ATI Inc.

Good morning, everyone, and welcome to the Allegheny Technologies Incorporated fourth quarter 2020 results conference call. All participants will be in a listen-only mode. Should you need assistance, please send to 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 and then one on your telephone keypads. Withdraw your questions, you may press star and two. Please also note today's event is being recorded. At this time, I'd like to turn the conference call over to Scott Minder, Vice President, Treasurer, and Investor Relations.

Sir, please go ahead. Thank you.

Good morning and welcome to the Allegheny Technologies fourth quarter and full year 2020 earnings call. Today's discussion is being broadcast on our website at atimetals.com. Participating in today's call are Bob Weatherby, President and Chief Executive Officer, and Don Newman, Senior Vice President and Chief Financial Officer. Bob and Don will focus on full year and fourth quarter highlights and key messages, but may refer to certain slides within their remarks. These slides are available on our website, atimetals.com, and provide additional color and details on our results and outlook. 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'll turn the call over to Bob. Thanks, Scott.

Good morning. No surprise, we're glad 2020 is over. It was a challenging year, amplified by significant uncertainty, yet we made the best of it. Our team persevered and focused on doing the right things, quickly and decisively, to position ATI to emerge from the crisis stronger, a company focused on aerospace and defense. The fourth quarter results reported this morning exceeded expectations as we safely delivered for our customers, continued strong cost controls, and improved working capital efficiency. For the year, our free cash flow generation was positive overall. At $168 million pre-pension contributions, free cash flow exceeded our full-year guidance by 18%. In today's call, my remarks will focus on three major themes. Leadership priorities that drove our actions and results, our transformation to a more profitable aerospace and defense-focused company, and our outlook for our key markets. So let's start with our leadership priorities. 2020 began with reasonably strong customer demand and without a hint of a looming global pandemic. ATI posted solid first quarter 2020 financial results. We enjoyed the benefit of stable jet engine demand bolstered by increased customer volumes that were delayed from the second half of 2019. While these results will make for a difficult year over your comp in the first quarter of 2021, they did help to offset the significant headwinds we faced in the subsequent three quarters of 2020. When the pandemic took hold late in the first quarter, we responded quickly and decisively. The leadership priorities shown on slide four drove our results and continue to guide our actions today. First and foremost, we focused on keeping our people safe. Safety is a core ATI value. We quickly enacted policies and procedures around the world to ensure a virus-free work environment, mitigating the risk of spread. Our efforts continue to be largely successful. We remain vigilant to ensure our people go home safely each and every day. Second, we took the necessary actions to preserve cash and maintain liquidity. We ended the year with more than $950 million of total liquidity, including nearly $650 million of cash on hand. We extended our debt maturity profile and now have no significant debt maturities before mid-2023. Don will cover some additional achievements in more detail in a few minutes. Third, we proactively and aggressively optimized our cost structure. Our close customer relationships enabled us to match capacity with their rapidly declining demand expectations. We did what was necessary to ensure ATI would not only survive the global recession, but emerge stronger in recovery. By quickly reducing our costs, we've minimized decremental margins, limiting the steep demand drops impact on our bottom line. We eliminated approximately $170 million of costs in 2020. We continue to pursue operational improvements. We expect total cost reductions to grow to at least $270 million over the next few quarters as actions implemented in the second half of 2020 reach their full run rate. Importantly, we expect about $100 million of these cost savings to become structural, continuing to benefit ATI as we return to growth over time. It's worth noting that the additional savings we announced in December as part of our strategic transformation are incremental to these savings. Fourth, we focused on supporting our customers through continued strong execution and operational excellence. Our customers count on us to deliver the mission critical materials and components to keep their planes flying, vehicles moving, energy flowing, and medical equipment and electronics working flawlessly. I'm proud of how the team has led through 2020, focused on our people's health, our company's financial health, and strengthening our customer partnerships. Being recovery ready, our fifth leadership priority positions ATI to serve our customers and become a more sustainably profitable company over the long term. We've been rewarded with more of our customers' business as a result. In 2021, our share of jet engine materials and components on key programs is increasing. We've also won new business on airframes and are well positioned to win upcoming specialty energy projects. The bottom line here, we've accomplished a lot in 2020. Our actions created the necessary foundation for the transformation we announced in December. You may recall we're exiting standard stainless sheet products by year-end 2021 as we redeploy our capital to high return opportunities. These actions are major steps to becoming a more profitable, focused aerospace and defense leader. We're accelerating