Allegheny Technologies Inc

NYSE:ATI

Earnings Call Transcript 2019-Q4

[Operator]

Good morning and welcome to the Allegheny Technologies Fourth Quarter and Full year 2019 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.

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

[Scott Minder, Vice President, Treasurer and Investor Relations]

Thank you, Andrew. Good morning and welcome to the Allegheny Technologies fourth quarter and full year 2019 earnings conference call. This call is being broadcast on our website at atimetals.com.

Participating in the call today are Bob Wetherbee, President and Chief Executive Officer; Segment Executive Vice President, John Sims and Kim Fields; Don Newman, Senior Vice President, Finance and Chief Financial Officer; and Kevin Kramer, Senior Vice President, Chief Commercial and Marketing Officer.

If you’ve connected to this call via the Internet, you should see slides on your screen. For those of you who have dialed in, slides are available on our website. After our prepared remarks, we will open the line for questions. During the Q&A session, please limit yourself to two questions. We will attempt to get everyone in the queue within the allotted call time. Please note that all forward-looking statements are subjects to various assumptions and caveats as noted in the earnings release and shown on this slide.

Now I would like to turn the call over to Bob.

[Bob Wetherbee, President and Chief Executive Officer]

Thanks, Scott. Good morning and thanks for joining us. Before we get started today, I want to welcome our new CFO, Don Newman to his first ATI quarterly call and to thank our retiring CFO, Pat DeCourcy for a dedicated and distinguished ATI career. Don brings a wealth of multi-industry financial experience, including from his most recent role as the CFO of Stelco and for nearly seven years as CFO of Headwaters Inc, a leader in the building and construction materials industry. Throughout his career, Don has focused on business growth, effective capital allocation and transformation. We look forward to his contributions to ATI, and you'll hear directly from Don later in the call.

I'm going to start off today by revealing our focus and 2019. And the significant progress we've made on our strategic imperatives, and then move to our expectations to maintain this momentum in 2020. First and foremost, we continue to be an industry leader in on-time delivery of high quality materials and components. Our successful aerospace ramp execution has earned us customer commitments that will generate future profitable growth for many years.

This linkage to execution was clear as we extended several aerospace and defense related long-term agreements, earning increased market share in most. We continue to leverage our material science capabilities and unique process technologies to expand our business with new and existing customers. We're confident that this will continue in 2020 as we finalize the next set of long-term contract extensions, and capitalize on new opportunities.

Flat Rolled products achieved its third straight year of profitability. This is despite the negative impacts from Section 232 tariffs as well as elevated retirement benefit expense related to 2018 pension asset decline. While we fell short of our 2019 expectations in this segment, we were profitable. We remain focused on improving our cost structure, continuously improving our operations, and driving profit growth in specialty products.

We took significant steps in 2019 to further strengthen our balance sheet. First, we extended and upsized our asset based lending agreement to ensure ample liquidity through 2024. Second, we reduced gross debt by $150 million in the fourth quarter, which will lower interest expense by roughly $9 million annually starting in 2020, and resulted in a corporate credit rating effort.

Finally, we further reduced risk associated with our US defined benefit pension plan through a $95 million annuitization of approximately 1,800 retirees in the third quarter, and contributed approximately $145 million to our US defined benefit pension plans during the year. Reducing pension liabilities remains a top priority.

We're actively assessing options as part of our capital allocation and liquidity management process, while ensuring that we are well prepared and taking the necessary actions to handle the uncertainty stemming from the 737 MAX production suspension. 2019 was a year of strategic change and progress at ATI. We have a highly skilled and committed leadership team with a mix of ATI veterans and experienced newcomers and I'm highly confident that our progress will continue in 2020.

Let's move on to Slide 4 on a high level overview of our 2019 results. Starting with the full year, ATI generated solid earnings per share and net income growth. This was aided by the sales of non-core assets. Revenues increased year-over-year in both operating segments despite challenging market conditions. Total segment operating profit decline versus the prior year as an increase in HPMC driven largely by the performance of our specialty materials businesses, was offset by a decrease in FRP.

As previously discussed, this decline was primarily due to higher retirement benefit expenses, weaker standard stainless market conditions and above we started the year in our Asian Precision Rolled Strip business known as STAL. In the fourth quarter, excluding special items, ATI increased earnings per share by 20% versus the prior year. This growth was driven by operating profit improvements in both segments, including increased sales volume in the HPMC segment. I

In the face of commercial aerospace industry uncertainty and despite regulatory challenges, in the fourth quarter we generated year-over-year growth in earnings per share, free cash flow and revenue. We focused on the things that we could control and we made significant progress on our strategic imperatives.

Going forward in 2020, we're better positioned for a long-term profitable growth and industry leading execution on multiple aircraft and engine production ramps, including the 737 MAX when it turns to the skies. And let's be clear, the long-term fundamentals driving aerospace demand are still strong.

So and that's from me this morning, John, Kim and Don will cover the business and financial results in more detail starting with John for the HPMC segment. John, all yours.

