ATI's (ATI) CEO Bob Wetherbee on Q2 2022 Results - Earnings Call Transcript

Aug. 04, 2022 5:28 PM ETATI Inc. (ATI)
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ATI, Inc. (NYSE:ATI) Q2 2022 Earnings Conference Call August 4, 2022 10:30 AM ET

Company Participants

Scott Minder - VP, Treasurer & IR

Bob Wetherbee - Board Chair, President & CEO

Don Newman - EVP & CFO

Conference Call Participants

Richard Safran - Seaport Research Partners

Phil Gibbs - KeyBanc

Seth Seifman - JPMorgan

Gautam Khanna - Cowen

David Strauss - Barclays

Paretosh Misra - Berenberg

Josh Sullivan - The Benchmark Company


Welcome to the ATI Q2 2022 Earnings Call. My name is Ruby, and I'll be your moderator for today's call. [Operator Instructions]

I will now hand over to the team to begin the presentation.

Scott Minder

Thank you. Good morning, and welcome to ATI's second quarter 2022 earnings call. Today's discussion is being broadcast on our website.

Participating in today's call are Bob Wetherbee, Board Chair, President and CEO; and Don Newman, Executive Vice President and CFO. Bob and Don will focus on our second quarter highlights and key messages. A supplemental presentation is available on our website. It provides additional color and details on our results and outlooks. After our prepared remarks, we'll open the line for questions.

As a reminder, all forward-looking statements are subject to various assumptions and caveats. These are noted in the earnings release and in the slide presentation.

Now, I'll turn the call over to Bob.

Bob Wetherbee

Thanks, Scott. Good morning and thanks for joining us.

After many quarters of saying, we're preparing for the ramp, the time has come and I can say with confidence today that we are ramped. Our core markets, namely, aerospace, defense and energy, are accelerating. That's largely due to end customer demand, technology shifts, and geopolitical events.

Across our asset base, production is increasing to match this demand. This is what we plan for. We're ready and it feels great. Admittedly, we're in the early phases of this ramp, but we're confident we're positioned in moving forward. I'm not going to say it's easy. We're operating in challenging circumstances, labor markets are tight, and per costs are rising with inflation a global issue. Supply chain are fragile after two years of pandemic reshuffling.

Just like during the pandemic we're laser-focused on what matters most. I'm proud how our team is responding. We worked hard to be on track or ahead to fill open positions.

We're offsetting inflation with cost reduction initiatives and dynamic pricing. Our operations are producing and delivering high-quality parts and materials in a timely manner. But we are not perfect; we strive for perfection every day at every site. We owe it to our customers and they appreciate our efforts.

Across ATI, our actions are translating into strong financial results and significant long-term opportunities.

Three things do that for me in our Q2 results. First, revenue growth is accelerating. Our second quarter sales of $960 million were up 15% sequentially, equally supported by both business segments. This marked the highest quarterly sales since Q4 2019. It's worth noting that the previous period was before we exited standard stainless sheet and divested both our Flowform business and our Sheffield operation. The higher base in surcharge pricing provided the tailwind; expanding customer demand is the real driver.

Second, our margins continue to improve. Momentum is building in these early phases of the aerospace recovery. Q2 adjusted EBITDA margins were near 15% in the second quarter. This marks an improvement of more than 600 basis points year-over-year. Sequentially, margins were in line despite the second quarter results having significantly fewer government-related benefits. Actions taken during the pandemic to transform our cost structures and business portfolio are paying off. We expect this performance to continue.

And third, we're seeing an increase in free cash flow, as our forward order book continues to strengthen and input cost improve for the balance of the year. We had a modest use of cash in the second quarter. This was in line with our normal seasonal trends and our performance was better than we anticipated. Without stealing all down spender, we're increasing our full-year cash flow target to reflect these improvements. We'll still find working capital for the ongoing production ramp and capital projects for organic growth. As we do, we're making progress toward our long-term goal of converting 90% of net income to cash by year-end 2025.

Let's take a step back from our short-term results. I have three big picture observations to put ATI's performance in context. First, the strong demand for air travel has returned to the vast majority of global markets and should grow consistently for the next several years. My recent travels for the Farnborough Airshow clearly makes this point. Completely full international flights, both ways. Each row was jammed with people from around the world. Same model sent to the desert at the start of the pandemic have returned to service. At the show itself, both airframe OEMs announced customer orders for narrow and wide bodies.

Well, the narrow-body supply chains has recently experienced a few bumps, not unexpectedly, production rates on narrow bodies are still projected to ramp to record-setting levels. Wide-body engine spare parts demand is spiking as airlines address the recovering strength in international travel.

And how is all that relevant to our shareholders and our team? These trends benefit ATI even more than they did in 2019, for two reasons. One, our shares have grown; and two, the industry is moving almost exclusively to fuel-efficient next-generation jet engines where we have significantly more content. Now, more than ever, you can't fly without ATI.

My second big picture observation, Russia's invasion of Ukraine is changing the world in many ways. Some are big, others small, but most are going to be sticky for some time to come. Let's be clear, the Russian aggression is having a tragic impact on millions of people's lives. It's forcing significant migration primarily to other parts of Europe. We continue to stand in support of the people of Ukraine. We thank our employees, particularly those in Poland who have directly helped impacted Ukrainians.

