ATI Inc.

Good morning and welcome to the Allegheny Technologies Incorporated fourth quarter and full year 2018 results conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw from the question queue, please press star, then two. Please note that this event is being recorded. At this time, I would like to turn the conference over to Scott Minder, Vice President, Treasurer, and Investor Relations. Please go ahead, sir.

Thank you, Denise. Good morning, and welcome to the Allegheny Technologies' fourth quarter and full year 2018 conference call. This call is being broadcast on our website at atimetals.com. Participating in the call today are Bob Weatherby, President and Chief Executive Officer, John Sims, Executive Vice President, High Performance Materials and Components Segment, Pat DeCourcy, Senior Vice President, Finance and Chief Financial Officer, and Kevin Kramer, Senior Vice President, Chief Commercial and Marketing Officer. If you've connected to this call via the Internet, you should see slides on your screen. For those of you who dialed in, slides are available on our website. After our prepared remarks, we will open the line for questions. During the Q&A session, please limit yourself to two questions to allow time for others. We will make every attempt to reach all in the queue within the allotted call time. Please note that all forward-looking statements are subject to various assumptions and caveats, as noted in the earnings release and shown on this slide. Now I would like to turn the call over to Bob. Thanks. Thanks, Scott.

Good morning to everyone on the call and to those listening on the Internet. I'm pleased and honored to be with you today on my first quarterly earnings call as ATI's president and CEO. I'll start by providing a brief overview of our full year and fourth quarter ATI results and then turn the call over to my team to cover their respective areas in more detail. Let me start by saying that 2018 was a very good year for ATI. We achieved a significant majority of our objectives and clearly outperformed on several key metrics most notably free cash flow generation. ATI's revenues surpassed $4 billion for the first time since 2014, growing by 15% versus the prior year. This increase was led by double-digit growth in aerospace and defense markets, sales in both the HPMC and FRP business segments. Additionally, for the full year, revenues expanded versus 2017 in nearly all of our major markets. This is a testament to our ability to design, manufacture, and deliver a wide range of high-quality products. Our commitment to relentless innovation and disciplined operational performance fuels our ability to meet our customers' increased demand. 2018 segment operating profit expanded by 46% year over year. significantly outpacing our sales growth rate. This outsized operating profit growth reflects our efforts to increase sales of high-value, technically advanced products while reducing our exposure to more commoditized standard products. In addition to a favorable product mix, higher production levels led to increased utilization rates at our world-class production facilities, and we continued to vigilantly control our costs while growing our business. These positives came together to produce 2018 earnings per share, excluding a non-recurring gain recognized earlier in the year, of $1.51. This compares to an adjusted earnings per share of 48 cents for the full year 2017, equating to a year-over-year gain of more than 200%. ATI finished this year with solid fundamentals in the fourth quarter, achieving our fourth straight quarter of double-digit year-over-year earnings per share growth, Consistent with full year results, revenues grew by 14% versus the fourth quarter 2017, with strong contributions from both business segments. As evidence of continued strong underlying customer demand, seven out of our eight major markets posted higher fourth quarter 2018 sales compared to the prior year. Segment operating profits were essentially in line with prior year results, but fell below our expectations. Each business segment was negatively impacted by either the timing mismatch associated with falling raw material surcharges or by higher maintenance and energy expenses. Additionally, we continue to be hampered by a supplier delay within our HPMC segment. We will cover each of these topics in more detail later in this call. Our 2018 performance sets the stage for another year of financial growth in 2019. As we have discussed in the past, 2018's financial progress was not linear. While year-over-year revenue growth was relatively consistent in each quarter, operating profit and margins were higher in 2018's first half as compared to the second half. Looking ahead, customer demand remains strong, and we expect continued revenue and earnings growth in 2019. Similar to my earlier comment, these growth rates will vary quarter to quarter. In 2019, we generally expect second-half growth rates to be stronger than first-half growth rates due to known customer order patterns and anticipated raw material cost stability or improvement. Additionally, we anticipate a $35 million year-over-year increase in 2019 pension and other post-retirement benefit plan expenses for which Pat will provide additional details later in the call. With that as a backdrop, I'll hand the call over to John to provide a more detailed review of our performance in the HPMC segment, and I'll be back after John to cover the FRP segment results, and again following Pat to provide our first quarter and full year 2019 business outlook. John?