the creation of significant shareholder value. In the eight weeks since the announcement, we've hit the ground running and are executing. On slide five, you'll see two of the leading indicators we're using to track our progress toward this transformation, a streamlined footprint and an improved product mix. We have a third metric that we'll share in future progress updates. It tracks working capital release to largely self-funded projects' capital expenditures. Let me take a moment to review the major actions we're taking. First, we're consolidating our specialty roll products finishing operations to create a more competitive flow path focused on increasing production of high-value differentiated materials. This includes closing five plants within the AANS segment by year-end 2021. In the fourth quarter, we closed two finishing facilities, one in western Pennsylvania and the other in Connecticut. The three additional closures are expected in the second half of 2021. Second, we're on track to exit 100% of standard value stainless sheet products by year end 2021. In the fourth quarter, sales of these products represented 17% of AA&S segment revenues, down from 22% in full year 2019. And finally, as a reminder on the third action, we intended largely self-fund upgrades to our specialty finishing capabilities in Vandergrift, Pennsylvania. This investment of $65 to $85 million spent over three years will be largely self-funded through working capital releases triggered by the transformation. We'll make progress on this initiative as we streamline our footprint and we'll report our results as part of our next transformation update later in 2021. Let's cut to the chase here. With these actions, we're on our way to a leaner, more competitive aerospace and defense focused powerhouse. poised to substantially increase margins in the AA&S segment and generate a significantly higher return on capital for ATI. Success is largely within our control. We know we have more work to do, and we're doing it. With the demand recovery that we know will come, we're confident we'll meet our longer-term objectives. Before Don provides detail about the fourth quarter financial results, let me share my thoughts about our recent experience in key end markets and provide a near- to mid-term outlook for each. Let's start with commercial aerospace, our largest end market. As predicted in our last update, demand for jet engine forgings increased modestly in the fourth quarter. Demand for engine-related specialty materials, principally ingot and billet, continue to soften as customers destock to align inventories with near-term demand expectations. Looking ahead, we expect jet engine product sales to recover slowly in the first half of 2021, with the pace increasing in the second half of the year. We expect continued weakness in airframe sales throughout 2021 due to excess supply chain inventories. This is consistent with the guidance we provided last quarter, which already accounted for decreasing wide body production rates. Next up, defense sales. In the fourth quarter, we returned to year-over-year double-digit percentage growth. Each of ATI's defense market verticals expanded. Naval nuclear products, in support of the U.S. Navy's increased long-term demand for new ships, grew by nearly 50%. Military aerospace and ground vehicle armor each grew at a strong double-digit rate versus the prior year. We expect continued defense growth in 2021, albeit at a slower pace due to uneven demand levels across major platforms supplied by ATI. Let me give a couple of examples to illustrate what I mean by uneven demand across platforms. In naval nuclear, we expect continued demand growth. In ground vehicle armor, we expect a temporary contraction due to a one-year pause in demand on a customer's major program. Longer term, we expect ATI's advanced materials to be integral to the success of future government defense initiatives, such as hypersonics. We're also pursuing increased participation in defense applications in other parts of the world. Shifting to our energy markets. Sales continued to decline in the fourth quarter compared to prior year, but at a slower pace than in the third quarter. Our fourth quarter oil and gas and chemical processing sub-market sales dropped by more than 35%. Sales to our specialty energy markets were more resilient, declining only 6% versus the prior year. Growth continued in our civilian nuclear and pollution control product sales, while demand for electrical energy generation products remained weak. We expect fourth-quarter trends to hold in the coming quarters as demand for oil and gas remains soft. Specialty energy demand will improve due to ongoing nuclear refueling requirements and strength in Asia from land-based gas turbines, solar, and applications to reduce fossil fuel emissions. Robust demand for consumer electronics products was driven by two factors. First, customer product launches in China, and second, the increased need for our specialty alloy powders support the growth of next-generation consumer products globally. We expect increased demand levels to continue in 2021, with first-quarter sales falling sequentially, mainly due to the impact of Lunar New Year shutdowns at our precision roll strip operation in China. Our medical markets continue to decline both for MRIs and implant materials, primarily due to the effects of the pandemic. Fewer elective surgeries and restricted hospital access to install new equipment have reduced end customer demand and created excess supply chain inventory. We expect these negative trends to continue until vaccination programs reach critical mass. With that, I'll turn the call over to Don to cover our fourth quarter financial results and our first quarter and full year 2021 financial outlook. I'll be back with a few final thoughts before we open the line for your questions.

