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Executives

Dan Greenfield – Director, IR and Corporate Communications

Pat Hassey – Chairman, President and CEO

Rich Harshman – EVP, Finance and CFO

Analysts

David Martin – Deutsche Bank

Luke Folta – Longbow Research

Timna Tanners – UBS

Steve Levenson – Stifel Nicolaus

Michael Gambardella – J.P. Morgan

Brett Levy – Jefferies & Company

Brian Yu – Citi

Kuni Chen – Bank of America/Merrill Lynch

Gautam Khanna – Cowen & Company

Peter Jacobs – Ragen MacKenzie

Dan Whalen – CapStone Investments

John Tumazos – John Tumazos Very Independent Research

Sal Tharani – Goldman Sachs

Tim Hayes – Davenport & Company

Allegheny Technologies Incorporated (ATI) Q1 2010 Earnings Call Transcript April 28, 2010 1:00 PM ET

Operator

Good day, ladies and gentlemen. And welcome to the first quarter 2010 Allegheny Technologies earnings conference call. My name is Kesha, and I’ll be your operator for today. At this time, all participants are in listen-only mode. We will conduct the question-and-answer session toward the end of this conference. (Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I will now like to turn the call over to Mr. Dan Greenfield, Director, Investor Relations and Corporate Communications. Please proceed, sir.

Dan Greenfield

Thank you, Keisha. Good afternoon and welcome to the Allegheny Technologies earnings conference call for the first quarter 2010. This conference call is being broadcast on our website at www.atimetals.com. Members of the media have been invited to listen to this call.

Participating on the call today are Pat Hassey, Chairman, President and Chief Executive Officer; and Rich Harshman, Executive Vice President, Finance and Chief Financial Officer. All references to net income and earnings in this conference call mean net income and earnings attributable to ATI.

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. Please note that all forward-looking statements this afternoon are subject to various assumptions and caveats as noted in the earnings release. After results may differ materially.

Here is Pat Hassey.

Pat Hassey

Thanks, Dan, and thanks to everyone for joining today's call. Let's start by discussing our first quarter performance and some positive implications for our business going forward.

Sales were up 10% over last quarter to approximately $900 million. Apples to apples, earnings were up from last quarter's $0.10 per share, excluding $0.26 of positive LIFO to $0.24 per share without the healthcare legislation charge or 140%.

Shipments most of our products increased, the one exception being exotic alloys, in many cases by double digits compared to the fourth quarter of 2009.

More importantly, overall order receipts were up significantly causing lead times to extend by an additional two to eight weeks for high performance metals, again, exotic alloys being the exception.

Asset utilization rates increased throughout the first quarter with the highest utilization being in March. These are all signs that we are recovering from the global contraction that impacted our business in 2009.

In our business, recovery begins with volume, which improves capacity utilization. We are seeing continued positive signs, recovery and improving volume. Second quarter production schedules are basically booked full at our current utilization rates. Lead times are extending and scrap is in short supply.

Based on these continued market conditions, we believe there may be opportunities for improving base prices in the second half of 2010 as the business cycle continues to recover.

Raw material surcharges for the second quarter shipments will be higher due to rising material costs. However, in our flat roll product segment, base prices for many products, particularly stainless sheet plate, remain low because of these rapidly rising materials surcharges.

The customer's total transaction price is up, but the base or conversion price is still very low. We believe we can see some moderation of raw material prices, coupled with increasing base prices in the second half of 2010.

These are all signs that a true business cycle recovery is underway. With steady quarter-on-quarter improvement, we continue to see 2010 as the transition year to resumption of secular growth in our key markets.

One more point, our direct international sales increased to approximately 34% of sales in the first quarter 2010. Today, ATI is more globally focused than ever before. A particularly important note, our flat-roll product segment achieved record 35% of direct international sales in the first quarter of 2010.

Our international business is recovering. An example, first quarter 2010 order entry from Asia is more than three times the order level of the first quarter of 2009. Overall, our order book increased throughout the first quarter and continues to grow in the second quarter.

Of note in comment is ATI's total first quarter titanium mill product shipments. This includes our high performance metals plus flat-roll products plus Unity joint venture conversion.

Total titanium mill product shipments for the first three months 2010 were 9.2 million pounds. We now believe we will ship over 40 million pounds of titanium products in 2010. So stay tuned for more as we go forward this market.

Moving to our segments. All figures are comparisons of the first quarter of 2010 to the fourth quarter 2009 since this is the most current indication of cyclical recovery. In our high performance metal segment, shipments of our titanium based alloys increased 17%. Shipments of our nickel-based alloys, superalloys and specialty alloys increased 7%.

This increase follows a 21% improvement in the fourth quarter of 2009 from the third quarter of 2009. Jet engine supply chain has begun to recover as demand continues to build.

After reducing inventories in 2009, the supply chain is becoming more in line with current aircraft build rates and increasing after market demand. In addition, the jet engine supply chain appears to be more confident that the aircraft build rates are secure and may increase going forward.

Inquiry rates and orders for our premium titanium alloys, nickel-based alloys and superbased alloys and specialty alloys point to sustained improvement. Prices for many of our products are now beginning to increase as lead times are extending and this should benefit, again, the second half shipments of 2010.

We are also seeing increased activity from the oil and gas and medical markets. Shipments of our exotic alloys in the first quarter decreased substantially due to delayed but not canceled projects in the defense and chemical processing industries during 2009. We entered 2009 with a strong backlog for our exotic alloys.

After the global financial issues hit, the backlog was worked down over the last year. This is a business that historically lags the economy by about six months both up and down. Order increase for exotic alloys are just now beginning to increase, so we do expect shipments to gradually improve in the second half of 2010.

Operating profit in our high performance metal segment was approximately 22% of sales, excluding the idle facilities and new sponge facility startup cost of nearly $10,000 – $10 million in the first quarter.