Thanks, Bob. Turning to slide four. Echoing Bob's earlier ATI comments, the HPMC segment had a very good year in 2018. Revenues exceeded our expectations, growing by 13% versus 2017, led by an increase in commercial jet engine product sales of 20%. This growth came on top of double-digit percentage commercial jet engine sales growth in the prior year, reflecting our strong position in the ongoing and significant aerospace industry production ramp. Year-over-year segment operating profit growth of 36% outpaced revenue growth and was driven by ongoing improvements in product mix related to higher next generation jet engine product sales and increased asset utilization to support our customers' elevated demand levels. Our jet engine OEM customers are increasingly ordering more next generation materials required to meet their aggressive production schedules. ATI's next-generation forgings, components, and materials accounted for 48% of total jet engine product sales, an increase of nearly 50% versus 2017 levels. As a result of revenue and segment operating profit growth, margins rose to 14% of sales, representing a 250 basis point improvement versus 2017. This exceeded our initial expectations for a 200 basis point improvement, but fell short of our revised mid-year expectations for a 300 basis point expansion. As shown on the slide, disruptions from ongoing supply issues, higher maintenance and energy costs in the period, and uneven customer order patterns each contributed to second half 2018 financial results that were below those achieved in the first half of the year. The HPMC segment's fourth quarter financial performance was solid. but fell short of my expectations in some areas. Revenue growth exceeded our outlook, increased by 15% versus prior year, in line with our solid 2018 full-year results. This growth was led by higher commercial jet engine and airframe market sales. Fourth quarter 2018 operating profit rates closely mirrored revenue growth, increasing by 16% versus the prior year. The outsized benefits normally associated with strong next-generation jet engine product sales growth were tempered by higher maintenance and energy costs and an ongoing supply disruption. First, we continue to suffer negative impacts from erratic nickel powder billet supply from a key provider to our isothermal forging operations. We believe this issue will persist throughout 2019's first and second quarters, but begin to moderate in the second half of 2019, as we assume 100% supply of those materials over time. While this situation presents a short-term challenge, it also represents a significant long-term opportunity. Second, our production facilities in the Pacific Northwest were negatively impacted by higher energy costs in the region, resulting from disruptions following a utility-owned pipeline explosion in Canada, which occurred midway through the fourth quarter. We expect this disruption to continue in the first quarter. Finally, we experienced higher than anticipated facility maintenance costs during our year-end shutdowns as we took advantage of the opportunity to prepare our equipment for another year of volume growth and on-time deliveries. This impact should not continue in the first quarter of 2019. Collectively, the impact of these issues reduced fourth quarter segment operating profit results by approximately $7 million. Turning to slide five, the pie chart and accompanying table show the HPMC segment's full year 2018 sales by market with a comparison to prior year. In the aggregate, segment revenues grew by 13% with year-over-year growth in most major markets, including continued double-digit percentage growth in the segment's largest markets, aerospace and defense. Customer demand growth was widespread across our product lines. led by increased sales of our advanced forgings, high-value specialty materials, and titanium investment castings. Full-year aerospace and defense markets grew by 13% year-over-year, with mixed performance by major sub-markets. Commercial jet engine revenue expanded by 20%, led by a 49% increase in next-generation product sales versus the prior year. Sales of next-generation forgings, components, and specialty materials were 48% of total jet engine product sales for the full year, nine percentage points higher than 2017 levels. We expect these sales to continue climbing, becoming a larger part of total jet engine sales over time. However, due to uneven customer order patterns, the benefits from these rising volumes will vary quarter to quarter in 2019. Full-year 2018 commercial airframe sales grew by 7% versus prior year, led by emergent demand growth from our primary OEM customer, particularly in the second half of the year. We received these additional orders in part due to our on-time delivery performance after a successful conversion to the customer's new supply chain management system. This growth was partially offset by lower year-over-year sales to our distribution customers. 2018 sales to government and defense markets were lower compared to the prior year. Military, jet engine, and rotorcraft product sales increased, but were more than offset by naval nuclear product sales declines. Looking beyond the aerospace and defense markets, the majority of HBMC segment smaller markets saw year-over-year sales increases as well. Construction and mining market sales grew by 42%, driven by our customers' demand for their large off-road trucks. Sales to the oil and gas and electrical energy markets grew by 17% and 16%, respectively, for the full year 2018. Medical market sales were mixed throughout the year, finishing with a modest full-year decline of 1%. Within our medical market sales, biomedical, especially materials sales growth, was marginally offset by declines in other product lines. In summary, the HPMC segment posted broad-based and strong year-over-year revenue growth in 2018. Next-generation jet engine and airframe product sales expanded ahead of expectations. These additional sales volumes drove significant operating margin expansion, and these important markets should continue to grow in 2019. We exited 2018 with a much improved business. one that achieves significant revenue and profit growth while able to fully satisfy our customers' increasing volume requirements. As Bob said earlier, our growth is unlikely to be linear quarter to quarter, and there are production and cost headwinds to overcome, but I am confident that we will meet our 2019 objectives. I will now turn the call back to Bob to talk about our performance in the FRP segment.

Thanks, John. Turning to slide six. The FRP segment likewise demonstrated strong financial performance in 2018 despite significant raw material related headwinds in the fourth quarter. Revenue growth exceeded expectations with year-over-year expansion in all major markets led by the high value product intents oil and gas, aerospace, and defense markets. In clear demonstration of the value of our product mix improvements and business transformation efforts, And in line with our expectations, segment operating profit more than doubled versus the prior year. This represents a full-year margin increase of 200 basis points. The key driver behind this performance was the benefit from increased volumes in our high-value nickel, titanium, and precision rolled strip product lines. In the fourth quarter, despite significantly lower raw material surcharges, FRP segment revenues increased 13% compared to fourth quarter 2017, with solid double-digit growth in aerospace and defense, electrical energy, and the automotive markets. Our fourth quarter sales growth points to a continuation of strong underlying customer demand despite geopolitical and global trade concerns. However, segment operating profit declined by 50% versus the prior quarter, primarily due to the predicted negative impact of falling raw material prices on our pricing surcharge mechanism. In addition, our A&T Stainless Joint Venture was unable to fully overcome the negative impact of the Section 232 import tariffs while continuing to operate at approximately 40% of target volumes. This coupled with reduced raw material surcharges caused the joint venture to generate a modest loss for the quarter. We remain actively engaged at the highest levels of the U.S. Commerce Department in constructive dialogue around the facts of our tariff exclusion request and still firmly believe that our request offers a very compelling case for their approval. Looking ahead to the first quarter, we again expect continued raw material headwinds to segment financial results as both ferrochrome and nickel prices declined versus fourth quarter values, resulting in a surcharge timing mismatch. And seasonally lower slit sales, driven primarily by the Chinese New Year holiday from our precision-rolled strip-joint venture in China. We believe that the FRP segment's 2018 financial results clearly demonstrate the success of our actions to generate improved operating profit levels. Our strategy to focus on high-value product growth along with capital efficient asset utilization increases, grow significant financial improvement in 2018. Turning to slide seven. Let's take a minute to dive deeper into the FRP segment's 2018 revenue growth. As I commented earlier, each of the FRP segment's major markets experienced year-over-year growth in 2018. This growth was most significant in some of our more technically demanding high-value markets. 2018 oil and gas market sales were up 33% versus 2017, primarily due to significant new business wins in downstream hydrocarbon and chemical processing projects and hydrocarbon pipeline new builds and repairs. Many of these sales came from products that require the unique capabilities of our hot rolling and processing facility, or HRPF. These products tend to be either exceptionally wide, exceptionally thick, or not historically hot rolled to finish gauge or surface condition. 2018 sales to the aerospace and defense markets increased 30% year over year, with growth in all sub-markets. Airframe sales increased most significantly, including emergent demand from our largest OEM customer. Defense market sales, while still relatively modest, saw a significant increase in titanium product sales in the fourth quarter due to the ramp-up of our previously announced armor plate contracts with General Dynamics Land Systems. Finally, FRP's automotive market sales were up nearly 20%, counter to industry build trends as our products are increasingly used to enable hotter, more fuel-efficient engines that help our customers meet tightening fuel efficiency standards around the globe. Again, our strategy to produce more high-value products while maintaining a base load of commodity stainless products is clearly working and will continue to work going forward. For full year 2018, nickel and specially alloy sales were up 36%. titanium sales were up 25%, both compared to 2017. In addition, sales of our precision rolled strip products, increasingly being consumed and produced in China and Southeast Asia, were up 11% year over year. During the same period, 2018 sales of our traditional stainless products rose between 4% and 5% versus prior year. In summary, we enjoyed a strong year of customer demand across all our diverse end markets and demonstrated our ability to sell a wide range of differentiated high-value products around the globe. We're truly transforming the FRP segment from a producer of highly commoditized products into a technology and efficiently focused supplier of advanced materials to our increasing customer roster. All that said, we have more work to do. building on our significant 2018 progress to achieve our 2019 goals. Now I'll hand the call over to Pat DiCorsi to talk about our fourth quarter financial performance and key elements of our 2019 financial outlook. Pat?

