Allegheny Technologies Inc

NYSE:ATI

Earnings Call Transcript 2023-Q1

[Operator]

Hello, everyone, and welcome to the ATI First Quarter 2023 Earnings Call. My name is Bruno, and I'll be the operator of today. [Operator Instructions] I will now hand over to your host, Tom Wright. Please go ahead.

[Tom Wright, IR]

Thank you. Good morning and welcome to ATI's first quarter 2023 earnings call. Today's discussion is being broadcast on our website. Participating in today's call are Bob Wetherbee, Board Chair, President, and CEO, Kim Fields, Executive Vice President and COO, and Don Newman, Executive Vice President and CFO. Bob, Kim, and Don will focus on our first quarter highlights and key messages. Before starting our prepared remarks, I would like to draw your attention to the supplemental presentation that accompanies this call. Those slides provide additional color and details on our results and outlook that can be found on our website at atimaterials.com. After our prepared remarks, we'll open the line for questions. As a reminder, all 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, Board Chair, President, and CEO]

Thanks, Tom, and good morning. Q1 marked another strong quarter of consistent performance and sequential top-line growth for ATI. Our team continues to build momentum, driving our business forward. I'll summarize my thoughts on our first quarter performance in three points. Number one, we're delivering. What did this solid quarter include?

Our quarterly revenue again exceeded $1 billion, up 3% over the prior quarter, and 25% higher than a year ago. Sales and high-performance materials and components segments were up 6% over the prior quarter. That's 38% higher than a year ago. And adjusted earnings per share for the quarter was $0.49, that on the higher side of our guidance range. We know the importance of delivering on our commitments. Today's results reaffirm the importance we place on that consistency.

Our results also reflect the incredible work being done every day by our team. They're driving operational efficiencies, capitalizing on new opportunities, and growing our capabilities. After my remarks, ATI Chief Operating Officer Kim Fields will share her perspective on how we're doing that.

Message number two, continuing momentum in aerospace and defense is driving historic demand for ATI's materials. Despite some supply chain and delivery delays, the signals are clear. The aero ramp continues. I don't think any of us expected a flawless ramp, and we haven't been disappointed in that expectation. A couple bumps in the supply chain around incoming materials and forgings from non-ATI sources is probably the number one issue that we're dealing with. Even so, all signs indicate a positive trajectory this year.

OEMs are bullish about aircraft deliveries, reaffirming future build rates. We're seeing it first-hand. In Q1, airframe sales grew by 81% versus the prior year period. ATI's significant wide-body content provides strong tailwinds across our commercial aerospace portfolio. We're excited to see this progress and expect growth in this core market to continue.

Quarterly jet engine sales grew by 58% over the same period last year, driven by continued growth in specialty materials and forgings. Obviously, we expect this growth to continue as well, quarter after quarter after quarter. Quarterly defense sales grew 24% over the same period last year. These gains were led by growth in titanium armor, military jet engine, and materials serving allied naval systems.

There you have it in defense. It's roll, fly, and float, and business is really strong, and we expect that to continue into the future. In Q1, aerospace and defense markets represented 56% of ATI revenue. That's up from 44% in the first quarter of last year. It highlights the tremendous progress we're making toward our 65 percent A&E sales target.

Q1 energy sales were up 32% over the prior year period. This was driven by growing demand for materials serving civilian nuclear power and conventional oil and gas applications. As we shared with you last quarter, we continue to see softness in our smaller industrial markets.

Remember, we've dramatically reduced our exposure to cyclical changes in these markets through transformation of our specialty rolled products business. More specifically, we're also seeing continued softness in China. This pertains primarily to the electronics and automotive markets served by our Asian precision rolled strip business, remembering also that this business accounts for about five percent of our total sales. We see emerging signs of moderate year-over-year and sequential growth in China, but the economy there continues to significantly lag 2019 levels. More information about ATI sales to critical applications and adjacent markets can be found in the corresponding presentation on our website.

Now, my third message. We are executing. Our titanium and specialty alloy customers are asking for all we can produce, in many cases, even more. To deliver on these opportunities, we have the right team and the greatest capabilities. Across the enterprise, we're laser-focused on optimizing flow times, accelerating inventory velocity, and extracting every ounce of output possible. We want the maximum value from every operation, every flow path, every asset, every melt batch.

Now, I'll turn it over to Kim so she can share recent actions on our path to unlocking ATI's full potential.

[Kimberly Fields, Executive Vice President and COO]

Thanks Bob. It's great to join you and Don, and I'll provide details of how we're delivering this tremendous performance. I'm going to follow your lead and continue the trend by sharing three key highlights. First, I'll give an update on the new capabilities that we're bringing online. Second, share the success we are having in getting more capacity from existing assets. And third, give insights to the steps we are taking to meet the historic demand for titanium. First up, I'm excited to share that we are in the final stages of commissioning the new Bright Anneal line in our Vandergrift, Pennsylvania operation.