[John Sims]

Thanks Bob. Turning to Slide 5, the HPMC segment increased revenues and profits in 2019 versus the prior year, despite an environment that was dominated by several key issues; a large jet engine customers yearend cash management actions, a rapid decline in cobalt prices early in the year and industry turbulence around the grounding of the 737 MAX.

For the full year profit margins were essentially in line with 2018 levels with year-over-year margin growth accelerating in second half of 2019 offsetting declines in the first two quarters of the year as we dealt with supply chain shortages.

Fourth quarter financial results provided the best year-over-year improvement in 2019 with sales excluding divestitures increasing by 10% led by our aerospace and defense market. Segment operating profits grew by more than 20%, demonstrating the asset utilization benefits due to increased production volumes as well as from our early divestiture of to lower margin businesses. As a result segment operating profit margins increased by 270 basis points year-over-year.

Looking ahead to Q1 2020, we expect the 737 MAX production suspension and lower LEAP 1-B engine builds to negatively impact operating profit by 15 million to 20 million. We're confident that we will be able to mitigate a significant portion of this decline in Q1 through a combination of increased jet engine production shipments with other OEMs including those originally delayed in 2019 due to customer cash management actions.

Opportunistic volume growth still open capacity and strong cash management and cost discipline. We will continue to monitor this dynamic industry situation and will provide updates on subsequent 2020 earnings calls. As of today, based on the input from our customers, we are assuming that the 737 MAX production will restart in the second quarter in advance of a mid-2020 return to service. We're in near constant contact with Boeing and the engine OEM partners and our coordinating wisdom to ensure an adequate supply of our critical materials and components in advance of their production.

Turning to Slide 6, looking at HPMC revenues by market, full year 2019 segments sales excluding divestitures increased 7% versus the prior year. This growth was led by the aerospace and defense markets despite jet engine product sales being relatively flat year-over-year. 2019 commercial airframe product sales grew by more than 20% versus prior year, including double digit percentage growth in the fourth quarter, when adjusted for divestitures building on strong prior year growth.

We have been successful in winning emergent business due to our strong operational execution. 2019 provided a significant growth opportunity in this area and we expect a return to more normalized volume levels due to lower 737 MAX production in 2020. We did not expect the announced 787 rate reduction to negatively impact 2020.

Defense market sales saw a robust expansion in 2019, increasing by more than 30% year-over-year on an adjusted basis, including a double digit percentage increase in the fourth quarter. This growth was balanced across all of ATIs defense sub markets, led by materials and components for naval nuclear, military jet engine and space applications. Jet engine product sales modestly declined principally due to a large customer's cash management action.

Of course in 2019, we also announced signing a multi-year contract extension with Rolls Royce for next generation and legacy jet engine materials, and multiple long-term agreements with GE Aviation to supply advanced forgings and materials. Revenues under the GE contracts alone are expected to exceed 2.5 billion over the life of the agreements. These contracts will enable ATI to deepen its relationships with these key customers, as well as continue to increase market share in the high growth jet engine market space. Don will talk about certain strategic investments we're making to support these organic growth opportunities and commitments under these key contracts.

Sales to our smaller non-aerospace and defense markets were mixed, with medical declining mainly due to an increasingly competitive biomedical implant sector, while our energy market sales increased primarily due to export sales into Asia.

I will now turn the call over to Kim to talk about our performance in the FRP segment. Kim?

[Kim Fields, Executive Vice President, Flat Rolled Products]

Thanks John. Now, turning to Slide 7, after a challenging start to 2019 due to a first quarter that fell below our expectations for both the US business and the STAL Precision Rolled Strip joint venture in China, the FRP generated solid profitability for the second, third and fourth quarters, ending the full year 2019 in the black for the third straight year. This positive result was largely due to growth in high value products along with benefits from additional HRPF carbon conversion volume.

As Bob mentioned earlier, and as we reported through the course of the year, the FRP teams worked hard to overcome the combination of the ongoing section 232 tariffs on A&T Stainless joint venture and carbon conversion volume and secondly, increased retirement benefit expenses and softer end market conditions for our standard value stainless products and related costs and efficiencies.

Despite these issues, the FRP segment generated solid operating results in the fourth quarter. As predicted, revenues declined sequentially, mainly due to strong nickel alloy sales in the third quarter to fulfill a large oil and gas pipeline project. Sale to the aerospace and defense markets continued to expand in the fourth quarter, helping to offset lower market demand for our standard value stainless product.

Fourth quarter operating profits improved year-over-year and outpaced our near term expectations. The segment benefited from ongoing strong high value product sales, a favorable raw material search hype timing mismatch driven by nickel prices and a narrow operating loss through our A&T Stainless joint venture.

With regards to A&T Stainless joint venture we recorded an impairment charge due to the negative effects from the ongoing section 232 tariffs and their impact on the entities long-term financial outlook. We continue to operate the joint venture focused on minimizing the losses as we await the outcome of our second tariff exclusion request.

Without relief, the Midland, Pennsylvania plant will likely close impacting hundreds of the US jobs, US steel capacity utilization and national security, running counter to the goals established in the 232 report and the President's March 8, 2018 proclamations.