On the business side of this issue, the situation in Ukraine has focused the industry on shifting aerospace titanium purchases to western sources. Customer discussions on this subject are pervasive, active and lively. We're disciplined in our response. We're balancing the need to help our customers and repositioning their supply chain with our commitment to benefit our shareholders at the same time, balancing short-term and long-term interests of both.

We announced a significant titanium share gain in July with GKN Aerospace. It's a great example of how we're finding the best ways to allocate our increasingly tight capacity to the greatest strategic benefit.

The impact of Russia's aggression in Ukraine goes well beyond aerospace share shifts. I have three examples that are meaningful for ATI. First, countries in and connected to geopolitical hotspots are increasing their national defense investments. In the near-term, this means increased demand is combat weapons systems are replenished.

We're also seeing increasing demand for all types of military vehicles, some near-term, and some extending into the medium-term. In the longer-term new capabilities like Hypersonics are a priority for development. These require extreme material science expertise, which is ATI's sweet spot.

Second impacted note, security of national energy supply has become critical. Countries are assessing vulnerabilities created by procuring energy from potential adversaries, renewables, such as nuclear, hydrogen and solar are the long-term environmentally-friendly solution for most. At the same time increased fossil fuel usage sourced differently will be required until the new sources can be built at scale. ATI serves both.

And third, looking beyond aerospace and defense, customers in other key ATI markets are working to eliminate Russian-made input materials. This is clearly visible in the medical markets where sourcing a titanium and other inputs are shifting to Western-based suppliers. Again ATI is well-positioned to service these supply chain shifts.

My final observation is 100% of our own making. We are now fully out of standard stainless sheet products. I expect this will be the last time I mention this product line in my earnings call remarks as we sold our last coil in the second quarter and closed our facility in Illinois, the fourth in our transformation of Specialty Rolled Products. Expansion of our Vandergrift, Pennsylvania operation is on track who will be the best finishing facility for specialty materials.

We're winding down those operations left at our Ohio facility, in the first weeks of July, we've idled all but one operation -- one last operation, actually at that facility. The team is doing great work. With the standards team exit and the second quarter's divestiture of Sheffield, our portfolio transformation is largely complete.

We're a leaner, more-focused company. We're investing our energies growing our strategic core. We've embraced the name, you know what's that, ATI is our official name and we've adopted Dallas as our new headquarter city. We're expanding the vision of what we can achieve. We haven't just transformed physically. We've also evolved our culture. Our Specialty Rolled Products team continues to increase the percentage of business under long-term agreements with OEM, building and mitigations for raw material fluctuations. Our Specialty Alloys & Components team continues to explore innovative and valuable uses for the exotic alloys and materials we produce.

The same can be said within our High Performance Materials & Components segment, where our force products and Specialty Materials businesses are working together more closely than ever before. It's about delivery, lead time and quality. We have the winning combination in this market.

Let's shift to a quick overview of our Q2 performance by market and what we see for the quarters ahead. First, in our largest end market, the commercial aerospace resurgence is well underway. Jet engine related sales increased year-over-year by over 90% and nearly 30% sequentially. What drives these significant increases in demand, narrow-body production rates, LEAP engine share gains and service part demand for wide-body engines.

We're in the up cycle. Early phases perhaps but the trend lines are upward and solid. Rounding out commercial aerospace, airframe sales increased for the second consecutive quarter as we realized volumes from our previously discussed share gains and new business wins. With relatively low wide-body aircraft field rates and significant wide-body channel inventory, ATI’s aircraft OEM sales are expected to remain subdued into 2023, before accelerating in 2024.

Last week's announcement on the resumption of 787 deliveries is an important positive catalyst for ATI and the industry. Bottom weighted good news and clarity we can work with. Growth outside of production rate increases is possible with a likely additional share shift from Russian suppliers. Our airframe category also includes space applications, which we expect to grow.

Next up let's talk about defense. Sales improved sequentially largely due to higher naval nuclear volumes. When compared to prior year, sales were down due to shipment and program timing for naval nuclear and rotorcraft customers. Looking ahead, expect defense sales to advance driven by ongoing geopolitical events and our broad-based new business development efforts.

Moving beyond our core A&D markets, energy demand growth accelerated in the second quarter, increasing nearly 70% versus prior year and 25% compared to the prior quarter. High oil prices and global energy supply chain disruptions pushed customers to fund exploration and expansion projects including downstream processing.

Specialty energy markets grew across technologies as well from pollution control systems, natural gas turbines, and renewables. The ongoing push for energy security and reduced carbon emissions will continue to drive demand for ATI's materials and components over the coming quarters.

Lastly, we saw year-over-year demand growth in medical and electronics. Sequential revenue comparisons were mixed with medical sales up almost 10% and electronic sales down 4%. In medical markets, elective surgery volumes continue to increase post-pandemic. This drives customer demand for implant and MRI materials. We expect this trend to continue augmented by ongoing customer shifts away from Russian made materials. In electronics, demand for consumer devices has slowed somewhat as a result of customer supply chain issues and reduced discretionary spending.

Additionally, our Asian Precision Rolled Strip sales were lower as a result of COVID-related lockdowns in Q2. Demand for ATI's Hafnium and magnetic alloys continues to expand in part to support 5G microchip production.