Thanks, Bob. Turning to slide eight, over the next few minutes, I will provide an update on our four-year and fourth quarter financial performance, as well as give our initial 2019 free cash flow guidance. At our 2018 Investor Day in November, we provided an outlook for 2019 through 2021 free cash flow on average. Now that we've closed the books on 2018, we are able to provide a more detailed estimate for 2019. Free cash flow generation improved significantly over the past year, and our year-end 2018 cash balance reflects that outperformance. At the end of the fourth quarter, we had more than $380 million of cash on hand. This represents a notable increase of 170% over year-end 2017 levels. Additionally, we had an approximately $350 million of borrowing capacity available under our asset-based lending agreement, or ABL. We continue to have no outstanding borrowings on our ABL's line of credit at year-end 2018. Full-year 2018 capital expenditures were $139 million. As previously communicated, This exceeded the upper end of our full year expectations. This elevated spending was primarily focused on two key growth related projects. One required to meet increasing demand for advanced jet engine forgings within our long term agreements, and the other to address growing international demand for our high value precision rolled strip products. These projects are our fourth isothermal press and heat treating expansion located at our isothermal forging center of excellence in Cudahy, Wisconsin, and the second, capacity expansion at the Stull Joint Venture Facilities in China. To continue to meet increasing demand levels within our long-term aerospace customer contracts, 2019 capital expenditures will increase versus the 2018 levels. Boeing and Airbus each project higher production rates in 2019, increasing again in the early part of the next decade. Due to the long cycle times required to install and qualify aerospace-related production assets, we must undertake initial payments on these multi-year investments in 2019. We expect 2019 full-year capital spending to be between 165 and 170 million, which is at or below our 2019 full-year depreciation and amortization level. After year-on-year sales growth, In the first half of 2018, managed working capital decreased by nearly $75 million at year end, primarily due to changes in accounts payable and accounts receivable balances. Inventories were approximately 3% higher for the full year, expanding much more slowly than our revenue growth rate, reflecting success on our ongoing efforts to reduce inventory levels across ATI. Year end managed working capital as a percentage of sales stood at 31.6%. representing a decrease of 650 basis points year over year, significantly outpacing our full-year reduction goal. This gain was achieved despite significant year-on-year business growth in both segments. Looking ahead, we anticipate ongoing improvement in 2019 versus the prior year, albeit at a slower pace. Our long-term objective is to achieve managed working capital as a percentage of sales of 30% on average throughout the year. Turning to our long-term liabilities, we continue to make progress on reducing ATI's exposure to legacy pension and post-retirement health care. Earlier in the year, we announced that the company's U.S. defined benefit pension plan was fully closed to new entrants. In the fourth quarter, we continue to make progress on our long-term pension liability management strategy by completing a $97 million risk transfer of a portion of the U.S. pension obligations through the purchase of an annuity contract. As a result of this action, we reduced participation in the A-type pension plan, our main U.S. qualified defined benefit pension plan, by approximately 3,700 people. Today, roughly 15,000 participants remain in this plan, of which less than 1,600 are actively working in our facilities. Lastly, I would like to provide our initial expectations for 2019 free cash flow generation. In 2019, we expect to generate at least $290 million of free cash flow. This is on top of a significant increase in 2018 versus the prior year. We anticipate continued strong managed working capital performance along with increased year-over-year capital spending support to our critical growth-related projects. We continue to focus on cash generation and accretive cash deployment in 2019. We expect to further reduce balance sheet risk and financial leverage while positioning ourselves over time for a return to investment-grade credit ratings. Turning to slide nine, I will quickly cover a few detailed 2019 financial assumptions to assure that those of you modeling ATI's 2019 financial results have clarity on the anticipated values for these key line items. The most significant year-over-year changes relate to our 2019 retirement benefit expense and pension contributions. Both of these items were negatively impacted by the significant equity market decline in December 2018. While we anticipated returns below our long-term assumptions throughout the second half of December's steep decline had a significant negative impact on our full-year pension asset returns. As a direct result of the December decline, we expect to contribute an additional $20 million to our U.S. defined benefit pension plan in 2019, increasing the $125 million contribution estimate provided at our 2018 Investor Day in November. Additionally, we anticipate significantly higher defined benefit pension and other post-retirement benefit plan expenses, increasing to approximately $88 million from $53 million in 2018. It is worth noting the 2018 pension contributions and retirement benefit expenses were lower due to the strong asset return in 2017. As I previously described, we expect 2019 capital expenditures will be between $165 and $170 million to support future profitable growth opportunities. 2019 interest expense will be marginally lower due to assumed higher interest earned on cash deposits. Based on current proposed regulations related to the 2017 Tax Cuts and Jobs Act and our current 2019 outlook, we expect our 2019 effective tax rate to be between 5% and 7%. of pre-tax income. Diluted share count is expected to be similar to 2018 levels. As a reminder, ATI's diluted average share count includes shares associated with our convertible debt due 2022. When calculating our earnings per share using the diluted share count, you must add back approximately $3 million of quarterly interest expense to the assumed earnings figure in the numerator. I will now turn the call back over to Bob to provide our 2019 outlook and wrap up.