Looking ahead to the first quarter, we anticipate significant raw material headwinds compared to the fourth quarter 2019 related to the decline in nickel prices. Market conditions are improving for standard value stainless products, but pricing continues to lag. We continue to aggressively manage our costs including the full year 2020 benefits from our fourth quarter restructuring action to mitigate the impact of these ongoing challenges.

We anticipate year-over-year improvements from STAL in Q1, but are keeping close watch on business activity as China deals with the coronavirus outbreak and our thoughts go out to our employees and our families in the region dealing with this crisis.

Lastly, we are engaged with the US Steel Workers to negotiate a New Labor pact to replace the current contract which expires at the end of February. We're making progress and expect to finalize a mutually beneficial agreement in a timely fashion.

Now, turning to Slide 8, let's take a few minutes to dive deeper into the FRP segments full year revenue growth. 2019 saw a year-over-year sales growth in several key end markets. Aerospace and defense continued to expand growing by 30% for the year. Since 2017, sales to these end markets have grown by nearly 70% complimenting the strong HPMC segment growth and showcasing the success of the one ATI approach.

Energy markets revenue grew significantly led by increased demand for marine scrubbers and flue gas desulfurization materials. Sales to FRPs largest end market oil and gas remained solid, but declined somewhat compared to a strong 2018.

And lastly, our consumer electronics business continued to expand primarily in Asia, as we leverage STALs most recent capacity expansion. Looking ahead, we have line of sight and expect to capture additional growth opportunities in our key and markets in 2020 to capitalize on our unique production capability.

Shifting to revenue by product, we continue to see the success of our value over volume strategy with meaningful growth in high value products. Nickel alloys and titanium materials increased by double digit percentages versus the prior year. Sales on a standard value stainless products contracted by 9% due to lower demand in the automotive and other consumer facing markets, but also due to purposeful actions on our part.

Now I'll hand the call over to Don to talk in more detail about our financial performance and 2020 outlook.

[Don Newman]

Thanks Kim. Turning to Slide 9, the fourth quarter capped a year of solid progress in cash generation, strengthening our balance sheet and unlocking value through the sale of non-core assets. We ended 2019 with over $490 million of cash on hand in part due to strong cash generation from operations in the fourth quarter, as well as significant non-core asset sales earlier in the year.

I'm pleased to report that we achieved our managed working capital stretch goal of 30% of sales at yearend, and will continue to work for improvement in this key area in 2020. 2019 capital expenditures were $168 million in line with expectations as we continue to balance the needs for additional capability and capacity required to me future profitability and growth expectations along with other capital allocation priorities.

In the fourth quarter, we made significant progress toward our long-term goal of achieving an investment grade balance sheet by reducing gross debt by $150 million. We successfully launched new $350 million notes at 5.875% and used the proceeds along with cash on hand to early redeem our January 2021, 5.95% notes. Together these two actions will save the company $9 million in annual cash interest expense starting in 2020.

In recognition of ATI's ongoing balance sheet improvements, Moody's upgraded ATI's credit rating in advance of the new debt issuance. As a result of the early notes redemption, we paid a medical [ph] premium of $21 million, which was the bulk of the fourth quarter debt extinguishment charge of $22 million and we accelerated payment of $13 million of interest due to bondholders.

In total we generated nearly $460 million in free cash flow for 2019 a 60% improvement over 2018. Excluding the interest payments on the early redemption of the 2021 notes, which was initially planned for 2020, we largely achieved our 2019 free cash flow target, which we had increased in October.

Now, let's turn to Slide 10 and talk about 2020 expectations. The 737 MAX and related LEAP 1-B impact make providing certain financial guidance a bit more challenging. Of course, we have a better visibility in the near term, but the second half of 2020 is more fluid and less visible. Despite those challenges, we'll provide some important information that we believe to be helpful in understanding how we see the business performing in 2020, including the key assumptions in our range of earnings per share expectations for the overall business for Q1 and full year 2020.

The 737 MAX production suspension will likely impact each 2020 quarter as the previously forecasted ramp will be delayed and elongated, differing, but not diminishing our growth expectations around this important program over time. We estimate that 737 MAX related headwinds both airframe and engine will reduce ATIs first quarter operating profits by $15 million to $20 million. We continue to work to offset the deferred 737 MAX and LEAP 1-B related production and to control our costs during this industry wide event.

Reflecting the 737 MAX impacts, non-raw material related headwinds and quantifiable production and cost offsets, we expect to generate between $0.12 and $0.16 of earnings per share in the first quarter of 2020 assuming a 23% to 25% book tax rate. This compares to $0.12 in the first quarter of 2019, which utilize a 4.7% effective tax rate. For comparison, on a like-tax basis first Quarter 2019 earnings were $0.09 per share. Using the tax adjust to 2019 figure, we expect first quarter 2020 earnings per share to increase by at least 30% year-over-year.