I'll wrap up by saying we're laser-focused on what makes ATI great. Material science and our advanced process technologies coupled with strong operational execution that produces incredible product quality and reliability. We put ourselves in a strong position and we're executing to deliver on strong demand.

Now let's hear from Don. I'll be back after that to conclude and take us into Q&A. Don?

Don Newman

Thanks Bob.

Let's start with the bottom line upfront. Our revenue growth is accelerating and is strong in both business segments. Each segment grew the top-line sequentially by at least 14%. Year-over-year growth was even more substantial. That's compared to a prior year period impacted by the pandemic and a labor strike.

Adjusted EBITDA margins were nearly 15% in the second quarter. Our adjusted earnings of $0.54 per share is above our guidance range, driven by strong volumes and benefits of our accelerating business transformation. As a result, we're increasing full-year earnings guidance for the second time this year, this time by nearly 40%. With increasing confidence in our forward visibility, we're improving our free cash flow guidance as well.

Now, let's dive a little deeper into the second quarter's results. Q2 sales were just below the $1 billion mark at $960 million. We fully expect to cross that billion dollar threshold in the coming quarters, getting back to 2019 levels on a run rate basis. That's after exiting standard stainless sheet products and divesting of Flowform and Sheffield, that's a stunning recovery in a short amount of time.

Our earnings and margin improvement were equally impressive. In Q2, we generated adjusted EBITDA of $143 million. For the second quarter in a row, adjusted EBITDA margins roughly 15%. This compares to full-year 2019 margins of 10.7%. We're proud of this achievement. It's a testament to our team's hard work during the pandemic. They ensured we emerge ramp-ready. It also reflects their hard work streamlining cost structures, improving product mix and fully offsetting the negative impact from inflation through mid-year 2022.

In our February Investor Day, we gave long-term EBITDA margin guidance of 18% to 20% by the end of 2025. Our 2022 year-to-date results clearly show that we're building momentum.

Our Q2 adjusted EPS came in at an impressive $0.54, up $0.14 from the first quarter. This is despite significantly lower federal employment credits and grants in the second quarter. On a GAAP basis, we posted an EPS loss of $0.31. The second quarter adjusted EPS excludes non-cash charges related to the sale of our Sheffield operations. You'll recall that we sold Sheffield because it was not well aligned with their strategic focus and generated negative EBITDA in 2021. For us this divestiture is a case of addition by subtraction.

Now, let's take a deeper dive into segment results. I'll start with High-Performance Materials & Components or HPMC. The aerospace recovery is accelerating, driving increased demand for our specialty materials and forgings. In the second quarter, revenues were almost $400 million, 80% of those sales came from the aerospace and defense markets. That's an important milestone in the journey to reaching our long-term financial goals. Revenues increased 16% sequentially and 32% year-over-year, largely driven by sales to the jet engine market.

HPMC adjusted EBITDA in Q2 was $60 million representing a 62% increase over the prior year. Earnings decreased by about $8 million sequentially, as a result of lower government employment benefits. Recall that our first quarter included $23 million of benefits from the Aviation Manufacturing Jobs Protection Act and other employment programs. Q2 results included only $6 million of similar benefits. The significant difference in value more than accounted for the sequential earnings decline, offsetting the strong segment operating performance.

What do these results showcase? Revenue growth potential, mix improvement toward next-generation materials, and benefits from our cost-cutting efforts. We expect this progress to continue during the commercial aerospace ramp.

Let's shift to Advanced Alloys & Solutions or AA&S. Our transformation, again, significantly and positively impacted our financial results. Q2 revenues were $563 million, an increase of 14% versus Q1. Year-over-year were up nearly 80%.

Now, keep in mind, prior year revenues were impacted by the multi-month labor strike, the strike which concluded in July 2021, impacted our Specialty Rolled Products or SRP business. Sequential and year-over-year gains were across most major end markets led by aerospace and energy. And from an earning standpoint, AA&S continues to post strong results.

Second quarter adjusted EBITDA was $105 million. That bears repeating. AA&S EBITDA was more than $100 million in a single quarter. That's an increase of nearly $30 million, sequentially, and almost $70 million year-over-year on 2021 results that were adjusted for the labor strike impact.

Q2 margins were an impressive 18.6%. That's an increase of 330 basis points, sequentially, and 720 basis points versus prior year. Q2 2022 results included about $10 million of Section 232 recoveries on tariffs paid in prior-periods.

As Bob announced, we're completely out of the standard stainless sheet business. But the impact of our transformation reaches far beyond simply eliminating low-value products. The SRP business has improved its customer mix and grown the percentage of business under long-term agreements. As a result, we've significantly increased our ability to recover higher input costs and have materially reduced our exposure to metal volatility. Most importantly, we're being more fairly compensated for the value that we're delivering. The transformation is working as planned. We expect to eliminate additional costs in second half of 2022 as the final stainless related facility is idle. And we anticipate further product mix improvements as we reduce lead times and increase capabilities at our Vandergrift facility.

Now let's talk about the balance sheet. We continue to take actions to reduce leverage and strengthen our financial foundation. Late in Q2, the remaining $84 million of our convertible note converted into roughly 5.7 million shares. To help offset that shareholder dilution, we've repurchased roughly 3.5 million shares in 2022. More color in that in a moment.

