ATI Inc.

Good morning and welcome to the Allegheny Technologies Incorporated third quarter 2020 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 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. Good morning and welcome to the Allegheny Technologies' third quarter 2020 earnings call. Today's discussion 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. For today's call, we will not display or advance slides as Bob and Don speak Their comments will focus on highlights and key messages. The slides provide additional color and details on our results and outlook. They are available on our website at atimetals.com. After our prepared remarks, we will open the line for questions. During the Q&A session, please limit yourself to two questions. As a reminder, all forward-looking statements are subject to various assumptions and caveats, as noted in the earnings release and in the slide presentation. Now, I will turn the call over to Bob. Thanks, Scott.

Good morning. It's an understatement to say that 2020 has been a challenging year for all of us, especially those who serve the commercial aerospace market. Despite these headwinds, the relentless ATI team continues to rise to the challenge, guided by the leadership priorities we established at the outset of the pandemic. This morning, I'll share my thoughts on three key topics. First, how we've taken control of what we can control, thus accelerating cost savings and strengthening our position. Second, our strong balance sheet puts us in an excellent position to weather storms ahead as well as to fuel our growth. And third, our view of the markets and our confidence in a stronger future for ATI thanks to strategic share gains and ATI's unique capabilities. So first, where we are today. We began taking decisive action as soon as our forward-looking demand signals flashed red. Our customer connectivity continues to give us the insight to assess market dynamics in the moment. From this, we gained conviction to make critical decisions, aligning our cost structures and inventory levels with changing demand expectations. We've acted thoughtfully and with urgency to reshape ATI for 2021 and beyond. As a result of these proactive efforts, our third quarter financial results significantly exceeded our previous guidance. We accelerated benefits from our cost savings initiatives through aggressive implementation. This included capacity up. Cold, dark, and quiet facility idlings reduced our fixed costs. Minimized variable costs. Swift execution on our restructuring programs eliminated costs to align with demand declines. reduced overhead. We've intensely reviewed every administrative and non-production-related expense, continuing only what was critical. Overall, we've significantly variabilized our cost structure. Costs historically viewed as fixed are now turned on and off in sync with demand, which gives us tremendous control over our costs. This will be a lasting impact of the actions we've taken during the crisis. Through it all, our people have been extraordinary. First and foremost, they're keeping each other safe while efficiently and consistently delivering critical materials and components to our customers. The frequent production adjustments we've made in response to demand shifts and end market forecasts have not been easy for them. Growing levels and shift schedules have fluctuated as a result. I sincerely appreciate the entire team's effort and dedication and personal economic sacrifice. Their continued actions demonstrate a shared commitment to ATI's future success. The deliberate actions we've taken and will continue to take are crucial to our ability to emerge a stronger company as the economy recovers. Looking ahead, we're confident demand will eventually recover. We expect these difficult times to continue for several quarters to come. Yet we do believe we're reaching the bottom with some signs of upcoming stability. Secondly, let's talk about our balance sheet and the solid position it puts us in. We've worked diligently to ensure ample liquidity levels and a manageable debt maturity schedule. Our strong balance sheet gives us confidence to manage through the COVID crisis and fuel our future growth. We're fueling growth in three ways. First, based on customer commitments, we're investing capital to enable strategic share gains and new business awards that we'll start to see in 2021. Next, by organically expanding our presence in adjacent high-value markets where our material science expertise is valued. And finally, when the time and economics are right, we'll pursue acquisitions to rapidly build out scale, expand capabilities, and capture profitable core market opportunities. As we accomplish our growth goals, we'll intensify our presence in aerospace and defense materials and components. We'll continue leveraging our material science capabilities and advanced process technologies to generate aerospace-like margins in adjacent markets along the way. Looking forward, We're confident that the demand for commercial aerospace products will recover. We see it as growth deferred, not lost. No matter what form you believe the coming economic recovery will take, it could be a V, could be a U, could be L-shaped, when you're at the bottom, it's difficult to predict when you'll reach the other side. But we know we'll get there. We're positioning ATI to emerge stronger, leaner, and more efficient no matter how the recovery comes. Here are some examples of how I believe we're doing just that. We're expanding our presence in growth markets like defense. We have solid positions in adjacent markets that are likely to recover faster than commercial aerospace and can generate aerospace-like profitability. Lastly, our efforts to lower costs and streamline our manufacturing footprint while deploying growth capital will pay dividends for the long term. Broadly speaking, and not surprisingly, our Q3 sales across most markets were negatively impacted by the ongoing pandemic and resulting economic downturn. Defense remains a notable positive exception. A little more color on our view of what we expect going forward. Let's start with commercial aerospace. Both jet engine and airframe continued to decline significantly versus the prior year. Aggregate year-over-year sales were down 60% in the third quarter, driven by factors we're all familiar with, quarantines, travel restrictions, and low 737 MAX production. Aggressive jet engine customer inventory destocking in the near term will better align future production levels with demand. Forest borders at engine product sales will remain relatively weak as forgings begin to slowly recover. Specialty materials will likely lag for an additional couple of quarters. ATI sales into airframe applications will remain subdued for the balance of 2020 and likely throughout 2021 as the impact of announced future wide-body production rate reductions work their way through the supply chain. In 2021, ATI will benefit from engine market share gains and new airframe business. The positive impact from these wins will increase over time as aerospace industry volumes recover. Our second core market, defense, remains a source of strength. Excluding titanium armor, ATI's diversified defense sales were at more than 20% year-over-year, led by naval nuclear and military aerospace growth. Titanium armor plate sales were down significantly due to timing for both a domestic and an international program. We're investing resources to accelerate growth in the defense market, leveraging our material science capabilities and advanced process technologies to develop and produce materials and components to both power and protect. Near term, we expect continued growth in the fourth quarter and into 2021. Next, let's talk about my thoughts on three important adjacent end markets. Third quarter sales were down significantly in the energy and medical markets and up in electronics. When it comes to energy's oil and gas sub-market, we saw a lack of end customer demand and a resulting inventory glut reducing exploration and downstream processing activities worldwide. We expect this market to remain weak in the fourth quarter. The bright spot within energy is the specialty energy submarket, including pollution control, nuclear, and renewables. These sales grew year over year, and we expect the specialty energy market to continue to outperform the larger hydrocarbon-based markets in the fourth quarter, mainly driven by large international pollution control projects. Our medical market is principally comprised of biomedical implants and MRI material. Sales versus prior year were lower to customers in both categories, mainly due to the challenges presented by COVID. Patients postponed elective surgeries and hospitals limited facility access to equipment suppliers. Looking ahead, we believe medical sales will accelerate as patients regain confidence to reenter medical facilities, either due to an effective COVID vaccine or disease treatment protocols. Finally, electronic sales move higher year over year. This is mainly due to ongoing consumer goods production in support of new product launches and year-end holiday sales. We anticipate modest growth trends to continue in the fourth quarter. With that, I'll turn the call over to Don to cover our third quarter financial results and outlook for the balance of the year. I'll be back to offer a few final thoughts before we open the line for your questions.

