Allegheny Technologies' (ATI) CEO Rich Harshman on Q4 2015 Results - Earnings Call Transcript

| About: Allegheny Technologies (ATI)

Allegheny Technologies Incorporated (NYSE:ATI)

Q4 2015 Earnings Conference Call

January 26, 2016 8:30 AM ET

Executives

Dan Greenfield – Vice President-Investor Relations and Corporate Communications

Rich Harshman – Chairman, President, and Chief Executive Officer

Pat DeCourcy – Senior Vice President-Finance and Chief Financial Officer

Analysts

Steve Levenson – Stifel

Gautam Khanna – Cowen and Company

Josh Sullivan – Sterne Agee CRT

Richard Safran – Buckingham Research

Kevin Cohen – Imperial Capital

Michael Gambardella – J.P. Morgan

Operator

Good morning, and welcome to the Allegheny Technologies Incorporated Fourth Quarter and Full Year 2015 Results Conference Call. All participants will be in a listen-only mode. [Operator Instruction] After today’s presentation there will be an opportunity to ask questions. [Operator Instruction] Please note this event is being recorded.

I would now like to turn the conference over to Dan Greenfield, Vice President, Investor Relations and Corporate Communications. Please go ahead.

Dan Greenfield

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 on our website at www.atimetals.com. Members of the media have been invited to listen to this call.

Participating in the call today are Rich Harshman, Chairman, President, and Chief Executive Officer; and Pat DeCourcy, Senior Vice President, 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 considered 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 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

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 a pound in December of 2014.

The base price for the most common commodity stainless sheet products 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 hydrocarbon processing industry markets, were down $100 million or 28% compared to 2014. This more than offsets strong sales in the first half of 2015, led by approximately $145 million of nickel-based alloy flat rolled 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 by – 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 years 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 castings 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 completed the 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 cost and accelerate our growth. And we can better leverage and align our engineering talent and technical capabilities to create value for our customers and our shareholders. 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 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 in demand.

As previously announced, we plan to idle 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 U.S. 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 actions 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’s Pat DeCourcy, ATI’s Chief Financial Officer, for a more detailed discussion of the 2015 fourth quarter financial results. Pat?

Pat DeCourcy

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 2015 are as follows: fourth quarter 2015 results include a $54 million pre-tax, 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 2015 ATI commenced the salaried workforce reduction in both the High Performance Materials & 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 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, a 7% of our 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 & Components segment since the currency used for our sales to the international aerospace market is mostly in U.S. dollars and most of our cost are incurred and paid in U.S. dollars. However, the relative strengthening of the U.S. 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 & Components segment sales were $457 million, a decrease of nearly 4% compared to the previous quarter and nearly 9% lower than the fourth quarter 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 the segment.

Flat-rolled products segment sales were approximately $282 million, 21% lower than the previous quarter and over 48% lower than the fourth quarter 2014. Segment operating loss was $120 million. Beginning in the third quarter segment sales – segment results excluded all the impacts of LIFO and NRV inventory reserves and includes retirement benefit expense attributable to the segment.

Turning to Slide 9. We maintained a solid liquidity position with $150 million in cash on hand and no borrowings outstanding under our $400 million ABL at the end of the quarter. The five-year $400 million ABL facility is collateralized by 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 shifted to early 2016. We currently expected 2016 capital expenditures to be approximately $240 million, including our nickel alloy powder expansion, final payments on the HRPF, and the expansion of 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 nearly end of our extraordinary capital expenditure cycle that has transformed and modernized ATI. We have built the 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

Thank you Pat. Turning to Slide 11, ATI 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 for 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 space and defense to grow significantly as a percentage of ATI sales, due to expected growth and next-generation of legacy engines, aided by particularly strong growth in our forgings and casting business, as a result of LTA signed in 2014 and 2015. Well I’ll provide additional comments in a few minutes.

We significantly reduced 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.

I 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 rightsized 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 flowline 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 rightsizing actions.

