality titanium industry is looking at alternatives. So I think the answer to your question is, yep, we've heard from them, right? And we continue to hear from everyone. I think some of the engine manufacturers are more titanium intense than others based on the parts they manufacturer and where they fit in the supply chain.

But I think they're all acting reasonably and proactively looking to make sure that this is not the issue that slows down the supply chain. So I give them credit for that. I'm trying to get real estimates in terms of how much of a potential Russian supply is going to be displaced and for how long. It's probably the biggest issue. I think in the current time there is a lot of focus on 2023, making sure they're positioned for 2023 and into early 2024, and then there's kind of some longer term opportunities that come after that. So I've kind of bifurcated near-term, long term. But the long-winded answer to your simple question is yep, we've heard from them.

[Gautam Khanna, Cowen]

Okay. And I would presume that you guys, like you said, looking for long-term volume commitments and attractive pricing. Do you think the customers are willing to go down that path of better commitments for you guys or are they threatening to self-certify? I'm just curious like what's the urgency on their end to move forward, and then I [indiscernible] that.

[Robert Wetherbee, Chairman, President & CEO]

Yeah. Good question. Just to be really fair to them, I think they are acting with urgency, and I think they are acting deliberately and intentionally to make sure that they have the supply commitments in place, I think they are understanding that the world is a changing place as it relates to inflation around energy, transportation and certainly the raw material component. So – in my conversations and it does get to my level, we do hear a lot about how they're thinking differently about their procurement. Clearly, they would not want to miss an airplane delivery for a dollar or a pound here or there.

So the bottom line is, we're in a good position to solve the challenge they're now facing. It wasn't a problem of our making and it was a problem of their making, but because of the capabilities and the range of products that we supply, we're in the mix because we have to be part of their solution. So I think that the answer is, they're acting with urgency, they leave in what we can bring to them. And over the last few years, we've become very good at quickly assessing potential issues and dynamically reacting and that's kind of one of the outcomes of leadership in the COVID environment is they just have to adapt and I think that's what they're doing. It's hard politically in some areas of the world to do those kinds of things, but I think they're trying to do the right thing.

[Operator]

And our next question comes from Josh Sullivan of The Benchmark Company. Josh, your line is now open.

[Josh Sullivan, The Benchmark Company]

Hey. Good morning.

[Robert Wetherbee, Chairman, President & CEO]

Good morning, Josh.

[Josh Sullivan, The Benchmark Company]

Just on the widebody MRO activity, what type of product flow are you seeing or expecting through the year? Are you able to see any difference between demand for heavier versus a lighter maintenance? Just anything to point to either uptick existing fleet usage, bringing back aircraft from long-term storage. Just trying to get some more color on what you're seeing in that widebody demand in the aftermarket?

[Robert Wetherbee, Chairman, President & CEO]

Yeah. We normally say well, we don't really see aftermarket demand separated from OEM original equipment type demand, but because of the unique nature of the widebody business we are actually seeing more specific MRO activity. So I think there is some engine programs that are going through. I call them upgrades or upgrade packages, so we're seeing some of that. We're seeing the shop visits accelerating in older product lines plus freighters, seeing a lot of activity there. And I think we're starting to see getting ready to refresh for the uptick on the international routes.

So I would say at the moment our MRO business is anywhere from 50% to 75% kind of above the normal rate percent of -- if you look at our business and you say, hey, what percent is MRO? It's probably a quarter or so. We're probably as a percentage seeing much higher MRO business to the tune of 50%, 60%, 70% depending on the hard, depending on the program, depending on the supplier, but it's been strong coming into ‘20 -- started in 2021, it's been strong through 2022, and every indication is it's going to be strong through 2023.

[Josh Sullivan, The Benchmark Company]

Got it. And then just one aerospace titanium gets the headlines on potential Russian supply chain de-risking, but just given the special capabilities at the HRPF facilities, are there any emerging Russian related opportunities there?