For the full year 2020, assuming a second quarter 737 MAX production restart, LEAP 1-B engine production aligned with guidance given during GEs earnings call last week, stable nickel prices and minimal global impact from the current coronavirus epidemic, we expect to earn between $0.75 and $0.90 per share utilizing a 23% to 25% book tax rate. This range reflects the dynamics related to the 737 MAX situation and its impact on the supply chain. This 2020 range compares to $0.96 per share in 2019 on a like-tax basis.

2020 free cash flow is expected to remain positive and fall in the range of $135 million to $165 million excluding expected US pension trust contributions. To achieve these results, we anticipate aerospace and defense growth outside of the 737 MAX, including ongoing emergent demand fulfillment throughout the year. As we have talked about several times on this call, we fully intend to maintain our costs and working capital discipline and will benefit from proactive efforts to improve earnings in 2019, including our fourth quarter restructuring action.

Slide 11 provides a few detailed 2020 financial modeling assumptions to ensure clarity on key line items. We expect our full year 2020 defined benefit pension contributions to be about $130 million. We anticipate total retirement benefit expense to be approximately $60 million, down nearly $30 million versus prior year. Our 2019 actions to lower debt levels will reduce annual cash interest expense in 2020.

We expect 2020 net interest expense to be between $86 million and $90 million down from $99 million in 2019. Aligned with our recent guidance, we anticipate a normalized reported or book tax rate of between 23% and 25%. We expect the cash tax rate to be between 5% and 7% due to ongoing benefits from our net operating loss carry forward.

2020s diluted share count is it expected to be relatively consistent with 2019s diluted share count. As a reminder, ATIs diluted share count includes shares associated with our convertible debt due in 2022. When calculating our earnings per share using the diluted share count, you must add back approximately $2.4 million of quarterly interest expense to earnings assumed in the numerator.

We intend to invest approximately $200 million to $210 million back into the business through capital spending. This includes approximately $100 million per added billet an isothermal forging capacity and capabilities in support of the long-term aero engine supply contracts announced in 2019, as well as other share gains earned in contractual agreements.

We've committed to having these strategic assets fully operational in 2021 and 2022. Apart from these strategic investments, capital spending to support ongoing operations is expected to be below current depreciation and amortization levels. We are committed to enhancing cash flows and improving capital allocation in part through continued improvements and manage working capital, including inventory levels.

With that, I will now turn the call back over to Bob.

[Bob Wetherbee, President and Chief Executive Officer]

Thanks, Don, lots of good stuff in your update today. It won't be lost on the audience that we've changed our approach to guidance in an uncertain and turbulent times, I think we all know clarity is a darn good thing. So appreciate the detail and the concrete assumptions that you went through today.

So 2019 is now history. It was a year filled with significant challenges and strategic actions capped with solid financial results in the fourth quarter. We focused on controlling the things we could control, streamlining and unlocking value from our asset portfolio, improving the health of our balance sheet, perfect timing for that, given the uncertainty that we see here in the first quarter, generating cash from operations and concluding contract renewals and expansions in growing markets that will generate considerable profitable growth for the long-term.

As I said although the aerospace industry experiencing a significant turbulence, the long term market fundamentals are still intact. Heading into 2020 we're taking action to counter the negative headwinds from the 737 MAX production suspension. John, Kim and Don talked about them. Today, we've initiated a cost savings program, adjusted our near term operating capital spend, secured our balance sheet and are working diligently across the organization to capture emergent demand to offset the anticipated order deferrals.

We're creating a robust future with our customers built on continued strong execution. We're proud of what we accomplished in 2019. But we recognize there's more to be done to generate value for our shareholders. And we're confident we have the team to be successful in 2020.

With that, Scott, let's open the call for questions.

[Operator]

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Phil Gibbs of KeyBanc Capital Markets. Please go ahead.

[Phil Gibbs, KeyBanc Capital Markets]

Hey, good morning.

[Bob Wetherbee, President and Chief Executive Officer]

Good morning, Phil.

[Phil Gibbs, KeyBanc Capital Markets]

Great work on the balance sheet.

[Bob Wetherbee, President and Chief Executive Officer]

Thanks. It was a team effort and timing worked in our favor and decision making was good. Appreciate that Pat ran to the finish line to finish that up for us and Don a good balance sheet to start the year with.

[Phil Gibbs, KeyBanc Capital Markets]

Thanks. Well welcome, Don. And congratulations, Pat, wherever you are listening to this.

[Bob Wetherbee, President and Chief Executive Officer]

He's listening to it. Yeah, he wouldn't let us go solo.

[Phil Gibbs, KeyBanc Capital Markets]

Yeah, I wouldn't think so. In terms of the leap build rate assumptions for 2020. I know there's ups and downs with the LEAP 1-A and the downs with the 1-B, but how are you thinking about that collectively in terms of the impact?

