ATI Inc. (NYSE:ATI) Q3 2023 Earnings Call Transcript

ATI Inc. (NYSE:ATI) Q3 2023 Earnings Call Transcript November 2, 2023

ATI Inc. beats earnings expectations. Reported EPS is $0.55, expectations were $0.52.

Operator: Hello, and welcome to the ATI Third Quarter 2023 Results Conference Call. My name is Alex. I’ll be coordinating the call today. [Operator Instructions] I now hand it over to your host, Dave Weston, Vice President of Investor Relations. Please go ahead.

Dave Weston: Thank you. Good morning, and welcome to ATI’s third quarter 2023 earnings call. Today’s discussion is being broadcast on our website. Participating in today’s call to share key points from our third quarter results, are Bob Wetherbee, Board, Chair and CEO; and Don Newman, Executive Vice President and CFO. Before starting our prepared remarks, I would like to draw your attention to the supplemental presentation that accompanies this call. Those slides provide additional color and details on our results and outlook. It can be found on our website at atimaterials.com. After our prepared remarks, we’ll open the lines for questions. As a reminder, all forward-looking statements are subject to various assumptions and caveats. These are noted in the earnings release and in the slide presentation. Now I’ll turn the call over to Bob.

Bob Wetherbee: Thanks, Dave. Good morning, everyone. Q3 marked another solid quarter of A&D growth and continued margin expansion for ATI. This morning, I’ll highlight 3 major points: first, aerospace and defense market demand for ATI products is strong, and we expect continued growth for years to come; second, our transformational actions are driving meaningfully improved results, better still, we’re in the early stages of the journey with many benefits yet to come; third, our strong execution is delivering for our customers and shareholders. And now some insights into each of these. First up, the continued strong aerospace and defense market demand for ATI’s products. Order lead times for some specialty product lines are out as far as the first quarter of 2025 and we’re still years away from peak airframe build rates as recent world events reinforce safety, security and sustained performance remain more important than ever.

ATI is well positioned to deliver on this expectation. We have the right products, the right capabilities and the right team. A&D sales hit 61% in the third quarter, up from 58% in Q2. This is an all-time record for ATI, and we’re well on our way to our 65% target. What drove this expansion? Another significant step-up in airframe demand, notably in titanium. Shipments of airframe materials surpassed $200 million in the third quarter. That’s up more than 50% from the third quarter last year. It’s a new record for us, surpassing our prior Q2 2019 high watermark. How do we achieve this? Ramping build rates, realization of well-earned share gains and a lot of hard work industry analysts commonly referred to as operational execution. Our increased titanium melt capacity in Oregon has been a critical enabler to our top line growth.

The modest investment to restart these 3 furnaces, coupled with additional steps that optimize overall melt throughput helped expand our titanium melt capacity by 35% over the 2022 baseline. It’s now producing at full run rate. Customer commitments for ATI titanium are so strong that we’re currently bringing online a fourth and most likely the last furnace at that same Oregon Milk facility. This additional furnace will produce high-value specialty titanium alloys that are in fierce demand by our customers with critical applications. It fills another gap left by the much discussed geopolitical disruption to the supply chain. This latest incremental step, coupled with highly efficient execution by our operating team will enable an additional $50 million in titanium revenue per year.

We’re on track to ramp capacity in the first half of 2024, reaching that higher full run rate in the second half. This investment falls within our existing CapEx guidance. All in, we’ve increased titanium capacity by 45% through restarts and optimizations, up from the 35% we previously forecast. And we still have our Richland, Washington melt expansion coming online in 2025. How strong is titanium demand today? In just 12 months, total ATI titanium sales are up approximately 75%. It’s an incredible ramp, strong demand, customer commitments and these timely and efficient capacity additions, some cases, we’re the only game in town. And the stronger bottom line results are clearly ahead for us. Pretty exciting time to be part of ATI. Let’s move to my second point.

Our transformational actions are making a difference. They’re delivering increased profitability with more room to expand. ATI’s transformation, which began in the depths of COVID is driving meaningful results in the business today. This was another quarter of sequential EBITDA growth and margin improvement. HPMC’s EBITDA margins hit 21.5% in Q3. We’re making great and steady progress. By 2025, we target delivering HPMC margins consistently in the low to mid-20% range. We’re working every day to accelerate shipments, debottleneck and streamline operations and optimize flow times throughout the system. As this high-value material works its way through ATI’s finishing facilities, downstream operations are being tested and are delivering more than ever before.

