ATI Inc.

Good morning and welcome to the Allegheny Technologies Incorporated second quarter 2020 results conference call. All participants will be in a listen only mode. Should you need assistance, please signal a conference specialist by pressing this 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 your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Scott Minder, Vice President, Treasurer, and Investor Relations. Please go ahead, sir.

Thank you, Chad. Good morning, and welcome to the Allegheny Technologies Second Quarter 2020 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, and Don Newman, Senior Vice President and Chief Financial 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. We will attempt to get everyone 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 will turn the call over to Bob.

Thanks, Scott. Good morning. Let's get right to it. The urgency of the situation created by the global pandemic required significant and comprehensive action. You may recall the discussion of our leadership priorities as part of our first quarter earnings call. They continue to focus our actions as we work to maintain a solid foundation to ensure long-term profitability and growth. and emerged from this global crisis a stronger, more focused company. Keeping our employees safe was and still is our foremost concern. The ATI team has done a great job doing that. Less than 1%, fewer than 50 of our coworkers have tested positive for COVID. Across our global footprint, our employees are being personally diligent in monitoring their health. Where necessary, they continue to work collaboratively through quarantines, aggressive cleaning protocols, periods of uncertainty, and operational disruption. They've kept themselves as well as their coworkers safe. This has enabled us to stay focused on delivering for our customers. This has been and remains an unprecedented challenge that led to a continuing unprecedented positive response. My thanks to the entire team for what we've accomplished together. Their actions speak to the strength of our commitment to our value for safety. Preserving cash and maintaining liquidity is high on the priority list. We entered the quarter in a strong position and took action to make it even better. These efforts, along with our free cash flow generation over time, will ensure that ATI has the ability to invest for profitable top-line growth despite the downturn. I'll leave the details of our actions for Don to discuss in his portion of today's review. The other three priorities focused our actions and have led to the second quarter results we're reporting today, prepared us to weather the storm of even lower aerospace demand in the next two quarters, and have positioned us for improved results in 2021. Driven by significant drops in near-term customer order levels, we've been aggressively adjusting crewing levels and work schedules across the system. Many locations have been completely idled with employees furloughed for multiple weeks. We've reduced salaries and benefits. We've implemented permanent layoffs and operations where we expect a significant period of time before recovery. We've also reduced staffing administrative functions. We've delayed capital investments and are actively managing our maintenance spent. We proactively curtailed melting operations to accelerate the alignment of our inventories with the new demand expectations. All of these actions were thoughtful, deliberate, and necessary. As we took these immediate actions, we did so with full recognition that the commercial aerospace market will recover. Fundamentally, we believe it's growth deferred, not growth lost. It may take a few years to get back to 2019 levels, but we're confident we'll get there. As such, it's imperative that we retain an appropriate cadre of skilled operators to respond to the previously announced aerospace market share gains set to begin in 2021. We kept this firmly in mind as future accruing levels were set. We're committed to strong execution in the near term and will be recovery ready when the market accelerates. So let's move to slide four and look at our second quarter revenues by market and our forward expectations for our core aerospace and defense markets, as well as the differentiated applications we supply. Starting with our view on the jet engine market, several of our major customers gave updates last week and Our view is consistent with those, both in terms of market conditions, near-term demand, and the continued potential COVID resurgence caveat. You may recall we saw initial leap engine order rate reductions starting in late 2019 triggered by the 737 MAX production stop. The reductions accelerated through the second quarter as the impact of the pandemic became evident. Subsequently, sales in the quarter were significantly below prior year. Stabilization of the forward order book for engines appears to be on the horizon. We expect a low point in demand to stretch from the second half of 2020 into early 2021 before improving in the second half of 2021. Thus, we're projecting four more quarters to realign the supply chain to real demand levels. At that point, accounting for the order lead time lag between delivery of our product and the delivery of the OEM's engine, we expect our order levels to more closely track increases in underlying engine production. As mentioned earlier, we've worked proactively to adjust our mouth schedules and institute short duration facility idlings to minimize stranded and or excess inventory in our operations. Regarding demand for materials we provide to the airframe supply chain, destocking was apparent in our second quarter results, but at a slower pace compared to the jet engine market. Airframe destocking is expected to accelerate in 2021. Until the grounded 737 MAX fleet returns to service, it's going to be difficult to predict when order levels in the airframe supply chains will reflect real demand. As we approach year end, if and as needed, we'll adjust our operations to align with lower 2021 order levels for airframe materials. As a reminder, in both the jet engine and airframe markets, we have significant new business share gains and margin enhancement actions that will begin early next year. While the magnitude of the positive benefits from these wins will be muted in 2021 due to the lower industry demand levels, The impact will be magnified as the market recovery gains momentum in 2022. Our defense business continues to post solid year-over-year growth. This strength is broad-based across many subsectors. It's led by demand expansion for naval nuclear materials in support of our customer, BWXT, and ultimately the United States Navy. Additionally, our missile component sales continued to increase, as did demand for our titanium armor plate materials used for land-based vehicles. We expect our defense revenues to expand in the second half of the year as the programs we supply remain mostly insulated from negative COVID impacts. We continue to work directly with the Armed Forces Research and Development Labs and the large defense prime contractors to develop next-generation applications that perform better with ATI material science and advanced process technologies, leading to meaningful ATI growth opportunities in the future. As for electronics, primarily served by our China-based precision roll strip business known as Stahl, second quarter volumes modestly exceeded expectations as domestic demand improved faster than expected. Looking ahead to the second half of the year, we expect this market to experience modest demand growth in support of anticipated year-end holiday sales. To date, China's economic recovery continues, but a significant regional or global COVID resurgence has the potential to negatively impact second-half demand, given the worldwide reliance on China-sourced consumer electronics. In the energy markets, the COVID impact has been significant. Based on the well-publicized supply-demand imbalance and related price declines, drilling and exploration activities were severely curtailed. Production, both on and offshore, was greatly reduced. Our customers are destocking inventories as they focus on repair work. Although offshore oil and gas applications drive ATI's largest energy submarket, Demand from other areas was markedly better, including specialty alloy products for industrial pollution control systems, civilian nuclear refueling, and land-based gas turbines, particularly in Asia. Looking ahead, oil and gas prices have started to improve as producers reduce supply. Demand has slowly begun to recover. We continue to expect overall energy demand to be soft in the second half of the year, with potential upside from government sponsored ultra deep water projects that require high value nickel alloy materials. These projects are expected to be awarded late this year for shipment in 2021. Turning to the medical market, second quarter sales declined after first quarter growth. The anticipated return of elective surgeries and the need for diagnostic MRIs were delayed due to the resurgent pandemic. We expect second half 2020 sales to remain moderately depressed due to lingering concerns about visiting medical facilities for non-critical procedures in this environment. With that, I'll turn the call over to Don to cover in more detail our second quarter financial results and our outlook for the balance of the year. I'll be back at the end to offer a few final thoughts before we open the line for your questions. Don?