As a result of rapidly improving EBITDA and debt reduction, our net debt to adjusted EBITDA ratio dropped to 3.3x.

Looking ahead, expected strong second half financial results and cash generation should help further reduce our leverage metrics. We're quickly moving closer to our goal of maintaining a 2x net debt ratio across the business cycle.

At the end of Q2, total available liquidity was $730 million, including $274 million of cash on hand. Looking ahead, we expect to increase our cash balance as the year progresses.

Managed working capital as a percent of sales improved sequentially by nearly 300 basis points. At quarter end, it stood at 38.5%. This figure remains elevated largely due to: one, strategic raw materials that were purchased at the onset of the Russian invasion; two, rising commodity prices; and three, funding inventory for our growth ramp. This metric should continue to improve in the second half of 2022. We expect to end the year much closer to our longer-term target of 30% of sales.

Capital expenditures were $29 million in Q2 and $55 million year-to-date. We expect this pace to accelerate due to organic growth-related projects in the back half of the year. However, we will likely spend the lower initial 2022 guidance range of $210 million to $225 million. Our new 2022 target per capital spending is $205 million to $215 million, which reflects our continued discipline around capital deployment. I want to reiterate our capital allocation priorities and highlight where we stand today.

First and foremost, we're consistent with what we said at our Investor Day in February. Our priorities are straightforward and well-aligned with our strategy. First, we'll fund growth. We have a robust list of organic growth projects with strong returns, and current market conditions support investments. Acquisitions remain of interest, but it's important to stay disciplined and we will.

Second, we want to reduce debt and funder pension obligations. Debt is $84 million lower as a result of the convertible note maturity. In terms of the pension, we intend to make a $50 million voluntary contribution to our defined benefit plans in the second half of the year. This contribution, coupled with increased discount rates, could meaningfully move us closer to our pension funding goals at the end of 2022.

Our third priority is to proactively return capital to shareholders. Year-to-date, we've purchased 3.5 million shares under our share buyback program at a total cost of $90 million. $16 million remains on our current board authorization. We'll be thoughtful executing that mandate, balancing our cash needs, the stock price and shareholder interest. The good news is we're in a position to tackle multiple priorities simultaneously.

Now, let's talk about guidance. We continue to outpace our earnings expectations due to strong customer demand, healthy product mix, and our ability to offset inflation. After our strong Q1 results, we increased our Q2 and full-year expectations. We're back in that enviable position today. Thanks to our strong Q2. We're increasing our expectations for Q3 earnings. We expect Q3 EPS to fall within a range of $0.50 to $0.58. At the mid-point, this is in line with our Q2 adjusted results.

Our revised forecast takes into consideration, the expected negative impacts from business seasonality, scheduled outages and lower commodity costs. And we don't anticipate additional federal employment incentives or Section 232 tariff recoveries in Q3.

We're also substantially raising our full-year adjusted EPS guidance as a result of our year-to-date and Q3 performance. Our new 2022 guidance range for adjusted earnings is $2.00 to $2.14 per share. This is an increase of almost 40% at the mid-point versus prior guidance. For reference, this compares to adjusted EPS of $1.18 in 2019, excluding benefits from the sale of our oil and gas rights in that period. Our businesses performing and we're keeping our foot on the accelerator.

Lastly, we're updating our free cash flow guidance. As we see our improved earnings convert to cash. For full-year 2022, we expect to generate at least $110 million of free cash flow, excluding any voluntary pension contributions. This represents an increase in free cash flow guidance of more than 80%. We're working hard to increase cash conversion rates toward our goal of converting at least 90% of net income to free cash by the end of 2025. This is a step in the right direction.

In closing, we're pleased with the momentum building in the business and strong underlying demand in our key end markets. Our investments in ramp readiness and business transformation have fundamentally changed the trajectory of the business for the better. We have the right strategy and are confident in our team's ability to successfully execute for the benefit of our customers and our shareholders.

With that, I'll turn the call back over to Bob.

Bob Wetherbee

Thanks, Don.

As I listened to your commentary this morning, I think we agree it's fair to describe our Q2 results as robust, not a word we use a lot, but certainly appropriate for this time. They reflect our decisive actions taken to position us for this moment, this moment with a strong market recovery.

Our outlook demonstrates that we expect these positive trends to gain momentum. We expect higher sales, earnings and cash flows. Our end markets are improving, particularly commercial aerospace. Demand for new aircraft and the materials needed to keep them flying are expected to benefit our business for years to come.

The defense and energy markets are also contributing to our positive performance and outlook. Our success is not only a function of great markets, but also our team's heavy lifting. And I use the word team purposefully. It's been a total team effort. I'm proud of their achievements, and I know they're proud of what they've done as well. It's not always fun, easy or on a simple schedule, but I'm proud of how they've gotten what they needed to get done, done. We've had a lot going on at ATI.

We've put ourselves in a position to be successful and it's paying off. Our cost structures are lean. Our footprint is streamlined and we have the workforce largely in place to accelerate along with our customers' production plans. Our assets and capabilities are unmatched. We've transformed our physical structure, our culture and our performance.

Our incredible people are leveraging these tools to unlock new opportunities, create long-term shareholder value like never before. And we recognize we have more work to do. We're challenging ourselves, setting high expectations, and we do what we say we will, we raise those expectations higher. We're truly proven to perform and our customers recognize and reward us for it.