Completing the last step in the transformation of our Specialty Rolled Products business, the new line has state-of-the-art equipment and control systems that deliver best-in-the-world finishing capabilities. These include higher quality surface finish for a wide range of sensitive specialty materials, improved formability and dimensional control of thin-gauge products, wider coil sizes that provide customer flexibility for their forming processes, and it delivers the shortest material flow times in the world, with cycle times reduced by more than 50% in many cases. This has the potential to meaningfully lower fabricating costs and reduce metal risk for our customers, creating advantages over their competition. The project's on track to qualify for production by the end of Q2.

The new Bright Anneal line rounds out our specialty rolled products' triple threat of capabilities. First, tremendous melt capabilities with our Latrobe, Pennsylvania upgrades, which were completed during the pandemic, combined with the world's most powerful hot rolling mill located in Brackenridge, Pennsylvania. And lastly, our world-class finishing capabilities in Vandergrift.

Why is this important? It's key to our commercial transformation, helping the specialty rolled product business establish strong direct connections with major OEMs in key markets. We're no longer relying on commodity stainless distribution channels as our primary go-to-market approach. Our strategy is to be a leader in the aerospace and defense markets, and we are seeing results. The first quarter A&D revenue in our advanced alloys and solutions segment grew by 65% compared to the prior year period.

On to my second key point and highest priority this year. Across the system, every single member of my team is focused on operational excellence. Our goal is to increase production output of existing assets through increased efficiencies and improved product yields. The demand is out there, and these improvements will allow us to capture more of it with higher product quality and improved margins. What's this look like? A lot of hard work and incremental improvements at every step in our operational process. We're increasing our productivity right first time and throughput day after day.

In some operations, we're seeing efficiency improvements of as much as 10% to 15% in one quarter, relieving process bottlenecks, increasing product flow, and ultimately resulting in improved delivery performance for our customers. It's like since Lombardi said, it's a game of inches, and inches make the champions. We are playing the game with laser focus and disciplined execution that will position us to win. Benefits from these efforts are already starting to show. Across both segments, we broke multiple operating records in Q1.

For example, our specialty materials business unit set its highest Q1 sales record in decades. Every major work center in this business unit is at or beyond its 2019 operating level. This is key because it sets the pace for the majority of our vertically integrated aerospace and defense flow paths. In the advanced alloys and solutions segment, the benefits of our transformation are showing up in record levels for inventory flow times, leading to improved product velocity, and significantly lower metal volatility in specialty role products. The benefits are incremental for now, but we know that inches add up.

As Bob mentioned last quarter, most of our workforce is in place after adding 1,000 new employees last year. Now we're gaining on the training curve too. Our newest team members are gaining experience through repetition and cross-training on multiple operations. This adds flexibility and nimbleness to our operations, allowing us to react and meet our customers' changing needs. The benefits our team brings grow every day. We've made great progress in the first quarter, and I thank every member of our team, both new and experienced, for all they're doing. We have a great team out there. We believe these efforts enable us to capture upside demand that our competitors can't. In an industry where lead times of 50 to 70 weeks are becoming the norm, everything we do to increase yields and maximize uptime allows us to delight a customer.

My third topic, the unprecedented demand for titanium. We're really working to increase titanium melt capacity. With the tragic situation in Ukraine, the world has lost access to a third of the titanium supply that was in the market in 2021. We're meeting our commercial commitments. Our customers appreciate this performance and are asking for more.

As Bob has shared in earlier calls, we're increasing production from existing titanium assets 35% over the 2022 baseline. This includes restarting previously idle capacity in Oregon. While we're coming online, our team continues to exceed expectations using creative solutions to reach melting milestones faster than estimated while requiring minimal capital investment. Still modest output for now, but they're on their way, accelerating every day. As this capacity comes on, there will be initial bottom line impact in the back half of 2023, and we expect to achieve the full run rate in 2024.

Customers are taking full advantage of this increase in our titanium capacity. From where I sit, ATI is well positioned thanks to our increased capability, improved operational efficiency, and expanding titanium capacity. We're operating as a system, maximizing our assets and productions across the business like never before. Every aspect of our operation benefits from this rising tide, and so do our customers. That should do it for me, Bob.

[Robert Wetherbee, Board Chair, President, and CEO]

Thanks, Kim. Everyone benefits from what your team is doing, our business, our customers, our team, and our shareholders. Keep up the great work. Thanks to you and your leadership. It matters, and we appreciate it. Kim will stick around for the Q&A session after our prepared remarks. Now it's Don's turn to share details of Q1 financial performance and what's ahead for the rest of the year.

[Donald Newman, Executive Vice President and CFO]

Thanks, Bob, and thanks, Kim, for the operational update. Today, I'll provide details on two key areas, our Q1 results and our outlook. The first quarter marked the third quarter in a row in which we earned more than $1 billion. Revenue was $1.04 billion, a 25% increase year-over-year, driven by continued strength in aerospace and defense, as well as growth in energy.