Great. Thanks, Bob. Turning to slide five, Continued delays and 737 max production and strong macro headwinds driven by COVID significantly impacted our Q2 results. They're expected to create continued challenges in the near term as well. As a team, we remain focused on what we can control. Keeping our employees healthy, de-risking our business by managing costs and staying in lockstep with current demand, and by being recovery ready. Before I cover the results by segment, there were a couple of significant non-cash charges at the corporate level. These charges were driven by the current economic environment and were required by generally accepted accounting principles or GAAP rules. First, we took a $287 million charge for a partial goodwill write-down at our Forge Products business, which remains profitable and with good long-term growth prospects. The second charge, totaling approximately $100 million, is related to valuation allowances for our deferred tax assets, including net operating loss carry-forwards, or NOLs. The valuation reserve was triggered under GAAP rules largely due to the goodwill impairment charge. The valuation reserve does not impact cash taxes paid. We have substantial tax attributes, including NOLs, which we expect to provide a tax shield from U.S. federal taxes for years to come as we return to profitability. These charges did not reflect the positive long-term growth and profitability potential we see in the underlying business. We also recognized pre-tax charges for debt extinguishment for the partial redemption of our 2022 convertible notes and for further restructuring and severance actions. In aggregate, These totaled approximately $40 million. Excluding these charges, adjusted EPS was a loss of 2 cents per share. This is better than our prior guidance range for an adjusted EPS loss of 7 cents to 17 cents. While business conditions did deteriorate with revenues down nearly 30% year over year, we worked diligently to control our costs and deliver already melted materials from inventory. Moving on to our segment results, AA&S's second quarter revenues were down 14% versus prior year. Declines in commercial aerospace and energy were partially offset by growth in defense, electronics, and HRPF conversion services. From a business unit perspective, sales grew modestly in our specialty alloys and components business, declined somewhat at our stalled JV, and were meaningfully lower and are specialty rolled and standard stainless products businesses. A&S segment operating profits declined in the second quarter versus prior year as the impact of lower volumes that are SRP and SSSP businesses caused costs under absorption challenges. Lower raw material prices created a negative surcharge timing mismatch, and stainless scrap prices declined, causing a decrease in related inventory values. Partially offsetting these negatives were lower production and overhead costs, both from our aggressive facility idling efforts and from significant back office cost reductions. We also sustained reduced losses from the A&T stainless JV. Shifting to the HPMC segment, revenues declined nearly 45% year-over-year, primarily driven by commercial aerospace OEM production decreases, at both our specialty materials and forged products businesses. The medical and energy markets declined considerably in response to the COVID pandemic, while defense market sales increased due to demand for naval, nuclear, and missile materials. Segment operating profits decreased due to lower volumes and associated manufacturing costs under absorption. Cost savings efforts, largely related to the facility idling schedule and reduced overheads, help to offset the cost inefficiencies and work down inventory levels. Let's turn to slide six for a look at current liquidity, cash flows, and our capital structure. As a leadership team, we spent considerable time working to ensure that ATI has the best possible capital structure and ample liquidity to weather any storms. and even thrive when opportunities to create value are presented. In the second quarter, we continued to take decisive and prudent actions to maximize liquidity levels and preserve our ability to strategically invest and grow our business over time. In the quarter, we took the opportunity to further manage debt maturities. Including a small over allotment in July, we issued $291 million of new convertible notes redeeming $203 million, or more than 70%, of our 2022 convertible notes. The new convertible notes carry a lower cash interest rate, 3.5% versus 4.75%, have a higher conversion price, $19.76 per share versus $14.45 per share, provide for more flexible cash settlement options, and are callable after three years. In addition, we exercised a low interest rate $100 million term loan option under our ABL facility that would have expired at the end of the second quarter. These steps all have favorable impacts to our liquidity profile and are part of our continuing efforts to opportunistically improve our debt maturity schedule. Today, Our next significant debt maturity is now three years away, April 2023. We ended the second quarter with approximately $1 billion of total liquidity, including approximately $540 million of cash on hand and $460 million of available capacity on our undrawn ABL revolver. Further, we see opportunities to add incremental liquidity by optimizing existing collateral to support the EBL borrowing base, even as we convert inventory and receivables into cash through our initiatives. From a managed working capital standpoint, we made great progress in the second quarter. To that end, we reduced inventory levels by $78 million in the quarter. While in some cases that meant lower cost absorption due to selling from inventory rather than producing, it was a healthy tradeoff for cash generation. We also maintained our discipline of producing to customer orders to avoid creating stranded inventory. While we made good progress reducing inventory in Q2, we expect this favorable managed working capital trend to actually accelerate in the second half of the year. Now let's turn to slide seven and talk about Q3 and full year 2020 expectations, along with some initial thoughts on 2021 and beyond. Similar to my comments on the first quarter call, the uncertainty around end market demand, particularly for commercial aerospace, and the pace of recovery makes it very difficult to predict ATI's revenues beyond the next quarter with any level of precision. Therefore, we are still unable to accurately estimate full-year 2020 EPS. We can, however, better predict near-term demand and earnings as we have better visibility into firm customer orders and understand the timing and impact from our cost savings plans. The assumptions laid out in our initial 2020 guidance and updated in May are still relevant guideposts today. Our current view on these items have evolved over the past three months. First, 737 MAX production did restart at a low rate in the second quarter as predicted. Given the ongoing recertification process and as reported by Boeing last week, the plane's production rate will remain low for the balance of 2020. Second, while nickel prices improved in the second quarter, They're still below our original range of $6 to $6.50 per pound. And over the past few weeks, average prices have been above $6. With a likely third quarter 2020 average prices higher than second quarter, but below prior year levels. Finally, with regards to the impact from COVID, We've seen significant and continued deterioration in the business conditions as a result of this pandemic. The current U.S. resurgence and continued worldwide spread has had and will likely continue to have a pronounced negative impact on the end markets we serve. We continue to pursue reductions as we adjust our cost structures to the new demand expectations while maintaining critical capabilities and remaining recovery rates. On our Q1 earnings call, we announced 2020 cost reductions of between $115 and $135 million. It was a decisive response to a rapid change in demand focused on what we could control. Those efforts continued in Q2, and we have increased our 2020 cost savings targets by $25 million, or 20%. This brings our range to between $140 and $160 million for calendar 2020. Additional plant idlings, employee furloughs and severances, and tighter cost controls all aligned with our lower production requirements drove the increase in the range. Across both segments, we expect our initial cost savings to ramp up to the full annualized run rate in the third quarter. The second quarter's additional savings amount of $25 million will reach run rate in the fourth quarter. These will help to mitigate the deteriorating market conditions expected in the back half of 2020. All of these cost reductions improve decremental margins in the downturn, but the structural savings also expand margins in the up cycle. To that end, We expect 40% to 50% of these cost reductions to become permanent. As a result of these poor market conditions, we expect to lose between $0.62 and $0.72 per share on an adjusted basis in the third quarter. This estimate assumes marginally higher decremental margins than experienced in Q2 due in part to accelerating jet engine revenue decline rates, lower production levels, and unfavorable product mix. we assume a 0% tax rate in the quarter. Due to our significant efforts to reserve cash, we are maintaining our 2020 full-year free cash flow guide to generate between $110 and $140 million. This excludes U.S. defined benefit pension contributions. Looking beyond the third quarter, we expect some modest improvement in the fourth quarter, primarily outside of commercial aerospace. We also anticipate meaningful improvement in 2021, particularly the back half of the year. This is due to the end of destocking at our jet engine customers, orders better aligned to increasing LEAP engine production, the full impact of our cost savings initiatives, and improvements from our share gains, new business, and margin enhancement actions. Partially offsetting these improvements is the likely continued destocking in the airframe supply chain. We are aligned with our customers on the longer-term industry view, echoing their belief that commercial aerospace production rates will take three to four years to recover to 2019 levels, with narrowbodies returning more rapidly than widebody aircraft. However, it is likely that ATI's other end markets will improve more quickly and, in the case of defense, continue to grow. That, coupled with the ATI-specific benefits that I outlined a moment ago, will help our company to mitigate lingering commercial aerospace softness. I'll now turn the call back over to Bob to add some closing comments.

