PITTSBURGH Jan 26, 2016 (Thomson StreetEvents) -- Edited Transcript of Allegheny Technologies Inc earnings conference call or presentation Tuesday, January 26, 2016 at 1:30:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * Dan Greenfield Allegheny Technologies - VP of IR & Corporate Communications * Rich Harshman Allegheny Technologies - Chairman, President and CEO * Pat DeCourcy Allegheny Technologies - SVP of Finance and CFO ================================================================================ Conference Call Participants ================================================================================ * Steve Levenson Stifel Nicolaus & Company - Analyst * Gautam Khanna Cowen and Company - Analyst * Josh Sullivan Sterne Agee CRT - Analyst * Richard Safran Buckingham Research Group - Analyst * Kevin Cohen Imperial Capital - Analyst * Michael Gambardella JPMorgan - Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Good morning and welcome to the Allegheny Technologies Incorporated fourth-quarter and full-year 2015 results conference call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Dan Greenfield, Vice President of Investor Relations and Corporate Communications. Please go ahead. -------------------------------------------------------------------------------- Dan Greenfield, Allegheny Technologies - VP of IR & Corporate Communications [2] -------------------------------------------------------------------------------- Thank you, Keith Good morning, and welcome to the Allegheny Technologies earnings conference call for the fourth quarter 2015. This conference call is being broadcast at our website at www.ATIMetals.com. Members of the media have been invited to listen to this call. Participating on this call today are Rich Harshman, Chairman, President and Chief Executive Officer; and Pat DeCourcy, Senior Vice President of Finance and Chief Financial Officer. All references to net income, net loss or earnings in this conference call mean net income, net loss, or earnings from continuing operations, attributable to ATI. If you have connected to this call via the internet, you should see slides on your screen. For those who have dialed in, slides are available on our website, www.ATIMetals.com. After some initial comments, we will ask for questions. During the question-and-answer session, please limit yourself to two questions, to be considerate of others on the line. As always, we will make every attempt to reach everyone in the question-and-answer queue within the allotted conference call time. Please note that all forward-looking statements this morning are subject to various assumptions and caveats, as noted in the earnings release, and on this slide. Actual results may differ materially. Here is Rich Harshman. -------------------------------------------------------------------------------- Rich Harshman, Allegheny Technologies - Chairman, President and CEO [3] -------------------------------------------------------------------------------- Thank you, Dan. Good morning to everyone on the call or listening on the Internet. 2015 was an incredibly difficult year, and the fourth quarter was the most challenging of the year. In 2015, average monthly LME nickel prices declined 45% to $3.94 per pound in December of 2015, from $7.22 per pound in December of 2014. The base price for the most common commodity stainless sheet product fell 25% to approximately $0.45 per pound in December 2015, which represents an historic low, from $0.60 a pound for most of 2014. Total 2015 ATI sales to the oil and gas, chemical process industry, and the hydro carbon processing industry market were down $100 million or 28%, compared to 2014. This more than offset strong sales in the first half of 2015, led by approximately $145 million of nickel-based alloy flat roll plate for a large oil and gas pipeline. In our high-performance materials and components segment, sales to the oil and gas market fell nearly 50%. In addition to these negative market conditions, ATI's 2015 operating profit was depressed further by $132 million in non-cash net realizable value inventory reserves, that offset LIFO reserve benefits resulting from significant raw material cost deflation. Negative headwinds from falling raw material prices should at least stabilize in 2016, since most raw material prices are low compared to the last 10 to 15 years. In the face of these difficult market conditions, we continued our strategy to focus on key global markets that have attractive long-term growth expectations, and require our high-value products that have significant technical barriers to entry. We have taken and will continue to take actions to return ATI to profitability, maintain solid liquidity, and improve our competitive position. First, let's discuss our strategy to grow our specialty materials, parts and components business. Specifically, forgings and titanium investment castings. A leading indicator for growth in forgings and casting is called NPI, or new product introduction. In 2015, we worked through our NPI forging and casting backlog of over 300 parts, won under long-term agreements secured in 2014 and early 2015. The majority of these parts are key components on the next generation jet engines that are expected to have significant growth over the next five years, beginning in 2016. As we have said, these new parts are expected to generate incremental sales in excess of $1 billion beginning in 2016, and extending to 2020, mostly to our strategic commercial aerospace customers. We competed a process to refocus our high-performance materials and components segment businesses into a more aligned