Well, this is not where we want to be. So where are we? First, our titanium and nickel-based alloys business did quite well, in market share and volume improvements. On the other hand, our exotic alloys business did not perform anywhere near 2009 levels because of delayed projects and programs.

Operating profit in our high performance metal segment was negatively impacted by $9.9 million of startup and idle facility costs, mostly associated with our Raleigh, Utah plant and the Albany, Oregon titanium sponge facilities.

Lastly, in the high performance metal segment, in our pricing mechanisms, we adjust raw material surcharges at the end of each quarter not during the quarter. So we expect to benefit from higher raw material indices in the second quarter.

Now moving to our flat-roll product segments. First quarter shipments of our high-value flat-roll products increased 12%, compared to the fourth quarter of 2009. Here are some highlights.

Shipments of our engineered and precision roll strip products improved 15%. Demand is recovering from the global automotive market. In the construction market, orders reached near historic highs for high efficiency gas furnaces.

There's some stimulus money. Demand from the aerospace and electronics markets continue to improve. In addition, we are just beginning to realize initial growth from our stall expansion in China.

Shipments of our grain oriented electrical steel products to the global electrical energy market increased 4%. Shipments of our flat-roll nickel alloys and specialty stainless alloys increased 34% due to increased activity with some restocking in the oil and gas, electrical energy and aerospace distribution markets.

First quarter shipments of our flat-roll titanium products, including Unity, improved to 3.1 million pounds. First quarter shipments of our standard stainless sheet and plate products are up 22%, compared to the fourth quarter 2009 and up 54%, compared to the first quarter 2009 are about 78,000 tons. 78,000 tons annualized puts us within the 300,000 to 350,000 tons we need to effectively pace our operations. We saw steady improvements in efficiency from volume each month in the first quarter.

Giving us more confidence in this market, industry data reflects service center inventories remained at two and half months, which is still the historical low.

Meanwhile, average base prices are still very low while surcharges are rising. The benchmark 304 stainless surcharge will be $1.10 in May and is expected to rise to approximately $1.25 in June, based on current monthly average raw material prices.

Engineered product segment was profitable in the first quarter as we continue to see improving conditions for many of our products, particularly in the oil and gas market due to increasing demand for our tungsten drilling products.

Today, I would like to focus on two of our key markets. First, aerospace and defense and second, oil and gas. We believe these markets are not only showing signs of recovery but we were seeing early signs of secular growth.

In the aerospace market, sentiment changed dramatically in late February and March – and into March. Boeing and Airbus both announced they are not cutting current aircraft production schedules but instead they plan to increase production in 2010 and ‘11. Refer to our last conference call a quarter ago. Airbus plans to increase production in their single L320 series later this year. Boeing plans to increase production in their 777 and newly upgraded 747-8 aircraft during the next two years.

In addition, Boeing continues to report that flight tests of their new 787 Dreamliner and upgraded 787 are going well. First deliveries are expected by the end of 2010. Last week, Boeing said they plan to make an announcement during the second quarter, regarding a possible increase to their 737 single aisle production rates and by the end of this year, both commercial air frame makers plan to decide on first a new single aisle or an updated reengine of their existing single aisle aircraft.

We like the way ATI is positioned to benefit from these aircraft production rate increases of both legacy and the new airplanes. We also are very well position to benefit from the next generation air frame and jet engine programs. First, both engines and air frames are big parts of our business.

We have had strategic relationships with most of the key players. We have continued to improve the strategic position with new and expanded long-term contracts and with innovative new products. We have new and unsurpassed manufacturing capabilities which, when coupled with our innovative new products, enable us to grow faster as well as larger in this growing aerospace and sense market sector.

We like the sector trends particularly, the trend to new lightweight aircraft powered by innovative new engines. We like the trend to near net shapes which helps our customers improve their buy to fly ratio, improve their parts making productivity and reduce their costs of making parts.

Near net shapes also provide ATI the opportunity to do more value added processing through both our flat roll products and long products businesses. For example, certain titanium long product near net shapes.

We start by melting the raw materials into an ingot, forging a billet, hot rolling a bar and then hot rolling a shape. We sell the ingots, we sell the billets, we sell the bars and we sell further value-added near net shapes.

In the rock products, mill products near net shapes begin with melting raw materials to an ingot for long product or slab for flat roll products. We like this trend. International aerospace market continues to grow. Going out further in the decade, the new Comac, Bombardier and Mitsubishi have announced plans to introduce new aircraft that use future generation jet engines that are under development such as GE's LEAP-X and Pratt-Whitney’s geared turbo fan.

Also, ATI will continue to benefit from the new designs in future air frames or from modifications and redesigns in existing air frames that use our specialty alloys as well as from the reengine of legacy aircraft. Our specialty metals are being put on the front of the wagon while others materials are rolling off the back. Lastly, the need to up armor and lightweight land based military vehicles opens new doors through design for our latest alloys and products to protect our service men and women.

Now, turning to the oil and gas market. The world continues to use and need more energy as developing and advanced nations, grow their per capita GDP and their citizens move to modern conveniences and life improvement. According to a respected industry source, to meet growing global demand, "we need to find and get into production one new Saudi Arabia every three years."

Oil and gas exploration has moved to extremely demanding locations such as deep water offshore and to unconventional sources such as shale gas and LNG deep in the earth. These environments require the strong and highly corrosive resistant alloys that we have invented and make today.

Here are some facts that indicate ATI's first quarter 2010 penetration and performance in this oil and gas market. Sales to this market increased by nearly 50% compared to a year ago and increased by approximately 25% compared to the fourth quarter 2009.

Nearly 50% of our first quarter sales to the oil and gas market were direct international sales. It's a global market for us. We not only like the growth in rig count but we also like the factors in than ten growth in wells associated with shale gas and high pressure, high temperature exploration and production.

Offshore projects continue to be engineered around the globe and ATI is well positioned to benefit. We are improving our position with our existing key customers, adding new customers, becoming more global and seeing good growth in our innovative products such as our family of super duplex and lean duplex stainless alloys for umbilical sub C applications and top side applications.

