Ati Inc Q1 FY2023 Earnings Call

Hello, everyone, and welcome to the ATI First Quarter 2023 Earnings Call. My name is Bruno, and I'll be the operator of today. I will now hand over to your host, Tom Wright. Please go ahead.

Thank you. Good morning and welcome to ATI's first quarter 2023 earnings call. Today's discussion is being broadcast on our website. Participating in today's call are Bob Wetherbee, Board Chair, President, and CEO, Kim Fields, Executive Vice President and COO, and Don Newman, Executive Vice President and CFO. Bob, Kim, and Don will focus on our first quarter highlights and key messages. Before starting our prepared remarks, I would like to draw your attention to the supplemental presentation that accompanies this call. Those slides provide additional color and details on our results and outlook that can be found on our website at atimaterials.com. 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.

Thanks, Tom, and good morning. Q1 marked another strong quarter of consistent performance and sequential top-line growth for ATI. Our team continues to build momentum, driving our business forward. I'll summarize my thoughts on our first quarter performance in three points. Number one, we're delivering. What did this solid quarter include? Our quarterly revenue again exceeded $1 billion, up 3% over the prior quarter, and 25% higher than a year ago. Sales in high-performance materials and components segments were up 6% over the prior quarter. That's 38% higher than a year ago. Adjusted earnings per share for the quarter was $0.49, that on the higher side of our guidance range. We know the importance of delivering on our commitments. Today's results reaffirm the importance we place on that consistency. Our results also reflect the incredible work being done every day by our team. They're driving operational efficiencies, capitalizing on new opportunities, and growing our capabilities. After my remarks, ATI Chief Operating Officer Kim Fields will share her perspective on how we're doing that. Message number two, continuing momentum in aerospace and defense is driving historic demand for ATI's materials. Despite some supply chain and delivery delays, the signals are clear. The aero ramp continues. I don't think any of us expected a flawless ramp, and we haven't been disappointed in that expectation. A couple of bumps in the supply chain around incoming materials and forgings from non-ATI sources is probably the number one issue that we're dealing with. Even so, all signs indicate a positive trajectory this year. OEMs are bullish about aircraft deliveries, reaffirming future build rates. We're seeing it firsthand. In Q1, airframe sales grew by 81% versus the prior year period. ATI's significant wide-body content provides strong tailwinds across our commercial aerospace portfolio. We're excited to see this progress and expect growth in this core market to continue. Quarterly jet engine sales grew by 58% over the same period last year, driven by continued growth in specialty materials and forgings. Obviously, we expect this growth to continue as well, quarter after quarter after quarter. Quarterly defense sales grew 24% over the same period last year. These gains were led by growth in titanium armor, military jet engine, and materials serving allied naval systems. There you have it in defense. It's roll, fly, and float, and business is really strong, and we expect that to continue into the future. In Q1, aerospace and defense markets represented 56% of ATI revenue. That's up from 44% in the first quarter of last year. It highlights the tremendous progress we're making toward our 65 percent A&E sales target. Q1 energy sales were up 32% over the prior year period. This was driven by growing demand for materials serving civilian nuclear power and conventional oil and gas applications. As we shared with you last quarter, we continue to see softness in our smaller industrial markets. Remember, we've dramatically reduced our exposure to cyclical changes in these markets through transformation of our specialty rolled products business. More specifically, we're also seeing continued softness in China. This pertains primarily to the electronics and automotive markets served by our Asian precision rolled strip business, remembering also that this business accounts for about five percent of our total sales. We see emerging signs of moderate year-over-year and sequential growth in China, but the economy there continues to significantly lag 2019 levels. More information about ATI sales to critical applications and adjacent markets can be found in the corresponding presentation on our website. Now, my third message. We are executing. Our titanium and specialty alloy customers are asking for all we can produce, in many cases, even more. To deliver on these opportunities, we have the right team and the greatest capabilities. Across the enterprise, we're laser-focused on optimizing flow times, accelerating inventory velocity, and extracting every ounce of output possible. We want the maximum value from every operation, every flow path, every asset, every melt batch. Now, I'll turn it over to Kim so she can share recent actions on our path to unlocking ATI's full potential.