Declines in electronics and automotive partially offset that year-over-year revenue growth. Bob highlighted our growth in A&D mix of 1,200 basis points year-over-year from Q1 2022. The sequential increase also speaks to the velocity building in our mix improvement. A&D as a percentage of sales improved 300 basis points sequentially. That's on top of a 200 basis point quarter-over-quarter mix improvement between Q3 and Q4 of 2022.

As we shared last quarter, we expect A&D mix to be above 60% by the end of this year. Why is A&D mix so important? We generate some of our highest margins in commercial airframe and latest generation jet engine sales. Within our defense market, margins are also typically accretive, reflecting our customers' recognition of the value of our differentiated products.

Overall revenue grew 3% sequentially. High-performance materials and components, or HPMC, grew 6% quarter-over-quarter, and advanced alloys and solutions, or AA&S, sales were flat from Q4 2022. The strong HPMC increase is tied to the growing A&D sales. We see this strength continuing, enhanced by our increasing capacity and improving efficiencies. What drove the flat revenues for AA&S? AA&S actually saw 15% sequential growth in commercial aerospace sales and 6% growth in energy. These gains were largely offset by declines in electronics and automotive market sales, primarily in Asia.

Now, let's talk margins. Consolidated adjusted EBITDA margins were down compared to a year ago, 12.8% in Q1 2023 versus 15% in Q1 2022. Remember, this quarter in 2022 included $29 million of COVID-related employee retention incentives, which enhanced margins by 350 basis points. Another factor impacting comparative margins is $9 million of incremental post-retirement benefit costs in Q1 2023. Those incremental costs do not impact our current pension contributions.

Year-over-year, they do create a 90 basis point margin headwind. What if we exclude the impact of the non-repeating COVID incentives and incremental post-retirement benefit costs? Well, underlying adjusted EBITDA margins would be 220 basis points higher year-over-year, increasing from 11.5% in 2022 to 13.7% in 2023. What drove these underlying improvements?

Shifting to a more value-added sales mix, increasing production levels, and diligent cost management. We successfully offset inflation impacts in 2022, and that success continued in the first quarter of this year. Price actions and cost improvements more than offset inflation impacts. We anticipate EBITDA margins will improve through the year due to continued growth, mixed improvement, and cost management actions Kim described.

First quarter unadjusted EPS was $0.48. Adjusted EPS for the quarter was $0.49, $0.01 higher than the midpoint of our guidance range. Adjusted items are tied to costs related to the restart of our existing titanium melt facility. It's part of the incremental 35% volume from existing assets Kim just spoke about. We ended Q1 with total liquidity of approximately $750 million. This reflects the Q1 $50 million voluntary contribution to the pension plan and $10 million of share buybacks. It also includes $30 million in CapEx accrued at the close of 2022 but paid in Q1 2023.

Managed working capital this quarter increased $347 million. That included $146 million in accounts receivable due to a late quarter surge in sales. Those receivables are being collected in Q2. Inventory increased approximately $90 million in Q1 due to investing in inventory to support ramping sales. We ended 2022 with managed working capital at 30% of sales. We expect to return to those levels or even lower by the end of the year. Q1 CapEx was $60 million.

As I mentioned earlier, roughly half of that spend was related to the payment of CapEx was accrued at the end of 2022. That's when equipment deliveries were delayed due to supply chain challenges. Overall, we remain on track with our disciplined capital investment plan.

In the first quarter, we completed the last $10 million of stock purchases under our previously authorized $150 million buyback. We are announcing today a new $75 million buyback program. As I said, we are committed to maintaining a balanced capital deployment strategy, funding growth while also delevering and returning capital to shareholders. This authorization is consistent with that goal.

Add in Q1's $50 million contribution to the pension plan, and we are deploying $125 million of cash to delevering and return of capital to shareholders. This is consistent with our 2023 free cash flow guidance range of $125 to $175 million.

Now let's talk about Q2 and full year guidance. For the second quarter, we expect adjusted EPS to be in the range of $0.53 to $0.59. The midpoint of the range, $0.56, represents a 14% sequential increase from the $0.49 adjusted EPS delivered in Q1. The guidance reflects continued strength in our core A&D markets and energy. It also reflects our expectation that sales in our Asian Precision Rolled Strip business will continue to be pressured due to China's economic conditions.

For the full year, we are increasing our adjusted EPS guidance. Our previous 2023 guidance range was $2 to $2.30 per share. Even though it's early in the year, we have the confidence to raise the bottom end of our range by $0.10. The new adjusted EPS range is $2.10 to $2.30 per share. This increases the midpoint of the range by $0.05 to a new end point of $2.20 per share. As the year progresses, we will continue to evaluate guidance, updating when appropriate.

I want to reaffirm several other key items we guided on our prior earnings call. First, we continue to anticipate 2023 full year free cash flow will be in the range of $125 million to $175 million. Second, 2023 CapEx will be in the range of $200 million to $240 million, including the organic growth investments that Kim noted. And third, we made the planned $50 million contribution to our pension plans in Q1, completing our expected contributions for the year. In short, we are on track and confident we'll deliver on our 2023 commitments.