and integrated business. This alignment and integration is designed to create a more agile, streamlined, cohesive and efficient business. Our improved supply chain effectiveness and standardized continuous improvement processes are designed to help ATI improve efficiencies, reduce costs, and accelerate our growth, and we can better leverage and align our engineering talent and technical capabilities to create value for customers and our shareholders. The hot rolling and processing facility, or HRPF, is in full operation, and has been operating at higher productivity levels than those experienced before the work stoppage. Finally, on December 10, 2015, we announced actions to reduce our exposure to commodity stainless sheet and grain oriented electrical steel products, due to the ongoing challenges resulting from excess global capacity and lower and slower demand growth. Turning to slide 4, market conditions for our commodity stainless and GOES products weakened further in the fourth quarter of 2015. We believe that challenging business conditions for these products is likely to remain at least for the next few years, due to excess global capacity, and slow growth and demand. As previously announced, we plan to idle our Midland, Pennsylvania commodity stainless melt shop and finishing line, as well as our Bagdad, Pennsylvania grain-oriented electrical steel finishing facility. The future restart of the Midland and GOES operations respectively will depend on future business conditions, and ATI's ability to earn an acceptable return on invested capital on products produced at these operations. These right-sizing actions are the result of an extensive strategic review and analysis of the current and expected medium-term market conditions, affecting our US flat-rolled products operations. These actions are designed to return the flat-rolled products segment to profitability as quickly as possible, and execute our strategy for sustainable long-term profitable growth. The action simplify and streamline our flat-rolled products operations, and better focus our efforts on the products and global markets that require and value ATI's technical and manufacturing capability leadership. Turning to slide 5, our discussions with the United Steelworkers resumed in earnest in late December. We met several times over the last three weeks, both with and without the participation of a federal mediator. Consistent with last summer's negotiations, the process to reach a comprehensive agreement is fluid. Overall, the dialogue has been generally constructive, and we continue to focus on reaching a fair and more competitive agreement. Our goal is to have the cost structure and enhance product mix that enable ATI flat rolled products to be profitable -- to be a more profitable and competitive business. Here is Pat DeCourcy, ATI's Chief Financial Officer, for a more detailed discussion of the 2015 fourth-quarter financial results. Pat? -------------------------------------------------------------------------------- Pat DeCourcy, Allegheny Technologies - SVP of Finance and CFO [4] -------------------------------------------------------------------------------- Thanks, Rich. Turning to slide 6, fourth-quarter 2015 charges for asset impairments, restructuring, and inventory were $267 million. ATI conducted its annual goodwill impairment analysis in the fourth quarter of 2015, and determined that the fair value of our flat-rolled products business was below its carrying value, including goodwill. As a result, fourth-quarter 2015 results include a $127 million pre-tax non-cash charge to write off all goodwill in the flat-rolled products business. Restructuring and other charges in the fourth quarter of 2015 are as follows: Fourth-quarter 2015 results include a $54 million pretax non-cash impairment charge to reduce the carrying values of the Midland, PA and grain-oriented electrical steel, or GOES, facilities. Fourth-quarter results also include approximately $4 million of charges for future idling costs at these facilities. In the fourth quarter of 2015, ATI commenced a salaried workforce reduction in both the high-performance materials and components segment, and ATI's headquarters. Severance charges of $6 million were recorded in the fourth quarter for this action. We expect $23 million in cost savings in 2016 from this action. Net realizable value inventory reserve charges were $51 million, which are required to offset ATI's aggregate net debit LIFO inventory balance that exceeds current inventory replacement cost. In December of 2015, based on current market prices for non-PQ titanium sponge, ATI recorded a $25 million non-cash charge to revalue this inventory. This charge includes revised assessments of the non-PQ titanium market conditions, and expected utilization of this inventory. Turning to slide 7, looking at the fourth quarter results from continuing operations, sales were $739 million. 