Thanks, Bob. Over the next few minutes, I'll focus on highlights from two key areas. First, our Q4 financial performance, and second, our expectations for 2021. 2020 was a difficult year for all of us. For ATI, it started with 737 max challenges that carried over from 2019. Of course, those challenges grew exponentially with the global pandemic. Its impact on our key end markets, including commercial aerospace, energy, and medical, was profound. Even with those challenges, we took the strategic and tactical steps necessary to improve our business and position it for a healthy future. Now let's discuss Q4 performance. For the third quarter in a row, our results exceeded expectations. In the Q3 earnings call, we noted seeing signs of stabilization in a number of our key end markets, like commercial aerospace. At that time, we said we expected our Q4 performance to be similar to Q3. In fact, Q4 revenue increased 10% to $658 million versus Q3 levels. We see this as a further indication of stabilization in our key end markets, and a sign that the worst of the lingering aerospace downturn is behind us. Our adjusted EBITDA increased 39% to $23 million in Q4 from Q3 levels. Adjusted EPS was a loss of 33 cents per share in Q4. This was better than the optimistic end of our EPS guidance range, which was a loss of between 36 cents and 44 cents per share. Our improved performance was largely due to stronger cost reduction actions and the higher than expected sales. Thinking of cost reductions, in early 2020, we announced targets to cut costs by between $110 and $135 million for the year. We increased those targets multiple times in 2020 as we built momentum. In the last earnings call, we shared a target of $160 to $170 million of 2020 savings. The final tally, reductions near the high end of our guidance at nearly $170 million in 2020. That means a run rate of $270 to $280 million of cost reductions that will benefit full year 2021. Those cost reductions continue to contribute to favorable decremental margins. which were below 30% for the third consecutive quarter. We expect approximately $100 million of those reductions to be structural. Those takeouts should continue to benefit earnings in the up cycle, increasing incremental margins in the future. Working capital actions initiated in Q2 and Q3 gained momentum in Q4. Our free cash flow was $168 million for full year 2020. well in excess of the top end of our guidance range of $135 to $150 million. We're extremely pleased that we closed 2020 with nearly $650 million in cash and more than $950 million of total liquidity. That's a great outcome and one that we can build on in the future. We ended Q4 with managed working capital at 41% of revenue, down 1,000 basis points from the end of Q3. Great progress. Our goal is to reduce managed working capital to less than 30% of revenue over time. I can assure you this will remain a key focus in 2021 and beyond. In addition to a strong cash and liquidity position, we continue to maintain a manageable debt maturity profile. Our nearest significant debt maturity does not occur until Q3 of 2023. Another area of success in 2020 was CapEx management, as we adjusted capital spending to fit the new demand levels. We started 2020 with a CapEx forecast of $200 to $210 million. Actual CapEx spend in 2020 totaled $137 million, 33% below the initial forecast. We managed that reduction by carefully analyzing future demand requirements, including recent share gains, and adjusting timing on large growth-related projects. We also ensured that our facilities were not over-maintained in the current period of low demand. We understand the importance of being recovery-ready, and we are prepared to handle our customers' desired pace of recovery. Now let's move to pensions. Despite the broader demand challenges, we also made meaningful strides managing our pension glide path. Our goal is to reduce our net pension obligations each year. We ended 2020 with a net pension liability of $674 million. That's nearly $60 million lower than the opening 2020 level. Strong pension asset performance and company contributions in 2020 more than offset an 80 basis point decrease in discount rates. This drove the drop in net liabilities. The lowering that pension level at the end of 2020 brings multiple earnings and cash flow benefits in 2021 and the coming years. I will detail that when I share the 2021 outlook. 2020 will be a year remembered for severe economic challenges and personal hardships for many. As a company, we have worked through this crisis to improve the business and prepare for the upcoming recovery. The team's work on strategic positioning, liquidity, and cost structures should benefit our shareholders into the future. With that, let's look ahead to 2021. While we are seeing stabilization, there is still uncertainty in terms of end market recovery timing as the COVID vaccines are in the early stages of distribution. With that uncertainty, we're going to continue the guidance structure that we started in Q2 2020. We'll provide EPS guidance for the upcoming quarter, as well as certain elements of our full year cash flows that we believe we can reasonably estimate. We'll also provide insights into what we're seeing as key trends and indicators in our business. Bob shared his thoughts regarding our key end markets. Let me recap our forward demand views and the pace of recovery within our business. We expect jet engine product sales to recover slowly in the first half of 2021, with the pace increasing in the second half. Weakness in airframe materials will continue throughout 2021, consistent with our prior estimates. Our defense sales will likely grow at a more modest pace compared to 2020 rates. Recovery in our other significant markets, namely energy and medical, is dependent on the global pace of containing the pandemic. And finally, our electronic sales should continue to expand. We expect adjusted earnings to improve in Q1 of 2021 relative to Q4 2020 due to a modest demand pickup in both segments, continued cost management, and lower pension expense. We expect a Q1 2021 adjusted EPS loss of between 23 and 30 cents per share. Let's talk about free cash flow. We expect to generate between $20 million and $60 million of free cash flow in 2021 prior to our required U.S. defined benefit pension contributions. How will we get there? Using the same discipline applied in 2020 by managing our costs, being disciplined with capital investments, and reducing managed working capital in pursuit of our working capital targets. Now, CapEx. We plan to spend between $150 and $170 million on capital investments in 2021. We adjust our 2020 capital spending to reflect the new demand levels. In 2021, we will maintain that discipline, but plan to increase spending marginally in anticipation of coming market recovery. As announced in December, we will also invest modestly to enhance specialty finishing capabilities within our specialty rolled products operations. I have good news on our expected 2021 pension plan contributions. As you know, contributions to the U.S. pension plans in 2020 were $130 million. Due in part to strong 2020 pension asset returns, Required contributions to the U.S. plans are anticipated to be $87 million in 2021, a reduction of more than $40 million year over year. 2021 pension expense will also decrease, dropping $17 million year over year. Pension expense will be $23 million in 2021, down from $40 million of recurring pension expense in 2020. In regard to working capital, we expect to continue improving our levels in 2021. We'll pursue our goal of returning working capital levels to 30% of sales as our key end markets recover. Working capital reductions related to our transformational project will also support the significant improvement. Overall, we expect working capital to be a modest source of cash in 2021, even after contributing significantly to our cash balances in 2020. Finally, in terms of income taxes, we do not expect to be a cash taxpayer in the U.S. for years to come. That said, we do anticipate paying taxes in certain foreign jurisdictions. We are not able to provide an estimated annual tax rate for 2021 due to uncertainty of the rates and low earnings. We can say that we expect to pay between $10 and $15 million in cash taxes during the year. We are proud of what our team has achieved in 2020 and look forward to continuing to build on our efforts to make ATI a leaner and more profitable company. We are well positioned to benefit from the coming aerospace recovery. This will be even stronger for us thanks to ATI-specific share gains and new business wins. With that, I'll turn the call back over to Bob.