Operator, we're ready for the first question.

Question-and-Answer Session


Thank you. [Operator Instructions].

Our first question is from Richard Safran of Seaport Research Partners. Your line is now open. Please go ahead.

Richard Safran

Listen. I'd like to get an industry perspective from you and then I have a follow-up. So given the constraints, what do you think is the ability to supply chain to support a narrow-body rate ramp? And where do you see the major issues? We heard Boeing mentioned 38 a month. We know Airbus is looking for higher rate. But how steep of a narrow-body rate ramp is possible in your view?

Bob Wetherbee

Yes. Rich, this is Bob. Good morning and thanks for the question. The question I've been getting pretty regularly for the last six months. Well, the good news in all this though Rich is ATI is not the bottleneck, so that's a good thing. We don't intend to be the bottleneck.

But to your question, I think on the ramp speed, we kind of look at the history of how I'm going to talk about narrow-bodies, but narrow-bodies it kind of go up about a build rate of 5 per OEM every six months until they get stable, maybe six months to eight months get that stability in and then make the next ramp, the next five and the next five. So I think we only produce to orders. We don't produce to build rates, but we factor it into our long-term planning with kind of a five for every six months to eight months until they achieve stability. I think they recognize that a stable supply chain that's coming along at their pace is really critical.

I think the second part of your question was around where are the problems today? I won't speak to the castings issue. I think a lot of people have talked about that and they're probably closest to it, but I think it's somewhat broader than that. And it's little things, so you see some specialty alloy forging billet supply issues pop-up and become a problem on some of the specialty stuff. You'll see a fire here or a fire there and a melt shop. You'll see deferred maintenance causing a press to break down. I think we're going to see those kinds of issues, coming up that I think castings is probably the biggest issue and then make sure that the forgings demand is keeping up. But we're keeping up with what the industry's forecasting and we have really confidence in the customer dialogue and there've been some recent announcements lately, but we're not seeing anybody take their foot off the accelerator or handoff that throttle. I think 2022 into 2023 is going to be a good ramp for the industry. And we're going to get to these record levels in due time. So hopefully that helps answer your question.

Richard Safran

Yes, of course, it does. So next up maybe for Don, because I'd like to ask you about the remarks you just made and I'm not trying to put you on this spot, but in light of GKN, what can you tell us about further share gains and what this means to that long-term forecast you gave back in February? Your remarks now just mentioned like EBITDA margin. So here we are six months later and it looks to me like advanced alloy EBITDA margins ex the Section 232 are pretty much in line with your 2025 guide for mid to high teens. So I'm kind of wondering if share gains make your February guide a bit obsolete. I'm just trying to get a sense of at least how you're thinking about it now.

Don Newman

Yes, I appreciate that perspective. And I agree with you, the business is performing really, really well. To get to the core of what you're asking, we're seeing broad-based demand across many of our key end markets. And in February, in our Investor Conference, we shared a 2025 guidance. And with that, at that point we had what we believe were very healthy and somewhat aggressive growth rates for the top-line and for margin expansion.

Then after the conference, obviously some events happened in the world, including the Russian invasion of Ukraine impacted a number of dynamics in the market and has created some opportunity for us. So the core question, I think that you're asking is done with the new world as it exists today are your numbers low.

And what I would say is the VSMPO related share gains, for example, that that have come up since our Investor Day are 100% incremental to the information that we shared in our Investor Day in our 2025 targets. So I see upside there would reinforce Rich that the opportunities we're seeing are beyond aerospace. It includes other key end markets in medical and energy. And I would say that the tailwinds that we're seeing are also not just related to the geopolitical stuff that we saw happen with the Russian invasion, although it's certainly impactful. So good news for us is our strategy and our capabilities have put us in a fantastic position and I think we'll see performance certainly at the high-end of the targets that we laid out in our February conference, and it's our goal to certainly beat those targets as time unfolds. We think we have a great opportunity to do that. And then we're also excited this broad-based demand, these tailwinds that we're seeing, look to us to be sustainable for our business and so that's good for all of us.


Our next question is from Phil Gibbs of KeyBanc. Your line is now open. Please go ahead.

Phil Gibbs

Last quarter, you gave a lot of good texture on your jet engine business and it was very heavy in terms of MRO. I think this quarter, while we don't have your opinion yet, it looks like, oh, you would have had to have picked up just given the strength of the baseliner or numbers in the first quarter for MRO. So maybe explain that, the texture of the jet engine business in the second quarter?

Bob Wetherbee

Yes. Sure, Phil. I think you're right on both themes, right. So as you might imagine over the last 900 days, our team has spent a lot of time with customers, not only at the air show but one-on-one, and I think the uptick in wide-body MRO demand, the repair business has actually been quite good, quite positive and looks to be sustained, probably sustained through, kind of, this middle-term cycle before they -- the new bills get delivered, and then transitioning into probably some of the narrow-body engine spares demand.

So, we've seen an increase -- historically we've said, 25% of our business is really spares. I would say today based on the feedback, it gets closer to 40%. And we think that's going to be for the next couple of years a sustained trend, based on the engine side. So we've gotten more clarity on that over the last 90 days.