Thanks Bob. It's great to join you and Don, and I'll provide details of how we're delivering this tremendous performance. I'm going to follow your lead and continue the trend by sharing three key highlights. First, I'll give an update on the new capabilities that we're bringing online. Second, share the success we are having in getting more capacity from existing assets. And third, give insights to the steps we are taking to meet the historic demand for titanium. First up, I'm excited to share that we are in the final stages of commissioning the new Bright Anneal line in our Vandergrift, Pennsylvania operation. Completing the last step in the transformation of our Specialty Rolled Products business, the new line has state-of-the-art equipment and control systems that deliver best-in-the-world finishing capabilities. These include higher quality surface finish for a wide range of sensitive specialty materials, improved formability and dimensional control of thin-gauge products, wider coil sizes that provide customer flexibility for their forming processes, and it delivers the shortest material flow times in the world, with cycle times reduced by more than 50% in many cases. This has the potential to meaningfully lower fabricating costs and reduce metal risk for our customers, creating advantages over their competition. The project's on track to qualify for production by the end of Q2. The new Bright Anneal line rounds out our specialty rolled products' triple threat of capabilities. First, tremendous melt capabilities with our Latrobe, Pennsylvania upgrades, which were completed during the pandemic, combined with the world's most powerful hot rolling mill located in Brackenridge, Pennsylvania. And lastly, our world-class finishing capabilities in Vandergrift. Why is this important? It's key to our commercial transformation, helping the specialty rolled product business establish strong direct connections with major OEMs in key markets. We're no longer relying on commodity stainless distribution channels as our primary go-to-market approach. Our strategy is to be a leader in the aerospace and defense markets, and we are seeing results. The first quarter A&D revenue in our advanced alloys and solutions segment grew by 65% compared to the prior year period. On to my second key point and highest priority this year. Across the system, every single member of my team is focused on operational excellence. Our goal is to increase production output of existing assets through increased efficiencies and improved product yields. The demand is out there, and these improvements will allow us to capture more of it with higher product quality and improved margins. What's this look like? A lot of hard work and incremental improvements at every step in our operational process. We're increasing our productivity right first time and throughput day after day. In some operations, we're seeing efficiency improvements of as much as 10% to 15% in one quarter, relieving process bottlenecks, increasing product flow, and ultimately resulting in improved delivery performance for our customers. It’s like since Lombardi said, it's a game of inches, and inches make the champions. We are playing the game with laser focus and disciplined execution that will position us to win. Benefits from these efforts are already starting to show. Across both segments, we broke multiple operating records in Q1. For example, our specialty materials business unit set its highest Q1 sales record in decades. Every major work center in this business unit is at or beyond its 2019 operating level. This is key because it sets the pace for the majority of our vertically integrated aerospace and defense flow paths. In the advanced alloys and solutions segment, the benefits of our transformation are showing up in record levels for inventory flow times, leading to improved product velocity, and significantly lower metal volatility in specialty role products. The benefits are incremental for now, but we know that inches add up. As Bob mentioned last quarter, most of our workforce is in place after adding 1,000 new employees last year. Now we're gaining on the training curve too. Our newest team members are gaining experience through repetition and cross-training on multiple operations. This adds flexibility and nimbleness to our operations, allowing us to react and meet our customers' changing needs. The benefits our team brings grow every day. We've made great progress in the first quarter, and I thank every member of our team, both new and experienced, for all they're doing. We have a great team out there. We believe these efforts enable us to capture upside demand that our competitors can't. In an industry where lead times of 50 to 70 weeks are becoming the norm, everything we do to increase yields and maximize uptime allows us to delight a customer. My third topic, the unprecedented demand for titanium. We're really working to increase titanium melt capacity. With the tragic situation in Ukraine, the world has lost access to a third of the titanium supply that was in the market in 2021. We're meeting our commercial commitments. Our customers appreciate this performance and are asking for more. As Bob has shared in earlier calls, we're increasing production from existing titanium assets 35% over the 2022 baseline. This includes restarting previously idle capacity in Oregon. While we're coming online, our team continues to exceed expectations using creative solutions to reach melting milestones faster than estimated while requiring minimal capital investment. Still modest output for now, but they're on their way, accelerating every day. As this capacity comes on, there will be initial bottom line impact in the back half of 2023, and we expect to achieve the full run rate in 2024. Customers are taking full advantage of this increase in our titanium capacity. From where I sit, ATI is well positioned thanks to our increased capability, improved operational efficiency, and expanding titanium capacity. We're operating as a system, maximizing our assets and productions across the business like never before. Every aspect of our operation benefits from this rising tide, and so do our customers. That should do it for me, Bob.