[Robert Wetherbee, Chairman, President & CEO]

Yeah, we think so. One of the products that we have to figure out for ourselves would be what people call pack rolled sheet and the titanium space. It's not a place that we've historically played, but there is a tremendous pull and customer commitment to pull us into that. The HRPF is a huge enabler to be able to move forward there. So I think you'll see that. As also from our -- the plate perspective in terms of capabilities that we didn't have, it seems like pre HRPF was a long time ago but it really wasn't from an aerospace contracting perspective. So we're able to leverage things like gauge control and profile control which is key to manufacturing in the aerospace machining space. So I think we are seeing some of those. I think we're going to take full advantage of it.

The other thing we're doing as part of our transformation away from stainless is a beautiful new bright and neo (ph) furnace as part of our transformation will give us better properties. For formidability you think about super plastically form car. So you think about dimensional control going into a press. There was -- the combination of the HRPF plus this new bright and neo, it's going to be exciting news to the industry versus the competitive benchmarks. So I think to answer your questions, yeah, we're getting a lot of pull and we're pretty excited to finally be talking about the startup and ramp of this stuff versus just the building of it.

[Operator]

Our next question comes from David Strauss of Barclays. David, your line is now open.

[Josh Corn, Barclays]

Hi. Good morning. This is actually Josh Corn on for David. So you had mentioned the 90% free cash flow conversion target at the Investor Day back in February. So can you just talk about why free cash flow conversion is only around 90%. If CapEx is going to be near DNA levels? No pension contributions and working capital contributing to cash.

[Don Newman, EVP, Finance & CFO]

53:59 Yeah. This is Don. So there was a target for everyone else's benefit, that was a target that we talked about in our Investor call as we discussed 2025 and in our trajectory to our 2025. What I would say is that, Josh, we understand all the levers that are available to us. I'll start with profitability and then obviously, managing your capital deployment including managed working capital. We are in the right glide path to pension and what I would say in direct answer to your question, 90% is a great start. And it doesn't mean that's our endpoint. We're planning on attacking that objective and doing everything we can to push right past it and do better than 90%.

[Operator]

Perfect. Our next question comes from Paretosh Misra of Berenberg. Paretosh, your line is now open.

[Paretosh Misra, Berenberg]

Thanks. Good morning and thanks for taking my question. I was hoping you could just discuss the major moving parts in your guidance versus three months ago. So 787 delays were probably a drag, but maybe you saw incremental strength that -- narrowbody demand. So, yeah, just if you could recap what has changed in your outlook versus three months ago?

[Don Newman, EVP, Finance & CFO]

Yeah. This is -- again, this is Don. So let me kind of give you the high level in terms of the reason for the increase. And if it's all right, I mean there is interesting information I guess around the move to Q2. But I think what's more interesting is what's driving the full year guidance that we provided, up 60%. So long-short, we are seeing increased demand across all of our key end markets, point that's just a period end point. And so with the strong demand in our Aerospace or jet engine as well as airframe going beyond that, we are seeing growth in the defense end markets as well as medical and other key end markets.

That is a key driver in the increase in our expectations around earnings. And that's -- those are our tailwinds that we saw certainly late in 2021, but certainly they picked up pace in the first quarter. And there's a number of reasons for that I think, underlying demand, recovery of the -- of air travel. Certainly, the market opportunities that are being created through the disruptions that happened through Russia, et cetera., all of those are positive in terms of increasing demand in our business. That's all that, so that's a top line, right? That's all that, we put in place the right mechanisms to manage our cost structures, starting in 2020 and through 2021, those structural cost changes that we made are continuing to benefit our bottom line.

Our organization learned a lot through the downturn in terms of managing costs and so those are benefits that we expect will continue to deliver. Add to all of that the transformation around our Specialty Rolled Products business is being executed extremely well, and in combination with the other initiatives we have around improving our mix, all of those contribute to a significant uptick in terms of our expectations for the full year.

[Operator]

Perfect. Our final question of the day comes from Timna Tanners of Wolfe Research. Timna, your line is now open.

[Timna Tanners, Wolfe Research]

Okay. Thanks very much. Just wanted to understand and sorry if I missed it, the new comment on Slide 7 that says evaluating need for additional strategic raw materials. And I was still a little perplexed with the comment that you have a modest use of managed working capital, but obviously a big move. So maybe you can also help us understand what's embedded in your guidance to raw materials prices. Thanks.

