ATI Inc. (ATI) Earnings Call Transcript & Summary

Hi. Good afternoon, everyone. I'm Kristine Liwag, Morgan Stanley's Head of Aerospace and Defense Equity Research. I'm very excited to host our next panel with ATI and very excited to have Kim Fields, who's our CEO of ATI. And I think Rob, who's also the CFO. He's going to read some disclaimers and I'll also read some. So maybe passing on to you, Rob.

Sure. Absolutely. Thanks, Kristine. So I'm Rob Rengel, IR head, over here at ATI. Just real quick, and I know everybody loves the disclaimer, but we may make forward-looking statements today. Those, of course, are subject to risks and uncertainties. For a full list of those risks and uncertainties. Just look at our most recent earnings slides or our most recent 10-K. That's it. Thank you.

Great. And my disclosures for important disclosures, please see Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. So with that, maybe Kim, starting off, you can see of ATI now for more than 2 years. So what do you think about when you think about your tenure and your role, what has been the most meaningful progress ATI has made? And where do you see the greatest opportunities going forward for the company?

Yes. Thanks, Kristine. Yes, as I look at ATI, through my tenure, it's really the transformation that we've done with the business. It started back in 2019 in the AA&S segment as we were looking at and working on SRP and that business. And focusing on our aerospace and defense portion of that business, exiting standard stainless, which at the time was about $400 million in revenue and really focusing our resources and investments at those differentiated products that bring the highest value to our customers. Here recently, we continued that focus around aerospace and defense and some scarce resources that we make, hafnium and zirconium. I've talked a lot about that on our calls. And those products go into everything from commercial nuclear naval nuclear, hypersonics, space launch and even jet engine additions for those alloys. And taking that with the commercial discipline that we've applied across our business, we were able to capture the value that we were creating for those customers and for that business. And we've seen phenomenal results in our second quarter alone, we were at about 22% margin in AA&S segment, 23% across the business. In the A&S segment, if you go back a year ago, it was at 14% so really substantial increase. For the segment, over the last 5 years, we more than doubled our aerospace and defense percentage of revenue, up to 44%. And so again, substantial transformation that has been going on for a long time, I've been talking about it, but really start to see those financial results come through in the last quarter. And so the team is very proud of the progress that they've made, the focus. Overall, from a company standpoint, we've increased our aerospace and defense percent of revenue up to 68%, 70% of our total revenue, and that was down around $50 million back in 2019. So when you just look at how quickly that we've transformed and focused our energy, our resources and our investments around those products that are differentiated and bring the highest value to our customers. it's phenomenal. It's been a phenomenal journey.

That's wonderful. I mean, those numbers speak for themselves. So with that, Kim, there are so many aerospace and design suppliers and you have a very broad portfolio and unique capabilities. But why ATI? And also what differentiates you from your competitors and for the products that you're making what's the commodity versus truly differentiated technology?

Yes. As I look across the industry and unfortunately, the time zone wasn't working with me today, I was up very early. But as I was thinking about this, there is no other company in the industry that has the same combination of differentiated unique products that ATI has. If I look at those areas where we are differentiated, one is the jet engine. We just talked a little bit about aerospace. Focusing on the jet engine. I've talked in the past on my earnings calls, there are 7 proprietary alloys that go into the hot section of the jet engine. We make 5 of them full source providers. The sixth, we split with another supplier and the seventh is made by the OEM themselves. When you think about that very unique characteristics and capabilities that we bring to this market. In addition to that, we have isothermal forgings. We're 1 of 2 globally that have that capability. Every disc that goes into a jet engine is made through an isothermal forge process. We have the capability. We've developed it. It's a very precise temperatures and pressures and time to make those disks. And again, very unique capabilities that our customers recognize and value. The other 2, premium quality titanium again, goes into a jet engine, but it also goes into miles. It goes into defense applications, and it goes into specialty energy applications. As we look across that portfolio, 1 of 2 globally that make premium quality titanium. We're in the process of qualifying our new asset that we just brought online out in Richland, Washington. And the fourth is our hafnium zirconium, we've talked a lot about that in my last earnings call, done phenomenally well. We are 1 of 3 western suppliers that are qualified to make that product. And the only one that doesn't have a captive commercial nuclear business, meaning they're supplying their own internal business first before they're selling it to the market. We're the only independent. And so when you look at that 4, that combination, that's where I see customers are coming to us. They come to us to solve their hardest problems. They come to us because we have knowledge of almost the full periodic table and we can work and say if we had a little bit of this alloy or a little bit of this element, we can change the properties to get to the performance specifications that you're looking for. And so that combination is just -- it's a phenomenal -- it's a phenomenal toolkit to have to bring to the industry. And when I look at our competitors, that, combined with decades long of process know-how and qualifications, We bring a ton of value to helping our customers solve not just today's problems, but the next-generation developments that they're doing.

Thank you, Kim. Now there's a clamor from your customers and the rest of the industry for more capacity. How do you think about capacity additions?