Turning to Slide 15 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 grey area shows the number of legacy engines. Our products here include such well-known alloys as ATI 718 nickel based super-alloy and ATI 64 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 make, such as ATI 718Plus, Rene 65 alloy, ATI 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 737 MAX and CFM LEAP engine. That’s 100% growth and a big driver of the improved sales and operating profit we expect from our high-performance materials 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 of 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 superalloy billet. ATI is one of the only two independent and integrated qualified producers of nickel-based superalloy powders and isothermal forge 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 737 MAX first delivery is scheduled for 2017. The first A320neo’s Pratt & Whitney geared turbofan engines. GE confirmed last week that the LEAP launch remains on track for midyear.

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 in 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 and 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 the 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 to the commercial aerospace market to reach about 70% of total segment sales.

Turning to Slide15, 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 rightsizing 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 rightsize the business and temporarily exit the commodity stainless sheet and GOES business. So I’ll 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 a number of projects in the first quarter and we have received additional orders for downhaul 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 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 rightsizing 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?

Question-and-Answer Session

Operator

Yes, thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Steve Levenson with Stifel.

Steve Levenson

Thanks. Good morning everybody.

Rich Harshman

Good morning, Steve.

Pat DeCourcy

Good morning, Steve.

Steve Levenson

It’s going to be sort of 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? And 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?

Pat DeCourcy

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 a structural. So see there are so many differences that drive that I can 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 to entry that use our technical capabilities and reward them. And so, obviously the aerospace market is really at the top of – of that pyramid because of the critical importance of really all the parts, and components and materials that go into a – both an airframe and or 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’ll 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 mill products 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.

So we’re 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 product side. There are equally attractive margins on the components side. The competitive aspect is always there, so I’m 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 park 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 a as close to a final machine part or a component as they can. So the machining aspect of that plays as well.

I think as we’ve said before, we look at the High Performance Materials and Components segment, as I look at it as more of a single business. I mean that’s why we made some of the organizational changes that we announced and implemented in the second half of 2015. I think there are synergy opportunities that we realized early on including some significant restructuring that results in about $23 million of annual cost reductions, most of that being in the segment some of that at the corporate level as well. I think there are more of those opportunities out there, not necessarily through headcount reduction, but through efficiencies, and streamlining, and best practice sharing, et cetera. I look at that segment as a segment that given the end markets that we’re in and given the technologies that we have, and given the fact that each one of those businesses have already have competitive cost positions.

I mean it’s not like the struggle we have in the flat-rolled product segment, where we’re trying to become more competitive in our cost structure. I think we are very competitive in our cost structure and high performance. It doesn’t mean that we’re perfect, that we’re satisfied. We will continue to drive that. But I think that segment needs to have and should have a level of profitability that is at least 20%. And I think over the next several years, that opportunity is there for us. The oil and gas market isn’t going to be down forever. And I think we see continued opportunities for growth, and efficiencies, not only in the commercial aerospace, but also in the defense market, in the medical market and the electrical energy generation market, et cetera.

So it may not answer your question very specifically, but it’s the overall strategy of what we’re trying to accomplish and what I think we are positioned to do.

Steve Levenson

That’s good, thanks. I appreciate the detail. One other one that’s not really business related, but as the change of the nature of the company switches towards aerospace, is there way to reclassify yourself the way some of your competitors are classified as aerospace companies and extricate yourself from the metals and Mining ETFs that create a lot of volatility?

Rich Harshman

Yes it does. I mean, that’s a true statement. It’s interesting ATI as it exists today, as you know, Steve, it’s really a result of some significant merger and acquisition activities going back to the Teledyne Allegheny Ludlum transaction and then following on with – our acquisition of Ladish. But when you look at this business on a pro forma basis, going all the way back in time, the largest end market has always been aerospace and defense. It wasn’t that case for Allegheny Ludlum, but it certainly was a case for Teledyne and Ladish and when you put them all together, aerospace and defense has been the largest end market and I believe we’ll continue to be large and we’ll continue to grow.

Steve Levenson

Got it, thank you very much.

Rich Harshman

Thank you.

Operator

Thank you. And our next question comes from Gautam Khanna with Cowen and Company.

Gautam Khanna

Hey, guys. I have a couple…

Rich Harshman

Good morning, Gautam.

Gautam Khanna

Good morning. I had a couple of questions. The first one just on cash flow expectations in 2016, you mentioned the depreciation of $180 million and the CapEx of $240 million, could you walk through some of the other puts and takes? And do you anticipate being free cash flow positive this year and if so what point in the year?