Thanks, Don. Well, there you have it, some pretty good outcomes, and we're proud of it. We accomplished a lot in 2020. It's still great to be starting 2021 with a clear plan, and we're boosted by the first signs of favorable multi-market trends we've seen in over a year. As Don described, we ended the year with a strong performance in a challenging market environment. Our progress in 2020 was a total team effort that delivered results. We worked diligently to control what we could and responded nimbly to what we couldn't. Our entire organization remains relentlessly focused on cash generation. I'm proud of how we're living our values, guiding us every step of the way. Today, in 2021, we still battle a fair amount of uncertainty, but there's already a lot less turbulence than we saw last year. We're gaining velocity, aligned and accelerating in a clear direction as we move ahead. We're well positioned to emerge from this downturn in a leaner, more profitable API, a fierce competitor not waiting for markets to recover as we gain momentum.

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

Ladies and gentlemen, at this time, we'll begin the question and answer session. To ask a question, you may press star and then one on your touch-tone telephone. If you are using a speakerphone, we do ask that you please pick up your handset before pressing the keys. To withdraw your questions, you may press star and two. We do ask that you please limit yourself to one question and one follow-up. If you do have further questions, you may re-enter the question queue.

At this time, we will pause momentarily to assemble the roster. And our first question today comes from Richard Safran from Seaport Global.

Please go ahead with your question.

Bob, Don, Scott, good morning. How are you?

Good morning, Rich. Welcome back.

Thanks, sir. So two questions both related to what a recovery looks like. First, with respect to jet engine products, I wanted to know if you could talk a bit about how jet engine products recover with higher volumes. Now, Bob, I think you mentioned forgings in your opening remarks. I think materials lag. But I was curious about how different types of forgings, castings, and alloy manufacturing, what that looks like in a recovery.

Okay, great. Yeah, so let me take the first part on the shape of the recovery from the market aspect. And then I'll let Don talk about kind of the shape of the recovery from the ATI perspective in light of the transformation that we're going through. So that's why we'll help get to that answer. I think when it comes to the jet engine materials, you're right. Our isothermal forgings are really kind of the leader of the pack for us in terms of the jet engine business. You know, we've started to see – well, I guess during the downturn, our jet engine customers were pretty aggressive at adjusting their supply chain inventories and the demand pretty quickly. And so we don't see a tremendous amount of inventory in the pipeline. We have a little bit of stranded inventory ourselves that we're working through. But you're right, the isothermal forgings will go – will kind of pace with increases in demand pretty quickly, lead times being what they are. We're starting to see, you know, real demand coming back. I think it will accelerate through mid-year and be stronger in the back half. That's coupled with some share gains that we have coming into 2021 as well. So I think the isothermal forgings will be our leader of the pack. We have some smaller aerospace forgings that will go along with that. You know, we're not in the castings business anymore, so we don't have quite as much visibility there, but I would expect, you know, they'll follow a similar trend. You know, when it comes to billet, bar, ingot, you know, we're starting to see what I'd call emerging demand. One of the things that happened in the downturn was that every company, I hate to say every man for himself, but every company was doing what they thought they needed to do to manage their cash. So not everyone in the supply chain that we supply is as well positioned for an uptick. So we'll see it a little lumpy. There should be some good emergency demand, and we think we're well positioned to respond to that. And you didn't ask specifically about airframe, but I think – By mid-year, I think the billet ingot bar will be moving in the right direction for us. We'll start to see it tracking with engines. But I think the airframe side, plate in particular, titanium plate, could be slow for most of 2021 before it starts to kind of work its way. And then 2022, we should start to see some increase there. So hopefully that helps on the jet engine side. But I think the worst of it for us was Q4. Q1 is still a little bit of stabilization. We're not seeing the ups and downs that we saw in the order book before. So, Don, maybe I'll turn it over to you, and you can talk a little bit about the transformation. Sure.

There's a few different transformation elements that we're talking about in the overall business. But in terms specifically of the jet engine and – and how we're managing our inventory and being recovery ready. I think one point to reinforce is we've done, I think, a very good job in managing down our inventory levels, but it's always been with the mindset of being recovery ready. So as the market does turn and the demand signals are sent, we're in a good position that we can meet those demands. But there's a broader effort around transformation that we've been doing in the business that are going to benefit us beyond just the jet engine market. jet engine space that you're talking about. And I think it's an important thing to think about as you consider what this business looks like in the recovery. And so let me kind of walk you through and give you some perspective. You know, we've got a number of initiatives that we've got in place that we've talked about throughout 2020. Those initiatives include a lot of cost takeouts that were delivered in 2020 that are going to have a wraparound effect. in 2021, and we've got a transformational project that we announced in December that's going to materially change our specialty road products business. A fair question to ask, Rich, if this is kind of what you were pointing toward is, hey, when you add up all this transformation, what does the new business look like at a normalized level? And so, you know, as you think about that, In 2019, which is called a normalized period for us, we generated $440 million of EBITDA and we generated about 11% EBITDA margins off of that. With the cost takeouts that we have captured through 2020, as well as the transformational project that we spoke to in December, Between those two efforts, the result is upward of $200 million of run rate EBITDA added to what we delivered in 2019. And so the effect of that is pretty profound. That 11% 2019 EBITDA margin, and with a pro forma reflection of what we've captured on cost reductions and what we are capturing and highly confident we can capture with the transformation in the SRP business, really makes this a 17 plus percent EBITDA margin at 2019 volume levels. And so that's 600 basis point expansion in EBITDA margin. So as you're talking about transformation, as you're talking about how the business is evolving for 2021 and beyond, that's really how we think about the business and the benefits of these actions that we carry.