Thanks, Kim. Everyone benefits from what your team is doing, our business, our customers, our team, and our shareholders. Keep up the great work. Thanks to you and your leadership. It matters, and we appreciate it. Kim will stick around for the Q&A session after our prepared remarks. Now it's Don's turn to share details of Q1 financial performance and what's ahead for the rest of the year.

Thanks, Bob, and thanks, Kim, for the operational update. Today, I'll provide details on two key areas, our Q1 results and our outlook. The first quarter marked the third quarter in a row in which we earned more than $1 billion. Revenue was $1.04 billion, a 25% increase year-over-year, driven by continued strength in aerospace and defense, as well as growth in energy. Declines in electronics and automotive partially offset that year-over-year revenue growth. Bob highlighted our growth in A&D mix of 1,200 basis points year-over-year from Q1 2022. The sequential increase also speaks to the velocity building in our mix improvement. A&D as a percentage of sales improved 300 basis points sequentially. That's on top of a 200 basis point quarter-over-quarter mix improvement between Q3 and Q4 of 2022. As we shared last quarter, we expect A&D mix to be above 60% by the end of this year. Why is A&D mix so important? We generate some of our highest margins in commercial airframe and latest generation jet engine sales. Within our defense market, margins are also typically accretive, reflecting our customers' recognition of the value of our differentiated products. Overall revenue grew 3% sequentially. High-performance materials and components, or HPMC, grew 6% quarter-over-quarter, and advanced alloys and solutions, or AA&S, sales were flat from Q4 2022. The strong HPMC increase is tied to the growing A&D sales. We see this strength continuing, enhanced by our increasing capacity and improving efficiencies. What drove the flat revenues for AA&S? AA&S actually saw 15% sequential growth in commercial aerospace sales and 6% growth in energy. These gains were largely offset by declines in electronics and automotive market sales, primarily in Asia. Now, let's talk margins. Consolidated adjusted EBITDA margins were down compared to a year ago, 12.8% in Q1 2023 versus 15% in Q1 2022. Remember, this quarter in 2022 included $29 million of COVID-related employee retention incentives, which enhanced margins by 350 basis points. Another factor impacting comparative margins is $9 million of incremental post-retirement benefit costs in Q1 2023. Those incremental costs do not impact our current pension contributions. Year-over-year, they do create a 90 basis point margin headwind. What if we exclude the impact of the non-repeating COVID incentives and incremental post-retirement benefit costs? Well, underlying adjusted EBITDA margins would be 220 basis points higher year-over-year, increasing from 11.5% in 2022 to 13.7% in 2023. What drove these underlying improvements? Shifting to a more value-added sales mix, increasing production levels, and diligent cost management. We successfully offset inflation impacts in 2022, and that success continued in the first quarter of this year. Price actions and cost improvements more than offset inflation impacts. We anticipate EBITDA margins will improve through the year due to continued growth, mixed improvement, and cost management actions Kim described. First quarter unadjusted EPS was $0.48. Adjusted EPS for the quarter was $0.49, $0.01 higher than the midpoint of our guidance range. Adjusted items are tied to costs related to the restart of our existing titanium melt facility. It's part of the incremental 35% volume from existing assets Kim just spoke about. We ended Q1 with total liquidity of approximately $750 million. This reflects the Q1 $50 million voluntary contribution to the pension plan and $10 million of share buybacks. It also includes $30 million in CapEx accrued at the close of 2022 but paid in Q1 2023. Managed working capital this quarter increased $347 million. That included $146 million in accounts receivable due to a late quarter surge in sales. Those receivables are being collected in Q2. Inventory increased approximately $90 million in Q1 due to investing in inventory to support ramping sales. We ended 2022 with managed working capital at 30% of sales. We expect to return to those levels or even lower by the end of the year. Q1 CapEx was $60 million. As I mentioned earlier, roughly half of that spend was related to the payment of CapEx that was accrued at the end of 2022. That's when equipment deliveries were delayed due to supply chain challenges. Overall, we remain on track with our disciplined capital investment plan. In the first quarter, we completed the last $10 million of stock purchases under our previously authorized $150 million buyback. We are announcing today a new $75 million buyback program. As I said, we are committed to maintaining a balanced capital deployment strategy, funding growth while also deleveraging and returning capital to shareholders. This authorization is consistent with that goal. Add in Q1's $50 million contribution to the pension plan, and we are deploying $125 million of cash to deleveraging and return of capital to shareholders. This is consistent with our 2023 free cash flow guidance range of $125 to $175 million. Now let's talk about Q2 and full year guidance. For the second quarter, we expect adjusted EPS to be in the range of $0.53 to $0.59. The midpoint of the range, $0.56, represents a 14% sequential increase from the $0.49 adjusted EPS delivered in Q1. The guidance reflects continued strength in our core A&D markets and energy. It also reflects our expectation that sales in our Asian Precision Rolled Strip business will continue to be pressured due to China's economic conditions. For the full year, we are increasing our adjusted EPS guidance. Our previous 2023 guidance range was $2 to $2.30 per share. Even though it's early in the year, we have the confidence to raise the bottom end of our range by $0.10. The new adjusted EPS range is $2.10 to $2.30 per share. This increases the midpoint of the range by $0.05 to a new end point of $2.20 per share. As the year progresses, we will continue to evaluate guidance, updating when appropriate. I want to reaffirm several other key items we guided on our prior earnings call. First, we continue to anticipate 2023 full year free cash flow will be in the range of $125 million to $175 million. Second, 2023 CapEx will be in the range of $200 million to $240 million, including the organic growth investments that Kim noted. And third, we made the planned $50 million contribution to our pension plans in Q1, completing our expected contributions for the year. In short, we are on track and confident we'll deliver on our 2023 commitments. With that, I'll turn the call back over to Bob.

