ATI Inc. (ATI) Earnings Call Transcript & Summary

Good afternoon, everyone. Welcome back to the Aerospace Defense Track at the 2024 JPMorgan Industrials Conference. I'm Seth Seifman, the U.S. Aerospace Defense Equity Research Analyst. We are very glad to have ATI with us now and very grateful that Don Newman is here, CFO; and Dave Weston from Investor Relations. We're going to start off. Don is going to talk a little bit about -- give us a little bit of lay of the land for ATI right now, and then we'll do some Q&A. I'll ask a few questions and we'll open it up to the audience as well. But Don, welcome. Thanks for being here. And yes, maybe if you want to start us off at a high level of how things are going at ATI?

Very good. I'll give a short introduction as well as to what ATI is? If that sounds okay. First of all -- and of course, my General Counsel would be disappointed if I didn't give some sort of forward-looking statement comments. So what we're going to talk about today, no doubt with Seth good comments or questions. We're going to get into forward-looking statements. I would just point out obviously that future performance could be different than the statements we're making today, for various reasons, including things we don't know about today that could happen. I would ask that you guys refer if you would, to the resection of the 10-K we recently filed just to get a better idea of how we think about risks in our business and can be thoughtful around assessing that. So first, ATI, what is ATI? Well, ATI is a very special business. We have some extraordinary capabilities in producing products that are sold into Aerospace and Defense. Our products include titanium and nickel applications, for example, used in some of the most extreme performance requirement applications that you can imagine. We have significant share with OEMs, both in the airframe, as well as in the jet engine area of commercial, as well as military and our end market growth is on a very nice upward and to the right trajectory in terms of Aerospace and Defense. But we're not just about Aerospace and Defense. While Aerospace and Defense is responsible for about 63% of our sales, that was a Q4 number, just this last year. We also sell 10% to 15% of our products into what we call aero-like end markets. Those are specialty, energy, medical, as well as electronics. And those involve as well as titanium and nickel, we produced some really amazing products that are based upon things like hafnium and niobium and zirconium that are all extreme high-performance alloys that are used in things like thermal management for high chip applications, hypersonic, weaponry propulsion systems, things of that sort. So pretty special business. From a financial performance standpoint, it might be helpful to share kind of where we're at. This is a transforming business that is certainly going in the right direction. If you think about back in 2019, this business did $4.2 billion at 10.7% EBITDA margins. Just as last year, we were at, again, $4.2 billion in revenue, but our EBITDA margins had expanded, about 400 basis points. And we see them increasing significantly over the coming few years. And that has a lot to do with those end market exposures and the profitability actions we're taking in our business. So we do see this business growing, continuing to grow at strong double-digit rates. If you think back to 2022, our top line, if you exclude the effect of pass-through metal impacts, our top line grew almost 30% in 2022, grew almost about 10% in 2023. We expect growth again this year overall in the upper single digits. And we expect that, that growth is going to continue, largely, again, because of these really special end markets that we play a key role in. And we see 2027, this business getting north of $5 billion in revenue. From a margin standpoint, EBITDA margins should live north of 20% by 2027 and even by 2025, I expect we're going to be pretty consistently in the upper teens, when it comes to this business. All that's great. It doesn't matter if you're not putting cash in the bank. And so from a cash conversion standpoint, we're making significant headway, in terms of cash generation. The guide that we just gave on 2024, is excess of 70% increase in free cash flow generation versus just last year, and we expect to consistently see our free cash flow to net income conversion ratio north of 90%. And so very significant improvements to the business. Really, ATI is the right business in the right place, at the right time. Our end market exposures are broadly to end markets that we expect significant growth. And we're bringing the capabilities that are critical to each of those end markets.