[Bob Wetherbee, President and Chief Executive Officer]

Yeah, I think the good news is we moved our call back a couple of days so we could actually let those closer to the end market go first with Boeing, Spirit, GP, for sure. And as you as you do that triangulation on those things there was a pretty strong alignment between them. And that's really the base assumption for us. What is Boeing saying was Spirit saying what are GP saying those are the leaders? We wanted to be aligned with the GE leap production outlet because they provided last week and so that's the base assumption for us. I think they were pretty clear on their call what they're headed for. And clearly, we believe that there's top end to our guidance, it's achievable with a few tailwinds. But the opportunity here for us is to stand and sync. And we've said many times, and we don't really produce to a build rate, we produced to our orders that are very active six weeks since mid-December when Boeing announced the suspension. But we've had near constant contact with the customers across the supply chain. As they look to do what's best for their business, recognizing fully that the engine producers are not going to zero, they're still producing. So we have a little bit of this disconnect between airframe builds and engine builds which is unique for us, but so far, the order pattern is very clear for us and obviously this growth's going to be played and the orders differed but not at loss.

[Phil Gibbs, KeyBanc Capital Markets]

Bob when you look at the airframe side of things, I think it's a little bit tough from our standpoint to understand really the dynamics because I know when you go in and you add to these long-term agreements with Boeing or Airbus respectively, there's often and MAX agreements and make whole agreements as they go below men's and things of that nature, which doesn't necessarily exist with the engine guys. So how do we think about that, I mean, obviously MAX is not producing until whenever they do. But there are agreements in place in terms of parachutes, which protect in cases like this to some degree. So I just wanted to hear your thoughts on that.

[Bob Wetherbee, President and Chief Executive Officer]

Yeah, I think fair question. When you look at the airframe sides, we look at our order book and the lead times to the order we send their out, they'll significantly through the major part of the year, probably into the third quarter. And obviously, they're committed, our customers are committed to keep their commitments within that lead time once they commit. There are mid Max's, I think what's going on in the industry is people who are executing in the market are being rewarded with the merchant demand and we certainly see the benefit of that in some of our contracts renewals. Most of our contract renewals, we're saying share gains, they don't all click in at exactly the same time, so there are changes there that we're dealing with. And certainly some of the changes in the supply chain around how information is passed is still improving and we're staying well connected to the end user as more digital technologies get involved in the supply chain process. We actually have Kevin Kramer with us here this morning, and he's back from the road busy signing up contracts in the fourth quarter. Kevin, do you want to add to Phil's question?

[Kevin Kramer]

Sure, Bob. Thanks and Phil, good morning. As Bob said –

[Phil Gibbs, KeyBanc Capital Markets]

Good morning.

[Kevin Kramer]

Good morning, as Bob said some of the contract men in Max's are clearly confidential. And yet on the upside, as we stated our fourth quarter results, we did benefit certainly with Boeing on some emergent opportunities. It's our expectation to continue that in 2020. So clearly the base purchase volumes will be different versus 2019. With regard to Airbus, as we've shared on previous calls, we continue to be engaged with contract conduct negotiations and to lose we stay very connected with Airbus. But that decision we're still estimating will be at the end of the first quarter. And again, we remain hopeful that there will be an appropriate share that we will earn across all the products on the fly bolt side and the special material side.

[Phil Gibbs, KeyBanc Capital Markets]

Kevin, just as a sub question to that and I'll hop off. Does your CapEx for this year – you call it guide to or anticipate that appropriate share with Airbus that you're talking about?

[Kevin Kramer]

Yes.

[Phil Gibbs, KeyBanc Capital Markets]

Thank you.

[Operator]

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

[Gautam Khanna, Cowen and Company]

Hi, guys. Yeah. And congrats to Pat as well and Don, thank you for the detail. I was wondering if you could talk about – so you have the Q1 guidance, you have the annual guidance. And it appears by definition that things accelerate through the year. And so I was just curious, what are your leap expectations, Q2, Q3, Q4, I mean, do we expect a ramp from the Q1 rates? And then relatedly like, are you actually taking production down or is that you're building inventory kind of in Q1, so you're going to have better absorption reflected in the numbers. So that we – but your shipments maybe pick up in Q2 and beyond? Just being in frame sort of what's going on?

[Bob Wetherbee, President and Chief Executive Officer]

Okay, let me start Gautam and then I'll hand it off to Don and John to make whatever comments they want to add. So I think at a high level the one point I'd like to start with is that there's more to our aerospace and defense business than the 737 MAX. So we have a wide variety of customers on every program. So I think one of the things you're going to see that we committed to in the fourth quarter was the particular customer that had a little bit of a cash management issue in 2019 is saying following through and we're actually seeing growth at that account. And we're seeing Q1 materialize as we expected. So there's actually growth in our business in aerospace and defense beyond the MAX. So I think that's an important thing to understand, particularly evident in Q1. I think in terms of the balance of the year, I think the guidance that most of the others in the supply chain have given have been full year guidance. We do, I don't know if Pat left us the legacy trademark to use the word lumpy, but I do believe there will be ups and downs through the course of the year. And so our guidance is really for the full year. To predict what's going to happen in every 90 day period, given the critical decision that Boeing needs to make, when they're going to restart, we're confident in the full year, we do expect things to move around during the quarter-to-quarter and be a little more variable, but full year should be where we want to be.