Thanks, Pat. Turning to slide 10. Looking ahead to the first quarter, we anticipate continued strong underlying customer demand across our portfolio. However, we again expect to be negatively impacted by recent raw material declines in the first quarter 2019, primarily within our FRP segment and a continuance of some of the fourth quarter's headwinds in the HPMC segment. Higher 2019 retirement benefit expenses will impact both segments throughout 2019. Within the HPMC segment, we anticipate first quarter 2019 revenues to increase by a mid to high single-digit percentage year-over-year, slightly below full-year expectations as aerospace production rates will accelerate in the second half of 2019. From a segment operating profit perspective, we expect modest first quarter 2019 increases versus prior year as we work to offset the continued negative impacts from the previously discussed cost headwinds. First, we anticipate the ongoing nickel powder billet supply issue to remain throughout the first and second quarters, but to improve in the second half 2019 as we assume 100% supply of these materials. Second, we expect continued higher energy costs in our Pacific Northwest operations related to the Q4 2018 regional energy pipeline outage. And finally, our product mix will be less favorable in the first quarter compared to a prior year period that included additional production of some of our highest margin next-generation jet engine forgings and materials. As I commented earlier, year-over-year HPMC segment financial growth rates, both revenue and operating profits, are likely to accelerate in the second half of 2019. We are reiterating the 2019 HPMC segment full-year expectations provided at our recent investor day meetings. Segment revenues are expected to expand by a high single-digit percentage over prior year, and segment operating profit margin growth expectations now include approximately $8 million of increased retirement benefit expense. Moving to the FRP segment, we anticipate mixed results in our first quarter as compared to the fourth quarter 2018. Overall revenues are expected to decline as U.S. demand growth is offset by lower raw material-driven product surcharges. Operating profits will decline approximately $15 million versus the fourth quarter 2018 results. This decrease is primarily related to three things. the timing mismatch between raw material price declines and the surcharge pricing mechanism, the increase in retirement benefit expenses, and seasonally lower sales of precision rolled strip produced by our joint venture Stahl in China as it works through the impact of the Chinese New Year holiday. With regards to FRP's full year expectations, we anticipate continued solid FRP segment revenue growth to be tempered by the impact of lower raw material surcharges in the first quarter. While nickel prices have recently stabilized, it's difficult to predict the direction or pace of future raw material price changes. One 2019 challenge is clear. The segment will be negatively impacted by approximately $23 million of additional retirement benefit expenses. While potential positives remain, such as continued product mix improvements, benefits from a tariff exclusion for ANT stainless joint venture, and an increase in carbon steel conversion volumes from existing or new customer agreements, and additional sales of precision rolled strip produced by the recently completed stall expansion, we now expect the FRP segment operating profit to be between $75 and $80 million for full year 2019. In summary for ATI, we anticipate solid continued solid customer demand across our markets, particularly in commercial jet engines. The negative impacts from raw materials, increased retirement benefit expenses, continued nickel powder billet supply issues, and ongoing but temporary energy cost increases will temper our first quarter results. We are working aggressively to offset these challenges in 2019 and to create new opportunities to take advantage of our world-class capabilities and assets, as well as our reputation for high quality and on-time delivery. I'm confident that we will be successful in 2019, both growing our business and our profitability while positioning ATI for long-term success. Turning to slide 11. As I started out the call by saying, ATI had a very good year in 2018. We experienced significant and profitable year-over-year sales growth, increasing in nearly all of our major markets, in part through supplying our customers with additional high-quality parts and materials that enabled them to deliver the record number of jet engines and aircraft required by their customers. Much improved financial results followed our operational successes. We increased adjusted earnings per share by 215% versus the adjusted prior year results and turned those earnings into cash at an improving rate. Cash on hand at year-end 2018 increased to more than $380 million, an improvement of $240 million over 2017, in part due to an impressive reduction in managed working capital. In addition to delivering strong operational results, we continue to reduce balance sheet risk. In 2018, we fully closed our U.S. defined benefit pension plan to new entrants and continued to reduce the plan's population through proactive efforts, which resulted in a reduction of nearly 20% of plan participants. We remain active strategically with expansions of and qualifications for our key facilities. Additionally, we signed our first significant HRPF carbon steel conversion agreement with NLMK USA in the fourth quarter. The production ramp-up is well underway. I look forward to another year of growth for ATI in 2019. We have a great team, and I'm proud to be their leader. Operator, may we have the first question, please?

Thank you, Mr. Weatherby. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If your question has been addressed, you may withdraw from the queue by pressing star then two. We do request that you ask one question and one follow-up. The first question will be from David Strauss of Barclays. Please go ahead.

Thanks. Good morning.

Good morning.