Rich Harshman

Yes I’ll let Pat will answer that.

Pat DeCourcy

Yes we got and we do expect to be cash free flow positive but largely driven in the back half due to all the actions we had to take in the first half with the idling of the GOES in commodity stainless facility. So we will generate free cash flow for the year though and be positive for the full year, largely driven in the back half though.

Gautam Khanna

Okay. If there are any desire – I mean, I imagine you’re going to reduce some inventory as well as you exit back half [indiscernible]?

Pat DeCourcy

Yes we have targets to reduce inventory, we have turned improvement goals we intend to achieve. And we’re also getting rid of the balance of the CPP related inventory that we had associated with the work stoppage. A little bit of that will ship in Q1. Also exiting those two commodity businesses will draw the inventory down in the flat-rolled products business. So there will be some significant cash generated out of inventory this year.

Rich Harshman

Yes Gaut [ph] on the commodity business, the commodity stainless business had pretty good inventory turns, but there is a large inventory balance associated obviously with being in that business. The grain or electrical steel, because of the fact that we melted it in Breckenridge, so we had to campaign those melds and it also required us to do wash sheets and then after that campaign and that created inventories that took a while to flush the through the system including producing the finished product.

So there are significant efficiencies, I should say, that accrue to flat-rolled products by simplifying the business. It’s not something that we wanted to do quite frankly, but the market conditions are such that the products we make have to be profitable. And if they are not, then we’re not going to make them.

Gautam Khanna

Yes and to that point, Rich, clearly GOES and closing Midland and Bagdad probably are idling them. I imagine with whatever 25% of sales but it will be a much higher percentage of the unit volume that runs through flat-rolled because it is a lower value mix today. I was wondering if you could comment on how did you think about the baseload dynamic that you guys have discussed in prior years having any contribution margin on a lot of volume absorbs a lot of fixed overhead.

I just wondered at this point given we’re going to have a substantially reduced volume running through HRPF. How did you think about the profitability of that aspect as we move forward?

Rich Harshman

Yes…

Gautam Khanna

You’ve talked about…

Rich Harshman

I think the important part – the important thing to think about as we’re taking out a whole melt shop right? So when we idle that melt shop, I mean, it’s not a warm idling, it’s a cold idling. So the incremental costs on an annual basis of basically just keeping the plan secure and things like that is just that it is minimal. So all of those costs are coming out. So you’re actually lowering your costs based from the standpoint of meeting that volume. And we simplify the Breckenridge melt shop we have – we won’t be operating at the same level of capacity there, but you schedule to melt shop differently, right?

And the HRPF is an interesting animal, because it’s not really a people-intensive business. So it’s a very efficient business, I mean obviously what you’d like to do is have business conditions that you could fully load the HRPF. But that requires demand and prices for the product that you can make money on, if not, at least the contribution margins.

So the problem with the commodity business as it exists today, that the transaction prices are at a level that the contribution margin just isn’t there. So you have to take the actions and view the fact that at the end of the day, right there is no such thing as a fixed cost. So you have to get rid of those fixed costs, and we do that really by idling Midland and idling the draft, and becoming much more efficient and lower cost and Breckenridge on the whole Breckenridge campus. The Breckenridge melt will probably be 15 – 19 terms. We certainly believe we can be efficient, and competitive and profitable at that level.

The HRPF is going to run as much as it’s needed to run. The finishing assets will really be pretty efficiently filled because most of the commodity products that we finish at least on the larger coil sides were all done in Midland. And that operation won’t be operating until business conditions can improve.

Gautam Khanna

Okay. And for modeling purposes, what should we anticipate the run rate CapEx to be in 2017 and beyond? And then I just want to frame our inventory reduction in our models for this year? I mean, could it be as high as $100 million? Or how should we think about that?

Pat DeCourcy

Yes, inventory $100 million is a good number to use for the inventory reduction and the CapEx 17, 18, 19 will be around a $100 million total. And then when you look at our maintenance CapEx with the revised footprint we drop down to be about $55 million to $60 million in total maintenance CapEx per year. So we are estimating a $100 million per year. We’ve been running well over $200 million. So significant step down in CapEx

Gautam Khanna

Thanks a lot guys.

Rich Harshman

Thank you Gautam.