Thanks for that. Just quickly as a follow-up, those specialty energy projects that were referenced in your opening remarks, could you just discuss a bit about how much they're worth and when do you see those decisions being made?

Yeah. A lot of those decisions have actually been made in terms of other two types of things we're talking about. I think there's the pollution control activity, which is nickel alloy type materials that are going into A lot of those decisions have been made, and that will actually happen in 2021. I think the orders, if they're not in hand, they're here. The commitments have been made. We're also, you know, seeing, you know, continued strength in the solar space. Certainly, we're starting to see signs of land-based gas turbines kind of coming back. And then the last piece of that is really probably you're referring to is the clad pipes. And a lot of those are being let, like, right now, right? So I think there's a pretty good order stack up over the next two, three years of some fairly major projects. We won't win them all, but we're going to be competitive on all of them. And so I think we'll start to see that probably hitting in Q2 from a shipment standpoint. That's our expectation. Does that help, Rich?

It really does. Thanks for the color, guys. I appreciate it.

Yep.

And our next question comes from Gautam Khanna from Callen. Please go ahead with your question.

Hey, guys. Good morning.

Good morning, Gautam.

Just wanted to ask maybe two questions. First, on the quarter itself, the high-performance EBIT margin, you know, stripping out DNA and everything, was, what, negative 5.4%. I was wondering if there was anything... It didn't look like mix was materially different sequentially. Was it just working days or something of that nature that brought it down sequentially? And then I have a follow-up.

Okay, so I'll take the first one, Gotham. I think what you saw in Q4, in addition to a slightly weaker mix, a little more transactional business that wasn't in the aerospace category, so that contributed to it. The other thing that was going on in Q4, we actually had some proactive inventory management, so we wrote off some inventory

that uh obviously affected the margins in q4 but there's not going to be an ongoing concern okay and and just to be clear on your as a follow-up the um you're quite convinced it sounds like that uh engine destocking has sort of peaked at this point so on a sequential basis q1 q2 it should get better than what we saw in Q3 and Q4, and obviously then pick up with rates on the A320 and the like in the second half of the year. I just want to make sure I understood that. And secondly, as a related airframe titanium, despite all the Boeing 787 developments since the third quarter, you know, where they haven't been delivering aircraft, that does not change what you previously were expecting on airframe tie in 2021.

Okay, so let's see. So the first answer to your question, and I'll add a little cover, is yes, we're confident in the jet engine side, partly because of the, you know, the day-to-day pulse with those customers. I would say there's always going to be, you know, adjustments to schedules, you know, but I think what we're seeing is more clarity. And we were fairly confident that, you know, a lot of the adjustment that came to us really in jet engines started in late 2019, you know, related to – issues related to the MAX. I think most of those supply chains got adjusted quickly. I think the wide body issues, we've had probably three quarters since a lot of that activity started to become known. I think the jet engine side, there's always going to be exceptions, but I think generally the answer to your question is yes, we're confident that we should see improvement really throughout the year, but accelerating in Q, or in the first half, and then looking much better in the second half as we get ready, the pipeline gets ready for 2022. I guess the jet engine question, and I think going back to your other question about tide plate, yeah, we believe 2021 will be the low water mark. I think we're following and tracking with Boeing's announcement of where they're going on a build. And I think, you know, we are picking up share in the airframe business globally. So that'll help us in the back half of 2021. But I think it's going to be a, it'll be for Tide Plate specifically, what you asked about, I think 2021 will be the low watermark for us there.

Thanks a lot, guys.

Our next question comes from Phil Gibbs from KeyBank Capital Markets. Please go ahead with your question.

Hey, good morning.

Good morning, Phil.

My first question is just on the free cash flow bridge. I think you had pointed to being $40 million positive at the midpoint, excluding pension. When I think, Don, about cash contributions, I've got about $100 million of interest, $160 million of capex and cash taxes, and then you've got some offset from net working capital. You know, I'm ranging somewhere between $225 and $250 million of cash needs for you all this year. Should we kind of take that as a decent range in terms of what you're trying to communicate and then add free cash flow to that to back into an EBITDA view in terms of what you all view as the potential for the year?