Excellent. So with that overview, maybe we'll dive into some Q&A, and I'll start, and then we can open it up to the group. Maybe one significant piece of news that we learned this year since earnings, was planned for CEO transition at ATI. And so Kim Fields is going to become the CEO in July. She had been President and COO, so maybe not a complete surprise that, that was going to happen at some point. But maybe you can talk a little bit about why this is the right time for that transition and the capabilities that Kim is going to bring to the job, that will further the transformation of ATI that you're talking about?

Sure. I'm happy to talk about that. First is an exciting change for ATI. Bob Wetherbee has been our CEO for several years. He's done an amazing job in helping to develop a real winning strategy for this business. And really moving us away from commodity type products, transforming some of our business units from low profitability to very strong profitability. So no surprise. Bob is approaching 65 years old by the end of this year. And as part of that, he's anticipated and been planning for his eventual retirement. And so what was announced just recently was the promotion of Kim Fields, who's our President and Chief Operating Officer, into the CEO role. Clearly, Kim is going to be responsible, like you said, beginning of July onward, for the strategy of the business, as well as running the day-to-day operations. Good news is, Kim is extraordinarily capable of doing that. This has been a thoughtful transition and preparation process that Bob and Kim have gone through over the last several years. If you think about it, because Kim has been our Chief Operating Officer, she has had her hands on running the vast majority of the business from a day-to-day standpoint, for a number of years. And her style is to get into the businesses, really understand how they work and build relationships, that is going to equate to a really smooth transition for us. A lot of consistency in executing the strategy that's in place. Sometimes, Seth, we get the question, hey, with this change to Kim, is there going to be a change of strategy or outlook? The short answer is; this is not really Bob's strategy. This is a strategy that both Bob and Kim developed together. And Kim has had a very key role in executing over these past years. So I do not see any material changes to the strategy that we're deploying to, which is aerospace and defense, value-added products. From an outlook standpoint, again, Kim has had her fingerprints on the setting of the outlook for the business. I do not expect to see any significant changes in those 2025 -- in 2024, 2025 or 2027 targets that are out there. The good news is we're going to be in very capable hands with Kim. The team is very supportive of her. She's got great relationships with our key customers. It's been done very thoughtfully. And then we'll still have Bob as our Executive Chairman. He'll oversee the activities of the Board, as you would expect. But he'll also continue to be involved with things like our government outreach to Washington, D.C. and other special projects that Kim may ask him to take the lead on. But we've had a very collaborative team. And that collaboration is going to continue, and it's to the benefit of our shareholders.

Excellent. So turning to, I guess, the last quarter and coming out of the last quarter, we learned about some outages in the business, both in the HPMC business. and in the AA&S business. So I guess, can you update us on how that capacity is coming back online and how that -- how that is -- how that compares to the plans that you have?

