Good morning, and welcome to the ATI Second Quarter 2021 Results Conference Call. [Operator Instructions] Please note, this event is being recorded. At this time, I would like to turn the conference over to Scott Minder, Vice President of Investor Relations, Corporate Communications. Please go ahead.

Thank you. Good morning, and welcome to ATI's Second Quarter 2021 Earnings Call. Today's discussion is being broadcast on our website. Participating in today's call are Bob Wetherbee, Board Chair, President and CEO; and Don Newman, Senior Vice President and CFO. Bob and Don will focus on our second quarter highlights and key messages, but may refer to certain slides within their remarks. These slides are available on our website. They provide additional color and details on our results and outlook. After our prepared remarks, we'll open the line for questions. As a reminder, all forward-looking statements are subject to various assumptions and caveats. These are noted in the earnings release and in the slide presentation. Now I'll turn the call over to Bob.

Thanks, Scott. Here we are over a year since the world went into lockdown as a result of the COVID-19 pandemic. So much has changed in the last 4 quarters, and it's easy to focus on the more challenging aspects of this period. At the same time, it's important to remember that we also changed some things, those within our control for the better. Like many, we quickly innovated within our digital technology infrastructure to thrive on remote collaboration. Technology allowed us to streamline our processes and work more efficiently overall. We'll continue to drive these improvements utilizing new skills and tools to provide more flexibility to our employees and create better connections with our customers, and we'll capture the associated structural cost savings. I'm pleased to see millions of people returning to the skies for the summer travel season. Every day seems to bring another sign of recovery in airframe and jet engine demand. The current economic reawakening and everything from travel to consumer goods to energy is real. Despite lingering pandemic-related uncertainties, I'm confident the desire to travel is significant and growing worldwide. Ultimately, that drives the sustained lengthy backlog for any airliner programs. At ATI, we're ready to produce what our customers need. With that as a backdrop, we generated second quarter financial results that showcase the improving trends in our end markets. At the same time, they reflect the negative impact of the recently concluded strike by the United Steelworkers at our Specialty Rolled Products or SRP business. Excluding the $40 million cost attributed to the strike and a small improvement in our restructuring reserves, we lost $0.12 per share in the second quarter. Despite the earnings loss, the aerospace recovery is readily apparent beneath the headline numbers. Our jet engine product revenues were up over…

Thank, Bob. I'd like to cover several areas, including our Q2 financial performance, our balance sheet and our outlook. On a reported basis, ATI lost $0.39 per share in the second quarter. Excluding $40 million of costs associated with the strike and a small favorable true-up to our restructuring reserves, the company lost $0.12 per share in the second quarter. To get a true sense of our performance, you have to go beyond the headlines. As we told you on the last 2 earnings calls, the commercial aerospace recovery, particularly in jet engines, is gaining momentum and becoming more broad-based within our business. This is readily apparent in our HPMC segment results where jet engines account for more than 40% of overall segment revenues. As Bob shared, jet engine revenues increased by more than 20% sequentially for ATI as a whole and for HPMC. Volumes in our Forgings business continue to expand, building on growth in the prior 2 quarters. Underlying demand for our Specialty Materials accelerated meaningfully for the first time since the pandemic began. In addition to jet engines, revenues in each of HPMC's key end markets grew versus the first quarter, led by specialty energy, including materials for land-based gas turbines produced in Asia. As a result of our profitable jet engine growth and increased asset utilization, HPMC EBITDA margins increased by 220 basis points compared to the first quarter and nearly 300 basis points versus the second quarter of 2020. We anticipate third quarter growth across HPMC's key end markets, most notably jet engine and specialty energy and further utilization benefits from increasing production rates across our network. We expect robust incremental margins over the coming quarters as profitable jet engine revenues increased and structural cost improvements executed throughout 2020 are maintained. Turning to AA&S. Q2…