We’re not immune to challenges, new bottlenecks emerge and sometimes legacy electrical transformers fail. That was the case at our Lockport, New York mill operation in Q3. While the operating team got the power back on relatively quickly, the outage created a potential divid in our Q4 shipments. The team has responded aggressively taking steps to significantly offset what otherwise would be a Q4 bottom line impact. Strong demand means we’ve been running hard. So we’re increasing our focus on preventive maintenance to ensure consistent operations. In our Advanced Alloys & Solutions segment, aerospace and defense mix continues to improve. It reached 35% in Q3. That’s 8 points higher than a year ago. That’s good news when you think about long-term growth opportunities for these markets.

Industrial demand softened. We know that’s caused by transitory conditions. Operationally, we’ve taken actions to align our near-term cost structure with this lower demand. Commercially, we’re focused on optimizing our product mix. It’s another reminder why being an aerospace and defense leader is at the core of our strategy. We’re at our best in markets with long-term growth potential, where ATI’s differentiated capabilities are critical to our customers’ success and where the returns generated reflect the essential value of those materials. What else are we doing to transform? In October, we announced that we have reduced our qualified pension obligations by 85% through annuitization and made additional contributions, which we expect will fully fund the remaining 15%.

Let me take a second to be really clear here. This is a huge milestone for us and for the team at ATI. We worked on this a long time. We’ve talked about it in almost every earnings call for 5, 6, 7, maybe a decade years. But we’ve been very deliberate in getting here, meeting our commitments to our retirees and to our shareholders. And I’m pleased that we’re at this point, appreciate the team’s hard work and diligent preparation for something like in for what we accomplished. It’s great. This transaction significantly derisks ATI’s balance sheet and enhances our ability to generate substantial cash flow going forward. As we shared this pension annuitization of greatest benefit to the AA&S segment where we should see meaningfully lower pension expense starting this quarter.

My third point today, ATI continues to deliver. Our adjusted earnings per share were $0.55. This is above the midpoint of our August guidance. We see this momentum continuing into 2025 and beyond. Now Don will take us through the financials and talk a bit about Q4 and what’s ahead. Then I’ll be back to close out and take us into the Q&A. Don?

Don Newman: Thank you, Bob. Our third quarter reinforces our strong foundation, rooted and growing A&D content. It’s serving us well. Our adjusted EPS of $0.55 per share outperformed the midpoint of our guidance. Keep in mind, the prior guidance did not include $0.03 of interest expense related to debt supporting the pension annuitization and funding. The strength of our A&D business allowed us to increase total adjusted EBITDA margin while delivering our fifth consecutive quarter of revenue above $1 billion. As we look ahead to the fourth quarter and beyond, the resiliency of our performance and growth continues to carry our business and support value creation. In HPMC, our A&D content increased 200 basis points to 85%, supporting an increase of EBITDA margin to 21.5%.

The mix, pricing and performance of this segment, all in line with current market conditions and the optimization of ATI around this building demand. EBITDA margins in our AA&S segment at 10.4% reflect the previously communicated seasonal Q3 outages, which impacted the quarter’s margins by approximately 200 basis points. AA&S margins should increase in the fourth quarter driven by our production cycle and continued growth in our A&D and A&D like markets. We will also see initial benefits from the recent pension actions. I would also note that we are ahead of our SRP transformation time line, and we remain confident in our ability in delivering AA&S’s 2025 EBITDA margins in the mid- to upper teen percentage range. Turning to the balance sheet.

We have a lot in motion as we continue to reshape this business for strong future cash generation. Managed working capital remains a focal point. Despite the level remaining near 40% of sales through Q3, we project meaningful improvement to manage working capital levels in Q4. This will be driven by inventory reductions as well as receivable and payable performance. Those initiatives are in process as we speak. Inventory is a key target area for improvement as demand in our front-end melt capacity increase, our team is optimizing that growth as it flows through to finished product and testing. We anticipate year-end managed working capital will be between 31% and 32% of sales. This is slightly higher than our previous expectations, but we expect to largely offset that impact through CapEx management and performance in other areas.

Therefore, we are narrowing our full year free cash flow guidance range to $130 million to $160 million. Q4 cash flow should be very strong. While talking about the balance sheet, I want to further highlight the impact of our recent pension actions, including the annuitization. You’ll recall, we’ve taken many steps to reduce exposure over the past several years. Even so, our pension assets and liabilities still represented an element of forward risk for our shareholders, driven by market forces beyond our direct control. With the pension annuitization, approximately 85% of that risk has been successfully transferred out of ATI to a trusted and fully qualified third party. As a result of additional planned contributions, we expect our remaining obligations to be fully funded.