In light of the guidance for HPM in 2019, I know it's similar to what you talked about, the investor day except for pension. Can you talk about what this potentially means for the 2021 target at 20% margins and maybe talk about what you're expecting for pension out through then?

Well, we see no change to our 2021 target. And again, on the pension side, it varies year over year based on largely our asset returns. So no change to the 2021 target, long-term target for profitability. And we believe that the pension asset returns will drive the pension expense. We'll see what happens in 2019.

Okay. I think you had previously been talking about, Pat, pension turning to income in 2020. How do you feel about that at this point?

Well, again, that's dependent upon asset returns, interest rates, and other assumptions. You know, we don't project at this point. You know, we can't see what the asset returns will be. But, you know, it's conceivable in the early part of the next decade that pension could turn to income, depending on the performance, again, so...

Okay. Bob, one for you. Mainly as it relates to FRP, can you talk about kind of embedded in your forecast for that business this year, what you're assuming for some of your largest non-aeromarkets, so oil and gas, auto, and how you're thinking about the impact of China deceleration on stall? Thanks.

Yep. So I'll give you kind of an overview, and then I'll actually ask Kevin Kramer to talk a little bit about specifically in oil and gas and in Asia. So I think we'll start with automotive. We continue to actually see increased penetration of applications in automotive that is tending to counter either the stable or the reduction of auto builds, the penetration in North America for you know, continued higher temperature engines, corrosion issues, turbocharged engines. That's helping with our gasket, flexible couplings, those kinds of products. And we're certainly seeing, you know, solid growth into 2019. On the oil and gas side, Kevin, do you want to give kind of a global perspective?

Yes, David. The oil and gas markets for us are critically important. It's historically been our second largest end market. But our key focus is more offshore. It's about 75% of our oil and gas revenues versus 25% onshore. With flexible flow lines, rigid flow line liners, nickel for wellhead inclusions, those are differentiated, more higher value add. We're starting to see that pick up on a global basis, especially on the subsea applications. You would also ask a question about China and specifically Stahl. Our bookings so far are on track versus prior year and our 19 plan. There clearly is some product repositioning with our largest end market, customers and consumer electronics. Again, with stall trees, capacity and capability, we continue to work on some new projects. Second largest market is automotive in China. We primarily just support the local Chinese auto build. Even with it remaining flat, it'll still be over 20 million vehicles in 2019. And as Bob said, as we see in the U.S. market, continued need for higher nickel content, higher operating temperatures, more corrosion resistance. And then the last point on stall is we continue to expand our export in Asia with consumer electronic and, again, automotive applications in Korea, Japan, Taiwan, and India.

That's a great point, Kevin. I think as the additional stall capacity comes on, you'll start to hear us talk more about Asia for stall, both consuming and producing in the region than just China. We definitely see the shift happening there. The other one you didn't mention, David, that I think is important for us in FRP in 2019 is in the titanium armor business. Certainly as we grow into the General Dynamics Land Systems, Abrams Tank, some opportunities in Europe. We really only had probably six, eight weeks of shipments into that program in 2018, and it's certainly going well for us, leveraging both the HRPF and some of our downstream assets. So we'll see that kicking up fairly significantly in 2019.

And the next question will be from Richard Safran of Buckingham Research Group. Please go ahead. Pardon me, one moment. We do have the next question from Richard Safran of Buckingham Research Group. Please go ahead.

Hello, can you hear me?

We can hear you, sir.

Thank you. Good morning, Rich. Good morning. Good morning, everybody. How are you? Great. Okay, first one I think might be for you on your CAPEX. I want to know if I get some additional comments for you about CapEx growing in 19. We've known about the build rates on engines for some time, so I was just wondering, is your CapEx spend reflecting some recent share gains? Does it reflect the need to support higher narrow-body production rates, which everybody's been looking at here beyond 57 for Boeing? Are you anticipating higher narrow-body production rates in 19 or 20, and Maybe if you could also, in your comments, comment on how you see CapEx trending even after 19.

So it is in response to increasing build rates, but it's also the existing contracts that we have and the growth that we're going to experience on those over the next several years, including the Pratt deal, which expands significantly over the next several years, as well as other major agreements that we signed within the last few years. It's really in response to that. We need to make some initial payments on some multi-year projects that will begin in 19. So it is in response to a commitment to that growth.

Hey, Rich, this is John. Let me clarify something Pat said. So during the investor day, what we commented on was that our current projections were based on the current published build rates and ramps. our capital spending is based on that as well.

Okay. Thanks, John. And this next one, John, while I have you, might be for you. So at high performance, am I right, I think you were expecting commercial jet engine revenue growth of greater than 10%. And I was kind of thinking that new jet engine builds might be growing at a higher rate than that. So I was just wondering, Does your growth expectation reflect expectations for new technology engine builds? Is there some headwind there, like maybe more aero engine aftermarket or something? And while we're on the topic, if you could comment on the aftermarket trends in 2019, I'd appreciate it.

Yeah, so I think our guidance on the jet engine market is really consistent with what we talked about. all of 2018, and especially during the investor day, is that we've got a combination of a higher percentage of new engines in the portfolio that we're supporting on the OE side, as well as some OE legacy engines. So what we're seeing is, as the transition occurring on the OE side, we still have a fairly healthy aftermarket support on the legacy programs. So that's still pretty healthy for us as well. And I think as we talked about, when we're talking about legacy engine programs, we don't necessarily know when someone is ordering a part, whether it's for an OE build or a spare. We don't really know that. We just know from what the customers tell us in their forecast to us that we build up into our plans. that there's a split between OE and spares. We just don't necessarily know part by part which one's a spare and what's for the OE build.

The next question will be from Gautam Khanna of Cowan. Please go ahead.