Thanks, Don. Our second quarter financial results showed solid sequential improvement. We're seeing commercial aerospace recovery and our forward order load. We feel momentum building at ATI, particularly within our HPMC segment. Improving aerospace market conditions will create an outsized benefit for ATI as we streamlined our cost structures and have higher shares of critical, high-growth customer programs. I'm confident that when these volumes return to pre-pandemic levels, we'll be an even stronger and more profitable company. The AA&S segment will be well served by growth in defense, energy, medical and electronics. Transformation is on track in our Specialty Rolled Products business. We've made significant and structural changes to rationalize our product portfolio, consolidate and upgrade our footprint and align our cost structure for future success. We're building a leaner and more profitable SRP business that out earns its cost of capital, has substantial profitable growth opportunities and compete successfully for investment within the company. I'll close with 3 important points. ATI is a growth-focused company with the cost structure we need for success. We're well positioned in key markets to achieve higher than GDP growth over the long term. And transformation of our product portfolio is on track and will deliver significant benefits. With a clear strategy and innovative team, we're accelerating our future. And with that, I'll ask the operator to open the line for questions.

[Operator Instructions] The first question comes from Seth Seifman with JPMorgan.

I was wondering if you could talk a little bit about the anticipated impact of the latest -- Boeing's latest rate actions on 787 for the second half of the year?

Seth, this is Bob. I think you can look at the 787 news, doesn't have a real material impact for us in the back half of the year. We continue to see the business coming from that particular OEM stabilizing, albeit at relatively low levels, but nothing significant in the near term. Obviously, we continue to monitor the longer-term and still have our expectations, our forward looks as international travel is probably going to be back by late '23, early '24. But we're not seeing any near-term impact from what's going on with the 787.

Okay. Great. And then maybe just 1 follow-up, if I could. In the HPMC business, the -- I guess the Specialty Materials there, the non-forging piece of it, do you guys ever disclose what the breakdown of that is between kind of narrowbody exposure and widebody exposure?

We don't disclose it because we don't always have the greatest visibility in the airframe side. When we sell a billet, bar, rod that comes out of our Specialty Materials business, it obviously goes into their distribution system and it varies -- the OEM will move product around depending on what they need and where they need it. So we don't actually have the clearest visibility to give you an answer, but we haven't also historically disclosed it.

The next question comes from Phil Gibbs with KeyBanc Capital Markets.

On AA&S, you said $25 million of additional costs. $25 million just means that's what you think the impact is going to be not in addition to what you already saw. Is that right?

Yes. This is Don, Phil. So the $25 million is our estimate of the incremental cost in Q3 related to the strike event. If you think about Q2, we shared that there was about $40 million of strike-related costs. So another $25 million in Q3. Good news is we don't expect any additional costs in Q4. So if you look across the 2 quarters that were affected, Q2, Q3, total is $65 million, $40 million plus $25 million. Suffice it to say, we're very, very happy that our represented employees are back to work, and we're re-ramping the business and addressing our customers' needs and getting this burn behind us.

And what are you expecting for inventories over the balance of the year? I had thought that you were going to chug through some of those inventories in the second quarter, just as you kind of shifted out of inventory, but that number surprised me to the upside. What are you expecting on the inventory side over the balance of the year?

Yes. What I would say is we are certainly expecting a healthy working capital release in the second half of the year. For the SRP business specifically, we had talked about the expectation that in Q2 we'd see a heavy release of inventory during the strike. We didn't accomplish as much as we had liked to in that release, but the good news is it's deferred, it's not loss. So we would expect in the second half to see more of that release happening in the standard stainless space. And not just standard stainless, to be quite clear, SRP sells quite a number of other products that we should also see a ramp in terms of shipping levels in those products as well.

Okay. And on pension and OPEB right now, your net liability, I think, is a little under $1 billion. You made mention of making a discretionary contribution in the third quarter. You also made mention about something on OPEB that's getting trued up here in the third quarter, and interest rates and returns have been a little bit in your favor. As you look ahead, I'm assuming nothing changes all too dramatically. Where could that pretax liability, the $950-ish, where could that go?