Thanks, Bob. I'll spend the next few minutes sharing highlights in three key areas. our better than expected third quarter financial performance, two, our strong balance sheet and cash position, and three, a look at our Q4 and 2021 expectations. From a performance standpoint, the adjusted EPS loss of 38 cents per share in Q3 is significantly better than our previous guidance of a loss of between 62 and 72 cents per share. Our Q3 performance reflects accelerated cost reductions and an improved mix in portions of our business. First and foremost, we are managing decisively. We are making the most of external demand despite market headwinds, and we're controlling what we can, our costs and capital deployment. Consider this. Our third quarter revenue dropped by more than 40% versus prior year. including a 60% decline in our high-value commercial aerospace business. The revenue drop was largely due to market factors that were not within our control. When market declines became clear earlier this year, we responded quickly, focusing on cost containment. Benefits of those efforts can be seen in our Q3 results. Despite the 40% drop in revenue, we posted a 25% year-over-year decremental margin in Q3. That's a meaningful improvement from the 28% decremental margins captured in Q2. Clear improvement resulting from quick action. Our cost actions are having meaningful impact, and they're accelerating. As Bob described it, we have significantly variabilized our cost structure. Costs once considered fixed are now variable. This means we are better prepared to deal with future demand fluctuations. Also keep in mind that structural cost savings will accelerate profitability in the recovery, expanding margins, and increasing our cash conversion. Looking beyond the income statement, our efforts to reserve free cash flow are producing results as well. We expect to be free cash flow positive in 2020. This is made possible through capital spending discipline and our ability to convert working capital into cash. I want to take a minute to acknowledge the fantastic efforts of our operating teams. They took quick actions to protect cash in the near term while maintaining our ability to grow and be recovery ready. We ended the quarter with approximately $950 million of total liquidity, including $572 million of cash in the bank. Our debt maturity profile also adds strength to our financial position. Our next meaningful debt maturity does not occur until 2023, three fiscal years away. We're focusing on three key levers to drive cash generation, cost structures, inventory levels, and capex. Expect to see continued focus on these three areas in 2021 as we adapt our business to fit dynamic and market demands. At the same time, we'll continue to protect our strong balance sheet. These actions will enable us to manage through the down cycle and capitalize on opportunities in the coming up cycle. In terms of outlook, looking ahead to the fourth quarter, we anticipate increasing demand stabilization in commercial aerospace. This starts with jet engine OEMs working to better align production and demand levels. Airframe OEM inventory destocking is expected to persist in the fourth quarter. Beyond aerospace, some industrial markets are seeing modest recovery. Others, namely oil and gas, will likely remain at low levels. As a result, we expect a fourth quarter adjusted EPS loss in the range of $0.36 to $0.44 per share, similar to our third quarter's adjusted EPS. Pivoting to our free cash flow guidance, our consistent efforts to generate and preserve cash have produced tangible results. We reduced managed written capital by $115 million in the third quarter in the midst of the steep economic decline. We expect to further reduce inventory in Q4. Just as the team quickly pivoted to cost reductions, we managed our capex spending to better match demand. To that end, We're again lowering our capital spending target for the full year. Our updated CapEx forecast range is $125 to $135 million, about 60% of the original 2020 projection. We are raising our full year 2020 free cash flow expectations to a range of $135 to $150 million before pension contribution. We're able to do this because of the successful achievements in working capital, capex, and cost structures. A great accomplishment in the midst of a very challenging environment. Looking beyond the fourth quarter, we will stay diligent to preserve or even improve on the gains that we made in 2020. First, we believe that working capital represents an opportunity for further cash flow improvement. At the end of the third quarter, managed working capital was approximately 50% of revenue. This compares to 30% at the end of 2019. We understand what it takes to get back to those 2019 levels, and we plan to make further improvements in 2021. Next, we'll continue to keep a close eye on our capital spending. We'll balance the need to fund growth and improve manufacturing efficiency with ongoing lower demand levels. Finally, we will stay disciplined on costs. We will carefully preserve our structural reductions and minimize additions as volumes return to the business. The way we operate today is fundamentally different than how we used to work. We will strive to maintain the hard-fought gains. With that, I'll turn the call back over to Bob to add some closing comments.