87% of sales in the fourth quarter were of high-value products, and international sales represented 42% of our fourth-quarter sales. For our international sales, we have minimal currency risk in our high-performance materials and components segment, since the currency used for our sales to the international aerospace market is mostly in US dollars, and most of our costs are incurred and paid in US dollars. However, the relative strengthening of the US dollar versus other currencies can impact our competitiveness. Net loss was $227 million or $2.12 per share. Excluding charges, the net loss was $59.6 million or $0.56 per share. Turning to slide 8, high-performance materials and component segment sales were $457 million, a decrease of nearly 4% compared to the previous quarter, and nearly 9% lower than the fourth quarter of 2014. Segment operating profit was $21 million. Beginning in the third quarter, segment operating profit excludes all impacts of LIFO and NRV inventory reserves, and includes retirement benefit expense attributable to this segment. Flat-rolled products segment sales were approximately $282 million, 21% lower than the previous quarter, and over 48% lower than the fourth quarter of 2014. Segment operating loss was $120 million. Beginning in the third quarter, segment results excluded all impacts of LIFO and NRV inventory reserves, and includes retirement benefit expense attributable to this segment. Turning to slide 9, we maintain the solid liquidity position with $150 million in cash on hand, and no borrowings outstanding under our $400 million ABL at the end of the year. The five-year $400 million ABL facility is collateralized by the accounts receivable and inventory of ATI's domestic operations. Moving to slide 10, capital expenditures were $145 million in 2015, almost half of which related to the HRPF. This amount was lower than our third-quarter 2015 estimate, because $40 million of HRPF payments have shifted to early 2016. We currently expect the 2016 capital expenditures to be approximately $240 million, including our nickel alloy powder expansion, final payments on the HRPF, and the expansion of our manufacturing capabilities at our STAL joint venture in China. The 35 million of 2016 CapEx for the STAL expansion will be fully funded by STAL's operations. The STAL JV is among our most profitable businesses. Depreciation and amortization expense in 2016 is forecasted to be approximately $180 million. We are near the end of our extraordinary capital expenditure cycle, that has transformed and modernized ATI. We have built a foundation for creating long-term value through relentless innovation. We have secured our position to grow faster than the market during this once in a lifetime aerospace market transition from legacy to next-generation airplanes and jet engines. Now, I will turn the call back over to Rich. -------------------------------------------------------------------------------- Rich Harshman, Allegheny Technologies - Chairman, President and CEO [5] -------------------------------------------------------------------------------- Thank you, Pat. Turning to slide 11, ATI's sales in 2015 were $3.7 billion. Our largest market was aerospace and defense, which accounted for 41%, or $1.5 billion in sales. Sales to the commercial aerospace market increased 8%, compared to 2014. The blue arrows on this slide indicate the expected direction of sales mix to our major markets beginning in 2016, as a result of right-sizing actions in our flat-rolled products segment. For example, we expect aerospace and defense to grow significantly as a percentage of ATI's sales due to expected growth in next-generation and legacy engines, aided by particularly strong growth in our forgings and castings business, as a result of LTAs signed in 2014 and 2015. We will all provide additional comments in a few minutes. We significantly reduce our exposure to the electrical energy distribution market, as a result of idling our GOES operations. We reduce our exposure to the automotive market, as many exhaust products are made from commodity stainless steel. We continue to expect growth in high temperature applications in the automotive market. These applications use our nickel-based alloys and specialty alloys. We also expect to reduce our presence in the food equipment and appliance, and construction and mining markets, due to reduced exposure to commodity stainless steel sheet. A comment on the oil and gas market. Looking into 2016, we see little recovery in the oil-field services sector, based on a continuing imbalance in supply and demand, and continuing low crude oil prices. ATI serves the oil-field services market sector with downhole and wellhead applications, primarily from our UK operations. In 2015, we right-sized our UK operations and refocused its assets on growth markets, including aerospace. In the offshore and subsea sector, we continue to receive project orders, and are seeing projects being tendered, although at a lower rate than during the past few years. These projects use ATI's specialty coil and specialty plate flat-rolled products for such applications as flowlines and pipelines. Slide 12 shows our 2015 revenue by product. Noted here, the blue arrows point to those products that will be impacted as a result of our flat-rolled products right-sizing actions. Turning to slide 13, in the upper left corner of the slide, we show the current market forecast of commercial aircraft build rates. The black line on this chart represents the number of next-generation airplanes in the build rate forecast. As we have said, this is a good proxy for ATI's aerospace market growth trajectory, since we have secured increased positions on many of the next-generation airplanes, and the engines that power them. As you can see, significant growth is expected beginning in 2016, and continuing through at least 2019. The chart in the lower left depicts where we are in the cycle, the beginning of the next-generation rate ramp is upon us. The gray area shows the number of legacy engines. Our products here include such well-known alloys as ATI's 718 nickel-based super alloy, and ATI's 6-4 titanium alloy. As shown on the slide, beginning in 2016, there is a more pronounced growth in the spread between declining demand for legacy products to growing demand for the next-generation products. The