As such, we no longer expect to make any material cash contributions to the qualified pension plans. I also want to emphasize that the annuitization and other pension actions taken in 2023 are expected to deliver substantial earnings benefits. Specifically, we expect to see annual pension expense drop more than $45 million from pre-annuitization run rates. These glide path steps have delivered the outcome that we were striving for. This largely gets us out of the pension business. Our cash balance exceeds $400 million following this activity. With a strong fourth quarter for cash flow, our outlook for net debt will only improve going forward. We intend to continue to deliver a balanced capital deployment strategy, funding growth while also delevering and returning capital to shareholders.

To that end, we purchased approximately $45 million in outstanding shares in the third quarter and expect to complete our remaining authorization of $30 million in the fourth quarter. We expect this cycle will continue and strengthen in the future with growth, performance and reduced volatility on our balance sheet moving forward. Let’s take a closer look at our guidance for the remainder of 2023. As we estimated previously and reinforced with these results, we’re tracking towards a strong fourth quarter and should carry momentum into 2024. As we approach the end of the year, we’re tightening our guidance range for full year EPS to $2.20 to $2.30 per share, holding the previous midpoint of $2.25 per share. At this midpoint, our Q4 EPS was center at $0.62, representing the highest quarterly result for 2023.

Robust A&D demand and increasing capacity along with optimized cycles and performance point to this high water mark in EPS as we look ahead. As I noted, our free cash flow estimate remains consistent with prior expectations. We’re balancing the working capital pressure driven by our increase in sales with continued prudence and tight discipline of our capital investment. All significant expansions and projects, including our newly announced classified facility for additive manufacturing remain on schedule. With that, we are still able to lower our current year capital expenditures to a range of $190 million to $210 million. While we’re not yet providing formal guidance for 2024, I will tell you that we see continued growth and expanding performance for next year, directionally in line with the targets we have previously outlined for 2025.

At our upcoming investor update on November 29, we intend to offer more clarity and visibility into this growth. We’ll also provide new perspective and details on the continued upward trend for ATI through 2025 and beyond, including insights into our 2027 financial targets. We hope you’ll join us in person at the New York Stock Exchange for that event. And by the way, registration is available on our website. With that, I will hand the call back over to Bob to conclude our opening remarks.

Bob Wetherbee: Thanks, Don. These are truly exciting times for ATI, and I’m confident in our sustained momentum and trajectory. Best of all, even 2025 won’t be the peak of growth for ATI. We have many more years of growth ahead with clear visibility and long-term agreements extending into the back half of the decade. We continue to shape our business to capitalize on increased demand while also insulating our business against future risk. I hope you’ll join us later this month for our investor update in New York. As Don said, we’ll talk a lot more about what that growth looks like and what it means for ATI and for our shareholders. With that, let’s open the line for questions. Operator, we’re ready for the first question.

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Q&A Session

Operator: Our first question for today comes from David Strauss of Barclays. David, your line is open. Please go ahead.

David Strauss: I wanted to clarify the outlook for AA&S in the fourth quarter, Don. So I think you talked about in the release about assuming stable performance in the fourth quarter. But then in your remarks just now, you talked about margin improvement on the back of the pension, lower pension as well as not having neology. So if you could just kind of square the two, what exactly you’re assuming maybe top line and margins for AA&S in Q4?

Don Newman: Yes. Great. Fair question. So for clarification, when we talk about stabilization, that was really a reference towards what we see in terms of sales trends. We’ve seen some headwinds around the industrial, but we also see some tailwinds and good mix change in A&S related to their A&D exposure. But when we look at that overall business Q3 to Q4, we’re really looking at a stabilization from a top line standpoint. But you’re right, when you look at the bottom line, you would expect, hey, if you posted 10.4% margins in Q3, are you saying you’re going to expect similar margins in Q4. The short answer is no. We would expect that the EBITDA as well as the margin should improve in AA&S in Q4. A couple of reasons to point to.

One, Q3, we had some major outage costs, think in terms of $8 million to $10 million of those outage costs. Those won’t repeat in Q4. Second good guide that we would expect in Q4 is tied to the pension. And we talked about the pension, $45 million good guide on a run rate basis. We will see some of that benefit hit us in Q4. And when you think about the effect to AA&S, you want to break it down like this. That $45 million annualized breaks down to about $11 million plus per quarter. And we’re not going to get a full quarter’s worth of that benefit. Of that $11-plus million at the corporation, we’re going to get somewhere between $7.5 million and $9.5 million just because it’s a partial period. I think we’re going to get the higher end of that element.

When you break it down and say, okay, how much of that is AA&S? Think in terms of probably about 75% is AA&S’s share. And then the rest would be split between corporate and HPMC. Does that help you a bit?