Sure. I'd be happy to do that. So just a refresher for those folks that aren't familiar with what Seth is speaking about. In Q4, and it was largely in December, we took some planned outages largely around melt assets. And that's the typical timing for those activities, when our teams go home for the Christmas break. We -- and the machines are down, we open those machines, and we do some maintenance. We have been driving our assets pretty hard, very intentionally, by the way, there's significant demand on -- demand for our products. And the reality is we're also, as part of our transformation of the business, really trying to nail down what are the capabilities of the assets that we have? We know we have world-class assets, but you need to know where their limits are. And so we've been running these assets hard for those reasons. When we took the outages, we found that there was some additional work on some of the assets that was required. In other cases, it was exactly according to time and scope. But for those assets that required some additional work, you're talking about, hey, it was a planned 7-day outage, there's some additional work we needed to do to set us up for a stronger future run, took 8 days, 10 days, 12 days whatever it is. So that impacted. Now we also had a press outage and that press -- and I'll talk about another press here in a minute, which has really derisked this situation from happening again. But that press had an unplanned failure. And so fortunately, it wasn't a major failure, but it caused a kink in our production process. The combination of those carried over to Q1. What it meant was that we had less inventory that we would be using to finish products in Q1 and that created that debit for us. One thing I want to be clear on is, this is -- these are not mistakes. Some things happen when you're running a business that are unplanned. It's not because we're under spending on maintenance. I don't see a trend of that at all. And we're trying to certainly be thoughtful in making sure that we have consistent production. So we are asked at times, okay, does this mean less outage time or less outage expense later in 2024. And the general answer is, yes, for HPMC, I would expect that. I would expect that, that would be marginally beneficial to us. Also, keep in mind, some of these outage cycles are 3- and 4-year cycles. And so you're seeing them happen a little bit earlier in, say, end of 2023 versus at some point in 2024, isn't really a dramatic change to the long-term production profile for the business. So I mentioned we had a press filling. And that press was unplanned. But the good news is one of the things we announced in our Q4 call was that we were bringing a new press online, and it's a billet press. And it's a really special asset. It's an asset that we started constructing really before COVID. We shut that project down during COVID because we didn't need the capacity, why spend the money, right, guys? And so with the demand that came back and at the right time, we restarted that construction to finish that asset off and it's finished. It's running now. If that asset was in place at the end of 2023, when that press outage happened, we wouldn't have the situation. What that really points to is that we're investing to do a number of things. Number one, we want a stable and predictable production platform. Number two, we are debottlenecking this business. And number three, we are derisking it. We are eliminating single points of failure risk happen that the timing on this one wasn't exactly perfect. But good news is that world-class asset is now up and running. It's going through qualification processes and that will be an asset that contributes to the bottom line for many, many years to come. And so we're excited about that. So that was one -- that was one of the outage situation that we talked about in our Q4 call. Another outage situation that impacts our Q1 was tied to a weather event that occurred in Oregon. And I do not really like to refer to weather, as an excuse for an impact to your bottom line. And in this case, its unique situation. So what happened? Well, think about the Arctic snap that we had in -- on the West Coast, in January, it was pretty severe. And for our business, as you picture that business out there, we have part of that activity, that picture a refinery, a bunch of exposed pipes doing refinery type things. And in January, we had a situation, where the weather was -- the temperature was below freezing for, I think, 20, 21 days in a row. That's a pretty -- that's a tough situation for a geography that's not used to that kind of sustained cold. Guess what? Our plant reflected that unusual weather. We had roughly -- I think the last I heard 50 pipes, 5-0 pipes that burst. And so guess what, they have to be replaced and they have to be repaired and all those good things. And so that was something, of course, we got on right away, and that's progressing extremely well. And I expect -- we did announce that we expected that weather impact to be about $0.03 in Q1, another $0.03 in Q2. It's still my expectation that we're going to see that kind of impact. But of course, we're doing our best to reduce that negative. Good news is, I do believe we're doing the right thing for our assets and for the production capabilities of the business. That, in combination with the capacity that we're adding, that I'm sure we'll talk about a bit, really sets us up in a strong position going forward.

Excellent. And then so I guess, to bring it into the financial statements, the challenges in Q1 and the guidance for the full year, kind of point to a fairly steep margin ramp as we exit the year. What gives you confidence in the ability to achieve that? And are there any other kind of seasonal dynamics to be aware of, as we move through the year?

In a normal seasonality for us is a couple of things I would point to. One is we have a working capital cycle that typically means, we have a greater use of cash in Q1 and then build cash throughout the year, and especially in Q4. So that's one seasonality item to note. I expect a similar pattern, although less of a divot in Q1 this year than we've typically seen. And we've shared our cash generation targets, which, like I said, north of 70% increase year-over-year. So I think there's going to be a good outcome there. Another seasonality thing to keep in mind is we vary typically in our AA&S segment, specifically specialty rolled products, typically take outages in Q3. And generally, that's been about $10 million of additional expense, as well as some impact on sales, marginal impact on sales. So I would expect a similar pattern in terms of those outages. Those are really the seasonal things, I would note. And the other question?