Thanks, Don. Your points were right on. It's been a real team effort in a very uncertain time and much appreciate the contributions of everyone. As part of ATI, our customers and our suppliers. Our comments today focus on what matters most to our shareholders and to us. These priorities are at the core of how we lead on a daily basis. First, we're managing decisively in times of great market uncertainty. That includes quickly and effectively adjusting our cost structures and inventories to match demand, and we're keeping our people safe. Secondly, we're preserving cash and maintaining liquidity. We're preserving our ability to deploy cash accretively for our shareholders. We'll be recovery ready, capitalizing on industry volume growth, as well as our strategic share gains and new business awards. Finally, we're working with our customers new and longstanding, who value our material science capabilities and advanced process technology. Our goal is to be integral to their success, helping them grow, solving even greater challenges together. In so doing, earning an ever-increasing share of their business. We're taking the actions necessary to emerge from this crisis a stronger, leaner, and more focused ATI.

Scott, back to you. Thanks, Bob. That concludes our prepared remarks. Operator, we are ready for the first question.

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the key. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. And our first question today comes from Josh Sullivan of the Benchmark Company.

Hey, good morning.

Good morning. You highlighted defense as a key market going forward. Can you just talk about how do you take share there, or is it on new program growth? Just as we think about defense budgets looking into 21 and 22, can the strength today carry over into the out years?

Great question, and good morning. Yeah, I think when you look at what we've been able to do in defense, it's being very program-specific. Clearly a big part of what we do is supporting what floats, so the nuclear navy and the propulsion systems there. We expect that to be a good, strong market for the years to come, as much in terms of fuel replenishment as anything. So I think that's a fairly solid growth opportunity for us. The other area we focus on is clearly military propulsion, both helicopter, rotary, road craft, fixed wing. So we're on very select programs that are growing, and we continue to see opportunities there. And those programs tend to last forever and obviously consume some portion of aftermarket type things that we enjoy as well. And then on ground vehicles, we're on very specific programs that are starting to gain traction. internationally or have implications for international growth on the armor side. We feel very confident. These are markets that value our material science capability, and certainly things like HRPF and our facilities at SA&C also contribute to that. Lastly, I think when you take material science and you look to the future, a lot of work going on in hypersonic type space applications. and either our very light-gauge rolling capabilities and our, you know, things like when you think about our alloy mix, zirconium, hafnium, niobium, tantalum, all those kinds of things, there's a lot of great applications for high-temperature, you know, light-gauge growth, which was really the catalyst for putting our SA&C business together with our specialty roll products business, you know, earlier this year to give that synergy and to make sure we were doing everything we could. defense, you know, continuing to be strong, you know, basically because of the programs that we're involved in.

Got it. Got it. And then, you know, just curious if you had thoughts on, you know, comments from Raytheon's announcement to do some more turbine airfoil production. You know, I know you guys have a very good relationship with the company. You know, just curious on your thoughts on what they might be doing and, you know, how, you know, you might be involved or just what you're thinking as far as that announcement.