[Robert Wetherbee, Chairman, President & CEO]

Yeah. As you know Timna, we haven't changed our guidance in terms of free cash flow for the full year. We adjusted our EPS guidance by about 60%. But the long and the short as you take a step back and you look at okay, what's happening with their managed working capital in Q1, and then how should you think about that for the balance of the year. Let me give you some data points. In Q1, we saw our inventory balances increased by $140 million, and I think I mentioned earlier, two-thirds of that increase is due to commodity prices increase in Q1. Secondly, with a number of dynamics, first dynamic will be the ramp. The ramp at least in our business is picking up pace. And so we made the decision that we would ensure that we have the right inventory in place to meet the ramp demand that our customers are signaling to us. So we put some additional inventory in place for that.

Add to that, the disruptions in raw material supply chains around things like nickel that are tied to what's happening in Russia. And in that regard, we made some proactive decisions very early on in Q1 to make sure that we had nickel supply tied up so that if there was a disruption of nickel coming out of Russia or some ripple effect of it, we are still in the position where we can make the products and meet our customers' demand. So with all that, we continue to look at the ramp, the pace of the ramp, as well as the supply chain. What's happening geopolitically and making decisions as to whether we need to continue to maintain safety stock or whether we would look to release some of that safety stock and unlock that cash and bring it back into our cash balances. So trying to be very thoughtful and strategic, and that's what you're seeing in terms of our current working capital balances and why we decided that at this point, we kind of hit the pause in terms of giving updated cash flow guidance and like Q2 play out a little bit.

[Operator]

Perfect. At this time, we currently have no further questions. So I'll hand back over to Adam Pechart for any closing remarks.

[Adam Pechart, IR]

Thank you. Bob, any last thoughts before we conclude the call?

[Robert Wetherbee, Chairman, President & CEO]

Yeah. Thanks, Adam. I certainly do. Number one, best wishes to ATI's Scott Minder. He's a little be one of the weather today, which is really unusual for Scott. So -- but its impact on the prep for today, it was significant, and I appreciate it. These -- one of our best salespeople in the industry. So that helps a lot. We'd be back in action soon. For those of you who missed them probably later this afternoon, but you got hard man to hold down. The other one is Adam, thanks for jumping in. I'm sure managing Don and I through a call process like this is as close to a career building experience as we can offer today. So thanks for doing that. And with Scott on the bench, it's a great appetite for me to go off script for a minute and I was probably a little nervous but a couple of final thoughts.

Number one is a shout out to our 400 employees or so at our forging operation in Eastern Poland, it's 50 miles, 60 miles from the Ukrainian border and we appreciate all day and their community are doing to support the influx of Ukrainian refugees. We're proud of what they're doing and support them from a far, but the big scheme of things we're talking about today, that's a bigger issue we appreciate what they're doing. But as far as the balance of ATI and all those things that are going on, we are moving quickly to being that aerospace and defense leader that we talked about in Investor Day. Q1 should demonstrate the progress we're making. I'd leave you with the thought that we have the team to win, they are totally committed to doing the right things the right way to help our customers achieve things. And normally it's extreme conditions, and extreme conditions usually are performance based. This is clearly a market base that we're adding to that list.

Number two, if it will come down to execution and we recognize that and we're fully invested in that. And lastly, creating meaningful value for our shareholders is top of mind as we take all these actions. So those are the thoughts coming out of the quarter. Going into the balance of the year, Don talked about what the potential is. Our order lead-times are pushing into the fourth quarter. So we see the demand that supporting that. No, I'd say, we are thriving and we do thrive and expectations are great and the barriers are high. I think on the titanium side, the barriers to entry continue to be high. So it's a matter of managing the global changes as they come and really getting a deal done that over the next 60 days. That's where we perform the best and are valued the most. And we get to test our value proposition here in the near term. But I'm proud of the team. They're unlocking our potential, and I'm proud to say they've proven to me that we are proven to perform.

[Operator]

Thanks, Rob. And thanks to everyone for joining us today. This concludes our Q1 2022 earnings call.