Thanks, Don. Thanks for the update. It's pretty active, last 120 days, if I say so. We'll end today's call where we started. These leadership priorities underpin everything we're doing at ATI and lead us to find straightforward solutions to challenging problems and market conditions. We first focus on the people who create and drive our success. From our R&D scientists to production workers and all the supporting team members in between, their relentless innovation and commitment sets us apart. We do our best to delight and serve our customers, partnering with them to solve their toughest challenges. This is what leads to long-term profitability for ATI and returns for our shareholders. And we achieve financial security and preserve the fuel for growth, no matter how choppy the waters we're swimming in. By investing our time and efforts on these things, we believe that we're on the path to being wildly successful in the inevitable recovery. This is more than a slide for us. It's how we lead every day. So our goal for today was pretty simple. We wanted to provide a complete picture of our current demand environment and our most up-to-date forward-looking views. We want to provide a comprehensive look at our actions to adjust to these dynamic conditions and share our expectations for third-quarter earnings per share and full-year cash flows. We know that our investors are making important decisions with less than perfect data. We strive to give you the best possible information on API's current state and forward outlook. Now, I can't tell you exactly when the COVID crisis will end or when the 737 MAX will be certified to fly globally or when demand levels will ultimately get back to 2019 levels in each of our core or differentiated markets. But what I can assure you is this. ATI will be a stronger, more focused, and profitable growth company as a result of the actions we're taking during this crisis. We remain focused on creating long-term shareholder value through the combination of material science, advanced process technologies, and with our relentless, innovative people. So, Scott, back to you. Thanks, Bob. That concludes our prepared remarks.