Yeah, we're still adjusting to the new name for Raytheon, and so our connection really obviously is with the Pratt & Whitney family that's there, and we feel we have some good, strong relationships to grow in the future. I can't really comment on what their plans are, but, you know, we continue to be very actively engaged with what they need on a material science basis, and so we're confident that they still have a good growth projection, a profile. Got it.

And then just one last one on commercial aftermarket, you know, for engines that are out of large-scale OEM production or even out of production altogether, you know, is there any demand pull on the aftermarket side for those engines, or how does the order flow look like for those engines that are out of large-scale OEM production at this point?

Yeah, I know that's a question you've asked a couple other times for us, and I think what we've always said is it's harder for us to see exactly where the aftermarket is. It's an important part of our business. Probably, I think we've said publicly, 20%, 25% of what we do is in the aftermarket. And so we track it by basically it's at the forging level, forging business, and we see the parts specifically coming through. But at this stage, we think it's still going to be there for a while. It's not a growth space for us when the engines start to I think we're well positioned for that next generation. Obviously, the leaps and the geared turbo fans, so that's really where the future is going to be for us.

Got it. I'll figure out a different way to ask the question next time.

All right. Well, it's okay. It's early in the morning. We're ready.

And our next question will come from Phil Gibbs of T-Bank Capital Markets.

Hey, good morning. Good morning. So as you guys look at your cost reductions and your new targets for 2020, which, Don, I think you lifted this morning, what's the implication in terms of how much incremental cost savings we can get in the fourth quarter relative to the third?

Yeah, we've made fantastic progress in terms of the cost initiatives that we triggered early on as soon as we saw the changes going on in the markets. To give you some perspective, Phil, if you think about it, we captured about 60 to 65 million of cost reductions in Q3. That was roughly twice the size of the capture that we got in Q2. So as you think about Q4, we feel like we've kind of hit a good pace. I would think some marginal improvement in Q4 relative to Q3, but still in that probably 65 million range for the quarter. That sets you up for a run rate in the 260 to probably 275 range for 2021. And so I think that's how you want to think about run rate. And of course the other key area of the cost reductions is how much of those cost reductions are we going to keep? What's structural? And for that, I would stick with the guideline that we gave you before, which is, you know, we said we were targeting 40 to 50% of our cost reductions to be structural. I would lean toward the 40%. And that, as you do the math, will set you up for about $100 million plus of structural cost reductions. And, of course, I don't have to tell you the math on that. Those structural cost benefits are gifts that are going to keep giving through the up cycle. They're going to be beneficial to expanding our margins and increasing our cash generation. And it should create some really substantial benefits. enterprise value for our shareholders. So we're really happy with the outcome that we've had so far on our cost reduction and the quick response that we've had from our team.

Thanks, Don. It looks like you did have a pretty healthy pension contribution in the third quarter, which I think we may have anticipated was going to be 4Q weighted. What do we have left on the pension contributions in the fourth quarter to come?

Yeah, you're right. We had in excess of $60 million of contributions in the third quarter. We're still targeting $130 million for the full year. That means we've got about $35 million left in Q4. So that sets us up on this glide path for getting our pension plan really fully funded, or at least to a de minimis level over the next number of years. And so As you think about, again, 2021, as everybody's trying to wrap their head around those expectations, we've said before that 130 for 2020. As you look to 2021 to 2023, we should be averaging closer to probably $80 million with 2021 kind of in the $100 million range. Again, really pleased with the glide path that we're in with our pension. We're heading in the right direction, and it's still a clear priority for us.

Okay, terrific. I'll hop back in queue. Appreciate it.

You bet.

The next question comes from Gautam Khanna of Cowan.

Hey, guys. Good morning. Thank you. Hey, good morning. Hey, just wanted to ask about your visibility on the aerospace side right now. I think there was a discussion about a recovery in the second half of next year, and you know, just if you could frame your confidence around that, you know, what kind of forward visibility do you have in terms of what you're expected, maybe jet engine or airframe deliveries are likely to look, do you have visibility out into the second half of next year or just how dynamic is that situation?