blue area shows the number of next-generation engines. Our differentiated products here include proprietary and unique alloys, as well as products that few others can make, such as ATI's 718Plus, Rene 65 alloy, ATI's 720 alloy large billets, plasma arc welded titanium alloys, powdered metals and titanium aluminides, as well as hot die forgings, isothermal forgings, and titanium investment castings. For ATI, this slide demonstrates the significant mix shift we see beginning in 2016. As we have previously said, ATI's content on next-generation and certain legacy aircraft is growing. This is due largely to new parts awarded under recent LTAs. Note the significant growth in content we have on the Boeing 737MAX and CFM Leap engine. That is 100% growth, and a big driver of the improved sales and operating profit we expect from our high-performance metals and components segment, beginning in 2016. We have already mentioned several of our differentiated products. Other capabilities that differentiate ATI are: We are currently the only qualified plasma arc melt producer titanium alloys used for jet engine rotating parts. Plasma arc melt, or PAM, is often the preferred process for titanium alloys used in jet engine rotating parts, as well as complex titanium alloys. ATI has the most powerful press forge in our industry, which enables industry-leading fine-grained structure in complex nickel-based super alloy billet. ATI is one of the only two independent and integrated qualified producers of nickel-based super alloy powders, and isothermal forged parts. Turning to slide 14, for ATI, the long-awaited era of next-generation jet engines is upon us. Airbus delivered its very first A320neo aircraft last week. Boeing's 737MAX first delivery is schedule for 2017. The first A320neos are powered by Pratt & Whitney geared turbo fan engines. GE confirmed last week that the Leap launch remains on track from the year. Beginning in the first quarter of 2016, we see improving shipments of forgings, castings, nickel-based alloy and titanium-based alloy mill products, plus an improving mix of next-generation mill products. As most of you know, mill product shipments for future use in forgings and components lead the cycle. Think of it this way: our next-generation mill products ship to all forges involved, including ATI, beginning the first quarter of 2016. For ATI, these mill products are forged and machined, then shipped to the OEM. So you will first see an increase in next-generation mill product shipments, followed by revenue growth in next-generation forgings made by ATI. As we have said, we expect to see growth early because we have won a significant number of forgings and castings that are new to ATI for legacy engines. These parts ship beginning in the first quarter of 2016. Also starting in 2016 and continuing over the next several years, as the airframe and engine OEMs build and deliver their record order backlogs, ATI expects to see significant growth in specialty materials mill products, forgings, and castings. Our new product introduction program has been going very well, and I'm very proud of the forgings and mill products employees who have earned ATI the reputation of the reliable supplier in the supply chain. As a result of the market demand, we expect 2016 high-performance materials and components segment sales through the commercial aerospace market to reach about 70% of total segment sales. Turning to slide 15, challenging conditions in many end markets, including very weak demand and record low prices for most commodity stainless products, continue to plague the flat-rolled product segment. We are implementing right-sizing actions that are designed to return the flat-rolled product segment to profitability as quickly as possible, and execute our strategy for sustainable long-term profitable growth. For the foreseeable future, we are reducing our exposure to commodity products, to better focus our efforts on the products and global markets that require and value ATI's technical and manufacturing capability leadership. ATI flat-rolled products is a global leader in specialty sheet and plate, which includes nickel-based alloys and specialty alloys, titanium and titanium alloys, as well as engineered strip and precision rolled strip products. Precision rolled strip is very thin stainless nickel-based alloys and specialty alloys, and titanium and titanium alloy base. The first half of 2016 is a transition period for flat-rolled products, as we right-size the business and temporarily exit the commodity stainless sheet and GOES business. So I will limit my discussion of the current market conditions and expectations to the differentiated products and markets we will continue to produce and serve. First, as expected, we are benefiting from the 48-inch wide nickel-based sheet capability provided by the HRPF. Stage reduction benefits and world-class coil geometry are being realized, now that the HRPF Rotary crop shear is fully functional. For our nickel-based alloys and specialty alloy sheet and strip, demand from the aerospace market is growing, consistent with my prior comments. Activity remains steady in the electrical energy generation market. Automotive market demand is expected to continue to be strong for our nickel-based alloy strip, for high temperature applications. While the oil and gas market is depressed, we plan to ship our products to be used in the number of projects in the first quarter, and we have received additional orders for downhole applications. Titanium coil product demand from the aerospace market is scheduled to increase, while demand for CP, or commercially