So with that -- so you start off some challenges from the outages in Q1, we've got maybe some specialty rolls downtime in Q3, but being able to ramp that margin through the year off with Q1?

Yes. So the key question is, why are you so comfortable with your second half?

yes, that's right.

That's really kind of the -- what's at the bottom of that? So there's a couple of things that are causing the inflection and Seth already touched on one of them. With the outage divot that we have in Q1 that we've been pretty transparent on, guess what, that's behind us in the second half, so that's good. Another thing that's happening is, when you get to the second half of the year, we have some capacity that we brought back online, it's titanium melt capacity, that has a meaningful impact in the inflection that you see in our guidance. And so let me give you some context around the economics tied to that plant. This is a plant that we restarted throughout 2023. It is expected to generate between $150 million and $170 million of revenue, at run rate, and think in terms of roughly a 35% contribution margin, okay? So our incremental margin, rather. So with that, that's at run rate. But the way that plant really, really ramps, there is a lag between when the product is produced out of that facility and when the product comes out the back door and goes to our customers. And the way to think about that is between production and shipping upward of probably 4, 5 months, sometimes 6 months. And so because the plant was ramping and hit its production ramp rate at the end of 2023, we would expect that it's going to hit its income statement run rate in the second half of the year, okay? There's also another element. So I said it hit its production run rate at the fourth quarter. That was true for 3 pieces of equipment. The main 3 pieces of equipment. They're called VARs, VAR melt. And so that was true. But we are starting a fourth VAR, and that restart is going to happen at the beginning of this year. And so we're in the process of doing that now. That means, again, you have the ramp and you have a lag between production and income statement. So the way to think about that fourth VAR impact, that's going to get really hit you in the fourth quarter. So those are important contributors to that inflection you see in the second half. What's another one. Well, here's another one. In the second half of last year, we saw a reduction in demand on some of our industrial end markets. With the transformation of the business, we've significantly reduced our exposure to commodity markets like standard stainless. And while we made a lot of progress here, we still have a stub of exposure related to industrials. We saw that demand dampen in the second half. In Q4, we saw it stabilize. And what we shared with investors is, hey, we expect full recovery in those industrial -- industrial cycle. We all get that. But we expect that the first half of 2024, those industrials, we'll probably see some early stages of recovery, but really, it's the second half of 2024, where you'll see a more robust recovery through those sales. So those are a couple of things to note with regard to first half, second half. Maybe just one more thing I would add for context, we haven't guided on every quarter, but one thing I've shared with folks is, as you think about the pattern of our earnings generation, first half to second half, I think in terms of general numbers, now you guys, not precise, but kind of 40% to 60%. 40% first half, 60% second half, as an indicator of how to think. Hopefully, that's helpful.

Yes. Absolutely. Absolutely. And I kind of anticipated my next question, which was about the ramp, in the industrial end markets in AA&S and whether in terms of the demand signals or the order books or anything like that, whether you're starting to see some of that now? Maybe that's the first part. And the second part, I guess, would we include in that the Precision Rolled Strip business, in that industrial sort of subset of businesses? And I guess the reason I ask is it's very much -- it's kind of outside my A&D wheelhouse. But just from the filings, it looks like that business was down fairly significantly last year. And it seems like it's a nice contributor to the profitability of that AA&S segment. And so we saw kind of pressure on AA&S margins through the year and it seemed to be coincident with that Precision Rolled Strip contribution?

And just to make sure I'm going to answer your question correctly. So that precision rolled, are you referring to the Asian Precision Strip?

Yes.