Yeah. Yeah. At the tail end there, that's the ultimate question. But thanks for the question. You know, the, There's a supply chain, and as an understatement, it's an ecosystem. It's always evolving in a current dynamic environment. But what we're doing is we really get the benefit of, I'd say, the forging business is kind of our starting point where you're looking at part-specific activity with specific programs and our relationships with the big OEMs. And we know that they were pretty aggressive in adjusting their inventories quickly, starting Q4 of last year into the first part of 2020. We think that we're in a pretty good inventory management position. As we get into the back half of 2021, we should be able to see that inventory burn off, but it's based on day-to-day talking to the customer, to be honest with you. We get a lot of different inputs. We actually listen to some financial analysts who talk about the build rates and talking to the customers, and it's really about their tactical activity. I think on the airframe side, we all recognize that the airframe supply chain was consuming more than they were needing into 2019 with the situation with the MAX. We also see lower wide-body production. So one of the great measurements match up with current order demand. As Don said, one of the great opportunities for us is right now we're at about a 50% working capital to sales kind of ratio. We should be much closer to 30%, if not better than that, over the long term. That's kind of our own internal indicator of where is the supply chain as we start to release our trapped materials. That'll tell you that they've started to burn off, but The real challenge, I think, is we're still waiting on the max return to service. And I think once that happens, you tell me when it's going to happen, but let's assume it happens, you know, and we start to see visibility coming back in January and February. I think that's when we'll get our first true look at what the recovery is going to look like. But it's still looking at inventory levels, talking to key suppliers, and certainly investing with our customers the time. There's no lack of conversation going on. It's a matter of the biggest wild card for us is the max return to service at this point.

And just maybe as a follow-up, Rich, I'm sorry, Bob, I apologize.

I go by lots of different names, God, it's okay.

I was just curious, you know, the jet engine sales number that you guys revealed in the slide deck, Do you think that is a low watermark, if you will? I mean, from here, do you – I mean, maybe Q4 drifts a little lower because there's always kind of channel destocking into the calendar year-end. But do you think that marks, you know, this quarter Q3, Q4 will mark kind of the low point? It is a destocked level, if you will, below underlying consumption of the end user. Or do you think, you know, we're going to be hanging out at a level like this or maybe even below that in the first half of next year. Just what's the shape of that? I'm just trying to understand what is underlying consumption versus what you guys are actually feeling today.

Yeah, I think I'll give you my comments with one caveat. So I think if you took Q3 with still a little bit of a transition quarter, Q4, Q1, and Q2, they all kind of have that they'll kind of resemble the same pattern. I think we are bouncing off the bottom. Some of that is when I look at the news that comes across my desk, I would say today it's more up than down, you know, where for the last 180 days, it's hard to believe it's only been 180 days that we've been in this pandemic that was mostly down, right? Negative type stuff.

So I think the mood has shifted quite a bit.

So I think Q4 to Q1, you know, the Q2 probably flat for the demand. I think a couple of tidbits we're working through is that we're going to have some tough comps going forward, right, and Q1 particularly. But I think if you look sequentially, I think you'll get a good track record. And then not all our friends in the OEM business are as effective at managing their forward demand as others. There's always one of the guys that we have to wait and see. They tend to do more of their adjustments in Q1. We could still get some modest inventory corrections from one or two players, but I think for the core customers that we depend upon in the jet engine space, we think we're at the bottom and it should flatten here for the next couple of quarters. Certainly, the work we're doing on the decremental margins, it should still be still got to be on our mind.

Well, thanks again. I appreciate the answers and the insight. Good luck with everything.

Yep, thank you.

The next question will come from Tim Natanis of Bank of America.

Hey, good morning.

Good morning. Sorry about the delay there. So thanks for all the detail. You could elaborate a little bit more on the CapEx and where it was cut and how low it can go going forward. And then also there was a comment I caught on the discussion about possible acquisitions. Just wanted a little more detail on that also.

Sure. This is Don. Let me take a run at that question. First, from a CapEx standpoint, we reacted very, very quickly to right-size our our CapEx to where we were seeing demand going. When we entered the year, we were expecting to spend in excess of $200 million. If you look at our Q3 numbers, Dimno, what you're going to see is a run rate closer to $120 million, so very positive. In terms of where the cuts have happened, it's really been pretty broad-based across all of the segments, and it's really about prioritizing where we're spending the CapEx. We're looking at it just like our cost structures. We're dismantling our capital spending. We're looking at what the highest priorities are from a maintenance standpoint. And then when it comes to any growth capex whatsoever, you know, we're, of course, interested in growing, but we can't spend a dime ahead of when it needs to be spent, and we have to be drop-dead certain that we're going to get the returns that we believe we're going to get with these investments. So what you've seen in 2020, you should expect to see in 2021. similar discipline, similar flexing based upon what the customer needs and what the demand levels are in the end market. The second part of your question, would you repeat that?

Yes, sir.