Well, so first, I'm happy to say that we are a lot under $1 billion. We ended last year 2020 with $674 million of net pension obligation and an OPEB obligation of a couple hundred million. So as you're pointing out, we're going to see that OPEB obligation drop by about $65 million in Q3, so that's a nice decrease. Then we're continuing to stay focused on the glide path, especially around the pension. We're -- we've said over the last several calls that we are committed to working down that pension obligation and getting it to a fully funded status, and we're keeping that focus. We think that we can achieve that over the next handful of years and make the pension irrelevant from a leverage standpoint. And that's consistent with our focus on delevering. We also believe that we have some -- if the books close today, we'd probably see a benefit around discount rates, which are an important element of calculating the net pension and OPEB obligations. And so if you look at our 10-K, it will give you some sensitivities, Phil. But for every 50 basis points of increase in discount rate, we would expect about $140 million, $150 million decrease in the pension obligation. So that -- the balances are definitely working down from where we saw them in the last couple of years.

The next question comes from Gautam Khanna with Cowen & Company.

This is Dan on for Gautam. So could you quickly explain what explains the year-over-year decline at next-gen jet engines in the quarter?

Largely mix, I think, is how you want to think about it.

Great. I think that's what it is, it's the mix.

Okay. Got it. Great. And then for the strike-related sales delays, are those going to be caught up? Or like are they deferred sales? Or were they lost entirely?

I think what you would see is a mix of -- certainly, with transactional sales, of course, there's -- it's more likely that those missed sales were not going to make up. But there is, we believe, the opportunity to make up a healthy amount of the sales that were missed in Q2. And we'll make every effort, obviously, in the business to do just that. So our guidance does reflect our expectation that we'll be picking up some of those missed sales in Q3 and then our cash flow guidance also expects that for the balance of the year.

If I can a little color to that for Darren. I think about the comments we made about accelerating our exit of standard stainless sheet products. Clearly, a lot of those went through the distribution channel, and we're not going to make those up. It actually accelerated. The curve of our exit shifted in the second quarter. And then at the same time, on our Specialty Products, out of that business, we saw distribution or some of our customers actually deplete their inventory. So there'll be -- there should be good demand to kind of get those stocks back in place as we start to see the ramp coming in other places. So I think Don's comments were right. Not going to see the replacement of the transactional standard stainless stuff, but clearly, the specialty, we feel good about having those orders for the future.

So do you think what can be made up will be made up in Q3?

I think what can be made up will be made up in the second half of the year.

The next question comes from Josh Sullivan with The Benchmark Company.

Can you just talk a little bit about the long-term cost out you guys have achieved through the downturn? And then maybe what you think you can keep long term versus some of these new inflationary pressures, be it labor, materials? Just as we ramp back up. The quarter clearly shows the benefit of volumes here, but curious if you're able to hold on to that just given some of these inflationary pressures that are coming through?

Yes, sure. This is Don. I'm going to -- I'll address that. So think in terms of 2 baskets. One basket is what we will be able to achieve in 2020. And our cost takeout capture in 2020 was about $170 million. The run rate on that was about $270 million to $275 million. And the way to think about that from a structural standpoint is we believe that of that $270 million run rate, about $100 million is structural. So that's a gift that keeps giving when it comes to our financial performance in the future. The second basket you want to think about is the cost savings associated with our transformation of the SRP business. And that's an incremental $50 million. And as you can imagine, as we've talked about that transformational effort, we're consolidating footprints, we're improving flow pads on our products, we're reducing transportation costs and just -- it brings it with it a lot of benefits from a cost standpoint. Not just costs, of course, there's also mix and other benefits we'll get from that transformation. But -- and just like that $100 million structural benefit in the first basket, that $50 million benefit from the transformation should also stick with us as a structural good guy. And so we'll benefit off into the future from that effort. One other thing, by the way, that I would add, when you talk about how to think about the cost structures going forward. With that transformation project, one of the benefits that we're going to get beyond cost reductions and efficiencies, we're significantly reducing the volatility in that business related to metal prices. We expect that, for example, with nickel prices, roughly 2/3 of our current volatility around nickel is going to be eliminated as we exit standard stainless sheet as part of that transformation of SRP. Hopefully, that gives you an idea of the new profile.

Yes. And then just secondly, is there any way to frame utilization for us? Now that volumes are on the upswing and given the leverage you guys can get on the commercial side, is there anything you can give us on the various segments, where utilization has been, where we are now to something with the number of shifts you guys have? Or just any way to frame utilization conversation.