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

[Robert Wetherbee, Board Chair, President, and CEO]

Thanks, Don. What should we take away from the call today? That ATI is in full growth mode. And remember, 2023 is really the first full year of the commercial aero recovery. We expect top line growth in our core markets to continue for years to come.

We've effectively built a resilient supply chain to ensure a steady flow of materials. We're delivering reliably to our customers, and we're living up to our commitments to add value every day. We're not saying it's easy. You heard Kim talk about how we're fighting for every inch. We put ourselves in a great position, consciously, deliberately actively choosing each step.

This is a big year for us. We have the right product mix. We're commanding the right price. We're hitting our stride with production and the bottom line to all of that, we are performing. There's one more P that gives us all confidence, our people. We have the right people in the right roles and their productivity is climbing. As the bar goes higher, our team strives to achieve more. It's what makes us proven to perform.

Operator, we're ready for the first question.

[Operator]

Thank you.[Operator Instructions] We have our first question from Richard Safran from Seaport Research Partners. Richard, your line is now open. Please go ahead.

[Richard Safran, Seaport Research Partners]

Good morning everybody. So one of your competitors was talking about titanium share gains this week from VSMPO. And so since you made a bunch of comments about titanium in your opening remarks, I just wanted to know if you could update us on the titanium share gains and could you also discuss capacity utilization a bit more? I'm just wondering what your remarks say about how close you are to being sold out on capacity.

[Robert Wetherbee, Board Chair, President, and CEO]

Great. Good morning Rich, this is Bob. I'll take the first part of that question and then hand it off to Kim Fields to talk about the capacity issues that are much discussed around the market today. So you know VSMPO pretty well, right, sponge to melt, to mill products to forgings. So I think the key for us is no products and some of the bar and plate products that are a subset of that. We're seeing growth to support aero structures, engines and actually in the medical space as well.

So I think the easiest way to summarize the share issues with VSMPO is more than our fair share, and the melt and our operating performance have been key enablers to that. So we were focusing on programs with sustained growth potential, and we're focusing on new positions that could come along with that share gain at the same time.

So I would say, in a nutshell, more than our fair share is where we ended up. The demand is here now, the growth is on the horizon. But she who has the melt will get the order for the next couple of years. And so we feel really well positioned for that. So I'd say on the share gains, hopefully, that answers your question.

I'll turn it over to Kim to talk a little bit about the capacity situation.

[Kimberly Fields, Executive Vice President and COO]

All right. Yes. So Rich, we are full. And I'd say all of our operations are pretty full. But as you heard in my remarks, we don't stop there, and we are continuing to set new records across the processes and the businesses. For example, I mentioned titanium is up, just in the first quarter, 10% to 15%. Our melt assets are operating at higher levels, and we're continuing to challenge nameplate capacity. So we are really focused on maximizing our assets and challenging those limits, and we are continuing to get more.

The bottom line, as I think about where we're at, when we take an order, we deliver on that commitment. Our customers acknowledge it. They've been sharing it with us. It's become even more apparent in this marketplace today. And we get recognized by getting more opportunities and more business and orders from them.

So as always, as everyone else, we're very full, and we're working to continue to see that. The team is doing a fantastic job. I do think there's upside and there's some additional capacity coming with some assets in order and coming online as well.

[Richard Safran, Seaport Research Partners]

Okay. Thanks for that. Don, this next one maybe for you. And -- because I've asked you this before. So if you don't want to answer, again, I'm glad to go to something else. But flowing in Airbus has said a lot, a lot of changes since you gave out your 2025 outlook. So I just wanted to know if you'd like to give an update on the numbers you've been out there given the changes that we've seen.

[Donald Newman, Executive Vice President and CFO]

Sure. I'll attempt to add some more information to the 2025 targets. So as you think about it, Rich, last quarter, we upped the high end of our expected potential growth rate through 2025 by about $150 million of revenue. That takes our targeted revenue to $4.4 billion, at the high end of the growth rate.

I think what I would say is, number one, we're very confident in our ability to achieve that -- those growth rates toward that high end of our range. I think also what I would say is Kim shared today some of the productivity opportunities that we're seeing within the business. And while she was modest about the inch by inch, we certainly see meaningful opportunity to create value through those kinds of activities.

So the punchline is, I would say, I think even at the high end of the range, we're very confident with our ability to hit, and we do see some potential upside beyond that. At the right time, we'll share updated 2025 targets and also talk past 2025. No surprise to you or probably anybody on the phone, we do not expect our growth to stop after 2025. We see a lot of growth opportunity beyond that.

But that's what I would say at this point in terms of 2025. It's looking good. We're very confident. And then as you take that -- take the other goals that we shared for 2025, the EBITDA margin guidance of 18% to 20%, again, our confidence level is very, very strong when it comes to our ability to generate to the mid or high end of that range, which creates a really interesting value proposition for investors when you think about a business that in 2022 delivered $550 million of EBITDA. And you do the math to 2025, and it's simple math based on the targets that we gave, and you see a business that should be generating $850 million or more of EBITDA. So I think that speaks well to the opportunities.