Acquisitions, that's right. Okay, so the way to think about it is it really comes down to what's your priorities with your capital. And, you know, our priorities around capital allocation, Tim, has not changed. Number one, We have to ensure that we have adequate liquidity in the business to keep it healthy. And we're there. Check that box. $950 million of liquidity. Second priority is we make sure that we're taking care of our people and we make sure that we're maintaining our assets. Check. We're doing that. Third, we are on a glide path to the pension. We're going to continue to make our pension contributions and see ourselves work down that pension commitment to a de minimis level over the next several years. Check. We've got that covered. At that point, our priorities really are focused on where we deploy capital to do kind of effectively two things. Crudely grow, and the second is really take care of our maturing debt facilities. So let's focus on the growth. It's organic or inorganic, and we do measure the differences You know, we understand that organic growth will get us so far in terms of our business. Inorganic growth may be an enhancer. How do we look at that inorganic growth and are we open to inorganic growth is what you're asking us, Tim. And the reality is we are. We have put ourselves very intentionally in a position to have choices. But it's also choices that are going to be executed based upon the discipline you've seen over these last few quarters. And as we look at M&A, it's also important to understand our priorities there. Our priority is aerospace and defense growth. That's our core. That's where we make our highest margins. That's where we've experienced the healthiest growth. And so as we deploy capital to growth, whether it's internal or external, it has the priority toward a preference toward aerospace and defense and will be opportunistic. We see opportunities really often, and we're pretty discerning and pretty careful as we make those decisions. But we do see it as a possibility.

Yeah, I think that's right, Don. I think it's about expanding into, you know, material science capabilities that can go into components, right? We understand our material science capabilities, but almost everything we sell, something else happens to it before it gets on the end use. We see some really unique opportunities coming in defense for high-temperature structures. powder metallurgy plays into that game, the form. There are times, Tim, now you might accuse us of being in the lumberyard business in some aspects of our business, and we think going up the value chain to be nearer to the end state is actually where there's an opportunity for further differentiation, leveraging our advanced processes and certainly our material science. Hopefully that helps with the color you were looking for.

Okay, thanks for that. Yeah, just trying to understand, like, if you're, you know, going to finish some of the isothermal forge press CapEx or where that stands relative to thinking about M&A and how those priorities would be going forward. But I can follow up offline.

Tim, I can actually answer that question for you. The answer is yes in due time. But it's really going to be dependent upon, you know, what the demand in the market is and when we would need it. those assets to be in place to meet the demand that our customers put in front of us. We're not going to rush to spend the money. They're still good investments at the right time.

That makes sense. So my other question was just to put you on the spot if we could, obviously election day in a couple days, and I was just wondering if you could comment at all if you have any insights as to the impact one way or another, specifically on trade, for example, if it's not too late to revive trade. some of the slab re-rolling opportunities at the rolling mill or with regard to defense spending. Any thoughts there?

Yeah, I think I'll start with the defense spending. I think in the near term, near to medium term, I think the defense spending will continue. I think that the opportunities for the programs that we're on specifically feel relatively strong for a long period of time, not necessarily driven by you know, politics, but by, you know, global threats and defense needs. So we spend a lot of time. We have a dedicated team in D.C. who is spending a lot of time with the Pentagon and various folks. And so I think on defense we feel relatively strong. In terms of, you know, assets that we might have idled, you know, they're always idled such that they could be returned to service, but we continue to deemphasize our position in stainless. And, you know, I think we're interested in – using the HRPF that we have in Pennsylvania for cash generation. We think there's still a lot of opportunities. We still get inquiries about using that capability. As we all remember, it was built for a capability, and it came with a capacity, and we still get inquiries to do that. The markets have been up and down over the last 180 to 200 days, so it's a little harder to tell where that may go. I think our focus is clearly on aerospace and defense. That's where we want to go. We also have our adjacent markets in electronics, medical, space. The places we're going to invest actually are in the aerospace-like profitability ranges. There are good opportunities there in those markets. We've been in that lower value space, you know, we're open to that.

Okay. Thanks, guys. Best of luck.

Thank you.

The next question comes from David Strauss in Barclays.

Thanks. Good morning.

Morning, David.

Apologies if any of these have been asked. I joined late from another call. Free cash flows, we think about 21 and the moving pieces there between, I heard the comments on CapEx, but CapEx, working capital, cash taxes, and I guess both including and excluding pension contribution. Would you expect it to grow in 21 versus 20?

Hey, David, this is Don. We haven't given guidance yet for 2021, but let me give you some colors. Of course, in 2020, we're expecting to generate somewhere between $135 and $150 million of free cash flow in a pretty challenging environment. How do we get there? Well, there's three levers that we're managing. It's about our cost structures, it's about our CapEx, and it's about our working capital. The way to think about 2021 is you're going to see, number one, the same discipline around the same levers. As we look at our cost structures, we're going to work very hard to continue to capture cost savings and maintain the gains that we've already captured in 2020. I've already talked about the structural savings being the range of $100 million even in the recovery, so I feel very positive about that. When it comes to our CapEx, the same discipline that you see in 2020 where we took our CapEx really shaped it to the new demand, took it from $200 million down to a run rate after Q3 at about $120 million. Expect to see that very, very same discipline applied as we look at what the market demand is in 2021. And then the last lever, and what's I think really key to understand how we're viewing 2021, and this will likely be reflected when we give our guidance for free cash flow, is how we're thinking about our managed working capital levels. So Bob already touched on this, but I want to drive home how important this is. We ended Q3 with a managed working capital as a percent of revenue at about 50%. And you know, David, that we ended in 2019. That metric was managed working capital at 30% of revenue. That 20% delta we see as a massive opportunity, and we are going after it aggressively today, and it's really going to unfold in 2021 as we release the captured inventory that we have and really apply some pretty solid methodologies to make sure that we're not creating any new stranded inventories. And that should be a significant source of cash generation for us.