Operator, we're ready for the first question.

Thank you. We will begin the question and answer session. To ask a question, you may press star, then 1 on your touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. Please limit yourself to one question and one follow-up. If you have further questions, you may re-enter the question queue. At this time, we will pause momentarily to assemble our roster. And the first question today will come from Phil Gibbs with KeyBank. Please go ahead.

Thank you. Good morning. Good morning, Phil. The question I had was just on the incremental cost cuts that you announced this morning. And, Don, I think you said 40 to 50 percent of those cost reductions will be structural in nature. With all the actions that you've done up until this point, What does that amount to in terms of an exit rate for 2020?

Sure. I'll take that question. So in terms of our cost reductions, our target range at 140 to 160, as you're thinking about the kind of hitting the run rate, which I think is kind of the core of what you're asking, Phil, What you want to do is think about it in two pieces. One is our original guidance was 115 and 135, and we expect to hit run rate on that tranche of cost savings by the end of Q3, and I would say probably early Q3. Our capture rate, to give you an idea, in Q2 was probably in the $30 million range. The second piece is the incremental $25 million that we're adding. out of this Q2 discussion. The run rate on that piece is going to be in the range of Q4. And I would think earlier Q4 rather than later Q4. So we should have full run rate by the end of this year.

So does that suggest that the all else equal the cost savings on an annualized basis are closer to 250 to 300 million?

Yeah, yes, exactly. That's the way you want to think about it. As you lay out the build toward that run rate, you know, we would expect to have annualized cost reductions in probably 250 to 275 range in 2021. And then importantly is how much of that is structural and going to stay with us. And as I noted, we're expecting between 40% and 50% of those cost reductions to stay with us as permanent reductions. One thing that I also want to stress as we talk about the cost reductions, you know, the team pivoted to this very, very quickly and I think has done an incredible job delivering a meaningful change in terms of our cost structure. obviously pointed toward focusing our cost structures to the new demand. But one thing I want to make really clear in this, Phil, is that, you know, we are in this business for the long run. We're also aggressively pursuing these cost savings, but we're not doing it and managing or mortgaging our future. We're going to have a goal in mind to firmly maintain our materials science leadership and capabilities and to maintain our skilled workforce. So as you're thinking about these cost reductions, just keep in mind, we are focused on the recovery and being recovery ready. So even with delivering these savings, we have the long-term in mind.