And that cascades, by the way, to cash generation. We are still very confident and focused on our cash conversion of 90% or better. And we're on track to achieve those targets. So hopefully, that's a bit helpful to you and answered your question.

[Richard Safran, Seaport Research Partners]

Thank you.

[Operator]

Our next question comes from Phil Gibbs from KeyBanc. Phil, your line is now open. Please go ahead.

[Philip Gibbs, KeyBanc]

Hey good morning.

[Donald Newman, Executive Vice President and CFO]

Morning, Phil.

[Philip Gibbs, KeyBanc]

Any texture you could provide on the increase in earnings expectations in the second quarter versus the first quarter? Maybe you talked about a $0.07-ish type pickup sequentially. Is that volume? Is that mix? Does it include both segments? Anything you could help us on there.

[Donald Newman, Executive Vice President and CFO]

Yes. So this is Don. I'll take a run at answering that. So first of all, yes, we are expecting sequential growth into Q2. There's a couple of drivers. One, we're expecting continued top line growth in the business and mix improvement as we've seen that mix continue to move in the direction we want it to go.

I think what you should also expect to see is, if you think about the Q1 earnings, we did carry over from the end of 2022 some elevated costs that were carried over in the form of inventory. When you think about the SM, for example, we're not just SM, the broader business we added about 1,000 employees. And with those new employees as they were learning their new roles, they, of course, were not as efficient through that process as they are today. That increased costs. Those costs ended up getting carried through in inventory. That inventory was largely worked through in Q1.

And so I would expect to see a benefit from that -- from lower costs to the tune of probably, I don't know, maybe $5 million to $6 million as you move from Q1 to Q2. So that will be a tailwind as well. So those are a couple of things that come to mind.

[Philip Gibbs, KeyBanc]

Now is this going to touch both segments in terms of improvement in both of them?

[Donald Newman, Executive Vice President and CFO]

Yes, I think you'll see improvement -- no, I think you'll see it in both businesses. But maybe it makes sense to just kind of take a step back and not so much focused on Q2. But hey, it wasn't a full year look like. And for full year, to give you some context, what we would expect is that the EBITDA margins for the overall business would be growing to probably something in the range of 14% on a consolidated for the full year period. That means that you're seeing growth in the HPMC margins, think in terms of they should be north of 19% certainly for the full year. And then we would expect, of course, increases with the A&S side as well.

[Philip Gibbs, KeyBanc]

And then just as a follow-up, the -- you mentioned some start-up costs for the restart of the Albany, Oregon titanium upstream operations. Can you take us through how that cadence moves through the year in terms of them restarting kind of ramping? When are they contributing? How meaningful could it be that sort of thing? I assume you didn't really see much in Q1. Thank you.

[Donald Newman, Executive Vice President and CFO]

So why don't I touch on kind of how we're thinking about the costs and the contributions, and I'll open it up also to Kim to see if she wants to share anything from an operational standpoint. But from a cost standpoint, from a restart, the costs have been relatively modest. And this is one of the reasons why you love doing projects like this because the cost of a restart, for example, can be very modest relative to the cost of putting in new assets. Also the speed at which you can bring those assets into a position to produce earnings and cash can be that much faster.

So I think as far as start-up costs, we saw between $1 million and $2 million of restart costs in Q1. I would expect it to be in that range, maybe possibly modestly higher than that, but you're talking about maybe instead of 1 to 2, 2 to 3, just as a placeholder in your model. And then as that production is ramping up, we've talked a bit about expecting to see the run rate benefits of that new production really in 2024.

And we'll see -- kind of stealing some of Kim's likely script here, but we're expecting it to be to full run rate production at the beginning of the second half. And then that production is going to start working through our business, resulting in revenues and earnings as it's converted into finished goods.

And so we would expect, from an earnings standpoint, off of that restart, probably maybe $0.01 to $2 of earnings in the Q3 time frame and then a bit more in Q4. But then when you get to a full run rate kind of scenario, what I would say is we'd expect 2024 revenues off of this 35% increase in production, which is, by the way, it's not just the 34th plant, but let's just draw a looper on all of that and say, okay, at full run rate, what would we expect the financial effect from this incremental capacity to be? And what I would say is think in terms of $115 million to $125 million top line and then assume probably a 30-ish percent incremental margin off that.

And what you can tell is these very modest investments that we're making restarting these assets and taking advantage of the assets that are sitting idle or underutilized, the returns on those assets and those investments are just incredible. We've shared before that we're expecting to spend less than $10 million to restart 34th, for example. I mean you're not going to -- it's hard to find a better returning kind of investment than that. So I don't know if I left anything for you to contribute but...

[Kimberly Fields, Executive Vice President and COO]

Sorry, Don, we'll turn you into an ops later yet. So just to add, I think Don covered most of it. Just to give a little color, the crews are in place, the assets are up and running. To your point, we didn't see a lot of that flow through in the first quarter. You will start to see that come through given our flow times through our processes, late Q3 into Q4. You'll see the majority.