In our data two, non-magnetic specialty alloy for drill strings and horizontal drilling, particularly in shale gas. We expect our shipments to the oil and gas market to continue to improve and to grow throughout 2010.

Finally, a quick update on our remaining strategic capital projects. We are pleased with the start up of our Raleigh, Utah, premium titanium sponge facility. We are operating more reduction furnaces and developing standard processes. This is a very big project, so we plan to ramp up the production throughout 2010 in a systematic manner.

The melt shop consolidation of our Brackenridge, Pennsylvania specialty melt shop is progressing on schedule. We reduced the footprint and we expect considerable cost savings and its production efficiencies from this project when it is fully operational later this year.

We expect the benefit by up to $30 million in annualized cost reductions associated with this project, again, beginning in the second half of 2010. We are now in the critical final vendor selection process for a Brackenridge, Pennsylvania advanced hot rolling and processing facility.

All permits are in hand. The site preparation work is nearly completed. Overall, we expect 2010 capital investments to be approximately $375 million. Before we open the call to questions, a final comment. First of all, our first quarter performance, operating performance as well as execution as well as improving order entry for most of our products reinforces our view that 2010 will be a year of steady quarter-on-quarter improvement.

We continue to believe 2010 is the transition year from 2009's global contraction to the resumption of secular growth trends, previously achieved in our key global markets. We expect to recover and then grow faster than our core global markets because we have an improved market position as demonstrated by our improving volume and forward load, new customers and expanded LTAs, innovative new product offerings, new and technically advanced manufacturing capabilities and finally, a globally focused and – focused reach that combined with the solid reputation of ATI and a solid international customer base in our key growth markets allows us to grow rapidly.

I think with those comments, operator, we will now open the call for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of David Martin with Deutsche Bank. Please proceed.

David Martin – Deutsche Bank

Thank you, good afternoon. I wanted to ask you about the stainless steel market. Can you just give us a bit more color on this business and its competitive landscape today and I'm curious as to whether you've sacrificed some market share in this business as I think your shipments were up a little over 20% quarter-over-quarter. I think NAS reported volume growth in excess of 50% last night.

Pat Hassey

Just depends on how far down you're starting from, I guess. But no, we haven't sacrificed a lot of share. We're concentrating more on the value added products. We mentioned here, I think very clearly, that our oil and gas business is growing rapidly. We are shipping a lot more product on an international basis than what we have in the past. So if you want to come back to exactly general distribution or what is the product mix, what kinds of things are you doing, I would say that you are going to continue to see us growing in this business again.

We mentioned in my comments that we need 300 to 350,000 tons of base load and sheet plate. We are going to generate that 300 to 350 tons. We are around 320 annualized in the first quarter and we'll be better in the second quarter. Our prediction is it will get better in the third quarter and better in the fourth quarter. We don't want much more than that, those products.

David Martin – Deutsche Bank

Okay. And then secondly, how much are your shipments in the first quarter were exported and also, I'm just curious –

Pat Hassey

34% of the revenue overall and 35% of revenue for flat rolls.

David Martin – Deutsche Bank

Okay. And what was your operating rate in the quarter and where does it stand today?

Pat Hassey

We announced at the end of last year, we were running about 50%, plus those operating rates have continued to improve throughout the first quarter. And the last rates, I would say we're running about two-thirds capacity overall, across the entire company, not just flat roll.

David Martin – Deutsche Bank

Okay. Thank you. Good luck.

Dan Greenfield

Thank you.

Operator

Your next question comes from the line of Luke Folta with Longbow Research. Please proceed.

Luke Folta – Longbow Research

Good afternoon, guys.

Dan Greenfield

Hello, Luke.

Luke Folta – Longbow Research

First question, got a couple on titanium. Just firstly, can you give us a feel for how the certification process is coming along in Utah and also maybe some color on when you, or some timing around when you might bring Albany back.

Pat Hassey

On the certification process, there is two things that have to happen. One is that the flat has to be up where we consider it operating at the standard practices. Meaning repeatable practices that have been fine tuned to what we would consider then practice that we would certify. And so this first part of the year, we are working on optimizing those practices for an optimized product.

So the certification process doesn't begin until we have standard processes in place. A standard process that would be used across all of our 36 ships sets, but production sets. So the first step in this is to get the process standardized, standardized work, if you will. Then the second part of that is determined by producing a lot of material in different sizes, mostly small sizes that we will use in different kinds of applications that we will certify those applications before it goes into anything in a jet engine. And so that process usually takes another year. So we are really talking about getting this plant to full certification in the next 18 months.

Luke Folta – Longbow Research

Into Albany?

Pat Hassey

Albany depends on the market. There is lots of opportunities that are program opportunities that if any of those particularly hit with us, will be looking hard at the Albany plant. Albany plant is our swing plant and it's in good shape. It's warm, it's ready to go. The work force I'm sure there would like to be back into operation. We don't need it today. And so when that time comes, outside of where we are and that really has got more to do with project work than where we are today, that plant could come back into operation quickly at any time.

Luke Folta – Longbow Research

Okay. Thank you. And on secondly, when we think about titanium spot prices, we are starting to see evidence that we are going to start to see some uptick here. When should we expect that to start flowing through your realizations in the high performance metals segment, understanding that you have some contracts that are indexed and also lead time extending and all that? Can you give us a feel from when the trough is likely to be realized there?

Pat Hassey

Well, I think the trough for the year has been realized. I think when you look at what our surcharge mechanisms are, as I mentioned in my comments, in our high performance metals business, we do not raise our indices at the ATI all back operations until at the end the quarter or the beginning of the next quarter.

So while we were producing in the first quarter whatever the indexes were on January 1, that's what the indexes would have been on March 31. So first of all, those indexes, as was publicly announced, are all up. So you can see the prices going up now. Secondly, those same indices for materials are used in our contractual methods, so all prices are up. So I would say the first quarter is the bottom and we are going to see prices increasing.