Thanks for that. And you've provided guidance for the third quarter at this point. Certainly a big piece of that's going to be due to revenue stepping down. but you do have more cost reductions coming through and it sounds like the China business is better. How much of that step down and implied EBITDA sequentially is just due to the fact that you're blowing through all this networking capital and that obviously has a margin impact. So that part of it's probably a bit temporary as you bleed through that inventory in the back half. So trying to understand just how much of this drop in profits is due to the fact that you're just underabsorbed on your assets?

Yeah, it's a great question. You're right. As we're focused on managing down our inventory levels, that means we're making decisions to not produce, and that creates underabsorption. We haven't talked a great deal about the financial magnitudes of underabsorption. You know, just as a placeholder, I would think in terms of, you know, probably something in the $20 million-ish range may be impacting Q3. But it's, you know, it's obviously a dynamic number based upon a whole lot of assumptions. But, you know, we're going to continue to stay the course when it comes to right-sizing our production levels, staying focused on that working capital reduction, and then the cost savings, which – In Q3, you're right, it's going to be a contributor in terms of our ability to hit the $0.62 to $0.72 per share. And we've kind of already talked about the run rate around those cost savings. So it will be meaningful. But the key thought in terms of Q3 guidance is, you know, you're seeing the effect of the anticipated decline in in the jet engine and aerospace parts of the business hitting in Q3. And we're thinking Q3 and Q4 could be our trough. The good news is that we do see green shoots of recovery in 2021, and conditions should improve.

And then lastly, if I could, your liquidity improved here sequentially by roughly $100 million. Based on your current free cash flow guidance for the full year, I think that implies more free cash in the back half. But how that mends itself or intermingles with the ABL, unclear. You would know that more than I. But where is the plan to exit the year on liquidity all else equal with this free cash flow guidance?

Thanks. Yeah. So let me kind of answer that question in layers. So, you know, as you look at Q3 and Q4, to answer one of your questions, you know, what does it look like from a cash generation standpoint? We would expect to be a cash generator in Q3 and Q4. Of course, that excludes the impact of contributions to the pension plan. But we are expecting the pace of inventory relief, or release rather, to pick up in the second half. And then as you think about the interplay between the conversion of inventory into cash and availability under the revolver, what you can expect is, you know, we started an initiative in the last 90 days that was really all about taking great – the greatest advantage of our undrawn revolver. It's a $500 million instrument. And as we're converting inventory into cash, we're taking those inventory balances down. How do we replenish the inventory in a cash-efficient way? Well, one way to do that, Phil, is we have pockets of inventory and accounts receivable that have historically not been included in the ABL borrowing base. We are working with our banking group to get those added. And so I would expect, and we've got some internal targets into the magnitude of what we can do there, but I think it could be meaningful. And what's meaningful? You know, my target is adding, you know, upward of something in the range of $100 million to our ABL borrowing base as a result of doing that. So you add up our Q3, Q4 cash generation, what we're doing around the – the AVL collateral base. My thought is right now that we could be heading toward the end of 2020 and finding ourselves in a similar position from a liquidity standpoint as we were at the end of Q2, which of course was about a billion dollars of liquidity. So we're managing all the levers. And I think we're heading in the right direction. Again, looking at 2021 is a bit out there, but I think we're going to enter in a very healthy position.

Thank you. And our next question will come from Josh Sullivan with The Benchmark Company. Please go ahead.

Hey, good morning. Good morning, Josh. You know, just following up on the inventory question there, you know, how comfortable are you, you know, how lean are you comfortable taking inventory to, you know, just looking at that growth and then lead times and what they might be in 21 and 22? You know, are the OEMs involved in those conversations? Are they concerned about where, you know, lead times might go if you completely lean out the inventory? And then how much of your contract base is in take or pay structures at this point?

So good morning, Josh. In terms of the inventory situation, the first part of your question, you know, as demand has come down, you know, our flow times have actually come down as well. So we actually have pretty good ability to respond to emergent demand or near-term changes, upticks in demand. So I think from a how nervous would our customers be, I'd say not very nervous. I think we're staying in good touch with them daily in most cases, if not weekly for the other cases. I think the other issue is that we're managing our melt very aggressively. And as such, we're not getting our melt way ahead of what we're working on. And looking at those value streams and how they flow, we're able to be ready to go and, as Don said, maintain recovery readiness. I think how lean can we go? We can get very lean in terms of our inventory levels and our ability to respond should be as good as it's ever been. As we said earlier, we've made a specific decision to hang on to as many of our highly trained people as we could and certainly the continuous improvement activities in our melting areas and downstream continue. Hopefully that helps.