Yeah, I think your logic is sound. What I would say is I wouldn't expect that kind of cash burn. But, you know, you think about where we're at from a cash generation standpoint. We've done a pretty good job pulling the right levers to manage cash through 2020 and ended at a really good, really, really good spot. I do expect net-net to be a cash burner in 2021. Maybe not to the degree that you're thinking, but one thing that was a great benefit for us in 2020 that will be less of a benefit for us in 2021 is working capital releases. And why is that? Well, with the decline that we had in the first half of 2020, we had pretty significant releases. around our accounts receivable. And then later in the year, we were picking up momentum on our inventory releases. As you think about 2021, as we see 2021, second half, we would expect to see some growth in the business, which would then be a requirement for putting working capital on the ground. But we still think net-net that working capital is going to provide a source of cash for us. So that may be missing a bit from your calculation. That plus, we are pre-disciplined when it comes to managing our levers. What we did in 2020, we adjust our CapEx pretty significantly to reflect the new demand. Expect that we're going to do the same things in 2021. And we will adjust our CapEx and we will adjust our inventory to really respond to the market signals. So that could be, again, a bit of a positive relative to the burn number that you were talking about. All that said.

Oh, Don, I wasn't talking about a burn. I was talking about the slide nine. From what I gathered, you had free cash flow, positive free cash flow of $20 million to $60 million, unless I'm looking at that wrong.

Yeah, that is pre-pension contribution. And so that's right. I think the key takeaway when you think about our cash flow for 2021 is I would expect, based upon what we know today, to be a cash user. But I think it will be a modest use. And we're going to exit 2021 with still a very, very healthy level of liquidity. And we'll adjust to the end market signals from a demand standpoint. accordingly, whether that means we need to add more working capital in the form of inventory or whether we need to pull levers to reduce capex.

Okay. And then just in terms of a follow-up, I know clearly there were absorption issues for you all in the second half. I think, Bob, you had just mentioned you had written down some inventory. Any way to calibrate in terms of how much the underabsorption plus some of these inventory write-downs impacted your P&L in the second half of the year? Could it have been $20 million a quarter, that type of thing? And when do you expect some of these things to desist in terms of the magnitude of impact? Thank you.

Yeah, I think your back of the envelope is not that far off, Phil. As you look at it, there are some adjustments we took in terms of carrying value around inventories, and there's the effect of the under-absorption. To think in terms of 10 to 20 million a quarter as a combination for those two through 2020, I think you're not that far off. How to think about it for 2021, again, it really depends upon the production level and the demand signals we get. In the first half, if we expect first half to look similar, to the second half of 2020, then you can think in similar effects to underabsorption. I think from an inventory carrying value standpoint, I would like to think that any net realizable value reserves that we had to book have already been taken, so we shouldn't see significant effect there. But underabsorption would still be a potential for us, especially in the first half. You get to the second half, it's a little bit different. And that really depends upon the pace of growth, right? And so it's a little bit harder for us to speak to that.

Thank you all. Appreciate it.

Our next question comes from Josh Sullivan from the Benchmark Company. Please go ahead with your question.

Hey, good morning, and congratulations on the quarter here. Actually, just following up on those cash burn comments for 2021, is there a scenario in 2022 where demand is going to potentially be picking up a little stronger where we would continue to see a working capital build in a cash burn? Or do you think you'll be set up exiting 21 where 2022 shouldn't see a burn even in a very strong demand environment?

So the short answer is if there's strong demand, I would expect that we'll be adding working capital. and 2022. It really depends on the pace of the recovery. It also depends upon our, you know, we've talked a lot in 2020 about our focus on improving our working capital efficiency. And we did a phenomenal job of that in Q4. I mentioned in the prepared remarks that we reduced our percentage of working capital from 50% at the end of Q3 down to 40%. in Q4, our internal goal is we want to get back to the 30% level and lower. Well, the pace for our being able to achieve that goal is going to be an offset to what we need to add to our working capital because of an uptick. And so if we're really fortunate, we can do a good job offsetting the requirement for investing in working capital. with becoming more efficient with working capital. But generally, I think you should think of 2022 as a year of investing for additional working capital to fund the growth that we're seeing in 2022, which is, obviously, that's a good thing, right? We don't mind investing for growth.

Right. No, thanks for that. And then just switching over to the strength in the Stahl venture in China, can you just provide us some color on the strength in those markets sequentially? We had Apple deliver its largest number of iPhones by some estimates ever. Is that strength for Stahl more broad-based than consumer electronics, or is that really the focus market for you guys?

Great question. So I'll start off with congratulating the team that runs our precision-rolled strip business in China. the fourth quarter was a record performance for them. And it's based on the investments we made there probably a year and a half to two years ago. So they were well positioned and they took advantage of it. Now, in terms of the broad base, I think you start with consumer electronics at the core. We're starting to see the initial opportunities in solar that we've been kind of waiting for, to be candid, for a year or two, but we think there's growth there. There are things in our precision rolled strip businesses there that go into medical applications. You can see some things, you know, hypodermic needles, various other things that PRS, precision rolled strip, goes into. And in automotive, it's still an automotive play for us in Asia. There are, you know, we're making stainless, especially stainless that is the thickness of a human hair. So there's a lot of applications and more sophisticated automotive applications that are there. So I think It is broader than just consumer electronics. So we feel good about, other than the Lunar New Year, which we can't do much about in Q1 seasonally, we expect that trend to continue based on the strength of the underlying markets.

Thank you.

Our next question comes from Timna Tanners from Bank of America. Please go ahead with your question.