Luke Folta – Longbow Research

Great. Thank you.

Operator

Your next question comes from the line of Timna Tanners with UBS. Please proceed.

Timna Tanners - UBS

Yeah. Hi, good afternoon.

Pat Hassey

Hi, Timna.

Timna Tanners – UBS

You talked about lead times extending out and I missed it maybe, but could you quantify that a little bit more and kind of talk about the trend as you mentioned through the quarter and how that progressed with regard to lead times and utilization?

Pat Hassey

Well, as the quarter goes up, what I said was that lead times in our high performance metals which is, excluding the exotic metals which has not had a good start as I mentioned, that's going to, I think begin to see more activity in the second half of the year as these delayed projects start to come back online and we can re-open those bids and those quotes. But in the high performance metals section, our lead times had been expanding as we moved throughout the quarter. So depending on the product area, it's two tonight weeks longer than it was at the first of the year. So depending on how far downstream you want to go into a bar or shape versus, say an ingot, those products schedules are out on a considerable basis.

I think I also mentioned that we are basically full at the current utilization rates for the second quarter. So you keep moving those out, which says that we will be adding more utilization back into the business. And we will be taking more product in the second half of the year. I think I also mentioned, I think Danny told me three times in this talk, so I will mention a fourth time, that we expect pricing improvement in the second half.

Timna Tanners – UBS

Okay. So my second question is along those lines, SG&A was really light as was corporate expense. So how should we think about that going through the year? As you mentioned, you are going to need to perhaps add up I guess shifts or some sort of cost to move your utilization up.

Rich Harshman

Yeah. Hi Timna, this is Rich. I think from the standpoint of SG&A, any add accruing wouldn't be in SG&A area. It would be in the touch labor, the manufacturing cost area. So I think when we look at corporate expenses, SG&A, there is obviously some movement on a quarter-to-quarter basis. But I don't think it would be all that dramatic.

Timna Tanners – UBS

Okay, great. Thanks a lot.

Rich Harshman

Thank you.

Operator

Your next question comes from the line of Steve Levenson with Stifel Nicolaus. Please proceed.

Steve Levenson – Stifel Nicolaus

Thanks. Good afternoon, everybody.

Pat Hassey

Hi, Steve.

Steve Levenson – Stifel Nicolaus

The mix right now is still about 57% flat rolled 34 high performance. How do you see that changing over the course of the year?

Pat Hassey

I think both businesses are going to go up, Steve. And I think that 60/40 relationship in terms of tons or in terms of pounds probably is going to remain if our flat roll products business, which we believe is going to continue to move forward with additional tonnage coming into it. So I don't know if the relationships, I think they are both moving together, our schedules have increased dramatically in our high performance area which is, as you know, mostly aerospace and other difficult to produce markets. A lot of oil and gas and land based turbines, jet engines, air frame. So we would expect more profits coming out of that business, but we would also expect very good improvement in our flat roll side, too.

Steve Levenson – Stifel Nicolaus

Okay. Thanks. And for the second permitted question, Boeing was out today saying that they are slowing deliveries of certain 787 parts to their final assembly facility. It sounds like there are shortages among some other parts. Do you think that is going to result in a spike in purchasing? Could that push guys out of their LTA limits and cause them to buy on spot rates?

Pat Hassey

I think there are a couple things that are always interesting as these thing goes up. And I kind of alluded to the fourth quarter conference call and other things. We talked back then about a disconnect between the supplier base and the OEMs on air frames and what they said they were going to make and what they were really going to do. And when we got – as you know better than I do, when we got into December and firmed up these rates, I think there were people out there that may have been cut – caught short someplace along the line or thought they could ramp up faster than they could.

So I think the bad news and the good news, the bad news is that they didn't order the parts when they could have got them in a smoothing type of schedule. The good news is that the business is picking up and people are trying to do some restocking as well as keeping up with the build rates. The very good news is the build rates are going to go up. The best news is that the 787 is going to get built and they are going to bring a lot of white tails up to sell at the end of this period of time. So I think in the interim, Boeing has the time while this plane is being certified to make sure that their supply chain in total is in good shape to meet the rates that they've said they are going to meet. And I have – my personal bet is that they are going to meet these rates.

Steve Levenson – Stifel Nicolaus

Great. Thanks very much.

Pat Hassey

Thank you.

Operator

Your next question comes from the line of Michael Gambardella with J.P. Morgan. Please proceed.

Michael Gambardella – J.P. Morgan

Hey, Pat, hey, Rich. Congratulations on a nice improvement in the quarter.

Pat Hassey

Thank you, Mike.

Michael Gambardella – J.P. Morgan

Two questions. Pat, I think I heard you say in your remarks earlier on that you would expect to see raw material prices go down and your base prices go up, though?

Pat Hassey

Well, I think when you see prices, Mike, in the stainless markets, pricing mechanisms are an interesting factor into the market as again, we saw raw material prices rise rather rapidly. But when we look at the best estimates of many of the people that make estimates on raw materials, we still see, for example in nickel, 300 million pounds on the LME. So we are pretty confident based on forecasts from third parties what we see that happened last year. Other kinds of things there will be some moderation from this rapid rise.

In contrast to that, while this rapid rise in surcharges and volume has been taking place, there has been extremely little movement in base prices or on the conversion price. So the history has been as these things level out and plateau or moderate or come down, then it's an opportunity to try to recover the prices that should be in effect for the amount of volume and market conditions on the convergent side. So my guess is that we will see base prices move up in some moderation on the surcharge mechanisms.

Michael Gambardella – J.P. Morgan

Just going forward, like if we look – say, look first look back to the last peak in your earnings cycle back in 2007, when you made over $7 a share, $7.26, nickel prices back then hit a high almost mid-year of $54,000, or more than twice what they are right now. You typically make a lot of money in very high nickel price environments, but can you – if you don't expect nickel to really go up, can you give us a feel for how the amount of money that you invested since 2007 in terms of new capability, how that could offset some of the earnings loss, say from the previous peak due to nickel prices being about half of what they are or back then?