And then on just take-or-pay structures, is that a meaningful portion, or how do those look?

Yeah, this is Don. I'll take that. So I wouldn't say that take-or-pays are a meaningful element. We do have some, but they're certainly not a material driver in our contract structures. Okay.

And then just moving over to the strength in the defense portfolio, can you dig into that a little bit? What does the visibility look like on the aviation or maritime platforms? Can that growth carry you through to 2021 as well?

Yeah, simple answer is yes. So when we look at our defense business, it really breaks down quite simply into things that float, things that fly, and things that roll. That's the easiest way to kind of break it down. So The things that float are principally long visibility areas, the Navy nuclear programs, pretty strong forward look there. So that should carry us into 2021 pretty well. On the stuff that's flying, again, we haven't seen any decline in demand there. So I would say our order visibility is good. And on the stuff that rolls, I think we continue to you know, see good demand. So I would say into 2021 we do see growth. You know, I think it's got to get a little nervous, but it's probably in the double-digit range as we go through into 2021 in the strong products, you know, the titanium alloys in particular. But certainly the Navy nuclear program is a contract we signed with WXT a few quarters ago. So all those are progressing well. And, you know, we still have a portfolio of new applications that are probably beyond 2021, harder to predict, you know, how those will actually come to bear. But we feel pretty strong for 2021 in defense.

Thank you for your time.

Yep, thanks, Josh.

The next question will come from Gautam Khanna with Cowan. Please go ahead.

Hi, thanks, guys. Good morning.

Hey, good morning. Good morning, Adam.

I was wondering if you could give us some color on, you know, you guys have the titanium contract with Boeing and, you know, earlier in the year, I think you were contracted for the minimums and then some. Has that, have you adjusted down to kind of below the contractual minimums? I'm just curious now if that's played out or is there another kind of leg to fall as we look and compare for 2021 on that program in particular?

Yeah, so if we take a step back and say where's our airframe demand, you know, a couple things going on. One is, you know, we've been close to the contractual targets, you know, in 2020. As you look forward, you know, we're not confident that those numbers will be sustained and that destocking will start. We've seen a little bit of destocking starting in Q2. We expect that, you know, kind of those levels, the bounce of the year, where 2021 would be lower, and then we expect it to level out and be sustained for quite a, you know, the next two or three years probably on the airframe side. That said, you know, I think we announced last quarter that we were expanding our participation in the airframe business, so we'll pick up some share and some position with other airframe manufacturers. And that should help offset some of that, probably a half to a third of the problem, you know, that we could see coming out of the Boeing contract. That'll start in 2021 and really kick in in 2022.

That's helpful. I appreciate it, Bob. And then also just as a follow-up, I'm curious, you know, in terms of destocking or Yeah, destocking or just clear demand signals on the engine channel. Do you think folks are now, that all your various customers are well aligned to the forward production rates, A? And B, I mean, are you still seeing, like how much longer should we see some destocking to amplify, you know, the declines your business may see relative to the underlying demand? production rates?

Yeah, that's a question we ask. Our customers engage with them every week, every day. I would say I do believe our engine customers are, for the most part, aligned with the near-term demand. So 2020, 2021 is probably where they are today. And we expect the stocking in the engine space to really be taking place through the balance of this year into the first half, probably the first two quarters of 2021. And then by the time we get to about mid-year, we should see pretty good alignment with true demand, you know, correlating with our orders. There's always a little bit of a lag that we've talked about with you forever and ever, but I think it's going to take another couple of quarters because it was a fairly significant decline in the end market. And certainly, their issues with engines running departures, as GE spoke to it last week. I think we expect them to be in line by mid-year, our inventories and their inventories by mid-year next year.

Thank you. Our next question will come from Timna Tanners with Bank of America. Merrill Lynch, please go ahead.

Hey, good morning. Hello, good morning. Just a high-level question. I wanted to just ask, you know, how – Any of your comments might change or not if there were a vaccine end of year early next year?

Well, you'd hear us cheering, number one, that there's a vaccine. I think it would give a lot of impetus to, you know, clearly increased air travel, which would lead to, you know, improvement in the spare side. And, you know, I think for us, we feel well positioned for the new builds. And I think one of the things we've seen in the aerospace industry is that the airlines are retiring the old stuff. And that positions us well for a, I would call it a faster recovery with the vaccine. So we feel with our next generation products on the next generation engines, that would be a plus. So, you know, acceleration of spares, followed by acceleration of demand for the new stuff. So we'd be more prepared. We're more bullish once we see a vaccine.