Thank you. Good morning, guys. Good morning. At a high level, I first wanted to just understand, you know, the change in guidance in aggregate relative to the investor day. Was it, in fact, just, I mean, this is a pension expense issue, effectively, relative to what you previously guided? Yes, that's correct, Gotham. Okay. Secondly, the A&T JV had a $4 million loss, you mentioned, in the quarter, and I think you gave a good explanation, but I'm just curious, what should our expectation be for the contribution from that in 2019, assuming the tariff exemption doesn't happen, all in, including the conversion fee, et cetera? Is it breaking in, or is it a loss? What do you think?

Yeah, fair question. I think in the last call, and it's still our target and our goal, our operating mantra to operate you know, at or near the cash break even for the year. If you look at 2018, we were cash positive from the joint venture through the sale of the 50% of the assets and then running through the fourth quarter. Part of the issue in the fourth quarter was kind of a mark to market on the inventory as the raw material prices fell. So I would say it'll be a modest cash loss, close to break even for the balance of the year. The team is committed to doing that as well as our partner. We have some work to do there in terms of working through, you know, getting the volume levels right and the pricing right. But it should be relatively close to a cash break even, which would probably on an earnings or IBT basis, because of depreciation and various things, show the joint venture could probably show an ATI loss of one or two million bucks a quarter due to the actual operations.

Okay, that's very helpful. You mentioned on the call the nickel-powder billet supply issue lingers through the first half, but then you guys, I thought I heard you say that you guys actually start to supply self-supply. Is that contractually going to happen, or is that sort of an on-the-come thing?

Yeah, I appreciate you raising that issue because it's a short-term bump but a great long-term opportunity for us that the team's worked hard to earn. And, John, you want to add the color that goes with that? Yeah, I got them.

I think to specifically answer your question, we're working on the contractual arrangement now. So similar to what we talked about during the investor day, we talked about really some longer-term opportunities for us in increasing the pull-through opportunity for between our specialty materials business and our forged products business. This is one of those. We didn't necessarily see that on the horizon in November. This is a very emergent situation that came up. Although it's been an issue we've dealt with for probably the last 18 months, we've been able to offset that. This is a situation where we could not, neither could our customer. So we've been working very hard with the customer over the last couple of months, and we're working with them now to more contractually solidify that situation. But in short, we're going to be aggressively ramping through 2019 to be in a position to increase our supply position for those particular programs, and we see that continuing.

The next question will be from Phil Gibbs of KeyBank Capital Markets. Please go ahead.

Thank you. John, to that end, I was under the assumption that this was a sole source agreement that really couldn't be broken over the next, call it three to five years. Did the issue just get so bad that the end customer on the engine side just said, you know, there needs to be a solution and there needs to be a solution fast because this appears to be a pretty substantial change that could benefit you guys pretty solidly from a backward integration standpoint.

Yeah, this is one, this particular customer was not a sole source situation. This was a dual source, and we were the other source. So we were fully qualified, albeit at a minority share position. And so this is one where we were prepared, but we have to aggressively ramp because it wasn't, It wasn't in our plans when we talked to you in November that we were going to be supplying 100%. So we're having to ramp hard to do that. Other programs and customers vary on what percentage we supply. And I think, as we said in November, we're working through qualification programs for all of those that we don't currently supply today. So there are opportunities there. in the out years as those contracts enable other sources.

So, John, this is a dual source where you have a minority position effectively going to a sole source?

Did I hear that right? You did. Yeah, you did.

Okay. Interesting.

Now, that's in the short term, short term being probably next couple of years what we're talking about. That may, as we as we finalize the contractual elements of that, that may change to a majority share position, which is different than what we've been in for the last five years.

Okay. Switching over to the flat-rolled side, surprised to see the flat-rolled business, I guess, below the break-even expectation for Q1. I guess that's what you're guiding to. Curious, Bob, if you look at kind of the stacked business, headwind in Q1 versus Q3, because I know you had some issues in Q3 from a timing standpoint, and it sounds like there's even more at the margin in Q1. If we look at just that raw material surcharge element to cost timing, what's that cumulative step-down number that you should ultimately get back once we get some stabilization?

Yeah, so I think just for 2019, we still see the target of $75 to $80 million for the year. I think Q1 has the benefit of, or I guess I'd call it the benefit of Chinese New Year at stall. That will recover clearly through the balance of the year as we see the opportunities in Asia continue to grow. We also have... the oil and gas industry our major pipeline activity there's quite a bit of stuff in the pipeline it's going to you know we believe it's going to hit late q1 early q2 and q3 so there's upside there and and clearly continuing to drive the growth that supports you know the aerospace and defense so we actually expect a low q1 metal prices stabilizing. Actually, we've seen a little bit of an uptick here already that's not in our plan, so that's an upside. And clearly, the additional ramp for cash of our conversion business with NLMK. So I think, you know, the guidance we gave to get to $75 million, $80 million, plus the cash flow from the conversion, you know, we do have the line of sight to do that. We need a few things to work in our favor commercially, as always, but you know, have the opportunities clearly in front of us. You know, Kevin, as you think about the commercial opportunities, are there anything you want to add to that?

Yeah, the only other thing I'd add, Bob, is, and you touched on it, the new products that have been enabled with the HRPF, the nickel, the cobalt products, specifically in both aerospace and energy applications for both sheet and plate. Again, we saw the benefits through 2018, and I would suggest we're going to see it through 2019 and 2020.

Yeah, and I think to Phil's point, the pension issues, while big and important for us, it goes back to our commitment at the Investor Day to talk about an investment grade balance sheet and using the cash flow that we have to reduce the risk for the long term. And I know Pat talked about that in the call, but we have not lost any focus on returning our balance sheet to investment grade. And that really means turning the variable debt of pension into more of a fixed opportunity, which we're committed to doing. So I think hopefully that answers your question.