Great, that's helpful. So you think the biggest lever to get back down towards that 30% range is on the inventory side more so than anything still to be done in terms of receivables and payables?

Yeah, receivables, you know, we're doing a good job around that. We're not seeing any issues, no delays. The receivables are working with their way down in the normal course. Payables, the way to think about payables, no step change in the DPOs. We have picked up a couple days in our favor around payables, but I'm not expecting a step change there. The real opportunity here and what we're focused on is really inventory. And in our mind, it's a really big opportunity.

Okay. And then... thinking about the trajectory on, on arrow and what you're talking about, uh, you know, in the second half of the year, next year, things, you know, maybe starting to get a bit better, um, between here and there, should we expect that you're, I mean, you've done a great job on incremental margins, uh, thus far, should we expect that, you know, the level of decremental margins would continue to, to shrink from here? Or you think kind of You know, 25% decrementals, which is, I think, what you did in the quarter. Is that the right way to think about what those will look like over the next couple quarters?

Yeah, I'm glad you asked the question. You're right. We made some really good progress around our decremental margins. Last quarter, too, we were at 28%. We worked that down to 25%. So how should we think about decremental margins going forward? Really, I think as you're modeling it, you want to think about our decrementals in the 25% to 30% range. Remember the fact that as we look at what's created those really favorable decremental margins, it's really about our cost initiatives. There's two baskets to that. One basket is what I call variable-related. We're variable-izing our cost structures, which is going to enable us to continue to flex as the end markets are moving up and down. So we're in good shape there. The other key thing, and it will continue to benefit our decremental margins as you go through 2021, and even the upcycle, are those structural changes. I know I've mentioned it several times, but it is quite important. As you guys are thinking about 2021 and beyond, As we keep that $100 million of incremental savings as structural, that's a gift that keeps giving. And it's going to contribute not just to beneficial decremental margins and incremental margins, but also our cash flow.

Okay. I guess in, you know, following up on that, I mean, bottle it. I mean, with this kind of business in the past, we've gotten used to 40%, 50% kind of decrementals. I mean, what is, you know, how has the approach been different this time to allow you to, you know, to be able to hold, you know, at much, much lower levels in terms of the decrementals we're seeing?

We've been very aggressive, David, on making sure we're running the right facilities. We actually – an indefinite idle today. They were our higher cost facilities and so the challenge there is we use the term cold dark and quiet candidly that you have to take those facilities offline and eliminate the cost to the maximum. Now for those facilities to come back online obviously they have to be justified, justified to reinvest the working capital and justified to add the capacity and in the meantime you know, making structural changes in those facilities that they'd be viable when they did come back. So I think what's different this time is primarily driven by the magnitude and probably the duration of the economic situation. We were able to take more structural change than we ever have before. And so that's been a huge contributor to that. Don, did you want to add some more color to Dave's question?

Yeah, I think certainly we're facing unprecedented times. And one of our key mottos internally is don't waste a good crisis. And so really the dramatic changes in the end markets driven by COVID have opened up new opportunities for us to make fundamental changes that maybe in the past were a more difficult thing to do. So for us and for our teammates in the operations, everything's on the table. And so that opens up new opportunities that maybe others hadn't seen in the past. And it's not bad. It's actually a really good outcome of a really tough situation with a crisis. I think that crisis gets us to recovery ready. We recognize that being recovery ready is important for our key customers.

It's not a generic term or a blank check, actually. It's really driven by what specific actions would we take in the supply chain And what's the lead time to take those? And candidly, on a weekly basis, we're looking at our customers' forward look. And candidly, the reports you put out and some of the other analysts as you look out, we try to gather where do we need to be and when do we need to be there. But we've taken a more conservative view, I think, of what demand is going to be in the near term to be positioned on a cost basis to achieve that.

Okay. Thanks very much for the call. I appreciate it.

Yep. Thanks, David.

Our next question comes from Paratash Musra of Berenberg.

Thank you. Good morning. Question about next year, 2021, regarding your jet engine and airframe business. Are you expecting any contribution from price increase also to your top line because maybe some new contracts starting with the new calendar year? or it's mainly a volume story as we look into next year, volume stabilizing and gradually recovering?