No, clearly, that would be positive in a lot of ways. I'm just wondering in terms of timing. So if we're considering that there's the destocking that's going to continue, I guess, for the next four quarters or so in jet engines and then airframes and destocking, and then I'm trying to reconcile the different end markets in terms of where we are with regard to actual demand and destocking. So, you know, automotive, obviously more likely to recover more quickly, kind of confused by the construction mining, although I know it's small. So just wondering if you can go through and tell us how quickly some of these could pivot if things were to recover.

Yeah, so you mentioned automotive and construction. They're smaller parts of our business today as we've, you know, de-emphasized our role in stainless. But I think we're seeing... a decent recovery. I think Don referred to some green shoots, I think, in automotive and as we get into early 2021, we should feel pretty good about it. Some of it's a capital spending cycle. Others, you know, consumer confidence. But it appears that the automotive side is recovering relatively quickly. We see that in the U.S., and we see it in Asia, actually, through the precision road strip business we have in China. So, yeah, I think the aerospace, the jet engine side would probably be the four quarters, but I think everything else we should feel pretty good about recovering in early 2021 in the other markets.

Okay. That's it for me. Thank you very much.

Thanks, Timna. Yeah.

The next question is from Paritosh Mithra with Berenberg Capital Markets. Please go ahead.

Thank you. Good morning, Bob and Don. So first question on your long-term aerospace revenue potential, I guess. So when airplane production rates, when they do come back to the 2019 run rates, whether it's in three years or four years, is it fair to say that your sales in the high-performance business should be higher than 2019, just given the progress in the last 12 months, you know, the market share gains, new contracts, repricing opportunities you've had, and just also the higher penetration of the next-generation engines?

Simple answer is yes. We do expect the longer term to benefit from the share gains and the margin enhancements and the new business, the new positions. that we've won. I think the other thing is that it couples with the defense growth that we talked about earlier. We see continued long-term growth in defense, some great programs coming down the pipe. Obviously, they have to be funded, but we're bullish on our core being aerospace and defense, materials and components. That's really where the strengths of ATI play the best. You couple that with the structural cost savings, and obviously then the financial performance of the company reaches a much better point.

And how sensitive are you to the wide body versus narrow body mix? Would that change anything?

So in a nutshell, you know, wide bodies tend to have more metallic content per unit. But when you look at the narrow bodies, obviously the quantity changes. tends to be equally important. So I think what I would tell you based on our product performance between wide body and narrow body, we're happy with every airplane that gets built anywhere in the world. And we're going to be on those engines and on those frames. So we're excited. So I'd say less concerned about what gets built, just that they are getting built.

Got it. And if I could just ask one quick one. If you look at your sales to jet engines to airframe, typically it's a two to one ratio, but it was pretty much lower than that in Q1. So how should we think of that in the near term? And would it revert back to two to one next year, second half of next year?

Yeah, I think by the second half of next year, I think, you know, the jet engine destocking is going to, make those historical numbers a little funky in the first half of the balance of the year just as we work through that. But, yeah, I would think long-term, especially with the, yeah, I think with the share positions, it's going to take a little longer, I think, to destock the airframe supply chain just because of where we sit in that supply chain. But I think over time, you're right, I think it will return probably to 2022 timeframe. We'd be back to historical comps.

Thank you. Our next question will come from David Strauss with Barclays. Please go ahead.

Thanks. Good morning. Hey, good morning. I know we've been over this a bit, the difference between the engine side and the airframe side in terms of destocking. But, Bob, can you tell us and maybe dumb it down for me what the explanation is in terms of the difference in the timing around destocking? engine versus airframe where you think airframe is going to extend, you know, all the way through 21?

Yeah, so I think from a destocking standpoint, I think the real issue is the engine group has gotten going first. You know, so they've gotten out ahead. We saw the disruption that occurred in late Q4, you know, with the announcements on the MAX and what was going on. I think The engine guys reacted pretty quick, and so we saw a major shift and a desire to get in line much faster, very quickly. I'll just say very quickly. I think on the airframe side, because of the length of that supply chain, it's taken them longer to understand when is the max coming back, what are the implications of COVID on long-term supply. airplane deliveries, and they've been working through that. And I think what we saw starting to happen in Q4 of 2019 on the engine side I think is happening in Q3 and Q4 of 2020 on the airframe side. So I think they just got a late start. And as a result, we'll see the pop-up in engines in the second half of 2021 because we'll be back to more demand. I think airline travel will be up. The spares will be up. whereas the airframe is kind of leveling out. We've said, I think, in previous conversations that one good thing about the airframe builders is over time they tend to smooth things out. And the history would say it just takes them a little longer to get there. And so that's what we're seeing. So it would be a quicker down and a quicker up for engines, a slower down and a slower up on the frames.