Yes. Capacity has been kind of top of everybody's mind as COVID we came out. First thing we do is we start with elevation. That is our operating model and our system, and it's the way we run our business. And it really encompasses everything from procurement savings to operational improvements as well as commercial discipline and portfolio optimization. So we looked at our full set of assets, and you've seen probably quite a few changes over the last few quarters as we continue to optimize at which markets, which customers, which products really leverage those specialized differentiated capabilities we have for the highest value. So we do that and then apply incremental improvement, right, continuous improvement in our facilities to get to increase the flow through the capacity bottlenecks, work on increased yields, work on improved productivity, reduce cost. And that's really the first step where we can get more out of the assets we already have invested today. Once we get to that point with our conversations with our customers, we look at putting in new capacity. And I've announced several new ones. A great example is the technical super-nice CapEx that we are putting in. In fact, I'm very happy to say we are in commissioning for the remelt assets today. So I'm excited to see that come into operation. And we'll have new primary -- mill coming next week -- or next year, sorry, at the end of next year, we'll be commissioning that. And that was really close collaboration with our customers around what is their demand. And as I talked about this year with our CapEx, about 20% of our CapEx is coming from customer-funded capital. This year, we're going to be between $280 million to $300 million and 20% our customers are said, we are going to give you capital because we recognize the differentiated capabilities have. And we want to invest in that, and we recognize we can't go and replicate it and move it or get it somewhere else. And so from a capital standpoint, that's the process we go through. We look to optimize our current installed base. But then more importantly, we look to partner with our customers for both contract and commitments, invested capital and maybe most importantly, their support at expediting the qualification process.

That's super helpful. customer-funded CapEx always sounds good to.me.

It sounds great to me. And I would say it seems like a very foreign concept both internally and to our customers, the first story of Rob, who is my CFO now, but he was the President at the first business that did that. The customer called me the next day and said, you got this crazy guy running your business out on the West Coast because he told me he wants me to give him capital but I'm not getting anything for it. All I get is a reservation for some capacity. And I said, no, you're not crazy. That's what we need if you want to go forward. And for our capital, internally, we made our internal benchmarks for all of our capital projects before any investment from our customers. So that's a 30% IRR target. And then any kind of investment they put in after the factor on top of that just accentuates that valuation. But I think most importantly for me, the payback from these capital projects is. And I wish I anticipate this completely. But the customers not only have skin in the game because they have the contract in place and they have capital now that they've put in place. But the most important part they've said is the scarce resource they have is their engineering talent. And with this capital comes a prioritization is saying, no, no, no, we need this product, they are 1 of 2 people in the world that can do it. And we've put our own money and our cash into that. We're going to have our engineering team put that as our first priority. And so that's allowed us to rapidly qualify new assets, bring them online as we've come out of COVID and get them up and running. And so -- some of our customers were a little surprised in the beginning. But I think even with current announcements, you're seeing this investment and focus on making sure that, that investment around critical capabilities and very unique capabilities and products are continuing to happen, and there is a willingness to partner to do that.

Thank you, Kim. Now on operations, ATI has been meaningful progress year-to-date. You called out the margin expansion also versus a year ago. And you seem to continue to raise the bar. So what gives you the confidence for the balance of 2026? How do you think about jet engines, airframes and defense?

Yes. So we're very proud of the progress the team has done. It's been a phenomenal year, as you just said, the year-over-year growth was up 57% second quarter. So really phenomenal work by the team. The confidence is coming from things that we already have in hand. We have committed customer orders that are on the books. We've got contractual price and mix improvements that are in place, and we're starting to ship against. We've got new capacity that's coming online that we've got commitments and support to qualify. And we've got that backlog and continued commitment from our customers. As you said, those markets that you mentioned is our 3 core markets. We've got phenomenal demand that's across all 3 of them. Aerospace continues to grow with jet engine being 50% MRO today for us on top of the OE growth that is continuing to come. Defense, defense has been a bright spot. It was up 36% last quarter. Missiles is a small piece of that. Most of our foundation is coming from the naval nuclear programs as well as the rotorcraft ice fixed wing. But defense is up -- our missiles are up 4x when you look at our growth, and it's a small part, but it's growing rapidly, and we're seeing increased activity around some of these missile and munition programs. We're starting to place some orders for Tomahawk. We're seeing inquiries and we're getting orders for FAD. So we're starting to see as this funding becomes more realistic and they're seeing that come through. We're starting to see those orders being placed. And then the last one is specialty energy. They all buy for the same assets, the fungibility of those assets go back and forth. There's tremendous demand around gas turbines, and now with nuclear refueling and restarting, we're seeing demand coming from both of those aspects. It's a unique time where we've got demand across all of our core markets, and we've got great contracts in place, and we're seeing those -- that execution through elevation really helped drive our volume and productivity.

Super helpful. Now on margins, diving deeper on that. You've had significant expansion already. Can you talk about what drove those margins step up? And also, when you look at this incremental volume that's about to come through, which sounds like quite substantive and with strong visibility? How should we think about incremental margins for these new programs coming online, too?

Yes. So we did share some of that in the earnings call. We have shared that we're at 50% incrementals today, and that's phenomenal, and we see that continuing through the rest of the year. As we look forward, we've got an Investor Day. That's going to be in November. And I'm happy to share lots of details about that forward path and what we're anticipating. But as I look forward, see that strength for all those structural changes and improvements that I shared with you.

Thank you. Now when you think about the -- I know it's a little early, but can we talk about 2027, how do you see the earnings trajectory into next year?