Yeah, hey, good morning. Morning, Timna. I just wanted to ask two things. One is if we could kind of continue the discussion about cash uses but talk a little bit instead of working capital maybe about CapEx needs going forward because I caught on to your comments about pushing out some projects and just wondering what that looks like when you catch up and how you're thinking about that and then I have a high-level question.

Sure. I'll take a run at answering that. As you think about 2020, we went into 2020. with the intent that we were going to invest somewhere between $200 million, $210 million in CapEx. And then, of course, when the pandemic hit, we hit the brakes. We did it in a very thoughtful way, but we really peeled back on that investment, took it down to the mid-130s, ultimately, for 2020. As you look at 2021, our guidance is 150 to 170. The increase year-over-year is a modest increase to with the idea that we do expect to see some end market recovery that is going to create some demand pull for investment in certain assets. It's in support of specific customers. This is not a build it and they will come kind of approach. That's not how we do our CapEx. So I think if the 2021 plays out like we expect it will be, we're going to be in that 150 to 170 range. Then if you're thinking past that, okay, what's the right way to think about capital investment post-2021? I think the $200 million to $210 million investment level that we were thinking for 2019, which was part of a normalized, coming off of a normalized 2019, getting ready for organic growth that we saw in the business, I can see where that number could come back to life in 2022 CapEx as we're preparing then for that delayed growth that was put on pause with the pandemic. And of course, I wouldn't expect that that's going to be an ongoing run rate for CapEx, but that's one way to think about 2021 and 2022. Okay, great.

That's exactly what I was looking for. Thanks for that. And then I'm I guess I know I'm asking you to kind of speculate here a little bit, and some of these things are still evolving, but in light of the Biden administration's kind of announced interest in shifting away from fossil fuels and kind of seems a bit aggressively toward alternative energy, can you remind us of the ATI suite of products and opportunities and where you might get hit because you used to supply some of those other areas, but Also, the opportunities, I know you've in the past been big in nuclear and maybe other green energy focus.

Good question. I think when you start with nuclear and we're still big in the nuclear space, so I think that's an upside opportunity for us out of our Oregon operations. I think we're starting to see opportunities in solar, which Although they tend to have a stainless base, they tend to be on the specialty end and really light gauge, tight tolerance types of things, kind of following the same issues with consumer electronics from a product standpoint. Then you add into that emission control systems. I think the flue gas desulfurization is what we used to call it, but it's really about what's going on with emissions. globally. It's not really a U.S. issue. It's more of a global issue. And then I think the other thing you'll see more of is the resurgence of land-based gas turbines. There's still a shift from coal and oil to various things. I think when you look at our product mix in the energy space, it's going to be the bigger chunk for us in the future. It's going to probably be 60 to 70 percent of what we do versus historically, the oil and gas. We spent in the old ATI, not the old, too old ATI, but the prior product mix had a lot of oil and gas, the, you know, consumer, or I'm sorry, chemical processing, hydrocarbon processing. I think you'll see us play less there. They tend to be more standard stainless type pipes and infrastructure types of things. So I think, you know, that we're going to be where corrosion, strength at high temperature, unique issues are, and I think for the specialty energy sector, corrosion is going to be a big material science issue that people are going to have to work through. I think we're well positioned in some parts of the world. It's a matter of which parts of the world go first. I think in electric vehicles, battery storage, hydrogen as a fuel, hydrogen as producing hydrogen, there's opportunities there for more specialty materials. Nickel and titanium will play probably more on the nickel side in most of these applications. So does that help with the answer you were looking for, Tim?

Yeah, it does. I just don't know how much of what you'd be losing that used to be hydrocarbon-focused versus what you'd be gaining with regard to the green energy. Is there a mix that's higher value-add, or is it an offset, or just rough numbers, what you think about incremental?

Oh, okay. Yeah, so two parts to that. Okay. Our decision to exit the standard stainless sheet is obviously a lower margin stuff, and the stuff we're moving into is definitely on the higher margin nickel alloy type products. They're harder to make, different dimensions and specifications. We think it's a positive from a product mix standpoint, and it's a positive from a fit with our material science technology. And it's part of the fundamentals of why exiting stainless was the right thing for us to do. So, yeah, it's a positive margin shift for us.

Okay, great. Thank you.

Our next question comes from from Barenburg. Please go ahead with your question.

Thanks, and good morning, guys. I was hoping if you could just elaborate a little bit about your isothermal forging business a little bit. So, first of all, just to confirm, is that 13%, 14% of your total sales? And then how much of that is direct sales to OEMs versus selling powder or feedstock to those customers so that they can forge it at their own facility?

Okay. There's a lot of questions in there, Paritash. I'm going to have to whittle them out. So, A third kind of at the end. So, yeah, isothermal forging is obviously what we do in our forged products business, primarily in Cudahy, Wisconsin. I don't know if we've actually ever said what percentage of our business is isothermal. You asked a secondary question, which was, hey, are you selling ingot, billet, and bar to other forgers? I would say today... Depends on the grade, depends on the alloy. I mean, our long-term goal was to make sure that our forging operation was 100% supplied by our own feedstock. Some customers provide the feedstock to forging. So over time, I would say today, probably 40% is what we consume and 60% would be sold to other people to forge. But it's somewhat, it's a directed buy situation. Um, and then back to your first question, you know, when you look at our forging business in general, um, it's in the HPMC segment, obviously, but, um, you know, it's, it's about, you know, 30% of, uh, HPMC business is the actual forging business. And that would include the forging itself, plus the value add of the raw material that we pull through. But, um, that that's 2020 and obviously that's depressed. in the current environment, and as we look forward, that team's done a great job of positioning the business for share increases and kind of focusing on jet engine and still has a non-jet engine business, but it's less important. So let's go back, and did that kind of cover the ground you were looking for an answer in?