Operator

Thank you. And the next question comes from Josh Sullivan of Sterne Agee CRT.

Josh Sullivan

Good morning.

Rich Harshman

Good morning Josh.

Pat DeCourcy

Good morning Josh.

Josh Sullivan

Can you just take stand on the utilization aspect of the high performance segment? How should we be thinking about that in 2016 or over 2016 and into 2017? And then maybe where is utilization now and where do you think its going to go?

Pat DeCourcy

Yes. Well, I mean it all depends on what facility you are talking about. But I think the overall utilization, overall will probably be up 10% across the operations in the high performance segment. I will give you an example of the refocusing that we did in the UK operations. The UK operations consisted and consist of a melt shop and GFM rotary forge and some finishing assets. And a significant and market of that has historically been oil and gas. But also there has been aerospace there, especially on the shaft side.

So what we’re doing is as we grow, especially the vacuum melted nickel alloys and super alloys, we have an asset in the UK that can, from a melt shop standpoint can be more fully utilized, especially with oil and gas where it is. And so we are offloading and from a capital efficiency standpoint, we are offloading some of the standard grade nickel alloys VIM melted products into the UK, where we also have the GFM. And then we can redeployed that capacity that’s in our North Carolina operations for the growth into the higher value aerospace market, the triple melt 718 et cetera, et cetera.

So I think that when we look in the increase is the utilization of the UK, that obviously increases the utilization of Monroe through growth, and we’re really seeing the same thing on the forging side. The one thing on our Forge product side, we’re going to be heavily utilized for some of our small, smaller part hot-die forging operations in Southern California. In the Wisconsin facility, that is a very versatile facility that serves as not only the aerospace market, but other industrial markets like construction and mining market. The construction and mining market, we are not anticipating to be very good in 2016. But certainly the aerospace market growth through the isothermal forge presses and all the ancillary equipment will increase the utilization and improve the absorption of the forging side.

And then on the casting side, once we can complete here in the first quarter, the new capital expansion on the casting side. As we look out here over the next three to four years with the LTAs we have in hand, where we will be at capacity in our casting business over the next three to four years.

Josh Sullivan

Okay, so then…

Pat DeCourcy

Overall I think operating volumes will increase about 10% overall.

Josh Sullivan

So that gets us to kind of the double-digit operating margin for 2016?

Pat DeCourcy

Yes that’s a big, well I mean, it is a combination of the improved efficiency and absorption. But it’s really the additional revenue volume and growth that we’ll see throughout 2016, resulting in a return to double digits during the second half.

Josh Sullivan

Okay. Right, and then I just wanted we saw the 747 rate come down the other day the A330 comes down at some point. Can you talk a little bit about what impact the decline in legacy in aircraft such as these versus the ramp on the next-generation aircraft is going to look like as we progress through 2016?

Rich Harshman

Yes, I mean, I don’t think its going to have a significant impact quite frankly. I think those adjustments to some of those lines are really temporary adjustments in transition to the next-generation platforms. So I don’t think it’s going to be a major impact to the supply chain. I think it’s more overwhelmed by the growth on the narrow-body side and the growth and increase in production on the XWB. You know the 777Xs and the 787, I mean, our participation in the Neo and the MAX, our participation in content on those platforms is higher than we’ve ever had before quite frankly on any platform.

I think as you look at the transition on the single-aisle, the CFM56 engine, for example a legacy engine, we’ve actually increased our participation in that engine while its still in production it will be gradually over the next seven years decreasing in production with the next-generation engines taking over. But quite frankly we’ve got in some cases on some parts from a 20% share to 100% share on those parts.

So we see the legacy side, especially on the parts and components side to be the growth for us over the next several years, despite the fact that they will be less being produced. But I don’t think that the adjustments that have been announced thus far are really significant drivers at this point to our business.

Josh Sullivan

Okay, thank you.

Pat DeCourcy

Thank you.

Rich Harshman

Thanks.

Operator

Thank you. And the next question comes from Richard Safran of Buckingham Research.

Richard Safran

Thank you. Good morning.

Rich Harshman

Good morning Rich. How are you?