Now, on the OE demand, I'll tell you, I showed you some of the charts the percentages are staggering, but again, we're starting from a low base, right. So when you look at the percent increases on that, all our major programs, we're well-positioned with the next-generation alloys, we're well-positioned on our next programs, and because we're shipping a lot of those products 12 to 15 months in advance, as long as we get our supply chain stays in sync, which is a day-to-day challenge to make sure we're in sync, we're going to see the OE demand increase pretty well. But I think the spares will stay pretty hot here for the short to medium term. So hopefully that helps.

Phil Gibbs

Yes. So it sounds like to me that if anything, the spares side has really been what's surprising to you all the less, maybe three to six months in terms of its strength.

Bob Wetherbee

That would say the last, yes, three to four months. It's been -- it started strong. We got a lot of indications in the middle of the first quarter that since we don't produced anything, but the orders have come in, I mean, just, want to buy incremental forging from us today, we're definitely into Q2 of 2023 booking. And so I think on the spare side, our team is being very conscious of it because it's we've some good products in the wide-body sector on the engine side, and we want to be supportive of those customers because they're -- they've got a engine in for repair or overhaul they want to make it work. So I think that what we're seeing now is more of a sustained trend than just an initial blip.

Phil Gibbs

Okay. Well, that's encouraging. And then one more follow-up just on the third quarter guidance. Mid-point, Don, is $0.54. You just did $0.54. Clearly, the tariff is moving away, labor credits moving away, but you do have the sustained recovery in aerospace. So it's fair to say that in that sequential stability you've got a pickup in HPMC, and that's equally offset by a decline in AA&S?

Don Newman

I don't know I would look for a decline in AA&S. I think we're -- like I said, we're seeing broad-based demand. Clearly the AA& S segment is performing very, very well, as is HPMC. So I think you're going to see good guys on both sides, especially as things unfold for the balance of the year.


Our next question is from Seth Seifman of JPMorgan. Your line is now open. Please go ahead.

Seth Seifman

Hey, thanks very much, and good morning. So just wanted to ask about one of the key themes we've heard on across the aerospace and defense sector this quarter has been of about sourcing labor and supply chain, but particularly, about sourcing labor given the, the ramp up in activity that you guys have in front of you, both in aerospace, and increasingly it seems in energy, as well. How you're positioned for that? And what, kind of, risks remain around, kind of; having the labor pool to make sure that you can deliver on, on the growth you expect over the next two, three, four quarters?

Bob Wetherbee

Yes, great Seth, and good morning. I think when you look at the hiring it starts with recruiting, right. This is a recruiting market, and so we've deployed differently in this ramp than we've ever done before to make sure we have a really qualified, broad, aggressive recruiting team, in the four or five major hubs that we operate, so North Carolina, Pennsylvania, Wisconsin and Oregon. And most of our focus candidly is in Wisconsin, North Carolina, and the team's done a great job.

So yes, it's been challenging but we're ahead, at or ahead of pace every given week. It's a onboarding, so it's a weekly scorecard that we look at. In Q1, I think we talked about adding about a thousand positions. To fill that ramp we probably got about 20% to 25% more to go balance of the year. So we feel we're at pace confident when recruiting aggressively.

We did a couple of things during the pandemic that are helping us at this point. It's different than some others in the supply chain. Our strategy is to keep each of our operations open. So it was a matter of moving people around, and maybe we had more technical, more skilled people doing less skilled jobs during the pandemic that they'd be able to get back to their jobs. And as we add people we're getting really good employees and onboard and trained quickly without a degradation in productivity. I think that's really been a key, it's hiring and recruiting is one thing but how quickly can you get them up to speed. So I think our strategy there has been good.

The Aviation Jobs Protection was helpful. It allowed us to do some things aggressively that we probably wouldn't have done otherwise. And we try to keep as much of the technical talent as we could. But to say the least we're pulling every lever, but we feel like, so far, we're keeping on pace with what we need to do through the balance of the year.

Seth Seifman

Great, great. That's very helpful. And then maybe just a follow-up a little bit on Richard's question earlier, the level of earnings in AA&S, you mentioned, emphasized that you sought on $100 million in the second quarter. There's a one-timer in there, but based on the EPS guidance for the rest of the year, it doesn't seem like that is coming down materially in the near term. And just in order to make sure that all of our expectations remain in check and don't get out ahead of ourselves, run rating at something close to 100 here for a good part of 2022, are there things in that that are, that we should think about as maybe not sustainable going forward because as we -- as we head to 2023, 2024, 2025, you would think that there's going to be growth in the business and that would lead to potential upside off this level. But just to kind of level that, is there anything in this year that's really not sustainable other than the tariff reimbursement?

Bob Wetherbee

Yes. So a couple of things to keep in mind. First, the underlying businesses, both segments are performing really well. As you think about transitioning from the first half of the year into the second half of the year, how should you think about it? Well as you go into Q3 in both of the segments what you would expect to see is some outages in Q3, that's kind of seasonal for us. There's also broader seasonal pullback into Q3 and that has to do with, for example, Europe taking their extended vacations in Western Europe, in the U.S. as well. It's a heavy vacation period, which can impact production that's normal.

I think another thing to keep in mind, you pointed out the 232 recoveries, obviously you would pull that out that was roughly $10 million good guide for us in Q2 that won't be repeating in the future.