Okay. So let me give you an idea. So 2-parter on this one. So first of all, for the industrial demand. So are we starting to see recovery. Again, at the end of last year, we saw a stabilization, which was great. And we expect second half of this year to see a nice recovery. But what happens in between, right? So what we're seeing, I would say, a certainly continued stabilization and green shoots that would indicate the recovery is going to happen like we expected it to. It's not broad-based. It's not like it's screaming, "Hey, we're up 30% between January and February. I'm not saying that at all. But what's encouraging is, you got to start seeing the green shoots of recovery, before you start seeing a more robust recovery. And it's playing out about like we expected and reflected in our guidance. So that's very encouraging. Then in terms of our Asian Precision Rolled Strip business, it's -- just for context, this is a joint venture. We own 60% of it. It is located in China. And it serves the electronics end markets and automotive generally. And Precision Rolled Strip is a really interesting product. But starting in latter 2022, as I recall, that business saw a downturn. And this is a business that before that downturn, think of it as revenue in the $300 million range, certainly, margins, EBITDA margins accretive to the overall business. And for a placeholder, think in terms of 20%-ish and really good business. And -- but it's tied to the China economy. And so as you guys know, China started to have some headwinds around COVID, and it's had some general economic headwinds. That absolutely affected our joint venture. And you noted that. What we saw was the revenues declined to a range instead of $300 million, more like $250 million. And of course, that carried through on the EBITDA, where now the EBITDAs are kind of banging around in the upper teens versus 20% or maybe even above 20%. And so that business absolutely stabilized. We saw that in 2020 -- in 2023. And our expectation is that we could start seeing some recovery in 2024. But to be quite frank, we're going to -- our guidance assumes it's pretty flat. And the reason we're doing that is we don't want to jump the gun, in terms of assumed recovery. We've done that. We've seen that and it usually doesn't -- it's not helpful to our investors. So for guidance purposes, think in terms of -- we put in some modest recovery, but it's super modest, you guys. There is one point of seasonality to, again, just keep in mind on this joint venture specifically, and that is Chinese New Year. So as you look at the performance of that business, you have a good idea of what the EBITDA for the full year is based on what I shared. But because of Chinese New Year, which happens every Q1, we would typically see a modestly lower EBITDA and sales generation out of that business in Q1. But again, that's just for note. Does that help? Does that answer your question?

Absolutely. Absolutely. Thinking about -- moving back to the Aero business, 737 has been in the news a lot this year. Maybe if you could tell us kind of the signals that you're getting with regard to the content that you produce for that program on 737? And I guess if there's any context you can put around maybe in broad terms, the impact on your growth expectations if it was a longer ramp, on 737. If it took longer to get that rate up?

Yes, fair question. You won't be surprised to hear that we've heard that question before. And -- when you think about our business, our business is in a fortunate position. We have shares on a lot of platforms, all the key platforms really, and we have a share, significant share with both airframers. We have a significant share with each of the jet engine OEMs. And so we're not reliant on any on any one model that's out there. But certainly, the 737 is an important platform. So to answer your first question, are we seeing any signals from demand signals, as a result of what we're seeing in the headlines these days? And the reality is we have seen sustained, high demand signals across the airframe and the jet engine OEMs and their respective supply chains. It hasn't -- that hasn't let up. And so order activity remains very, very strong. The discussions that we have with those key customers and imagine their weekly kind of conversations, just the nature of what we do for those important customers. They remain very, very positive. And we expect that, that key OEM is going to find the solutions necessary to stabilize and make sure that they stay on their trajectory for growth. I would remind folks that, when it comes to our outlook, we try to really share number one, our true views as to what we expect and also to lean toward conservatism, when it comes to our outlook. So with that, one place you can look is our '25 and '27 outlook -- we gave our '27 outlook at the end of November at our investor conference. We were very transparent. Our anticipated build rates in our outlook numbers are based upon lower build rates than the OEMs have indicated. And that doesn't answer the short term, but it certainly gives me comfort in the longer term. And -- so that's what I would say.

Yes. No, that's very helpful and good color. I guess, well a related question, thinking more broadly about your work in Aerospace on engines and airframes. How have lead times been trending this year in both of those areas?