Pat Hassey

We've continued, as you know Mike, to work on the efficiencies and cost –conversion costs in this business. We have a new finishing end, new capabilities in our plate business. We have new capabilities in our titanium sheet production, which is flat roll today. We basically have a dedicated sheet plant. We've modernized all of our cold rolling mills to state of the art flatness gauge tension controls. We have improved our melt shop situation with the commodity melt shop and a specialty melt shop of both electrical steel and our nickel based alloys and ingot casting where we will, before the end of this year in the second half, close a complete footprint down.

So it isn't really the same company. We have been able to demonstrate over the last year, when business was really, really bad very low, our utilization rates that we were still able to make some money even under the worst of market conditions. So it's a different equation as we go forward. And I think that if we had the typical rates for this typical conversion revenues for this kind of a business, coupled with normal surcharge mechanisms, we will do just fine in that business. Rich, you might want to add what you think.

Rich Harshman

Yes Mike, I think the other – your point and we've said this publicly, first of all, the one comment about higher raw material costs than the '07 time frame, a large piece of that from an earnings standpoint was obviously offset by significant LIFO inventory reserve charges since most of our inventory is on LIFO. So but I think going forward we would agree that, we might turn out to be wrong but we would agree that the amount of speculation that was going on in 2007 that drove raw material costs high to those levels is unlikely to repeat itself.

But what we do believe is that in addition to all the cost reductions that, Pat, has alluded to and the capabilities we have from a manufacturing and a capacity standpoint of the amount of business and focus that we have globally. The diversification of the company, the capacities and the value add focus that we have, we do believe that those kind of earnings that we achieved in the last cycle are achievable in the next cycle in just a different way. They won't be driven by some other raw material cost of volatility. So it will be driven by higher value added products, so different cost structure increased volume.

One of the things that we've said that we didn't have in place in 2007 that we will have in place as these markets grow going forward is the capability of producing $60 million pounds of titanium mill products in the kind of product mix focus that we want that we didn't have that capability before. And with the 787 ramp up and the industrial markets and the use of titanium and oil and gas, those opportunities we believe will be there. And in addition, we think in that time period, we will begin to see some of the demand growth from some markets that really weren't present in 2007 like nuclear.

Michael Gambardella – J.P. Morgan

So with the – say the current level of nickel prices or about half of where they were back then you feel you can still reach that $7.26 in earnings?

Rich Harshman

In what time period?

Michael Gambardella – J.P. Morgan

Well, in the next several years.

Rich Harshman

Our view in the next three plus years, we think that's achievable, yes.

Michael Gambardella – J.P. Morgan

Okay. Great.

Rich Harshman

For all of the reasons that Pat and I just articulated.

Michael Gambardella – J.P. Morgan

Okay. Thank you.

Pat Hassey

Thanks, Mike.

Operator

Your next question comes from the line of Brett Levy with Jefferies & Company. Please proceed.

Brett Levy – Jefferies & Company

Hey, Pat, Rich and Steve. Can you talk a little bit about the $375, how much is going to Raleigh, Utah, how much of it is going to Brackenridge? And then as you look forward to 2011, what do you see as a more likely number?

Rich Harshman

Well, Rowley will be finishing here largely from a cash expenditure standpoint in the first half. And then the timing of the spend as we begin ramping up the hot rolling and processing facility investment will begin in more earnest ways here in the second half. And that matches up with the completion of some of the big projects Rowley and the melt shop consolidation, et cetera that we have been talking about.

So as we look at the $375 million more than half of that is expected to be focused in 2010 on the hot mill and processing facility. And as you know, that's a roughly a four year project. So as we look going forward, we would expect the kind of capital expenditure level of $350 to $400 million to continue for the next several years until the hot mill project is complete.

And we can – we have the capability because of how we are structuring that project to speed it up or slow it down a little bit depending upon what business circumstances are. But it's certainly our strong desire to complete that project and have it up and running before the end of 2013.

Brett Levy – Jefferies & Company

Got it. And then in terms of the use of the $560 million in cash and less revolver availability, what are you guys thinking strategically? Pension paid out or I don't know acquisitions, deleveraging? What are you thinking in terms of the use of that liquidity?

Rich Harshman

Well, I don't think we will have – we don't believe we will have a need to do any more pension funding. We think that the pension with the actions that we took last year and the years before that. And hopefully, the smart asset allocation we have that we will be able to not be in a position to have to put significant amounts in there.

The other thing is, as you know, we look at cash deployment in a balanced way. So certainly, we focus on what our obligations are to take care of them and we fund managed working capital to grow earnings, which we did here in the first quarter and capital investments and the dividend policy. And if we have something left over I think we have demonstrated in the past that we look for the best ways to create shareholder value with that excess cash and free cash flow.

So fundamentally, we don't have a different viewpoint today than we've always had. We do like the fact that we have an untapped credit facility of $400 million. And we like that sitting there as well as a reasonable amount of cash on the balance sheet at any point in time. So that we maintain financial flexibility to do things that are in the best interest of our shareholders and that's the philosophy we operate to.

Brett Levy – Jefferies & Company

Thanks very much, guys.

Rich Harshman

Okay, Brett.

Pat Hassey

Thank you.

Operator

Your next question comes from the line of Brian Yu with Citi. Please proceed.

Brian Yu – Citi

Hi, thank you. With regard to the nickel alloy affecting prices in the high performance metals, I was looking at the sequential decline and Pat, I was wondering if you might be able to comment on it just thinking that a lot of improvements coming from the engine side. It's a bit counter intuitive?

Pat Hassey

So I think there is been some pretty interesting price competition on the nickel side of the business. But as the volumes go forward and lead times extend out, I think you are going to see less of some of the earlier pricing pressures. So we would expect in the surcharge mechanism again, remember we do it only once every three months. The second quarter has also had a price increase in all product shipping out from April, May and June. If the prices of nickel stay where they are, we will see another price increase in the third quarter again.