And then we had a modest amount on the HPMC side, in terms of these employment program benefits $6 million. I wouldn't expect that to repeat.

So that's one set of things that I would note. Another thing to keep in mind is that how is our business affected by metal prices. Now we've seen a lot of volatility in the first half of the year around commodity prices like nickel. And although, we have significantly reduced the volatility in our business related to metal price movements like nickel, we're -- we still are impacted by it. And so we've been seeing recently where nickel prices have moderated some. And so you would expect that that would create some sequential headwind for AA&S as those metal prices come down. And it affects surcharges and things of that sort, pricing may soften a bit as a result of those commodity prices coming down.

So not a lot of specific quantifiable things in that second group, but those are things that you would want to consider. Good news is, we do have this underlying tailwind in multiple end markets. Arrow is an easy thing for everybody on the performance it's point to understand. And we expect that as 2022 unfolds, we'll continue to see full on the business from that standpoint and finish the year quite strong as you can see by the math in our guidance for the full-year. Does that help you a bit?


Our next question is from Gautam Khanna of Cowen. Your line is now open. Please go ahead.

Gautam Khanna

I have a -- good morning. I had a quick follow-up on the titanium share opportunity. I was curious if the EU sanctions, which were I guess taking off of VSMPO specifically, does that reduce the urgency of Airbus or Safran to move away from that source of titanium? Are you seeing any -- I'm just curious, like did that do anything to the pace of negotiations and are those two prospective customers you do expect to gain share with over the next couple years based on the Russia situations?

Bob Wetherbee

Yes. Good morning, Gautam. And I think the issue about urgency is your first question. We haven't really seen any change in the level of urgency with anybody in the aerospace supply chain. There's been a tremendous amount of work to set up additional qualifications. There's certainly multi-market that Don referred to in terms of the markets that are looking for titanium shifts.

And certainly multi-tier. I think a lot of the commentary focuses on the OEMs, but there's a tremendous amount of procurement or directed buying where people are really concerned about that supply. So I never believe that, they would totally go away from Russian's supply. But I do think they're committed to managing their overall risk levels. And that's kind of what they've said publicly, and it's very much a diversification play to make sure they can deal with any eventual circumstance.

So I think most of us who are in this position will qualify and we will win some share. I think they'll also be emergent demand like there always is in this uptake -- uptick. So I do think the industry is repositioning itself, not a 100%, but significantly and yes, we do expect to win share across multiple different places. Not only airframe, but we're seeing it in defense, clearly in terms of armor systems, rotorcraft, engines, all those kinds of things, medical, and then even in the industrial and energy space. We backed away from our unity joint venture on industrial titanium to free up some units and those haven't lasted very long. So there's a lot going on, but I do believe they are going to shift and I do believe there's long-term benefit that will gain from that across the tiers.

Gautam Khanna

That's helpful. And I was wondering if you -- have you guys seen any emergent demand on the precision forging side because of potential bottlenecks with some of your competitors? Did that show up in the quarter or is it showing up in the bookings, right?

Bob Wetherbee

Yes. I would say the answer to your question is, yes. I mean, we obviously talked to our customers on a regular basis. I mean, they're looking at various options. There are some places that we're qualified that they haven't fully taken advantage of yet. But Q2 was -- I have to go back and say, the Russian situation developed in late February, early March. So I think with the order lead times, it's probably a late 2023 -- wait late 2022 into 2023 opportunity for us.

We're still growing into our share position in Europe that we announced, oh geez, a while back that I hadn't fully been exercised. But on the opportunity side, I would say, yes, there's some upside but it's going to be 2023 answer your question it's in the bookings, right.


Our next question is from David Strauss of Barclays. Your line is now open. Please go ahead.

David Strauss

Hi, thanks. Don, just to follow-up on I think it was Seth’s question. Your EBITDA was $143 million I think in the quarter. What do you view kind of the recurring number as when you strip out the one-timers and kind of the big benefit that you've had from higher nickel prices?

Don Newman

So I mean the easy math of course is to grab the two big chunks that I talked about. So if you start at $143 million and you strip out, it was $9 million to $10 million of 232 recoveries. And then we had about $6 million of federal employment grant types of benefits that gets you to a number kind of in the $130 million range. As far as metal tailwinds in Q2, I would say they're modest. If you're trying to get -- trying to wrap your head around what is kind of a recurring Q2 number, I would say in that certainly $125 million to $130 million plus range, as you think about Q2.

And then as you look into the second half of the year, Q3 I laid out, hey, we've got some seasonality, it's normal for our business, but we have this underlying demand. That's really creating some positive tailwinds in the business. And we have a continued transformation of the SRP business. And that that's really -- that transformation is pretty profound. It's impacting the top-line and it's impacting the bottom line of the AA&S segment results. It's improving mix. It's improving margins. We expect that that's going to continue to add benefit as well.

And I shared in the pre-prepared comments that, we expect some good guys in the second half around costs related to that transformation, because we have another facility that's going to be shutdown. And we've got some other mixed benefits from the transformation we're expecting. So that's the best -- probably the best color I can give you in terms of how to think about Q2 and then how to think about the go-forward from the second half.

David Strauss

Okay. And on your free cash flow guide, can you walk us through the moving piece on working capital? How you get there? I mean obviously you've had a pretty big inventory and receivable build here in the first half of the year.