Yes. You have 3 minutes or less, Josh, hopefully.

Any way you want to do.

So I think we'll start with our SM business, our Specialty Materials business. I would say we're probably, from an equipment utilization, probably at the bottom of the trough, clearly, we've started to see the uptick. So we're probably at 2/3 where we want to be, but we have a couple of projects coming that we slowed down. It will be coming online in the next year or 2. But I'd say probably at SM, we're probably in the 65% utilization rate. But obviously, we've adjusted our crewing to be cost effective. So that's really the lever for us to ramp up. On our Forge Products, I would say it's a little bit higher than that probably. We also have -- based on what we have online today in capacity, it's probably in the 75% utilization. But you're going to see we've got some ISO and heat treating capacity coming on. We opened a new facility in Wisconsin for machining and inspection. So there should be some upside there. So the denominator is going to change a little bit in Forgings. But it's feeling pretty good in terms of looking forward. In our SA&C business, in the electronics space, the nuclear space, we're probably at that 85%, 90% rate. We've got some upgrades and some expansions coming there for organic growth. But it's a very stable business. Obviously, we have what Don talked about with the summer maintenance outages. That's kind of a refinery there that we have in SA&C. So it kind of consumes itself a little bit. So we have to have annual maintenance. But it's been a good stable business for us throughout. So it should return -- but I'd say probably 85% is a safe number for SA&C. And then obviously, we're going through the transformation of our SRP business. So we are resetting the denominator. If you said to me, hey, where are you going to be in your downstream? I'd say we're going to be at probably 70% of where we want to be by the fourth quarter. I got lots of upside. Clearly, our HRPF, which we've talked a lot about today, is in the 30% range. But as we see line of sight to go to 50%, and then through 2022, could even get up to 70%. So we're pretty excited about what could come there. And then lastly, I would say, in our Asian Precision Rolled Strip business, which is predominantly electronics driven, we're probably closer to the 90% -- 95%. But there's always mix rationalization opportunities to really keep enhancing the mix there. So hopefully, that helps. Is that kind of in 3 minutes or less, what you were hoping to hear?

Yes. No. Absolutely.

The next question comes from Paretosh Misra with Berenberg Capital Markets.

So with regard to the restructuring actions that you announced last year for the AA&S segment, can you help me understand the year-over-year bridge for Q3? Because I'm thinking on a year-over-year basis, you should see a large decline in revenue, right, just because you shutdown what was that $400 million to $500 million of sales? Or are there other offsets in that math?

Yes. You are absolutely right. We announced the exit from standard stainless sheet, which on an annual basis in 2019 was about $450 million of revenue. What we're -- what you'd expect to see, I think, in the second half of the year, as we continue on that glide path to exit that standard stainless sheet business, we still have some inventory that we want to release out of the -- out of our inventory balances related to those standard commodity products. And we're working with our customers to help meet their needs as part of our glide path out of that space. So I think from a standard stainless standpoint, that's what you'd expect to see. Offsetting that, you would expect to see a ramp in terms of sales in the second half related to SRP specifically as we start making up for some of the lost sales that were experienced in the Q2 strike impact. And then some of that strike impact, of course, carries over into Q3. So that's why we talk really about the second half of the year. The other impact that would be a beneficial impact to us -- marginally beneficial impact to us in terms of the AA&S and specifically SRP revenue is related to the increase in metal prices. Nickel, as an example, has increased to almost $9 a pound since the beginning of the year, and I think we entered the year at about $7, $7.50. And so that actually creates a benefit to us in terms of sales that will impact the second half, presumably if metal prices remain at these levels.

Got it. Okay. That's very useful. So as this plays out over the next 6 to 12 months, can you describe in the context of your end market sales mix, which you provide every quarter, which are the end markets that you're moving away from as this commodity business winds down?