Thanks, Don. What should we take away from the call today? That ATI is in full growth mode. And remember, 2023 is really the first full year of the commercial aero recovery. We expect top line growth in our core markets to continue for years to come. We've effectively built a resilient supply chain to ensure a steady flow of materials. We're delivering reliably to our customers, and we're living up to our commitments to add value every day. We're not saying it's easy. You heard Kim talk about how we're fighting for every inch. We put ourselves in a great position, consciously, deliberately, actively choosing each step. This is a big year for us. We have the right product mix. We're commanding the right price. We're hitting our stride with production and the bottom line to all of that, we are performing. There's one more P that gives us all confidence, our people. We have the right people in the right roles and their productivity is climbing. As the bar goes higher, our team strives to achieve more. It's what makes us proven to perform. Operator, we're ready for the first question.

Thank you. We have our first question from Richard Safran from Seaport Research Partners. Richard, your line is now open. Please go ahead.

Good morning everybody. So one of your competitors was talking about titanium share gains this week from VSMPO. And so since you made a bunch of comments about titanium in your opening remarks, I just wanted to know if you could update us on the titanium share gains and could you also discuss capacity utilization a bit more? I'm just wondering what your remarks say about how close you are to being sold out on capacity.

Great. Good morning Rich, this is Bob. I'll take the first part of that question and then hand it off to Kim Fields to talk about the capacity issues that are much discussed around the market today. So you know VSMPO pretty well, right, sponge to melt, to mill products to forgings. So I think the key for us is no products and some of the bar and plate products that are a subset of that. We're seeing growth to support aero structures, engines and actually in the medical space as well. So I think the easiest way to summarize the share issues with VSMPO is more than our fair share, and the melt and our operating performance have been key enablers to that. So we were focusing on programs with sustained growth potential, and we're focusing on new positions that could come along with that share gain at the same time. So I would say, in a nutshell, more than our fair share is where we ended up. The demand is here now, the growth is on the horizon. But she who has the melt will get the order for the next couple of years. And so we feel really well positioned for that. So I'd say on the share gains, hopefully, that answers your question. I'll turn it over to Kim to talk a little bit about the capacity situation.

All right. Yes. So Rich, we are full. And I'd say all of our operations are pretty full. But as you heard in my remarks, we don't stop there, and we are continuing to set new records across the processes and the businesses. For example, I mentioned titanium is up, just in the first quarter, 10% to 15%. Our melt assets are operating at higher levels, and we're continuing to challenge nameplate capacity. So we are really focused on maximizing our assets and challenging those limits, and we are continuing to get more. The bottom line, as I think about where we're at, when we take an order, we deliver on that commitment. Our customers acknowledge it. They've been sharing it with us. It's become even more apparent in this marketplace today. And we get recognized by getting more opportunities and more business and orders from them. So as always, as everyone else, we're very full, and we're working to continue to see that. The team is doing a fantastic job. I do think there's upside and there's some additional capacity coming with some assets in order and coming online as well.

Okay, thanks for that. Don, this next question may be for you, and I understand if you prefer not to answer it. However, given all the changes at Airbus since your 2025 outlook was released, I wanted to see if you could provide an update on the numbers you previously shared in light of those changes.

Sure, I'll provide more information about our 2025 targets. Last quarter, we raised the upper limit of our expected growth rate through 2025 by approximately $150 million in revenue, bringing our target to $4.4 billion. We're very confident in our ability to reach that high end. Kim discussed some productivity opportunities within the business today, and while she was modest about the progress, we see significant potential to create value through these initiatives. Overall, we're confident about achieving the high end of our range and believe there is potential for further upside. We will update our 2025 targets at the appropriate time and discuss beyond that as well. It's no surprise that we don't expect our growth to cease after 2025, and we see considerable growth opportunities ahead. As for our other goals for 2025, we're targeting EBITDA margins of 18% to 20%, and we are very strong in our confidence to reach the mid or high end of that range. This presents a compelling value proposition for investors, especially considering we generated $550 million in EBITDA in 2022. Based on our targets, we anticipate generating $850 million or more in EBITDA by 2025, which indicates solid opportunities ahead. This is also relevant for cash generation, where we are focused on maintaining a cash conversion rate of 90% or better, and we're on track to meet these targets. I hope this information helps and addresses your question.

Thank you.

Hey good morning.

Morning, Phil.

Any texture you could provide on the increase in earnings expectations in the second quarter versus the first quarter? Maybe you talked about a $0.07-ish type pickup sequentially. Is that volume? Is that mix? Does it include both segments? Anything you could help us on there.

Yes, this is Don. I'll try to answer that. First, we are expecting sequential growth into Q2. There are a couple of factors driving this. One, we anticipate continued growth in the top line and an improvement in our mix, which has been moving in the right direction. Additionally, if you look at the Q1 earnings, we carried over some elevated costs from the end of 2022 in the form of inventory. For instance, in the broader business, we added about 1,000 employees, and while they were acclimating to their new roles, their efficiency was lower, which led to increased costs. These costs were reflected in our inventory, but most of that inventory was largely addressed in Q1. Therefore, I would expect to see a benefit from lower costs of about $5 million to $6 million moving from Q1 to Q2. Those are a few key points to consider.

Now is this going to touch both segments in terms of improvement in both of them?

Yes, I think you'll notice improvements in both businesses. However, it might be wise to step back and not focus solely on Q2. It doesn't represent a full year. For the full year, we expect the EBITDA margins for the overall business to grow to around 14% on a consolidated basis. This indicates that HPMC margins should exceed 19% for the full year. Additionally, we anticipate increases on the A&S side as well.