Don Newman

Yes. I'm happy to do that. So there's a couple of key data points to think about -- as you're thinking about our managed working capital, which is a really important influence when it comes to our free cash flow guidance. So on the one hand, keep in mind, our target around managed working capital hasn't changed. We were at 30% of sales in 2019. Our target is to get back to 30% of sales and then improve upon that. So as you look at where we ended Q2, we're at 38.5% I believe at the end of the quarter made about 300 basis point improvement in that position, that's great.

As you think about going forward, by the time we get to the end of 2022, we expect to be a lot closer to our 30% target. We're going to be in the neighborhood. We're not going to quite get there. But what it clearly indicates is a significant reduction in measuring capital levels from where we are today to where we're going to be at the end of the year.

So how's that going to happen? Well, first you want to think about why we're at where we are from our working capital standpoint. For one thing, we did add some strategic inventory and that was tied to what was happening with the Russian invasion of Ukraine. When that was transpiring, we made a strategic decision to add safety stock, strategic inventory in the business. Good news on that is, that elevated our inventory in the short-term de-risked us and we expect that by the end of this fiscal year, we'll burn through that inventory. So that would be a good guide for us.

Then one of the reasons why inventory has been elevated in the short-term is because higher commodity prices. Well, commodity prices around things like nickel, I think have certainly moderated some. Then we have all the structural efforts that are going into how -- what we need to do in order to get to the 30% target. Kim Fields, our COO and her team are doing some great work around that. The transformation that we've talked about is an important part of it. We've consolidated our footprint and reduced the number of manufacturing facilities in our SRP business, for example. Think about what that does to the flow of inventory and the need, or lack of need, after the fact, for inventory in certain positions.

So what you should expect is in the second half of the year is all this is transpiring. You should see a significant release of managed working capital and a generation of cash tied to our -- to our work on managed working capital.

The last thing I would say is, don't forget, on our business we very typically generate the majority of our free cash flow in the business in the second half of the year. And then, it's usually largely in the fourth quarter. That pattern will be in place in 2022 as well. So does that help you?


Our next question is from Paretosh Misra of Berenberg. Your line is now open. Please go ahead.

Paretosh Misra

Thank you. At your Hot-Rolling and Processing Facility, what sort of utilization rates are you seeing? And if you could give us any sense of how these conversion service sales are trending?

Bob Wetherbee

Hey, good morning, Paretosh. So this is Bob. I would say we're very pleased with the conversion business at the HRPF. It's actually settling in to being kind of a normal part of the process and we're probably in 60% plus or minus range. It depends on the week, it depends on the month, but it's turned out to be a positive and a positive earnings and cash generator for us, so, so far so good.

Paretosh Misra

And that's good to hear. And then maybe a follow-up are you expecting any major changes in Q3 versus Q2 in any of the corporate items, so corporate cost or depreciation, any of those things?

Don Newman

So short answer is, no, we're not expecting any significant changes in that -- those cost categories.


Our next question is from Josh Sullivan of The Benchmark Company. Your line is now open. Please go ahead.

Josh Sullivan

Just on the incremental defense opportunities in ground vehicles, what could that look like versus previous cycles? You know, a couple of years ago you made an effort to grow your Washington presence, or some titanium programs you've had exposure to. Just wondering what this ground vehicle cycle, if could be more meaningful than historically?

Bob Wetherbee

The simple answer is, yes, we expect this cycle to be more meaningful. I think, what we see as an industry trend that plays to our strength is actually light-weighting of military vehicles for a different potential conflict and it was contemplated in the past. So very strong for titanium armor. We've talked in the past about some of the programs we're on, Abrams, AJAX, and recently, there's been the announcement of the MPF opportunity that we see, and also saw the, our Mobile Protected Firepowers is what MPF stands for, I guess, to make sure the acronyms are clear. That's a big opportunity in the titanium armor space and titanium prices.

The other thing that's developed over the last six months is the opportunity related to ACUS [ph] and certainly naval nuclear programs have broadened, both submarines and carriers bigger than what we probably anticipated six months ago. Not necessarily in the titanium side, but, you asked ground vehicles, and we do see fairly significant upside to that compared to where we've been basically due to the geopolitical response that, a lot of the NATO countries are investing themselves in.

Josh Sullivan

And what are your thoughts on strategic M&A at this point. You've done a great job seen some portfolio shifting here. What do you see as far as a need or even an opportunity to maybe grow into some new markets at this point?

Don Newman

This is Don. What I would say is we don't want to get too specific in terms of the types of capabilities that we'll be looking for. But what I would say is, and this is going to be consistent of what we talked in our February Investor Conference about when it came to M&A. We are prioritizing A&D and we are prioritizing really unique capabilities that will increase our competitive advantages. And so with that, that means it is focused on differentiated businesses, businesses that have moved a needle from an economic standpoint, from margin standpoint, for us. And so we're being very discerning in terms of what we're interested in and why? And so are we considering opportunities? Yes. But assume that it will be extremely disciplined and well you won't be surprised if we were to pick something up, it will have an A&D focus on generally.


We have no further questions. So I'll hand back to the team for their closing remarks.

Scott Minder

Thanks again for all -- to all for joining us today. This concludes our Q2 2022 earnings call.


This concludes today's call. Thank you for joining. You may now disconnect your line.

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