So are you going to see pricing move up there and you are going to see volume since the lead times are moving up – volume moving up also. So I think this is a market that's just under recovery, Brian, not really declining. I think we've probably seen the worst of it.

Brian Yu – Citi

Okay. And one of your competitors yesterday said that they are seeing the lower end of nickel alloy market picking up quite a bit more. Is that an area that you are trying to capture of retain share and could mix have been part of the contributor factor in Q1?

Pat Hassey

I think there is – we are in the industrial markets and the oil and gas markets as well as the jet engine and other markets. So as that market is gaining strength, as we pointed out earlier in our comments, you might see some differential in pricing. But I think as the build rates can continue now to be confirmed and are secure and in fact projected to increase, then we will see a larger percentage of the business coming back toward jet engines and there should be some self correcting in that also.

Brian Yu – Citi

Okay. And then just a last one, I want to get a bit of clarification on your comments earlier about active versus hot idle capacity. In terms of taking it from two-thirds available to full availability, is it a matter of labor and adding additional shifts? Or are there additional things you have to do to raise equipment up time?

Pat Hassey

It is a matter of orderly bringing people back and orderly bringing up production. In our company, we bring shifts back we do reorientation, safety training, reorientation with the equipment quality training and so it takes a period of time to bring a shift back up get people back and familiar with the jobs and move it into production and then move it up.

It doesn't happen in just one week to next week, because the 2009 has been a severe enough reduction that coming back in requires us to go through the full element of training and safety. So it is people in shifts.

Brian Yu – Citi

Okay. And that's something you are doing now in anticipation of the back half pick up?

Pat Hassey

We are underway.

Brian Yu – Citi

All right. Thank you.

Pat Hassey

Thank you.

Operator

Your next question comes from the line of Kuni Chen with Bank of America/Merrill Lynch. Please proceed.

Kuni Chen – Bank of America/Merrill Lynch

Hi. Good afternoon, everybody.

Pat Hassey

Hi, Kuni.

Kuni Chen – Bank of America/Merrill Lynch

I guess just on nickel just to go back there for a minute. Obviously, we've seen a pretty big surge since the beginning of the year. Can you talk about how that maybe impacting your customer behavior both on the flat roll side and high performance side?

Rich Harshman

You are talking about the rise in nickel on the LME and the impact on customer buying patterns?

Kuni Chen – Bank of America/Merrill Lynch

Yes.

Rich Harshman

Okay. I think on the flat roll side or on the stainless side is always – that's always a potential factor. But we don't think at this point in time that it has been a major factor in terms of the demand improvement that we have seen thus far this year. And I think we would have an even stronger view of that being the case on the nickel alloy side and high performance metals.

We think that's purely fundamental driven for all the reasons that, Pat, actually began to articulate in the third quarter earnings release last year. And I think he predicted that what we are seeing now we would see. And that's what we were seeing.

Kuni Chen – Bank of America/Merrill Lynch

Okay. Great.

Pat Hassey

One of the comments that I made, just to clarify it is that we have improved our forward loads throughout the first quarter. And that those loads continue to improve as we are now moving through the second quarter. So the market is recovering and I think we did go through a period of some very, very competitive pricing and some changing around of shares and some changing around of contractual arrangements. And that disruptiveness sometimes creates different kinds of reactions that usually get solved as the market gets stronger and moves forward.

Kuni Chen – Bank of America/Merrill Lynch

All right. But again, just on you mentioned changes in some of the contractual arrangements. Has there been more discussion along those lines of customers looked to change the mechanism around nickel? Has there been more talk there about hedging perhaps? And maybe you could speak to how that could potentially affect you guys.

Pat Hassey

We haven't seen that, Kuni. We've seen our contractual arrangements, terms, conditions have remained the same. I was referring to long-term arrangements that we signed with major engine builders that we didn't have before.

Rich Harshman

Although Kuni, I would add that your question about customer hedging behavior. I think it is safe to say that unless it's a very specific more project oriented business. The customers do not appear to be willing or eager to hedge with nickel at the current level. They think it's going to correct down. So there was more desire when nickel was at $8 that may be hedged than there is with at $11 to $12.

Kuni Chen – Bank of America/Merrill Lynch

Okay. And then one last question. Can you give us an update at the electrical steel markets and updated view on what you see ahead for this year?

Rich Harshman

We've had some interesting times. We seen some depressed markets, but as we have had contractual arrangements with several of our major accounts. Our shipments have been the same or relatively flat throughout 2009 and they were up 4% in the first quarter. So we had interesting situations where we still have occasions where people are looking for a particular product because they need it right now and other occasions they are running out of warehouse material that they bought that they are using up or working down their inventories. So I would say our earlier comments that we believe the market is about flat for us, is what we would say. Although we had about a 4% increase in the first quarter.

Kuni Chen – Bank of America/Merrill Lynch

Thank you.

Operator

(Operator Instructions) Your next question comes from Gautam Khanna with Cowen & Company. Please proceed.

Gautam Khanna – Cowen & Company

Hey, guys. Just had a couple. I'm trying to get a handle on where the high performance margins can go from here through the year. You mentioned surcharges up strongly in Q2 sequentially. I got, if I look at my model it looks like they are up 25 to 30% versus Q1 at nickel. You mentioned lead times are extending, et cetera.

On the other hand, you didn't take a LIFO reserve charge this quarter and I assume that's because you assume these element prices will retrench through the year. But let's just say they stay where they are today across all of the products. How should we think about margins? Are we going to see expansion from here or is any expansion on the increased volume and surcharge rise going to be offset by LIFO?

Pat Hassey

I think we were in pretty good shape on the high performance side of the company. I am going to let Rich go through the technical explanation of how we look at LIFO and how we look at these margins. We said we thought that these prices on the nickel side would moderate in the second half, there is a lot of people predicting that. But basically, rising nickel in the end and all, at least as it's going up, should be good for us as we move forward. Go ahead, Rich.