Paretosh, this is Bob. I think there's 1 channel and 3 markets that I think we would be talking about. So we've talked about standard stainless. A large percentage of the stainless goes through, what I'd call, standard distribution channels. And they tend to be standard with standard gauges, standard grade. So that's the #1 issue for us that we're moving away from. Where those markets go? You'd see it in some of the oil and gas products, certainly automotive applications and in general industrial. You might see some in the building and construction space. You see some in the foodservice space that tend to be in those standard grades. So I think what you'll see for us in the future is the focus on -- clearly, aerospace and defense is the core of what we do. And then we leverage those capabilities into what we call specialty energy, which we talked about today, being land-based gas turbines. We talked about certainly the medical space that we see good growth, and certainly in electronics. So the backing away is oil and gas, automotive and the kind of the general industrial stuff as well as more OEM business. We always have distributors in the mix because they provide an important service to our customers, but will be less reliant on the distribution channels in the future.

Got it. And maybe a last one. Just going back to the free cash flow guidance, the $40 million cut. Just wondering if you can provide some more color as to what are the moving parts? Is that most -- like how much is EBITDA versus the strike-related costs versus working capital perhaps?

Yes. So you're right. When you look at the free cash flow guidance for 2021, what you see in new guidance is breakeven to a slight positive on free cash flow. The headline in terms of the biggest part of that bridge to the revised guidance is really about the strike impact. If you think about the $40 million of costs in Q2 and the $25 million that we're expecting in Q3, that's largely cash related, right? So that's a $65 million headwind that would not have been included in our original guidance. Now of course, we're working to offset that. How are we doing it? Through our working capital release, managing our CapEx with a lot of discipline and then we've got some other cash initiatives that we are working right now that are all pointing us toward let's get to our free cash flow for 2021 in the black. And I think -- I feel very, very confident that we're going to be able to pull the right levers and accomplish the goal that we set out with this new guidance.

Mr. Fields with Bank of America.

Just wanted to go back to the free cash flow guidance. So again, this breakeven is slightly positive. That is before pension contribution. And I just -- there's been a lot of sort of movement on that pension. I think last quarter, you said it was going to be below $87 million on the required basis. Now the required pension contribution is $17 million, but you're going to make a voluntary pension contribution of $50 million. Can you just give us what's the actual sort of cash into the pension this year, all in?

So first, I'm glad you asked the question because it is an important area. You're right. When we talked about the contributions to the pension plan as we entered 2021, we said is we were going to deposit $87 million, which was then the minimum. Then the federal laws around pension contribution requirements changed. And last quarter, what we told the market is, with the change in the law, presented the opportunity to be more flexible when it came to contributions to the pension plans. And by that time, we had deposited $17 million into the plans in 2021, and we kind of hit pause. We said, "You know what, give us the balance of the year to look at our liquidity and our balance sheet, and we'll make the decision on whether or not we're going to make further contributions." So the flexibility with the new laws, we were taking advantage of. Now we look at our liquidity position and our balance sheet, and we're in great shape. We ended the strike. We have a good trend in terms of end market recoveries. We feel good about making discretionary contributions to the pension plan. So with that, what we've said this quarter is, "Hey, in Q3, expect another $50 million to be deposited." That will make total deposits into the planned $67 million in 2021. From a definition standpoint, around free cash flow, you're 100% right. As we define free cash flow and talk about free cash flow, it excludes contributions to the pension plan. And we do that for a number of reasons, including providing comparability of our cash flow to peers who don't have defined benefit plans. So hopefully, that clarifies for you how to think about our pension contributions.

No, that's very helpful. And then I don't know if it's too early, but is the $50 million voluntary contribution this year take care of the required contribution to the pension for next year, in '22?

It likely would. But that's not the way we really think about it. We love the flexibility, right, as I said. But the reality is we're on a glide path. We want to continue to work down our pension plan. And so what's really going to drive our future contributions to the plan would be our desire to drive those plans to fully funded status in the next number of years.

Okay. And then a follow-up for me. Your borrowing base on your ABL was a little bit limited last quarter. It looks like it's further limited this quarter. As you are kind of trying to squeeze out cash from managed working capital, should we expect that revolver to be limited by the borrowing base while you're trying to kind of squeeze out managed working capital? Or do you think you can work that borrowing base back up and gain liquidity that way in the meantime?