Richard Safran

I’m doing very well, thank you. Gentlemen, and Rich, in reference to your, just to your recent comments here on aerospace sales up 8% and the comments you have been making right now. I’m trying to get a sense of how we should be looking at the performances topline growth and maybe long-term. Not just 2016 but beyond. Is this now a situation where we should be looking a high-performance growth in terms of the build rate increases for new technology aircraft? Do some of these share gains cause you to do better than build rate growth that sort of thing, any comment you could help there would be great.

Rich Harshman

Yes, I think the build rate growth – I mean it’s interesting. When you look at the raw numbers the build rate growth might not be all that eye-opening over the next five years. But it’s the mix that’s more significant to ATI, I think. I think when you look really across the platforms we see the growth and participation, not only in the mill product side, because some of the differentiated alloys that I mentioned in my comments, but also really on the parts and components side. And that’s been part of the strategy here, right.

Once we acquired Ladish there was a strategic focus there that we intended to fulfill over a number of years, I mean it was really dependent obviously on the market and how the market was moving. But we saw what was on the drawing board, we saw both the engine in the platform side. So I think that we’ve commented that we see in the high-performance side a $1 billion in growth over the next five years. So you are looking into a segment that we expect to go from $2 billion to $3 billion and that’s driven largely by aerospace. And I think that’s really kind of a conservative view in my opinion because we’re not banking on any significant growth in other end markets which may occur like oil and gas isn’t going to be where it is forever, right. And that’s an important market for us. Construction and mining isn’t going to be where it is forever. And that had been very important and significant market for us on the forging side.

So I think that the asset capability, and the technology and the products that we have on the high-performance side are really positioned largely driven by aerospace, but also by being more focused on us increasing our participation in the defense market that I believe we’re under serving and we’re focused on that, the normal growth in the medical market that we’ve seen consistently over the past 10 years to 15 years and some semblance of a return in the oil and gas and the electrical energy generation market I quite frankly would be disappointed if all that segment was $3 billion in 2020.

Richard Safran

Okay. And finally here, you always have a bit of an interesting take on the aerospace aftermarket. It looks like in 2015, there was continued demand for refurbished parts, sort of displacing demand for new parts. I was wondering if you have any comment on that? And also, if you have any comment on how the aerospace aftermarket did for you in 2015, and how it looks for 2016?

Rich Harshman

Yes I mean I think it was, 2015 was certainly better than 2014 and 2013 on the aftermarket side. I think that we expect some of the same type of demand profile in 2016 as we saw in 2015. So I think the comments are, from GE the comments are, that they think the aftermarket demand will increase. I think it really depends on the parts and components side. On the material on the mill product side, traditionally, over a very long time period, our demand was 25% to a third driven by aftermarket. I think that that’s probably consistent today.

On the parts and components side, it really depends on what platform you were on, right? So the old Ladish Company was more rolls focused and less GE and Snecma focus, so therefore their historic opportunity was not, from a growth strand point, was not as it would be if they were more single aisle or narrowbody focused, I should say. So because that’s really where the big driver of the aftermarket is more on the cycles on the engine, which happened more on the short routes, which lend their case to be more of a single aisle.

So I think our refocusing of that business to be more diversified gives us an opportunity, especially as we look at some of the parts and components we won on the legacy generation aircraft. Those aircraft are going to be flying for a long time and there will be a demand profile there.

So I think as we look at 2016, I see it relatively consistent with 2015. I think as you get further out in 2017 and 2018, those older airplanes will still be flying. They will be the drivers of the aftermarket. And I think we have opportunities for growth on the parts and components side, with stability on the mill product side.

Richard Safran

And thank you.

Rich Harshman

Thank you.

Operator

Thank you. And the next question comes from Kevin Cohen with Imperial Capital.

Kevin Cohen

Good morning and thank you for taking the questions. I guess, going back to the free cash flow topic. If the Company were not to source $100 million from inventory, would the Company still be free cash flow positive in 2016?

Pat DeCourcy

It’s a significant driver of our free cash flow, but we do of a bit of a margin there. So if we weren’t as successful as $100 million, even if we got say greater than $50 million, $60 million, we could still be positive for the full year.

Kevin Cohen

That is very helpful. And then the second question, just kind of looking at EBITDA in the fourth quarter, are there any one-time items or noise in numbers, as it relates to COGS and SG&A, just thinking about the clean starting point, if you will, as you head into 2016 at all [ph]?