The last question and I'll turn it over to Don to add some more color is your question about are we taking production down. And the answer is we're smoothing it out. There may be a short-term inventory rise here in Q1, but our target is to be at the 30% working capital as a percentage of sales and we believe we have the team and the systems to do that. We're not producing any significant amounts. We're staying connected with the order pattern. We're also not anticipating any layoffs or massive production reductions. We are committed through their airspace ramp. We've learned from the aerospace ramp to be ready to go and Boeing and GE say go, we're ready to go, we're not going to be the bottleneck in the supply chain and our track record of execution is earned a lot of these opportunities. So I guess that's kind of covers most of the points. Don color?

[Don Newman]

What I would add is we're very disciplined when it comes to managing our inventory levels, but we're also in daily contact with our customers and we want to be disciplined in what we carry and produce, but at the same time, we also want to be able to pull the trigger and make sure that they have what they need in order to execute the ramp. So there'll be a balance, but we have the right tools and the right people in place to manage that quite well.

[Gautam Khanna, Cowen and Company]

Okay, thank you and as a follow up you mentioned that 2020 guidance doesn't reflect any downtick in the 787 production rate. When do you anticipate you'd feel that and where would you feel that? I presume and titanium shipments, but can you give us some quantification on what do you estimate your 87 revenue per ship set to be today and so we can maybe frame that out as we move into '20?

[Bob Wetherbee, President and Chief Executive Officer]

Yeah, I think it's a fair question. I think on the 787 we expect through what we see for forward lead times to kind of smooth out the impact. We're not actually seeing it in 2020. We'll have to reevaluate 2021. At this point in time when it comes to revenue per ship set, it's a very unique time in the industry where the engine production candidly is disconnected from the airframe production. And so using those kind of metrics in the short-term can lead people to the wrong conclusions. So we are in the process of thinking those through. There's data that was relevant to our positions, Chair positions in 2016, 2017 and 2018. Good news is that the team is working very hard, no share positions are changing. So they're a little bit out of sync in total and by program, so we're not really going back to those in the near term. Kevin, anything you want to add?

[Kevin Kramer]

Yeah, just one additional comment, we're clearly tracking the build rate updates that Boeing has provided from 14 to 12 on the 787, which we do have on our plan reflecting that in the fourth quarter in 2021. We'll have to reassess if there's any further decline in the build rate which Boeing has indicated there could be. They haven't seen it yet. And they can let the emergent demand opportunities have covered any potential short-term issue there.

[Gautam Khanna, Cowen and Company]

Thanks guys.

[Operator]

The next question comes from Matthew Korn of Goldman Sachs. Please go ahead.

[Matthew Korn, Goldman Sachs]

Hey, good morning everyone. It's good to hear from you, Don. Following up, on the MAX you spoken of demand delayed, not destroyed. And what kind of cost savings initiatives are you then taking in the midterm – in the near term? And then at what point does 2021 become a concern where the ability of you and others in the chain to fairly quickly ramp up again becomes impaired? When does that happen? Is clarity still lacking as of mid-year? Is it sooner or is it later?

[Bob Wetherbee, President and Chief Executive Officer]

Alright, several questions in there, Matt, I'll see if I can cover them and then I'll ask John to jump in. So in terms of being prepared to ramp when the industry needs us to ramp up – we've done that a couple of times. I think we're well prepared for that with people and capacity and capability. In fact, the investments we're making here, the strategic investments we're making actually position as well for '21, '22 and really the growth and '23. So on the cost side I think, we're managing – we manage our overtime relatively tightly. We take advantage of attrition when it comes, but we're always engaged in the continuous improvement of our processes. I think Kim talked about what's going on in the Flat Rolled side. John, you want to add some color to how you see it in the HPMC side?

[John Sims]

Yeah. Sure Bob. Hi, Matt. Yeah, as Bob said, we have a strong focused on cost reduction and cost containment. So when we're in an environment like this one, we stay the course with the things we already are doing, which we view is more sustainable cost reductions, not temporary, per se. And we balance that against, as Don said earlier, our ability to flex when emergent opportunities present themselves. And especially, as we get towards the back half of the year where we expect to see more activity as we bridge into 2021, which based on the earnings calls in the last week or so, indicate higher production rates on the 1-B. So we're balancing that through primarily focused on maintaining our working capital disciplines. We know that our supply chain drops in rate, there's going to be an inventory build early that we have to burn off. While we're doing that, we can't affect our ability to react quickly when opportunities present themselves. So we're working our way through there. And then we also have to prepare for the change in shares associated with contracts that we earned and negotiated in '19. That will begin to affect us in 2021.

[Bob Wetherbee, President and Chief Executive Officer]

John, this is done, I think I would add as well we announced a restructuring with a modest reserve that we bought at the end of Q4. This is, I think, another key example. This is a culture of continuous improvement. We continue to look at our cost structures and identify where we have opportunities to improve efficiencies. And that particular example, with a $4.5 million cost to execute, has a run rate savings of about $8 million a year. This is one of quite a number of initiatives that are underway in the organization in the normal course, not just because of the 737 MAX issue. We see opportunity to become better every day. And we're going to continue to go after those deficiencies as well.