pure, titanium products for industrial applications remains challenging. Finally, specialty plate demand is expected to improve in the first quarter, primarily from the aerospace market, but remain weak from the oil and gas and CPI HPI markets. In summary, we will continue to focus on things within our control, and take all necessary actions to return ATI to profitability as quickly as possible, while we execute our strategy for long-term profitable growth. Our high-performance materials and components segment is positioned to begin a multi-year period of sustained profitable growth, supported by LTAs in place that secure significant growth for ATI on both legacy and next-generation airplanes, and the jet engines that power them. Volume from these agreements is expected to provide improved capacity utilization and product mix in our mill products, forgings, and titanium investment casting facilities, beginning in the first quarter of 2016. We expect to increase the pace throughout our operations as we progress through the year, driven primarily by the commercial aerospace market, with segment operating profit as a percentage of sales returning to double-digit levels by the second half of the year. In our flat-rolled products segment, our first-half 2016 results will reflect the ongoing right-sizing and restructuring activities. We expect shipments of our specialty coil and plate products to improve in the first quarter, and to benefit from the HRPF capabilities, particularly for our 48-inch wide nickel-based alloy sheet. And we expect the flat-rolled products segment to be modestly profitable by the second half of 2016. Our strategy includes being focused on actions to better align and integrate ATI's specialty materials businesses, enhance our competitive position, and continuously improve the cost structure and operating efficiencies of our businesses, to achieve long-term sustainable profitable growth. In other words, over the long term, to create value for shareholders and customers, and opportunities for our employees. Operator, may we have the first question, please? ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) The first question comes from Steve Levenson with Stifel. -------------------------------------------------------------------------------- Steve Levenson, Stifel Nicolaus & Company - Analyst [2] -------------------------------------------------------------------------------- This is going to be a complicated question, I'm sorry, but am I correct that in not too long, 50% of total ATI revenue will be related to aerospace? If you can give us an idea of the year past and the year coming, what percentage of that revenue is derived from metal, and what was from castings and forging? How will that be different looking forward? And I know you don't like to disclose particular margins, but can you give us an approximation of what the delta would be between selling metal and selling castings and forgings? -------------------------------------------------------------------------------- Rich Harshman, Allegheny Technologies - Chairman, President and CEO [3] -------------------------------------------------------------------------------- Well, I mean really, it depends on the alloy system, it depends on the product, it depends on whether or not it's a rotating component or a rotating alloy or structural, so Steve, there are so many differences that drive that, I basically just answer it maybe in general high level terms. I think that as you know, our strategy for a long time has really been to focus on those differentiated markets that are global, that have high barriers of entry, that use our technical capabilities and reward them. And so obviously, the aerospace market is really at the top of that pyramid, because of the critical importance of really all of the parts and components and materials that go into both an airframe and/or a jet engine, or a rotating part. I think your 50% number is reasonable. I think over time, especially if our near-term or intermediate-term view of the commodity flat-rolled market holds, that the aerospace and defense market, I will put both of those together, will continue to grow in importance and significance for ATI. I think the growth that we see is purposefully driven, not only by the parts and components side, but also by the milled product side. So we don't necessarily differentiate, when you have an integrated strategy that goes from an alloy innovation into the critical quality aspect of the melting and the hot working for the grain structures that are required, and the performance characteristics that are required, to make the parts and components, the forgings and the castings. It is all integrated together. So we view that as an integrated supply chain, and I think most of our strategic customers do as well. We are not necessarily just focused on making parts and components. We look at the whole supply chain and where is the best opportunity there. And there are very attractive margins in the mill products side. There are equally attractive margins on the components side. The competitive aspect is always there, so I am not going to differentiate and pick and choose which one I like best, right? I like the whole thing. I like the fact that we are now an integrated supplier, all the way from alloy development through a part and a component, and I think the customer value continues to be more towards not just the rough forging, or the rough casting, but they pretty much, the customers really want, the OEMs want, as close to a final machined part or component as they can. So the machining aspect of that plays, as well. |