Pat DeCourcy

I think we’ve highlighted everything in the release and in the previous comments. But there are some also work stoppage related costs that, obviously once this is settled that those would decline significantly going into 2016. So there are some we will call a trailing work stoppage related costs that we talked about. Some of the inventory that was produced earlier in the year and shift with a higher nickel number in it, those types of things. So there would be some drivers there.

Kevin Cohen

And can you remind us, I might have missed it, what that work stoppage cost, or opportunity cost, if you will, was in the fourth quarter?

Pat DeCourcy

We did not quote that number.

Rich Harshman

Yes. I mean its – its starts to get blended in and mixed with some of the decisions we’ve made of backing away from taking orders that didn’t have a positive contribution margin. So I think the first quarter in flat-rolled will still be challenging. I don’t think it will be as challenging as the fourth quarter. But it will be better, and I think as we move forward and eliminate some of the significant cost drivers that are still there as we exit and pull back on the commodity and the GOES markets, those will become less significant in the second quarter by a magnitude and be gone as we enter the second half.

Kevin Cohen

That is very helpful. And then just the last question. Stainless steel prices were reportedly down about 2% in the first half of January, I guess. Have you seen prices stabilize since then, or what are you broadly seeing out there on stainless prices?

Rich Harshman

Yes I think the commodity stainless prices were up, the base prices were up a little bit because all the producers announced about a two percentage point increase. So you are talking a couple of pennies a pound but it still – it’s gone from maybe $0.44 to $0.46 a pound, right. But still at historic lows. I think my long-term view has been that over a reasonable time period you don’t see base prices stay below $0.50 a pound very long because really hardly anybody – nobody is profitable on a pretax basis, and some are not profitable on a contribution margin basis.

But I still think the problem that exists in that market is one that you have such a large excess capacity in the world and you have slower growth in China, you have a slower growing economy in Europe, and you have the U.S. where you really see some inconsistent growth, especially on the manufacturing sector side. And so the demand growth for flat-rolled stainless is not very attractive at this point in time. And that’s going to keep pressure on pricing for a while.

Kevin Cohen

I appreciate all the commentary and good luck.

Rich Harshman

Thank you very much.

Operator

Thank you. And the next question comes from Michael Gambardella with J.P. Morgan.

Michael Gambardella

Yes, good morning.

Rich Harshman

Good morning, Mike.

Pat DeCourcy

Mike.

Michael Gambardella

I have a couple of questions. One, in terms of the high-performance business, you have mentioned that all of your contracts, or most of your contracts in aerospace are denominated in U.S. dollars. But I am assuming that there are a number of contracts that expire on an ongoing basis. How do you face ongoing competitive pressures of a high dollar against a non-dollar-based cost competitor, say in Europe?

Rich Harshman

Yes, well I don’t, first of all, I don’t think your first assumption is correct. I mean, I think most of the contracts that we have are multiyear contracts that have been renegotiated here over the last couple of years, and are going out anywhere from five to seven years. So I don’t really see any significant renewals coming up here in the short term, number one.

Number two, to the extent that were true, the competitive landscape coming out of Europe for the products that we make is not significant.

Michael Gambardella

So you really don’t have any of your contracts coming up for renewal over the next two years?

Pat DeCourcy

No.

Rich Harshman

Not significant, no.

Michael Gambardella

Okay. Can you then in broad terms, explain over the past year, from say a fourth-quarter 2014 to the fourth-quarter 2015, this very high value-added, high-performance segment had margins drop 1,000 basis points?

Rich Harshman

Yes, well I mean there’s a lot of factors that went into that including oil and gas, and construction and mining, all of the things that we’ve been talking about, Mike. And all the things we’ve been talking about for now a year and a half. So I don’t really have anything to add.

Operator

Okay. Thank you. This concludes our question-and-answer session. I would like to turn the conference back over to Rich Harshman for any closing remarks.

Rich Harshman

Okay. Thank you for joining us on the call today, and as always thank you for your continuing interest in ATI.

Operator

Thank you.

Dan Greenfield

Thank you, Rich. Thanks all of listeners for joining us today. That concludes our conference call.

Operator

Thank you. Thanks for attending today’s participation. You may now disconnect.

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