Rich Harshman

Yeah. I think when you look specifically at high performance metals and the impact on LIFO, you obviously can't just look at nickel. You also have to look at titanium…

Gautam Khanna – Cowen & Company

Sure.

Rich Harshman

…and titanium sponge. And you know what the public comments are about the contractual sponge prices year-over-year. So that combined with mix becomes pretty big drivers of the LIFO assumption. I think that as you know how we do LIFO, we are projecting what we believe our year end costs will be. Year end being based upon our inventory turns essentially the last quarter of the year across the businesses by individual pool to come up with a current year index and that applied to the LIFO calculation and the projection of year end FIFO inventory determines what the full year LIFO reduction or increase on the reserve will be and then we take that ratably on a quarterly basis. So we will update that on every quarter. Our view here at the end of the first quarter is that, as we've said, that raw material costs will moderate.

To the extent that they don't, obviously, that will be impacted in our revised assumption as we go on a quarterly basis. Having said that, to the extent that they don't, I think that you will see FIFO profits increase as well. So how that plays against the LIFO reserve change will remain to be seen. But I don't think at this point in time it will be a significant driver one way or another but we will see. It all depends on what raw material costs do.

Gautam Khanna – Cowen & Company

So just to summarize then, it sounds like you are anticipating some increase in HP margin through the year?

Rich Harshman

Yeah. I think that's true. And I think Pat made those comments in his comments that we aren’t satisfied with 22% margins when you pull out the start up costs and the idle facility costs. We think there are opportunities to be better.

Pat Hassey

Summarizing, Kuni, if you go back and – sorry, if you go back and look at the comments around exotic material business coming back in the second half which has very good margins and you look at the ability to achieve the surcharge mechanism at the end of each quarter and with the volume levels and schedule extending, if there is any prices available in the marketplace, those would tend to have us believe that we will increase the margin levels back to acceptable ranges.

Gautam Khanna – Cowen & Company

Got it. And one last one, you mentioned some price pressure in the HP nickel area. Where specifically? In which end markets are you seeing that?

Pat Hassey

Well, that was earlier. We talked about that. I was referring to the fourth quarter of last year, third and fourth quarter of last year more so than current times.

Gautam Khanna – Cowen & Company

Got it. Okay. And may I looks on another one.

Dan Greenfield

Excuse me, Gautam. Gautam, I apologize, but we do have a lot of people in queue.

Gautam Khanna – Cowen & Company

Okay. Fair enough.

Dan Greenfield

Operator, can we move on? You can get back and if we have time or call us a little bit later. Thank you.

Operator

Your next question comes from the line of Peter Jacobs with Ragan MacKenzie. Please proceed.

Peter Jacobs – Ragen MacKenzie

Yeah. Good morning, gentlemen. Two questions. Let me just ask both right now and then you can hit those. On the share count, why wouldn't we be seeing the dilutive effect of the convertible debt out? That's the first question. The second quarter, it will be for Pat and is that on the flat rolled revenue. Really, really nice move up from the bottom that we saw in revenue in the second quarter of 2009. And I'm just wondering what your sense would be in terms of what impacted inventory restocking of customers come into play. And on the sequential basis, how much more for movement might we see as the quarters progress throughout the year?

Pat Hassey

Go ahead, Rich.

Rich Harshman

Yeah. The question on the share count and the impact on the convertible. First of all, we’re governed obviously by the accounting rules in terms of how to deal with the diluted calculation on a convertible. And it's very fact specific depending on the company. So the drivers of that for us are the earnings, obviously, the tax rate and the interest expense on the convertible that’s flowing through the income statement on a quarterly basis. And in our case, that's also impacted by the fact that we capitalize a portion of our total interest expense under the accounting rules because of the construction of progress on our long-term capital projects. So the bottom line is when you put all of those factors in as it pertains to ATI, on a quarterly basis, using the $98 million share count which excludes the convertible effect, basically, our earnings per share have to be at or about $0.25 a share in the quarter before the convertible issuance is considered dilutive.

So because we were below $0.25, if we were above that, then we would have had to assume that the convertible shares were in fact converted which would increase our diluted shares up to about $108 million. But then we – $108 million shares. But then we would also have to add back to the reported GAAP net income a portion of the interest expense that is associated with that converted, because the convert assumes it's equity, not debt. But we have to adjust that for the amount of – pro rated amount of interest that we've capitalized. So that's a long answer. But the real impact, the real threshold is if you are at or below $0.25 a share using the $98 million shares, it will be anti-dilutive and therefore, not included.

Peter Jacobs – Ragen MacKenzie

Okay. That's good. I – having a sense of where that threshold is very helpful. And then the second question was on the flat rolled revenue and the outlook there.

Rich Harshman

The outlook is positive. Lead times, again, have moved in this business. Schedules are filling virtually across all of our product lines on flat rolled. I do believe there are some restocking going on as people are surprised maybe by some of the things that are – that they have seen. If they run out, they want to not only meet their current pull for their materials, but there is some restocking into the system. That especially happens if there is any schedule increases. Now, we have been able to bring back capacity in this business rather soon. We have been able to move up our melt shop schedules, move our hot rolling schedules up a bit, run some overtime quickly in the finishing end. And so there is still capacity to go.

But we were looking to – we are looking in our basic products to get up to that – in the stainless steel sheet and plate to get up around 350,000 tons. And then with the specialty products making up the other 40% more of that business, we would expect that if this trends all hold together and this recovery stays on track that it's on now, that we will see quarter-on-quarter improvement, quarter-on-quarter more tonnage until we are back to full utilizations or utilizations that we consider at practical capacity. So this is a pretty good recovery on the flat roll side that we seen over the last 90 days.

Operator

Your next question comes from the line of Dan Whalen with CapStone Investments. Please proceed.

Dan Whalen – CapStone Investments

Great. Just a quick question. As the market continues to improve and you begin to restart the remaining one-third of the capacity, what kind of restart expenses can we expect in the coming quarters here?