As a follow-up, you mentioned some start-up costs for restarting the titanium upstream operations in Albany, Oregon. Could you explain how that process will unfold throughout the year in terms of ramping up? When can we expect them to start contributing, and how significant could that be? I assume we didn't see much impact in the first quarter. Thank you.

I’d like to discuss our thoughts on costs and contributions, and I’ll also invite Kim to share insights from an operational perspective. In terms of cost for the restart, it has been relatively modest, which is one of the advantages of projects like this. Restart costs, for instance, tend to be significantly lower compared to the expenses associated with new asset installations. Additionally, the speed at which we can prepare these assets for generating earnings and cash flow is much quicker. We anticipate restart costs in Q1 to be between $1 million and $2 million, and I expect this range to remain similar, possibly slightly higher, so consider a placeholder of $2 million to $3 million in your models. As production begins to increase, we expect to see benefits from the new production in 2024. Looking forward, we aim to reach full run rate production at the beginning of the second half of the year. This production will then flow through our business, leading to revenues and earnings as it transforms into finished goods. From an earnings perspective, we project around $0.01 to $0.02 of earnings in Q3 from this restart, with a bit more expected in Q4. When we reach full run rate production, we anticipate revenues for 2024 from a 35% increase in production to be between $115 million and $125 million, assuming a 30% incremental margin. The modest investments we are making to restart these assets and optimize underutilized resources promise remarkable returns. We expect to spend less than $10 million to restart the 34th plant, which is an exceptional investment opportunity. I’m not sure if I left anything for you to add, Kim, but...

Sorry, Don, we'll turn you into an operations leader yet. To add to what Don mentioned, the crews are in place and the assets are operational. While we didn't see significant flow-through in the first quarter, you can expect that to start appearing from late Q3 into Q4. The bulk of it will come then. I want to emphasize that this is a seller's market. As we increase our capacity through efforts on productivity and yield improvements, as well as bringing new and idled assets in Oregon online, we're positioned to secure favorable transactional selling prices. Customers noticing delivery issues with others in the market are turning to us for their needs, which will help enhance our performance as we start to see those additional volumes reflected in our reports.

Thank you.

Thanks Phil.

Thank you very much and good morning. We have seen some stabilization in jet engine revenues while airframe revenues continue to rise. There is considerable growth potential for jet engines due to increased production in the aftermarket. Regarding the plateau in revenue, is it primarily a supply issue at this time? Have customers indicated they have the necessary engines for their current needs before moving on to the next increase? How should we anticipate the trajectory moving forward? Also, on the airframe side, is this primarily driven by widebody aircraft? Is there an indication that this is largely driven by the 787?

We'll try to explain that a bit more. I'll address the first part and then pass it over to Kim for additional details. In the first quarter, shipments were heavily concentrated towards the end of the period, which is what Don mentioned regarding receivables. You may wonder how that occurred. It’s important to note that these orders were placed as we were coming out of COVID in early 2022, leading to increased lead times. We chose not to accept orders unless we were confident in our ability to deliver, resulting in a later surge in orders. Therefore, I don’t believe Q1 accurately reflects the current market situation. If we could share the figures from March, you would understand why Bob mentioned quarter-over-quarter growth in jet engines. It’s mainly a timing issue for Q1, and we are optimistic moving forward. This is why we invited Kim to join us today, as much of their work allowed us to catch up in March and will support our progress in the future. You raised a few specific queries, so I’ll let Kim provide more insights regarding widebodies, airframes, and other related topics.

Our supply chain is more stable than it was last year. While we still face challenges, we've focused on creative solutions, such as using larger tanks and hydrogen generator backups for industrial gases, and exploring alternative sources. We're managing the supply chain, but we continue to face tightness that creates bottlenecks, particularly with forging billets, especially nickel-alloy powder and specialty steel billets. There was also a significant explosion at a melt shop in Q4, which has caused some delays in our non-vertically integrated billet supply. We are collaborating with our customers to seek opportunities for direct purchases or find alternative suppliers. Our OEMs are aware of these issues and are also working to secure the necessary materials. Regarding the airframe, the demand is primarily from single-aisle aircraft, although we are starting to receive widebody orders. We anticipate substantial growth related to our existing contracts, especially as orders begin to flow to us in the airframe segment.