The one add that I would add to this is, this is a seller's market. And so as we are bringing more capacity online, both through our incremental efforts around productivity and yield improvements as well as the new assets or the idled assets in Oregon coming online, we're more -- we're able to get transactional selling prices. And customers, as they're seeing maybe others in the marketplace that are missing delivery dates and so forth, we are being able to pick up that transactional business. And so it is going to be giving us a lift as well as those pounds start to come through and you see them in our statements.

[Philip Gibbs, KeyBanc]

Thank you.

[Donald Newman, Executive Vice President and CFO]

Thanks Phil.

[Operator]

Our next question comes from Seth Seifman from JPMorgan. Seth, your line is now open. Please go ahead.

[Seth Seifman, JPMorgan]

Thanks very much nd good morning. And good results. Wanted to ask, so on the jet engine revenues, we've seen a little bit of a plateau here, and the airframe revenues continue to grow. Obviously, there's a lot of jet engine growth out in front of us given production increases in the aftermarket. In terms of the plateau in revenue that we've seen, is that more of a supply side issue at that point -- at this point? Is it more that the customers have said, okay, we have what we need for this round of increases and then we'll be starting the next one soon? And how do we think about when that trajectory kind of moves forward? And then likewise, on the airframe side, is that primarily widebody-driven? And do you have a sense that, that is kind of 787-driven?

[Robert Wetherbee, Board Chair, President, and CEO]

All right. We'll try to unpack that a little bit. I'll take the first part and then hand it off to Kim to talk a little bit about it. So I think in Q1, we had a very back-end loaded Q1 in terms of shipments, which is what Don talked about on the receivables side. You said, well, how can that happen? Well, remember when those orders were booked, right, they were coming out of COVID early 2022 and the lead times really started to grow. And we were not willing to take orders that we didn't have confidence that we could deliver. So a lot of it got loaded late.

So I think -- I don't think Q1 is the greatest indicator of where the market is today. If we were able to disclose what March was, you'd say, holy smokes, that's why Bob said in his earnings call, quarter-over-quarter-over-quarter growth in jet engine. It's just a timing issue in Q1, and we feel confident. And that's why we invited Kim to join us today because a lot of the work that they're doing took us to catch up in March and now will be in place going forward. But you asked a couple of specific questions. I'll turn it over to Kim and let her add some extra color on wide-bodies, airframes, all the other stuff that you had in that question.

[Kimberly Fields, Executive Vice President and COO]

Sure, sure. So I'd say our supply chain, just to mention on that piece, it's more stable than it was last year. And I'd say we're not immune to challenges there, but we're just been focused on creative solutions like industrial gases, which were problematic. We were able to put in larger tanks and hydrogen generator backups, and in some cases, second and third sources. So I think we're managing the supply chain.

What I am seeing, though, that continues to be tight in creating some bottlenecks is around forging billet and mainly in the nickel-alloy powder billets and specialty steel billets, and there's a widely reported Q4 time melt shop explosion. So where we don't provide and aren't vertically integrated on our billet supply, we are seeing some delays due to billet. And a lot of these are directed buys. So we are working with our customers to identify opportunities where applicable, providing it ourselves or looking for other sources.

But rest assured this isn't lost on our OEMs. They recognize the issue as well and are working to get that material. As far as the airframe, we can talk a little bit about that. This was not necessarily driven by widebody. We are starting to see those orders come in. But I would say this is more the single aisle demand that you're seeing. And I believe we've talked about some of the contracts we've gotten in the past, and we're seeing substantial growth against those contracts, especially as everybody starts to get full and orders are moving to us on the AA&S side, in particular, on the airframe. That answers -- I'm trying to remember if I answered all your questions in there.

[Seth Seifman, JPMorgan]

Yes. Yes, it was an overloaded question. So I got all of it. And so yes, since it was so overloaded, I'll just -- for a follow-up, maybe just a really easy quick one. When we think about the CapEx trajectory through the year here, because I know Q4 last year, some of that kind of slipped into Q1 here, how do we think about that sort of investment trajectory for the rest of the year?

[Donald Newman, Executive Vice President and CFO]

What I would do, you obviously saw our guidance at $200 million to $240 million. I would expect it to be probably build throughout the year, just if you're looking for a pattern to model. But I'll tell you, I don't have in my projections any sort of anomalies from quarter-to-quarter. But sometimes those things do happen. It doesn't take much with a big invoice to shift $20 million from 1 quarter to another. But for modeling purposes, I would just assume it's relatively straight.

[Seth Seifman, JPMorgan]

Okay, great. Thanks very much.

[Operator]

Our next question comes from David Strauss from Barclays. David, your line is now open. Please go ahead.