I would say the morning pair test, three components to that. Some of the contract renewals we had did have, we call it margin enhancement, and it came from one of two sources. It could be unit price, but it also could be product mix. So we continue to drive as we get more share in the jet engine space and even in some of our airframe spaces, we've been able to get a better product mix that plays more favorably to either the alloys and or dimensions of products that we make. So I'd say there's some that is going to be driven by that, but the majority of it would be increasing in volume.

Got it. And with regard to the inventory of your products that your customers carry, on the jet engine side and the airframe side. Is that around three to six months typically, give or take, or higher?

Yeah, I don't know exactly how much inventory they carry per se, but I would say from a lead time perspective. Historically, we've seen the lead time from shipping of forging per se to being bolted on a plane can be six months. That's a nice average. And on an uptick, it tends to get a little tighter. It can be as short as four months maybe in the best cases. So if that's what you're asking, how long from delivery of an engine to a part supplied by us as a forging, that can be four to six months. When you get into other products like billet and plate, it can extend closer to 12 to 15 months depending on the product and the challenge of the supply chain.

Got it. And if I could just ask one quick follow-up on the last question about the decremental margin. I apologize if I didn't understand it correctly, but I think you're saying that you could keep the decremental close to 25% because of the structural cost saving, right? Like that's the target, I guess, is closer to 25%. Did I understand it correctly or

Yeah, partially. What I was saying was, as you think about our decremental margins going forward, consider them in the 25% to 30% range, and that would be consistent as you go through 2021 and think about how the change in revenue would affect the bottom line. Where I raised the comment about structural changes is really around how to think once we're in the recovery, how to think about the benefits of the cost actions that we've taken. We overall have delivered a significant amount of cost reductions in themselves in the range of $260 to $275 of annualized savings. But what's key to me is what happens beyond the down cycle? How much of that can you keep? And they're It's the structural changes, and those are those gifts that keep giving. And that's in the magnitude of about $100 million plus. And so that's what I was referring to. As I said, as you think about decremental margins often in the future, especially past 2021, once we're deep into the recovery, it's important to know that those decrementals and our incremental margins going forward are going to be pretty robust.

I appreciate that. Thanks, guys.

And our next question will come from Matthew Fields of Bank of America.

Hey, guys. Hey, just want to ask about liquidity. You know, you've obviously done a fantastic job of kind of managing the working capital. But I noticed that the ABL availability dropped this quarter, presumably because your borrowing base shrunk in accordance with that. How do you think about the trade-off between kind of squeezing out cash flow and kind of managing that ABL availability?

I'm really glad you asked that question. So when you think about what's going on with availability, you're right. Usually there is a trade-off between the release of working capital, get it into your cash, but, hey, you're losing some of your availability on your ABL. We, of course, are very aware of those mechanics. So here's what we're doing. We actually have a very healthy set of initiatives that we're targeting and we're capturing that are looking at our existing collateral baskets. There are some of those collateral baskets that have historically not been included in our borrowing base, things like international receivables. There are some inventory categories that may exist with third parties. What we're doing is we're working with our banking group to get those baskets of collateral included in our ABL borrowing base going forward. What's the benefit of that? Of course, it is that even though you're converting some of your borrowing base into cash, you're replenishing the collateral, and it's really kind of free collateral if you think about it that way, Matt. And so it can be very, very beneficial to us. Our goal is, you know, we're in great shape right now with $950 million of liquidity and We're going to continue to drive increasing our cash balances. It's the right thing to do. And we're going to look to maintain our overall liquidity, even in a challenging environment, by continuing to add baskets that have been underutilized in the past. So we're doing the right things to put us in, to keep us in a healthy position.

That's great. That's very helpful. And obviously, you know, you've built up, you know, kind of a war chest of liquidity for a downturn. But, you know, now that we're another 90 days into this, how do you feel about your maturity window? Obviously your first maturity of size isn't until 2023. Do you think that that's still, you know, plenty of time? Or do you think about wanting a longer runway? Or are you comfortable that the downturn won't be as deep as you initially feared? Any thoughts on that kind of, you know, maturity schedule, you know, policy? Okay.

Yeah, we're in great shape around our debt maturities. And the reality is, with the kind of cash and liquidity that we have right now, ultimately our choice, or excuse me, our objectives were to give ourselves some choices around things like you're just describing. How do you manage these debt maturities? I think we've got a lot of runway around our debt maturities. We're in great shape. In terms of when we maybe refinance the bonds, that are going to be maturing in 2023, I'll call that a game-time decision. You know, there's a lot of dynamics that go into managing capital structure and funding your business, the growth opportunities that Timna brought up. So, you know, right now we're in a fantastic spot to be able to make those choices. And the markets have been healthy and supportive as well, which is also, of course, helpful.

And this concludes our question and answer session. I would like to turn the conference back over to Scott Mender for any closing remarks.

Thanks, Laura, and thank you to all the participants and listeners for joining us today. That concludes our third quarter 2020 conference call.

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