Yes, it was a complex question, but I understood everything. For a follow-up, I have a quick and simple one. Considering the CapEx trajectory for the rest of the year, especially since some of last year's Q4 expenses carried over to Q1, how should we view that investment trajectory moving forward?

What I would do is, you obviously saw our guidance at $200 million to $240 million. I would expect it to be probably built throughout the year, just if you're looking for a pattern to model. But I'll tell you, I don't have in my projections any sort of anomalies from quarter to quarter. But sometimes those things do happen. It doesn't take much with a big invoice to shift $20 million from one quarter to another. But for modeling purposes, I would just assume it's relatively straight.

Okay, great. Thanks very much.

Thank you. Don, could you provide some clarity on the EBITDA margin guidance for the 2025 revenue target? The implied incrementals seem quite high. Could you help us understand the appropriate level of incremental EBITDA margins by business moving forward? I know there are pension costs and some one-time items from last year's figures, but what should we aim for as normalized incremental EBITDA margins by business?

Before I dive into the metrics, I want to provide some background on why you might notice what seems to be a strong performance in the incrementals. This is largely due to a significant increase in our latest-generation jet engine sales and higher-margin parts of our business, which is advantageous for us. Additionally, the way we are maximizing production from our assets is leading to better absorption, which in turn improves our margins. Alongside this, we are actively working to reduce costs and find efficiencies within the company. All these factors contribute to the higher numbers you're seeing. When we look closely at the underlying incrementals, they align with our previous expectations, which indicate incrementals in the business will exceed 30%. While I can't provide exact figures, the variations from period to period are expected. However, the numbers you see in your models, suggesting we need to reach those 18% to 20% EBITDA margins, make sense given these considerations. Is that clear for you?

I'm estimating a figure significantly greater than 30%. If I take the $4.4 billion in revenue and compare it to your current run rate and the implied EBITDA based on your margin, I'm arriving at a figure much higher than 30%. We can discuss this further later. That's fine.

One thing I would add that you might find useful is that as you calculate your incremental figures, it's important to consider the mix change occurring. We are transitioning away from lower profitability sales and reallocating resources to higher value opportunities, which will lead to an increase in the apparent incremental margin. This change means that every dollar sold is also contributing to the bottom line, creating what may seem like a distortion in your incrementals. Additionally, as we move toward 2025, we anticipate that this improved mix will also result in better pricing over time. While we don't emphasize pricing adjustments as some others do, it is another factor to consider as we delve deeper into these latest-generation profiles.

Okay, that's helpful. I think I've asked this before, so I want to revisit it. Regarding the 90% free cash flow conversion target, why wouldn't it be higher? Are you factoring in a pension contribution in those figures? I'm curious why it isn't closer to 100%.

I want to emphasize that our 2025 targets are conservative. Internally, we are aiming for over 90% in cash conversion. It's essential to us that cash conversion isn't just strong for one year, but consistently strong. While we've set a 90% target for 2025, that's not the maximum we believe we can achieve, and it's not a one-time goal.

All right. Thanks very much.

Our next question comes from Gautam Khanna from Cowen. Gautam, your line is now open. Please go ahead.

Hey good morning guys. You covered a lot of ground. I wanted to ask on your comment on pricing. Just at one point, I thought the urgency of some of the potential titanium customers who want to move away from VSMPO, I thought their price sensitivity was a little bit too high. I'm just curious, what has happened over the last quarter in terms of their urgency and their willingness to sign up at what should be more reasonable returns for you guys as you fill that void for them?

Thanks for that question, Gautam. I'll take a little bit of that, and Kim can add some color at the back end. I think we're actually at an inflection point here kind of in the second quarter around the worries that the big OEMs have, right? So the first priority really for the last 12 months was realignment of their global supply chains. And a lot of the contracts were not fixed volume. They were shares or they were share ranges. So a lot of the early work was within that range. So the guiding priority was, I got to displace upwards of 30% to 40% of my supply chain as fast as I can. And that was really starting to take effect in 2023. I think you'll see the full benefit because of inventory flow for people like us in 2024, right? But then now, once they've realigned the supply chains, I'll turn it over to Kim, and she can talk about kind of how they're looking at growth and kind of where they go from here as they start to really address the ramp.