[David Strauss, Barclays]

Thank you. Don, could you help us -- I mean you have this EBITDA margin guidance out there for 25 revenue guidance. I mean, we can kind of compute the implied incrementals, they seem really high. If you could maybe help us think about the right level of incremental EBITDA margins by business going forward? Obviously, you have pension and some of this onetime stuff that was in last year's numbers. But what should we target as kind of normalized incremental EBITDA margins by business?

[Donald Newman, Executive Vice President and CFO]

First, before I get into metrics, some color as to why you'd be seeing what appears to be a strong building on the incrementals, and that's because there is a strong build on the incrementals in part because of the mix change that's happening. When you think about where we're getting revenue growth, we're getting revenue growth largely in latest-generation jet engine sales, for example, some of our richer margin parts of our business. And so that's beneficial to us.

I think also what's incremental, what's affecting the incrementals, and you're seeing it, is the fact that as we continue to squeeze more production out of our asset base, that means we're getting better absorption. That better absorption means improved margins. At the same time, as we're doing that, we're also attacking cost structures and finding more efficiencies within the business.

So all of that comes together for probably some higher numbers that you look at and say, hey, could that be right? But really, when you look at the underlying, underlying incrementals are right in line with what we've talked about in the past, which is I expect incrementals in the business to be north of 30%. And I know that's not -- I'm not saying 37.4% or 33.68%, but the reality is it does change from period to period, but I doubt that the numbers that you're seeing in your model that require us to get to those 18% to 20% EBITDA margins and the growth, they probably are very sensible when you consider all those elements. So is that helpful to you?

[David Strauss, Barclays]

Yes, yes. I mean I'm coming up with a number well above 30% that's implied to -- if I take the $4.4 billion in revenue and 25 versus your run rate today and the implied EBITDA based on your margin, I'm coming up with a number way higher than 30%, but we can talk about it later. That's fine.

[Donald Newman, Executive Vice President and CFO]

But one thing I would add that you might find helpful as you're thinking about that. So as you're looking at -- you're doing the absolute right math, right, on the calculation of your incremental. But when there's a mix change that's happening and we're shedding lower profitability sales and we're redeploying that material to higher value opportunities, it will increase what the apparent incremental margin, right, because every dollar you're selling is also adding to the bottom line. So it will cause what appears to be kind of a distortion in your incrementals, but it's because that mix change is happening.

And then also, we do expect, as we evolve into 2025, we do see where that richer mix is also bringing some better pricing from period to period. We don't highlight what we're getting on pricing. We don't call that out like some folks maybe may do, but that's part of the element too as we get deeper into these latest-generation profiles.

[David Strauss, Barclays]

Okay. That's helpful. And then I think I've asked this before, but I'll come back to it. I mean the 90% free cash flow conversion that you're targeting, why wouldn't it be better than that? I mean are you assuming that -- I thought you've been talking about CapEx coming down in the out years, a lot closer to D&A. Are you just assuming a pension contribution in those numbers? How -- why wouldn't it be closer to 100%?

[Donald Newman, Executive Vice President and CFO]

I -- just like the other 2025 targets that we have out, you can assume that they're on the conservative side. And I can tell you internally, we are targeting better than 90% when it comes to cash conversion. Another thing that's important to us is it's not about strong cash conversion for a year, it's about consistent strong cash conversion. And so we put out the 90% target in 2025. But rest assured, that's not the number that we consider our ceiling, and it's not a one-timer from our standpoint.

[David Strauss, Barclays]

All right. Thanks very much.

[Donald Newman, Executive Vice President and CFO]

Thank you.

[Operator]

[Operator Instructions] Our next question comes from Gautam Khanna from Cowen. Gautam, your line is now open. Please go ahead.

[Gautam Khanna, Cowen]

Hey good morning guys. You covered a lot of ground. I wanted to ask on your comment on pricing. Just at one point, I thought the urgency of some of the potential titanium customers who want to move away from VSMPO, I thought their price sensitivity was a little bit too high. I'm just curious, what has happened over the last quarter in terms of their urgency and their willingness to sign up at what should be more reasonable returns for you guys as you fill that void for them?

[Robert Wetherbee, Board Chair, President, and CEO]

Thanks for that question, Gautam. I'll take a little bit of that, and Kim can add some color at the back end. I think we're actually at an inflection point here kind of in the second quarter around the worries that the big OEMs have, right? So the first priority really for the last 12 months was realignment of their global supply chains. And a lot of the contracts were not fixed volume. They were shares or they were share ranges. So a lot of the early work was within that range. So the guiding priority was, I got to displace upwards of 30% to 40% of my supply chain as fast as I can. And that was really starting to take effect in 2023.

I think you'll see the full benefit because of inventory flow for people like us in 2024, right? But then now, once they've realigned the supply chains, I'll turn it over to Kim, and she can talk about kind of how they're looking at growth and kind of where they go from here as they start to really address the ramp.

[Kimberly Fields, Executive Vice President and COO]

Yes. I think as Bob just mentioned, early in this -- in the reset on the supply chain, our customers were going from just in time to just in case. And so there was this rush. And as you've seen, our backlogs have grown. We're at a record $3.3 billion now. And I think it's not just in the aerospace industry. We are seeing demand across all 4 of our businesses in all of the markets, defense, medical, electronics that Bob talked about.