Yes, we very much appreciate all the details here. And then maybe as a follow-up on your free cash flow guidance, so just a quick one is that also the free cash flow guidance after the any dividends paid to non-controlling interests which i'm guessing primarily your jv in china because it seems like you paid 7 million in 2020 but a bigger amount about 15 million dollar dividend in sorry 7 in 2020 and 15 in 2019 so is that guidance after that yeah that would be excluding because the dividends that are paid to the minority

owner are actually in the finance section, so they're not part of the pre-cash flow definition or calculation. And the numbers that you mentioned are kind of in that right area. You expect them to be kind of in the $7-plus million range.

And our next question comes from Matthew Fields from Bank of America. Please go ahead with your question.

Hey, everybody. I just wanted to sort of touch on liquidity and sort of uses of cash. And I just find it interesting that you ended the year basically with exactly the same amount, $956 million of liquidity that you ended 2019. Just a weird quirk there. A weird quirk.

It's hard work. It's hard work to get to that number.

Yeah, maybe that's not such a coincidence. But You kind of said heading into the pandemic that you wanted to sort of boost liquidity, and you wanted to get your hands around kind of how deep the hole was going to be and for how long the hole was going to be before you kind of made any other moves. I just want to – if you see kind of – demand picking up in the second half of 21, when do you feel like you're going to be at a point where you can kind of deploy some of this potential excess liquidity on maybe debt reduction or other things?

This is Don. Let me take a run at that. Yeah, the outcome for 2020 was an outstanding outcome. As you can imagine, when you look at what was happening in the business and the decline to the top line, you know, being able to maintain flat liquidity in that kind of environment was an outstanding outcome based upon a whole lot of work on a whole lot of levers that were being pulled. So, as I said earlier, we'll continue those same efforts, and I would expect that we'll continue to maintain a healthy amount of liquidity in the business. The other part of your question is, okay, how do you deploy, when do you deploy? It really is, it reflects a lot of moving parts, one of which is, our number one priority in this business is to keep the business healthy, and number two priority is to give us choices. And so the choices fall in the second part of your question, right? You have the choices, when are you gonna start pulling the lever? And that's going to be driven by how we're seeing our end markets, what we see as a trajectory for the end market recovery and the opportunities to put the money to work. Fortunately, we see a lot of opportunities to put the money to work, but we don't want to pull that lever too soon. For example, if we see a great demand that's coming from customer A, but that demand is 18 to 24 months out, and we don't need to make that investment until, you know, nine months before that demand really hits us, we're not going to deploy the capital any sooner than we need to. And so, you know, it's hard for me to give you a definitive answer other than to tell you, be rest assured, we are very interested in putting our capital to work. We don't make money with the capital sitting in a bank account. We make the money by investing for organic growth, and we have every intention to do that, but we're going to do it with great discipline.

Okay. Um, and then, and then, you know, sort of building on that, it seems like the commentary around 22 is that, well, 21, you know, you're, you're forecasting after pension, you know, a burn of, I don't know, 30 to 70 million after pension. Um, and then 22, if, if this sort of demand comes back, it seems like you're trying to signal that there'll be a use of working capital CapEx could kind of ramp back up to that 200 million number. It seems like 22 will be sort of a more demanding cashier. Can you talk about kind of when we get further down the road this year in 21, as you see 22 coming more into focus, you know, what the choice might be between organic investment and debt reduction and kind of where you ultimately want to end up on that debt reduction lever and sort of how we get there?

Sure. You know, the temptation around cash is to look at one element of it and try to extrapolate and understand. You know, the reality is we get to 2022, we're going to have a few different impacts to our cash flow. First and foremost is profitability. So, you know, it's easy for, as we're talking about cash, to see the downside of needing to invest in working capital. But the reality is That means we're generating more cash through activities, through sales, which is a good guy for us. We're still going to have the same levers available to us to manage our capital, to manage our liquidity in 2022 as we do today, and that will be our working capital. Again, we've been, I think, pretty successful at becoming more efficient with working capital, and we intend to continue to become more efficient as we continue to make progress toward our longer-term goals. Same thing with, with CapEx, we'll be making decisions around CapEx that'll be driven by the opportunities that exist at that time. And so I wouldn't read too much into 2022 at this point, other than to say, if you're in the upcycle and you're, uh, and you're seeing robust growth in the core business, guys, that's where we make money. That's where we print cash. And so if I need to dedicate some more of that to working capital, specifically inventory and receivables on the shelf, it's not a bad environment to do that. We're happy in a high-growth environment. We'll manage that very, very well. Does that kind of answer your question?

Yeah, those are all fair points. Thanks a lot, and good luck in 21.

All right. Thanks, Matt. Okay. Okay.

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

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