[Matthew Korn, Goldman Sachs]

I appreciate all that color. Let me switch gears just a bit, a question for Kim then. Any effects so far that you're seeing in STAL from the coronavirus outbreak, anything around worker, absenteeism, movement along the supply chain, any color you can give there at all. It sounds like you're fairly confident since it's been a resilient business so far.

[Kim Fields, Executive Vice President, Flat Rolled Products]

Yeah, I mean, I think the government's put in some guidelines to try to reduce the movement of folks and then they have asked businesses to cut back on production and extend the New Years. So that has had a small impact on some of our production, but from a customer and order standpoint, it's been strong and again, we're seeing a strong first quarter versus kind of year-over-year. So we anticipate as they get this under control and businesses start back around, I think February first half?

[Bob Wetherbee, President and Chief Executive Officer]

Yeah, February the 10th.

[Kim Fields, Executive Vice President, Flat Rolled Products]

So they're going to be coming back on the 10th that we'll see kind of resumption as the demand that we saw before.

[Bob Wetherbee, President and Chief Executive Officer]

And again, this is Kevin, again, the historical basis for the STAL business around Lunar New Year and within the first quarter, it is a slower time of year for us, in fact, our slowest quarter. So as Kim said, we are following the guidelines. We're most certainly caring about our employees. It's about 550 people. And then we also have our offices ATI Shanghai and Beijing as well. And so we are following the mandate of the government and again, we expect to come up on the 10th. I mean, any other change and we should get back on plan through the balance of year.

[Matthew Korn, Goldman Sachs]

Alright, thanks folks. Good luck to you.

[Bob Wetherbee, President and Chief Executive Officer]

Thank you.

[Bob Wetherbee, President and Chief Executive Officer]

Thanks Matt.

[Operator]

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

[Unidentified Analyst]

Hi guys, this is actually Kay [indiscernible] on for David. Wanted to just circle back on pension, it's still kind of weighing on your free cash flow. And so wondering like when we could start to see substantially lower contributions, because we've talked about kind of potential annuity transactions, and I know you did some kind of pension reform this year. You guys also highlighted that kind of 500 million cash balance. So just any color you can provide there would be great.

[Don Newman]

Sure this is Don. As you pointed out, we did a meaningful annuitization related to 1,800 of the participants' $95 million investment through that exercise. Also contributed about $145 million in 2019 and will contribute at least 130 million in 2020. We're continuing to look at strategic opportunities to work down that obligation. And first and foremost, we're going to make sure that we have ample liquidity in the business to manage through the 737 situation in 2020. Of course, we have a lot of liquidity on our balance sheet. We have a rock solid balance sheet, which is quite fortunate. And through 2020, we will look at other opportunities to make headway with that pension.

[Unidentified Analyst]

Okay. Great, thanks. I'll keep it to one.

[Operator]

The next question comes from Josh Sullivan of The Seaport Global. Please go ahead.

[Josh Sullivan, Seaport Global]

Good morning. I like all the comments you've prepared and then welcome, Don. Just on the new contract with GE and others, can you give us a sense of timing when new firms can contribute. I think you said '21. Will that be for the full year? And then are they tied to any specific build rate assumptions.

[Bob Wetherbee, President and Chief Executive Officer]

Okay, so Josh a little bit hard to hear. So we heard you ask, I think about the – when does the contract kick in and John will kind of cover that topic for us. And then is it tied to any specific build rate assumptions? And I think as we said before we're producing to specific customer orders. So we're prepared to grow with the MAX and the LEAP specifically. And so we have the capability that we're investing in will position as well for '21 and '22. So it's not tied to any specific build rate assumptions. But we do believe that the share increases will be meaningful and starting to – certainly in early 2021. And so we'll actually start to see some of the manufacturing benefit to that in the fourth quarter as we move materials into the supply chain. As the industry goes today, we still see kind of six months from the time we ship to the time it gets on to engine or a plane for basically the specially materials and forgings. And certainly the longer term issue for mill products is still in the 12 month range. So that is a factor for us as we think about when the share increases occur and when the build rates occur and we certainly leverage that. So John do you want to talk more about the contract and what you see coming?

[John Sims]

Yeah, Bob. Hi, Josh. I think Bob said it correctly. These contracts kick in, in 2021, beginning of 2021. And they're not tied to specific build rates, as he said they're more share based contracts. And so as we look ahead into 2021, based on the guidance we've been given. So far, we anticipate an increase certainly in engine builds in '21 over '20 on the 1-B. As we said earlier, we participate in multiple engine and frame programs. So all of those together mean that part of the capital investment, the strategic capital we identified is necessary, even though the build estimates might be a little lower on the 1-B in 21, than originally thought. We still need that additional capacity. So we're preparing for that. And as Bob said, we anticipate seeing the impact of those in fourth quarter.

[Josh Sullivan, Seaport Global]

Great, I appreciate that and then just one Kim on the 232 issues. Yeah, I think in prepared remarks you mentioned the potential direct to address the Midland assets, what are the gating factors there? When do you think you would have to make a decision on those assets and then what is the current loss look like at that facility?