So I think there is a reset that's happened, and now they're looking at strategic inventories, especially as the widebody starts to gain momentum, and they're placing much longer strategic positions with companies and thinking about between now and 2030, 2035, how do we ensure that we've got the supply that we need as we look at the build rates that we're anticipating.

[Robert Wetherbee, Board Chair, President, and CEO]

Yes, Kim and I have been a part of numerous customer conversations. And I would say quality and reliability are really going to be the enablers for having the supply chain work for them going forward. So the shift from just in case to but I got to have it, right? And so to your point, Gautam, I think Kim said earlier, it's a seller's market and almost, I would say, every renewal or every extension or everything is really reflecting appropriate pricing for the long-term, right? And that's been helpful. It's a great time to renew some contracts, for sure, from our perspective.

[Gautam Khanna, Cowen]

Yes. And as a follow-up, you mentioned in the release, jet engine sales were up approximately 2% sequentially. And I think you mentioned that some of those were positioned later in the -- they're melted later in the cycle, and that's why you had a back-end load to the deliveries in the first quarter. Could you talk a little bit about where -- what is the potential capacity constraint to doing better than a 2%, 3%, 4% sequential kind of level of improvement in jet engine output? Like what is possible this year as you look at the jet engine capacity you guys have?

[Robert Wetherbee, Board Chair, President, and CEO]

Yes. So the first thing I would say is like we always answer the question the same way, we produced orders not to build rates, right? So it's really critical on how we take those orders. And I'll let Kim talk a little bit about the work that's going on to increase the capacity.

[Kimberly Fields, Executive Vice President and COO]

Yes. I think we mentioned a couple of them, and we are seeing that ramp of our production rate going. And as I mentioned, titanium, for example, was up 15% and 20% in the quarter versus Q4. And I anticipate you could see another 10% to 15% of our assets.

A couple of different things you asked about specific bottlenecks, one, our employees and experience are increasing. We're going up the learning curve. We are doing some cross training. So we're having the ability to move labor to where we need it to help produce. We're streamlining turnarounds. We're working on things like a pit crew. They're coming in. We're getting the machine and equipment back up and running as fast as possible. You're reducing unplanned downtime. We are looking at our equipment. We've talked about electrical upgrades that we're doing as well as changing out some of the equipment in the most harsh conditions in the melting so that we get longevity.

And so we're doing all those things in our current assets. And obviously, as we've talked about, we are bringing on idled assets in Oregon that are coming on ahead of schedule right now. The crews are in place and the equipment is running, and so that's continuing to flow through. So step one for us is focused on melt capacity, and we're seeing substantial gains there. That will fall through the downstream processing activities and businesses that we've got, and then you'll start to see that coming out, I would anticipate, third quarter into fourth quarter. I think that -- does that help?

[Gautam Khanna, Cowen]

Absolutely. No, that's helpful. And maybe one for Don. Just could you talk a little -- Don, you mentioned the $2 million, $3 million sequential pressure at high-performance metals. I was curious if you could just talk about all the sequential headwinds that you guys incurred, whether it be retirement benefit expense at that segment or any other items, just so we kind of calibrate properly.

[Donald Newman, Executive Vice President and CFO]

Sure. Yes, so a couple of things. And so I talked about the carryover of some inefficiencies into inventory, and we saw a lot of that release, not just related to the HPMC segment, but also AA&S. We did see some modest metal headwinds. And so while we don't highlight metal because it isn't a headline for us as you're digging in, of course, you need to consider it. So for both of the segments, we did see modest headwinds in that regard.

And I guess I'm not surprised when you think about some of our primary inputs, nickel being one of them. We saw some really robust increases in nickel prices in 2022. And while they're still at a robust level, they're at a lower robust level. And so we saw them pull back modestly in Q1, which has a modest impact to our business in a -- from a headwind standpoint. Other than that, we've been pretty open about the pension. We've been pretty open about year-over-year changes around things like COVID credits and things like that.

[Gautam Khanna, Cowen]

Okay. Thank you. RBE sequentially, though, how much was that up at HPMC?

[Donald Newman, Executive Vice President and CFO]

I'm sorry, say that again, please?

[Gautam Khanna, Cowen]

Pension. Pension sequential impact of at HPMC? Yes.

[Donald Newman, Executive Vice President and CFO]

So let me give you -- so the pension impact year-over-year, let me give the impact, so you think about AA&S, the year-over-year impact was $7 million in the quarter. And for HPMC, it was between $1 million and $2 million.

[Gautam Khanna, Cowen]

Thank you guys.

[Operator]

We currently have no further questions. So I would like to hand the call back to Tom Wright for final remarks. Tom, please go ahead.

[Tom Wright, IR]

Thank you for joining us today. This concludes ATI's First Quarter 2023 Earnings Call. A replay will be available on our website at atimaterials.com.

[Operator]

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines. Thank you.