David Strauss: Yes, that’s more than I was hoping for. A quick follow-up for Bob. So one of the large engine manufacturers, obviously, is to look to be replacing a lot of dips here over the next couple of years. Is there any incremental opportunity for you guys in terms of your Forged disk business to help out there and pick up some share?

Bob Wetherbee: Yes. Good question, David. And the simple answer — we’ll stick with simple answers and try to overexceed your expectations today, David. I would say, yes. Near term, we’re working very collaboratively with that engine producer to make sure their current flow paths continue to accelerate and flow well. Obviously, with the increase in shop visits, we’re seeing extra spares as other things come our way. I think in cases like this, a lot of times you see second sourcing or backup sourcing opportunities for both raw materials and forgings. And we have a great relationship there that I think will build off. So I think in the near term, it’s doing everything we can help them on the flow side. Longer term, yes, there’s opportunities probably on the raw materials and the forgings within our CapEx guidance that we’ve given you, we actually just finished an upgrade of one of our older isothermal forge presses with some new upgrade and controls systems.

So we feel pretty good about the upside for isothermal forging going into the engine. And those guys that relationship there can be a big part of that. So we’re pretty excited about the upside. Probably we won’t see until ’25, ’26, ’27, but definitely on the right track.

Operator: Our next question comes from Richard Safran of Seaport Research. Your line is now open. Please go ahead.

Richard Safran: So to the best you can, could you try to make an apples-to-apples comparison between 2022 EPS and what you’re guiding to for ’23. You strip out last year’s favorable aviation credits this year. You had pension increase. Is it correct to say that EPS is close to increase. Now those are my words, but I thought maybe you would bridge 2022 with what you’re seeing for 2023 kind of trying to apples-to-apples.

Don Newman: Rich, you’ve done all my math for me. So you’re absolutely right. But for the benefit of the other folks on the call, let me — I’m aligned with what you just said. So when you think about our 2022 performance, we posted a $1.99 EPS, but there were nonrecurring items that existed in there like COVID credits. And then we knew the pension expense was going to pop in 2023. If you pro forma for that, that gets you to about a 2022 EPS for full year at about $1.50, something in that range. And you compare that to the midpoint of the guidance, and this is the point that you’re making, I believe, Phil, you point to the midpoint at $2.25 and it implies about a 50% year-over-year increase in our earnings per share. And the good news there is, number one, it’s a great indicator of the underlying growth that exists in this business really being driven in large part by aerospace and defense strategy.

And the other good news is that we’re not expecting it to stop. We expect further growth, and we’ll talk about — more about that when we’re all together on November 29. But this — the increase you saw in 2023 is EPS, we think is a harbinger of good performance in the future as well.

Richard Safran: And then lastly is this, I think you talked previously about the transactional piece of the business, you were being more selective with it, high demand. I want to know if you could give a comment or 2 on the transactional part of the business, how that’s trending and if the work you’re getting is margin accretive.

Bob Wetherbee: Rich, I can go first. Don can add if he wants to at the end here. But it’s definitely accretive. We start there. We’ve never been known in the industry as the low price guy. So we tend to see the value in the products. And tend to be migrating to more of the challenging, more differentiated titanium and nickel alloys in that transactional business. The lead times are such that if you’re a distributor or some of the smaller OEMs, we said earlier, probably in May, if you know anybody who is looking for titanium or nickel as should get their orders on the books, and that’s definitely happened. So it’s accretive. We tend to migrate more to OEMs because of the lead times and less to the distribution channel. But I would say still strong and still some opportunity.

Our strategy is not to be 100% contractual, our strategies to be in the 80% contractual, 20% transactional. And we’re holding that mix pretty well, but we are being selective about what kind of alloys and what kind of systems we play. And then actually factored into our decision to start the fourth furnace in Oregon, which tends to be some of the more challenging alloys, but higher-value stuff, beta alloys, 53, those kind of alloys as we move into the more sophisticated critical applications. So hopefully, that helps, but definitely accretive.

Operator: Our next question comes from Phil Gibbs of KeyBanc Capital Markets. Your line is now open. Please go ahead.

Phil Gibbs: My question is just on big picture on pricing and mix improvement. Is that expected to be a big driver in ’24 and ’25. It’s obviously hard for us to see that and parse it out of the results. But I know intuitively, it’s a big enabler to margin improvement. For instance, a company like [Hamad] is saying they’re going to see about an $80 million increase next year, all of which goes to the bottom line, all else equal. So trying to just kind of see through in terms of how you all are thinking about that given the fact that you’ve got thousands of contracts.