Pat Hassey

I don't think we all have. Like I said, we bring people back in we have to train. We have some shuffling around to do. But basically, we are talking about equipment that has been kept in good shape. We are not talking about – we've already restarted all of the full capacity of our two major melt shops. We have some capacity in specialty metals to bring back up, but that's not expensive startups. So I don't see we will have anything that would be material or major at this point going forward in start up costs.

Dan Whalen – CapStone Investments

Okay. Great. That's helpful. Thanks.

Operator

Your next question comes from the line of John Tumazos with John Tumazos Very Independent Research. Please proceed.

John Tumazos – John Tumazos Very Independent Research

Thank you. First, is there a published price or reference for titanium scrap that we might use in trying to guess your make or buy point or reference titanium products?

Pat Hassey

I don't think there is a good index out there, John, any place. This is what you can buy from a scrap dealer. So there is – I can tell you that the prices have moved up dramatically from the fourth quarter, continuing to move up through the end of the first quarter. And there is some availability issues today with one supplier having to solve some quality problems and just the availability of material assets as a cycle picks back up. So I think in our particular case, we are glad to have the availability to us or the opportunity to move more sponge production in if we choose to versus the scrap market.

Other thing I think to consider is that as the programs of Boeing have some near net size kind of production coming out of Russia today, that that scrap that used to be in the U.S. is now held in Russia not coming to the U.S., at least that portion of it. So it's an interesting game that is changing from dealer to dealer, from week to week.

John Tumazos – John Tumazos Very Independent Research

I don't want anyone to misunderstand a earlier question response you gave. When you said it will take about 18 months to for Rowley to qualify for jet engine grade…

Pat Hassey

Highest grade rotating quality.

John Tumazos – John Tumazos Very Independent Research

So you didn't mean to communicate that Rowley would not show a profit for 18 months.

Pat Hassey

No, no, no. Rowley will be producing material that is salable and good. It is producing material that's salable today. It's the question of getting – the question was, when will you be fully qualified at Rowley for premium grade titanium sponge? Grade A sponge, we should be qualified pretty soon on for aerospace air frame and industrial products. I'm talking about the full qualification to put something at 4000 rpm, probably won't take that long.

John Tumazos – John Tumazos Very Independent Research

If I can ask one more. The AISI detail data for January showed about a 50% drop in electrical steel consumption. And they may have a different definition than you including shipments from integrated steel makers or new core or steel dynamics. Can you give us an update on grain oriented electrical market?

Pat Hassey

I would say that we are under contract with our major customers. And so our shipments, as I pointed out, were actually up 4%. But I think the market itself is not robust in any sense of the word. There is some specific areas that require specific products of grain oriented that are pulling. But I think basically, it's a flat market right now, maybe declining even in total and in the industry. Around the world, the market is up, that's for sure. The global market would be higher only when we consider India and China and other parts of the world. So you put it all together, I would say the world market is bigger. There is more supply there than what there used to be. But the U.S. market has yet to recover back to the levels that we would like to see.

Operator

Your next question comes from the line of Sal Tharani with Goldman Sachs. Please proceed.

Sal Tharani – Goldman Sachs

Good afternoon. Just wanted to – quick question on the titanium shipments for the year. You mentioned 40 million pounds. Does that include, I believe the flat roll shipments out of the flat roll division, is that correct?

Pat Hassey

Sal, there is three parts to it. It is the high performance metals. It is the flat roll shipments and it is any conversion work that we are doing for our Unity joint venture with VSMPO.

Sal Tharani – Goldman Sachs

Got you. So Unit and…

Pat Hassey

It's got a portion of all that.

Sal Tharani – Goldman Sachs

Okay. So Unity in flat roll was 3.2 million, 3 and change this quarter?

Pat Hassey

Right.

Sal Tharani – Goldman Sachs

So just to get an idea, we back out sort of 12, 13, 14 million out of that to see what the shipment will be at the titanium HBM division?

Pat Hassey

Yes.

Sal Tharani – Goldman Sachs

Okay. Great. Thank you.

Operator

Your next question comes from Tim Hayes with Davenport & Company. Please proceed.

Tim Hayes – Davenport & Company

Hey, good afternoon.

Pat Hassey

Hello.

Tim Hayes – Davenport & Company

Question on the startup costs at – for high performance metals. Do you have an estimate for Q2 and how long will those start up costs last?

Rich Harshman

I think Q2 will be somewhere in the same range of Q1, maybe a little bit less as we continue to ramp up. The number will continue to go down each quarter in 2010 as we begin to produce and grow the production of sponge. And we will be then at a cost level that we think is a reasonable standard cost and therefore, we'll be valuing the sponge and inventory at that level. Until then, basically in the first quarter, all the costs – pretty much all the costs associated with the sponge facility in the first quarter hit P&L as start up costs. It will be somewhat less than that in the second quarter. It will be less than that even more in the third and finally, in the fourth, we wouldn't expect any.

Tim Hayes – Davenport & Company

Okay. And then last question, when you do reset your raw material surcharges for the nickel alloys at the end of the quarter, what – how far back do you use the nickel prices? Is that an average from January to March for nickel? Or is it December to February? Just want to get the specifics on that, please.

Rich Harshman

It's basically a one quarter lag. So when we reset it, it's pretty much off of – when we reset for the second quarter, it's based off the average for the first quarter.

Operator

There are no further questions in queue at this time. I would like to turn the call back to Mr. Pat Hassey for any closing remarks.

Pat Hassey

Well, thank you, everyone for joining us today. This game becomes a lot more fun as we turn the corner and see a recovery in our markets. We'd like to thank you for joining us today and thank you for your continuing interest in ATI.

Rich Harshman

Thank you, Pat and thanks to all the listeners for joining us today. That concludes our conference call.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect your lines. Good day.

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Source: Allegheny Technologies Incorporated Q1 2010 Earnings Call Transcript
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