Yes, as Bob mentioned, during the reset of the supply chain, our customers shifted from a just-in-time approach to just-in-case. This led to a surge in demand, resulting in our backlogs reaching a record $3.3 billion. This trend isn't limited to the aerospace industry; we are experiencing increased demand across all four of our business sectors: defense, medical, and electronics. There's been a significant reset, and now customers are focusing on strategic inventories, particularly as widebody production gains momentum. They are establishing longer-term strategic partnerships with companies and considering how to secure necessary supplies from now until 2030 or 2035, in line with anticipated build rates.

Yes, Kim and I have been a part of numerous customer conversations. And I would say quality and reliability are really going to be the enablers for having the supply chain work for them going forward. So the shift from just in case to but I got to have it, right? And so to your point, Gautam, I think Kim said earlier, it's a seller's market and almost, I would say, every renewal or every extension or everything is really reflecting appropriate pricing for the long-term, right? And that's been helpful. It's a great time to renew some contracts, for sure, from our perspective.

Yes. As a follow-up, you noted in the release that jet engine sales increased by about 2% sequentially. You also mentioned that some of these were later in the cycle, which contributed to a back-end load in the first quarter deliveries. Can you discuss the potential capacity constraints that might limit improvements beyond the 2%, 3%, or 4% sequential growth in jet engine output? What are the possibilities for this year regarding the jet engine capacity you have?

Yes. So the first thing I would say is like we always answer the question the same way, we produced orders not to build rates, right? So it's really critical on how we take those orders. And I'll let Kim talk a little bit about the work that's going on to increase the capacity.

Yes, we have discussed a few points, and we are observing an increase in our production rate. For instance, titanium production was up by 15% to 20% in the quarter compared to Q4. I expect another increase of 10% to 15% in our assets. Regarding specific bottlenecks, our workforce and experience are improving as we advance up the learning curve. We are implementing cross-training, which allows us to allocate labor where it's most needed for production. We are optimizing turnaround times and introducing a pit crew approach to get machinery and equipment operational quickly, which helps minimize unplanned downtime. We are also assessing our equipment, making electrical upgrades, and replacing some machinery in more challenging conditions to enhance longevity. We are actively working on our current assets and, as noted, we are successfully bringing idled assets in Oregon online ahead of schedule, with crews and equipment now operational. Our primary focus is on increasing melt capacity, and we are experiencing significant improvements in this area. This will have a positive impact on our downstream processing activities, which I anticipate will become evident in the third to fourth quarter. I hope this provides some clarity.

Absolutely. That’s helpful. Don, you noted the $2 million to $3 million sequential pressure at high-performance metals. Could you discuss the sequential challenges you faced in that segment, including retirement benefit expenses or any other factors, so we can properly understand the situation?

Sure. There are a couple of things to mention. I've previously discussed the carryover of some inefficiencies into inventory, and we noticed a significant release related not only to the HPMC segment but also to AA&S. We experienced some modest challenges related to metal as well. While we don't emphasize metal since it isn't a key focus for us, it’s important to consider it as you analyze the situation. Both of the segments experienced some modest headwinds in this area. It isn’t surprising, especially when you consider our main inputs, such as nickel. In 2022, nickel prices saw significant increases. Although they are still high, they have decreased somewhat. We observed a slight decline in Q1, which has had a modest impact on our business as a headwind. Other than that, we have been transparent about the pension and year-over-year changes regarding aspects like COVID credits.

Okay. Thank you guys.

We currently have no further questions. So I would like to hand the call back to Tom Wright for final remarks. Tom, please go ahead.

Thank you for joining us today. This concludes ATI's First Quarter 2023 Earnings Call. A replay will be available on our website at atimaterials.com.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines. Thank you.