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

Hey, good morning. Good morning, Josh. Can you just expand on the first half versus second half acceleration in HPM? Is it the powder supply, the biggest driver of that going to 100%, or is it just the customer order patterns with fewer deliveries here in the first half?

Yeah, Josh, this is John. It's connected. So some of the headwinds from the powder billet supply affect the customer order patterns. So at the outset, that's back-end loaded for us. So it's something we're working on with the customer to see what we can do to pull in as a result of that. It causes us to adjust schedules, et cetera, and so on. So that's part of the headwinds, I would say.

And then just with regard to the additional carbon conversion agreements, how many are you engaged in at the moment? And then what's the expectation for 2019 to get any of those over the goal line?

Yeah, so good question. So the number one focus for our team at the moment is ramping up the NLMK opportunity. I think when we announced it, we had modest expectations, and I think the further and further we've gotten into the conversation and ramping up, we see really great opportunity with that opportunity with NLMK. So that's number one. Number two is we actually have two three other active conversations going on. I think people are still a little bit tentative on the 232 resolution to make sure that they have cost-effective slab supply available, whether that's imported without tariff or consistent from U.S. production. But they're working that. We see a lot of alternatives being tested So we're seeing slabs coming from a variety of different sources through the HRPF today. So we continue to believe in the business case of the HRPF servicing, you know, the carbon market. NLMK should be, you know, very successful here by the time we get to Q2 and success breeds success amongst the other carbon producers.

The next question will be from Timna Tanners of Bank of America. Please go ahead.

Yeah, hey, good morning. Happy 2019, guys.

Yeah, good morning, Timna.

Just thinking about variables that could change and change some of the forecasts you talked about, wondering what are the assumptions in your pension accounting, like what market return or what interest rates you have baked in just in the odd chance that that changes your numbers, or would you not remeasure in the middle of the year? And separately on the, yeah, go ahead.

We would not remeasure in the middle of the year. We do it once a year at the end. The long-term rate of return is 7.6% on our assets, and we use a 30-year bond model to value on the interest rate side. So no update will be forthcoming until the end of the year.

Okay, gotcha. Thanks for that. And then thinking a little bit about also other questions that we've been getting among investors about concern about the broader economy, can you quantify the level of visibility that you have into that second half acceleration? Like what percent of your revenues are locked in or have that kind of confidence and what percent might be more economically exposed?

Tim, this is John. On the high performance side, which I think that specifically relates to the vast majority of our revenue is covered under long-term contracts. And so that acceleration, that customer demand profile that our assumptions are based on basically reflect the order backlog we have and the projections we have from the customers. Okay.

I think on the FRP side, the Q2 and Q3 should be our strongest quarters of the year, certainly with the oil and gas, major projects in the pipeline, which we expect to have during that period of time, and the full output of stall and expansion in other parts of Asia, and the ramp-up with the armor. Those are fairly well committed, but clearly the biggest issues open issue for us is the major pipeline projects, which tend to be let and delivered within 10 to 12 weeks. So that's the shortest term visibility we have for the good stuff in our portfolio.

Gotcha. Thank you. Do I have room for another? I just wanted to note, if you could remind us, if Section 232 were to be removed, hypothetically, tomorrow, what is the swing in earnings that you would anticipate, just to help us quantify that potential factor?

All right. That's a good question. I'm sure Pat will be smiling as I say this answer. So in our commentary, we talked about couldn't fully offset the tariffs. So I'll give you a magnitude. So in Q1, I'm sorry, Q4 of 2018, the joint venture paid $6 million in tariffs, and we had a $2 million kind of loss from operations. So I think if the tariff goes away, we anticipate market prices being where they are today. You should see a fairly significant swing in terms of that. But we are offsetting the majority of the tariffs today. And then we'll see the volume uptick. So the impact of the tariffs is we can't sell the full product line today, as you may be familiar with the 316 stainless with the higher activity, higher alloying ingredients, when you add 25% to those higher mollies and mags, it's a problem for us. So we'll be able to see more volume in the second half. The other thing that we get is – With the approval is the return on the tariffs paid, which is a fairly significant amount of – I think to date we've paid $16 million as the joint venture. So not only do you get to not have future tariffs, but the tariffs paid can be refundable, which is why there's still a tremendous drive to – to keep the business focused on the future and for the long term. We see that the cost structure has been verified, that this works and can be competitive. And certainly we also see the upside of the carbon conversion coming into that same period of time as well. It's leveraging the same thing to bring slab in for stainless. You get the same learning with the carbon and the economies of scale from that. So hopefully that gives you enough to work your model.

The next question.

Quarterly numbers, right, quarterly numbers.

I apologize for interrupting. The next question will be from Chris Olin of Longbow Research. Please go ahead.

Hey, good morning, everybody. Morning. Morning. So, John, I thought that you and I could talk about vanadium costs in great deal. He's prepared for you, Chris. He's prepared.

I'll sit. I'll sit.

In the meantime, though, I was wondering if there was a way to quantify the EBIT impact from this powder billet issue as you were, you know, from a full year perspective, where you thought the business would be. And then was that impact part of the $7 million I thought I heard you say in the presentation?

The what? To answer your first question, there is a way to do it. I'm not going to do it on the phone. It was part of the $7 million that we talked about, although a minority of the $7 along the way. The majority of that was related to maintenance expense that we had and the impact of that maintenance. And again, that maintenance for us is a combination of projects that we had planned on existing equipment that, in some cases, may have scope changes as we get into repairing existing equipment. It may take a little longer impacting the absorption, so that's some of the financial impact of it. Some of that was opportunistic maintenance. So we saw opportunities to pull in deferred projects that we had to try to get that done because we anticipate higher run rates in 2019. And then some of that maintenance was related to capability enhancements that we were using, particularly on our forging assets, that enable us to do things in 2019 we were not able to do prior to that. So that was part of the expense. I would say it's things we were going to have to do anyway, We just took the opportunities when we saw it to take care of it now as opposed to trying to do it when we're in the middle of busy schedules. On the powder billet impact, these are things we've been dealing with on a sporadic basis for really the last two years probably. It just came to probably more of an acute issue for us really in third and fourth quarter of this year. And we see more of a long-term resolution to it, as I discussed earlier from some of the earlier Q&A.