Okay. Yeah, that's helpful. And then... You know, as you think about Q3 and the EPS number we're looking at, can you help us out at all in terms of what that bakes in for a revenue decline on the aerospace side? I think, you know, this quarter between engine and airframe on a, you know, adjusted for the divestiture, you were down, you know, in the low 40% range. How much are you baking in that you're down in aerospace and Q3 in that EPS number?

Well, we haven't given revenue guidance, right? So I'm reticent to do the math here. But what I can tell you is you can do the math. I don't mean to be cheeky about it. We just don't want to be out putting additional guidance out there. You know, clearly one piece of information I think would be helpful to you in doing your math, decremental margins. So if you think about our decremental margins, in Q2 – we were sitting at about 32% decremental margins year over year, excluding 2019 divestiture impacts. As you look forward in Q3 and Q4, you should expect decremental margins in the 30% to 35% range. Be a little bit wider the Q2 because, you know, with the jet engine declines that Bob was talking about, and some mix, I expect it widening out, but it's not going to blow out. So think in terms of maybe 35%. If you take our earnings guidance and you can do some modeling that will back into, you know, to get you a view on revenue, and you will find with certainty that our expectations are certainly going to be lower. I just hate to quantify it publicly.

Okay. Yeah, that piece on the decremental margin side is helpful. And, Don, I guess the last one on pension, any update thoughts on, you know, what you might look like from an expense standpoint and a cash contribution standpoint in 21 at this point?

You know, yeah, I said yeah, and then the answer is kind of. So 2021, I would expect that our expense will be down some. We should have about $60 million of expense in 2020, and I would expect that to drop down modestly based upon what I know right now. In terms of contributions in 2021, the guidance that we've given is that between – 2021 and 2023 we expect it to average uh about 85 million of contributions a little bit higher in the first couple years and then dropping down in the third year but averaging about 85 million the reality is we won't know with certainty what those numbers look like until we run our actuarial valuations at the end of the calendar year so but right now i would assume that uh that that Those figures I just gave you will hold and be kind of in the neighborhood for 2021. Should that help?

Our next question will come from Matthew Fields with Bank of America. Please go ahead.

Hey, guys. Just a modeling question for me. The 130 pension contribution for this year, is that expected to take place in 3Q or 4Q?

So as you look at the 130, so that's for the benefit of everyone on the phone, that's the estimated deposits into the defined benefit plan in 2020. So the way to think about that from a cash standpoint, we've contributed about 45 million of the 130 between Q1 and Q2. I would expect in Q3 we're going to contribute probably in the neighborhood of, you know, 18 to 20 million. probably on the lower end of that range. And then the balance will be contributed, balance of the 130 will be contributed in Q4.

All right, that's helpful. And then on the liquidity side, you know, you've done a good job of boosting liquidity so far, and I appreciate the comments that you expect to end the year at about a billion of total liquidity as well. Is that billion-dollar level kind of adequate and comfortable for you heading into, you know, another year or two of kind of down results in aerospace? Or do you think that there's a couple of extra moves you need to make to boost that even further?

Yeah, I mean, first of all, I feel like we're in a really good, really, really good spot from a liquidity standpoint. And, of course, our next nearest term maturity isn't until 2023, right? So we're lined up to continue to be in a very healthy position. And, of course, we'll continue to watch the demand, and we'll pull levers around cost structures, capital expenditures, and working capital initiatives to continue to shape our business to the demand. But I feel very, very good about our liquidity position. We did the financing, placed a new convert in June. That also was a healthy good guy for our liquidity profile as you look out past 2021. In terms of other moves, you know, really we're opportunistic. You know, I think what you're bringing up is we've got some 2023 maturities and we'll manage those in due course. But generally, cash needs in the business, we should be able to meet those quite easily. You know, to give you kind of a bookend on the cash needs, we typically need anywhere from $50 million to $100 million of cash in the business. So sit with a billion dollars of liquidity and in a very healthy position that we're in, is a good spot to be. I feel very, very fortunate to be in the position that we are with our balance sheet and our liquidity.

Ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to Bob Weatherby for any closing remarks.

Thank you for joining us on the call today. Clearly, we talked about the commercial aerospace industry's reset as it relates to COVID-19. but also heard us talk about our strong liquidity position, the significant actions we've taken to adjust our cost structures to the new demand reality, and certainly our strong product positioning for recovery. We remain recovery ready and believe ATI will outpace the industry as that occurs. So thank you for your continued interest in ATI.

Thank you, Bob. Thank you to all the participants and listeners for joining us today. That concludes our second quarter 2020 conference call.