I think the punchline is you should think of that liquidity from the undrawn ABL at around -- we were about $350 million at the end of this last quarter. Think of it being at that level probably through 2022. And there will be pluses or minuses, right, as we manage our overall liquidity and also work to reduce our working -- managed working capital balances, which will have some effect on the borrowing base. But think in terms of $350-ish million to, say, $400 million of available capacity under the ABL for the next year or so.

The next question comes from Richard Safran with Seaport Global.

I just have one question this morning. I hope it's not a bit too early to start asking you guys about capital deployment and just how the thinking is going about debt. Specifically, if things continue to improve, if you continue to generate cash, how much longer, for example, do you expect to focus on debt reduction? After that, how are you thinking about the balance between dividends and buybacks? I think a while back, if I'm not mistaken, you were leaning towards dividends, but it's been a while since I think you were asked about this. So I thought maybe you'd give us a bit of an update on what current thinking is?

I'm going to take a run at answering that question, Rich. And first, when it comes to capital allocation, where you want to start, obviously, is how much capital do you have available to you? We're in a really enviable position. When you think about our incremental margins and the ability of the business to generate strong cash flows in the ramp, we're in a great spot. And with the cost takeouts that we've put in place, that will increase profitability and cash flow as well. So we're going to have an ample amount of capital available to allocate. Then from a prioritization standpoint, the way I would describe it is a balanced approach. We are prioritizing, deleveraging. That includes bank debt, but it also includes the pension plan. Now we're fortunate in that our debt maturity profile gives us some flexibility. We don't have any near-term maturity. But I expect that we would delever first through growing our EBITDA, which should ramp quite nicely in the recovery and then also be in the position to choose to deploy capital to -- our cash to pay down debt. Then it's the pension, right? That would be the next element of how to think about delevering. Or we're already on this glide path. And even if you look at the contributions in 2021 at $67 million, they're really modest. And so as I pointed out on Phil's question, and we entered the year with $674 million of pension obligation, and we'll continue to make healthy contributions to work that down. And I would expect that, that will be fully funded in the normal course without having to do anything extraordinary over the next handful of years. But it's not all about delevering. It's important because it derisks the business and it…

That actually helps me quite a bit. That was terrific color.

And we have time for one last questioner and that will be Chris Olin with Tier4 Research.

I want to touch a little bit on the titanium market, and specifically thinking about the titanium scrap channel as it relates to your melting feedstock. I guess if you would look at the ramp in aircraft production that seems to be planned over the next 18 months and then consider supply or that revert coming back from aerospace, it looks like it's going to get awfully tight as we get closer to 2022. So I guess -- my question to you would be, do you feel comfortable with your ability to capture your future scrap requirements? And I guess second to that, can you remind me how you guys are protected in terms of like contracts or whatnot should scrap pricing serves like we've seen in some of the other metallics?

Yes. Chris, this is Bob. In terms of the -- I think your first question was how do we see the scrap market as the titanium demand starts to increase? See, I think because of the widebody situation, it's going to be a while before it gets back to higher than 2019 levels. You're going to see that gradual ramp. Obviously, there's a lot more narrowbodies than widebody. So that's the first issue. I think it's going to be a slower ramp on the titanium demand for structural stuff. So I think that will help us for a period of time, and we'll work through that. Clearly, the narrowbodies are strong, but we get a little bit of a delay on the widebody mix. So if that comes back, I think we're confident that we have access to sufficient scrap. I think it's going to be more of a gradual increase in that side versus a big spike, right? So we're seeing good growth in the engine space, 20% growth Q-on-Q for the HPMC engine components in general. So I think you're going to see it be slower. And I think that was the first question that you had. I think -- we don't really see a huge challenge with the scrap side. I think it's something we obviously are into every day. In terms of how we're protected if there's a big spike? I think a lot of our scrap is a closed-loop system. And so the customer that we're dealing with or the customers that are in the contracts, it tends to be a nonissue for us on the scrap price spikes, I think, that's probably the best way to look at it.

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

Thank you to all who joined us today. We appreciate your continued interest in ATI. And this concludes our second quarter 2021 conference call.

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