So lead times have continued, I would say, to generally extend. We've seen this. It's not a current phenomenon, right? But giving an indication when we think about aero, nickel and titanium, billet and bar. We're looking at lead times roughly a year, sometimes depending on the product. I would say, 70 weeks. And I would anticipate that with the strong continued demand that's hitting our business, despite good production that we'll continue to see extended lead times. Then in terms of our forgings for Aero. Forgings, we're seeing 12- to 15-month lead times. And I think as you think about lead times, when we talk lead times, in combination with what's happening with our backlog. If you look at either one in isolation, I think you can draw some bad conclusions. But our backlog is has the fingerprints of these extended lead times despite good production levels. And so what's happened with our backlog. Our backlog at the end of 2023 was nearly $4 billion. That increased roughly 30%, from the beginning of 2023. And just in Q4, it increased 9%. So not surprised. I'm not surprised by the math. It's a strong indicator that Aero demand is hitting us really strong. And I think with the ramp trajectory that we anticipate happening, this growth is going to continue for some time.

Okay. Maybe to take things in a little bit of a different direction and ask about cash deployment. You talked earlier about expecting cash conversion over time in the 90%-plus range. I think this year, the midpoint of the guidance is probably in the high 200s or so, in terms of your free cash flow, there's not a lot of debt to repay. Can you talk about your plans for that cash and whether there's potential to see more than, I think, $150 million or so that you penciled in for share repurchases?

Yes, fair question. So you're right. Our cash generation trajectory is going in a positive direction and should continue to build momentum. One of the important targets that we have is we want to be converting cash. Again, free cash flow over net income at a rate of 90% or better. That's our target, and we are absolutely heading there. So, from a cash generation standpoint to go from $165 million in 2023 to about $300 million in 2024 is good progress, and I'll call it a good start, but we're not -- certainly not done with it. So it's a fair question. What are you going to do with all the cash? Well, we've been very, very clear. There's 3 destinations for our capital. One is we're going to invest for growth. We have guided at roughly $200 million of average CapEx for the next 5 years, take us through 2027. And of that, if you split it between maintenance CapEx and growth CapEx, it's about $80 million of maintenance CapEx on average and the rest being growth. I don't see that as changing materially. The demand is strong. We're very disciplined in how we execute that and I'd love to talk about capital deployment because it is really critical to everybody in the room. Now that's on the growth side. We also deploy to delevering. And last year, if you're following us we delevered through our pension plan. We transferred roughly 85% of our defined benefit pension obligations, $1.4 billion. We transferred that to a third party. And then fully funded the remainder of those liabilities, which a gross liability of $250 million remains with us. That saved us $50 million in pension expense from where we were before those actions. So pretty excited about that outcome. Beyond that, we don't have any near-term debt maturities. So that gives us a lot of flexibility. I will say that I would prefer to not have $2.2 billion in our capital structure, as a permanent element of the capital structure. We want to reduce gross debt. We want to do it in a really disciplined and rational way, to derisk the balance sheet and it saves us on interest. So we will work toward that. We just don't have any requirements. We only have choices, which is a nice position to be in. Then that remains -- then leaves the remainder at well, what's going to our shareholders. So Seth was right. We have a $150 million program that was approved by our Board at the end of 2023. That will be executed in 2024. Add that to what we did in -- starting in 20 -- early 2022, and we've repurchased almost $400 million of shares under those programs. So I consider that again a good start. Do I expect as we're generating more and more cash that were done with share repurchases? Of course, not. I think our shares are very undervalued, and it would make perfect sense for us to buy shares. We'll have the cash to do it. Our Board has shown great support in doing that, and the management team has consistently made recommendations in that direction. So don't expect that the current $150 million program is the last repurchase program.

Okay. Excellent. I can continue asking questions all afternoon, but we are out of time. So we'll wrap it up here. Don, thanks so much for being here. I really appreciate it and for talking with us about ATI.

Very good. Thank you, everybody.