That's helpful. Thank you. Also, can you talk a little bit about premium melt capacity? I guess what I'm wondering is kind of where you're at in terms of operating rates for titanium and nickel-based alloy. And then do you think there's enough capacity out there from either your perspective or the market in general to to support Boeing and Airbus trying to increase rates in 2020 or 21 out there?

Well, that's a great question. I can see you're flexing your aerospace market muscles now. The popular question, too, we get that obviously a lot as we're conversing with our customers about longer-term projections and build rates. From an ATI perspective, we're running at relatively high levels of utilization on our nickel and titanium premium melt standpoint. We protect that capacity based on the contracts we have and the share within those contracts. And then we try to make sure that we reserve some capacity for not only developmental activities that we're doing, can't sacrifice long-term for the short-term, and as well as any, call it emergent demand that may come up. So we try to balance that as we go through it. So at this point in time, I think we're okay based on the contracts we have and the build rates that are there. As we go into negotiations for follow-on contracts, there may need to be some investments that we have to look at on both the nickel and the titanium side, but those are going to be more, I would say, out-year type investments that we have to consider. None of those are large-scale investments, but some things we may have to consider.

The next question, I'm sorry.

Nope, we're good.

Oh, thank you. The next question will be from Jeremy Klewer of Deutsche Bank. Please go ahead.

Hey, good morning. Thanks, Bob, for the color on the Section 232, what could possibly benefit, you know, if you guys get the tariff exemption removed tomorrow. But previously you guys have mentioned that you might miss out on kind of like the window to contract significant volumes in 2019. So could your volumes actually uptick that much from whatever the 40% you're running right now? Could they get up to a much higher number in 2019, or would that be a 2020 and beyond story?

Yeah, good question, Jeremy. I think most of the product coming out of the joint venture is going through the distribution channel in the United States. Customers have been supportive of the joint venture for a variety of reasons, mostly the quality, the short lead time, and the the potential for on-time delivery, which is a differentiator in a commodity market today. So I think there is good opportunity still in the second half. So I think you'd see a step in the second half of 2019 to get closer to full capacity in 2020. But I don't think it would be full capacity in the back half, but it would probably make – we'd probably go from a 40 to 65, 70 percent and then make the jump in 2020. So – kind of halfway there in the back half, and partly because we'd be able to add, without the tariff, we'd be able to expand the product mix into the other grades that we're currently restraining ourselves on.

All right, thanks. And then regarding pricing, you stated that the recent uptick in nickel prices was in your $75 to $80 million guide. So what prices are you guys incorporating in there? I'm just wondering, because you previously have also stated the $5 million impact for every $0.50.

Yeah, so we don't speculate on future nickel prices. Our basis is on $5 nickel. All right, thank you.

And the next question will be from David Strauss of Barclays. Please go ahead.

Thanks for taking the follow-up. I don't think this has been asked, but in terms of the free cash flow pad you had previously given guidance, 19 through 21 greater than $300 million extension. Does that change at all given the outperformance in 2019? Do you expect to give any of that back?

Not at this point. It's a little early to tell, but not at this point.

Okay. And then how should we think about the LIFO, if any, impact? I would assume that would be a positive in 2019. And if it is a positive, will you run that through or will you establish another reserve?

It's too early to project at this point for 2019. Way too early.

And the next question will be follow-up from Josh Sullivan of Seaport Global. Please go ahead.

Yeah, you mentioned naval nuclear declines, but just looking at the shipbuilding schedule on the Columbia, when should we think about that picking back up for you guys?

Josh, this is John. The decline we had in 2018 was really the result of the final year of a multi-year contract that we had associated with the Naval Nuclear Power Program. We are working through the startup of the next multi-year agreement that we'll see the impact of in 2019, and the volumes associated with those are much higher than we had in 2018. Thank you.

And the next question will be a follow-up from Chris Olin of Longbow Research. Please go ahead.

Hi. Sorry, I should have asked this question before, but In terms of the capacity limitation, just wondering about Airbus and if you have started the contract discussions yet. Do you expect to be on any of the new framed platforms first? And then second, I realize there's not much new out there, but a lot of headlines in terms of Russia and sanctions. And I guess I'm just wondering if you've seen a change in procurement strategies with all this uncertainty out there.

Thanks for the question, Chris. I think with Airbus, there's always a portfolio of contracts up for bid renewal or negotiation at any given time. Actually, the person who has the best view of that for ATI is Kevin Kramer. We'll ask Kevin to give his perspective both to that and your second question on the global trade issues.

Yeah, Chris, again, Bob's right. We've actually secured a number of contracts over the last couple of years, both in the flat-rolled products and the casting business. The con-bid contract, I think, is known, and it is out on the street, and yes, we are participating. So more to come over the next couple of quarters on that. With regard to the Russian sanction issues, we have not seen any specific impact negatively toward ATI. We have seen a couple of, I'll call it, emergent opportunities where customers are trying to hedge their bets a little bit, but nothing that I would suggest of significance at this point.

And, ladies and gentlemen, that will conclude our question and answer session. I would like to hand the conference back over to Bob Weatherby for his closing remarks.

Thank you for joining us on the call today. We appreciate your thoughtful questions, and thank you for your continuing interest in ATI.

Thank you, Bob, and thank you to all the participants and listeners who are joining us today. That concludes our fourth quarter and full year 2018 conference call.

Thank you. Ladies and gentlemen, the conference has concluded. Thank you for attending today's presentation. At this time, you may disconnect your lines.