[Kim Fields, Executive Vice President, Flat Rolled Products]

But we are – yeah, we have our second exclusionary question and so we're awaiting a reply, we've had quite a bit of interaction, providing information and so forth. So we hope to hear an answer. But as we stated in some of our publications, we'll prepare to idle that facility. And we've been paying tariffs now for 23 months something close to $40 million. And so we are getting close to the time where we're going to have to make a decision. And if this is going to persist may take a different course.

[Bob Wetherbee, President and Chief Executive Officer]

I think that's fair Kim, I think our situation warrants and exclusions National Defense and the security of the business that we run, it's into that category as well as domestic availability. If you can make money buying domestic it's not going to last and that's kind of – we pursued that option. We obviously believe the long-term health of the business is our primary concern. And we believe, candidly the tariffs signed unintended consequence, they're pretty big blunt instrument. But I think to Kim's point, we still see strong pull from our customers to do this. But there's a limit. You asked are we still losing money in the joint venture. And the answer is yes. And how much longer are we willing to go? You know, candidly, I think we deserve a decision from the government. And the process is well defined. I think the processes within the Commerce Department are geared to give an answer. And we're ready and we think we deserve one, so we're making our case more clear to those that control that process. And but patience is limited. We're to the point where the business strategy that we're on the just to move forward, but candidly, we're not going to make it easy for the government. They're going to have to decide and we believe that time is near.

[Josh Sullivan, Seaport Global]

Okay, thank you.

[Operator]

The next question comes from Matthew Fields of Bank of America Merrill Lynch. Please go ahead.

[Matthew Fields, Bank of America Merrill Lynch]

Hey, guys just want some clarity on free cash flow. You said 135 million to 165 million. That's before pension contribution, right?

[Don Newman]

That's right.

[Matthew Fields, Bank of America Merrill Lynch]

So after that it would be 5 million to 35 million?

[Matthew Fields, Bank of America Merrill Lynch]

Yeah, you're right, the 135 to 165 is ex pension contributions and pension contributions will be 130.

[Matthew Fields, Bank of America Merrill Lynch]

Okay, and then are there any other assets sales you envision in 2020? And you sort of had a lot in '19, are we done for a while or is that going to be a part of the 2020 cash flow story?

[Bob Wetherbee, President and Chief Executive Officer]

We don't have any that are in that plan to be clear and candid. We evaluate our portfolio on a regular basis looking at the different options. Clearly, we just talked about what might happen with our Midland joint venture. We could certainly see that eventuality. I think other locations and processes; we're always looking at those. The core essence of our company is really EVA, economic value adds type thing, so cost of capital is key to us. We understand that and that factors into it. But we're focused on maximizing the value of our portfolio. You hear us talk about share gains, top line growth, mixed enrichment, cost reduction, costs, energies, looking for opportunities across the organization to accelerate new product and new product growth. So I think there's still a lot of room for that. But the quick answer to your question is no. But there's a lot more color and context that goes with that.

[Don Newman]

One thing I would add, this is Don, one thing I would add on, as you think about our free cash flow, as I noted, CapEx range 200 to 210. That includes $100 million investment in capital that's tied to contract extensions, meaningful share increases, very meaningful growth opportunities in the business. So as you think about your free cash flow generation, you just want to keep that investment in mind as it will produce some nice benefits past 2020.

[Matthew Fields, Bank of America Merrill Lynch]

Understood, thanks very much for the clarity.

[Operator]

And we have a follow up from Phil Gibbs of KeyBanc Capital Markets. Please go ahead.

[Phil Gibbs, KeyBanc Capital Markets]

Hey, good morning. Just curious in terms of what the nickel impact is in Q1 versus the fourth quarter, obviously a pretty substantial reset. Not a lot of that is going to be sustained given it's kind of a mark down against higher inventory levels. What's the magnitude of that impact in Q1 sequentially?

[Bob Wetherbee, President and Chief Executive Officer]

Good question. We actually factored that into our guidance. We hadn't really broken it out separately for this call. But we can check with Scott and follow up. But we do see it declining. I think nickel prices today are in the 575 range, probably down from the sixes in the December timeframe. So it's probably a $0.50 about 10%, but we did factor that into to our guidance.

[Phil Gibbs, KeyBanc Capital Markets]

Thank you. And then Don on the pension, the $28 million year-over-year swing, is that all going to be below the operating income line in that line item?

[Don Newman]

Yes, it is. Yeah.

[Phil Gibbs, KeyBanc Capital Markets]

So no change in service cost then, okay.

[Don Newman]

No.

[Phil Gibbs, KeyBanc Capital Markets]

Thank you.

[Operator]

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

[Bob Wetherbee, President and Chief Executive Officer]

I'll be quick with limited closing remarks. So thanks for joining us on the call today. And thanks for your continued interest in ATI. And thank you to all system listeners for joining us today. That concludes our fourth quarter and full year 2019 conference call.

[Operator]

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