ATI Inc (ATI) 2004 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the fourth-quarter 2004 Allegheny Technologies earnings conference call. At this time, all participants are in a listen-only mode, and we will be facilitating a question-and-answer session towards the end of the conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes. I would now like to introduce your host for today's call, Mr. Dan Greenfield, Director of Investor Relations and Corporate Communications. Mr. Greenfield, you may begin, sir.

Good afternoon, and welcome to Allegheny Technologies' earnings conference call for the fourth quarter 2004. This conference call is being broadcast live on our website at AlleghenyTechnologies.com and on CCBN.com. Members of the media have been invited to listen to this call. Participating in the conference call today are Pat Hassey, Chairman, President and Chief Executive Officer; and Rich Harshman, Executive Vice President, Finance, and Chief Financial Officer. After some initial comments, we will ask for questions. Please note that all forward-looking statements made this afternoon are subject to various assumptions and caveats, as noted in the earnings release. Actual results may differ materially.

Here is Pat Hassey.

Thanks, Dan, and welcome, all, to our fourth-quarter conference call. Fourth-quarter results demonstrate that our strategy to transition ATI to profitability and position the Company for long-term success is working. Our markets have improved and do remain strong. We have expanded our capabilities and market positions with new and upgraded facilities, and we are benefiting from the ongoing cost reductions and productivity improvements being implemented. I would first like to review our 2004 accomplishments, as part of the transition and transformation strategy that we have been implementing.

In our Flat-Rolled Products segment, ATI Allegheny Ludlum is the stainless-steel market leader today. The J&L asset integration is on track, on schedule and executing well. Our new capabilities provide a low-cost commodity path with improved profitability, and have expanded our capabilities in specialty stainless-steel sheet. Our upgraded stainless-steel melt shop at Brackenridge, Pennsylvania provides lower cost and higher productivity.

The transition to a new progressive waiver agreement at Allegheny Ludlum is working well. As planned, 268 Allegheny Ludlum employees retired under the task (ph) program in 2004. Another 200 cap retirements are expected in the second half of 2005. The reduced number of job classifications are now in effect.

Our marketing approach and offering to our products in a variety of market segments has changed, and we are receiving added value for our specialty and commodity products.

In our High Performance Metals segment, during 2004 the aerospace market transitioned from a state of inventory balance to improving build schedules. We are now well-positioned with our advanced technical capabilities and products, and expect to benefit from strategic investments we have made in the US and in the UK.

Markets have also greatly improved for the companies in our Engineered Products segment. These companies are benefiting from our strategic renewal process of looking at products and customers and added operating efficiencies.

The ATI Business System connects our people to the processes. In many instances throughout the Company, the ATI Business System teams have increased productivity and customer service beyond what was previously thought to be possible.

We're improving the ATI balance sheet. Net debt to total capitalization at the end of 2004 was 43.8 percent. Cash on hand was approximately $250 million. Evidence of success is in the results. For the full year 2004, sales increased 41 percent to $2.7 billion. Operating profit improved to $167 million. Net income improved to $19.8 million or 22 cents a share.

Now, turning to the fourth quarter of 2004, sales increased over 61 percent compared to the same period last year. Operating profit increased to over $75 million. Net income was $35 million or 35 cents a share.

Some highlights from our three marketing segments -- in our Flat-Rolled Products segment, sales increased by 75 percent compared to the fourth quarter 2003. This segment had operating profit of nearly $26 million, resulting from increased volume, higher selling prices and cost reductions. These results included a LIFO inventory valuation reserve charge of nearly $25 million, due to higher raw material costs.

Total shipments in the fourth quarter increased 33 percent compared to the same period last year. Notably, shipments of our flat-rolled high value products increased by 32 percent. In our High Performance Metals segment, sales increased 52 percent and operating profit reached $43 million. Both ATI Allvac ATI Wah Chang posted impressive results. Demand for Allvac's titanium alloys and nickel-based superalloys was strong, due to the improving aerospace market build schedules, as well as strong demand from medical and oil and gas markets. Our new High Performance Metals long products rolling mill in Richburg, South Carolina is operating on schedule, and is providing enhanced capabilities and operating efficiencies. Our Wah Chang exotic alloys business did an impressive job of meeting strong demand for government applications and strong demand from the medical market and corrosion market, particularly the corrosion market in Asia.

In our Engineered Products segment, sales increased by 22 percent and operating profit improved to $6 million. These results are due to strong demand from several key markets -- again, oil and gas, mining and also transportation for Class A trucks, train locomotives and off-road construction and mining equipment. These operations have shown continuing operating efficiencies and cost reductions.

The effects of the ATI business system and resulting cost reductions were apparent in the fourth quarter. Employees throughout ATI deserve a lot of credit for these accomplishments. We achieved $142 million of cost reductions before the effects of inflation, significantly exceeding our $104 million goal for 2004. Through the ATI Business System, employees are involved in efforts to make ATI a better company. Teams at our ATI Allegheny Ludlum Vandergrift and New Castle plants have successfully increased capacity for our cold-rolled sheet by deploying the ATI business system at bottleneck operations. At the ATI Washington plate facility, the business system is deployed to synchronize and connect flow paths to maximize delivery performance and provide customers with improved leadtimes. At Wah Chang the teams (ph) significantly reduced cycle time and leadtimes through lean manufacturing of our niobium-titanium product used in growing medical applications such as MRI equipment. I just used these three examples of the ATI Business System to demonstrate that these are real projects and the impact is showing.

Looking ahead, we continue to be optimistic about 2005. While 2004 was a year of transition in transformation, we expect 2005 to be a year of revenue growth and accelerating profitability. Contract negotiations with our customers were successful. Overall, we expect base prices to be higher in 2005 than in 2004 for 95 percent of the 2005 shipments in our Flat-Rolled Products and High Performance Metals segments.

Many of our markets are remaining very strong. Here are some observations on key markets. Again, our largest single market in 2004 was aerospace. Production schedules in the aerospace market are improving. Global air travel is robust, with record load factors. International airlines are purchasing new and larger aircraft. Low-cost carriers are growing. The Airbus A-380 was recently unveiled, and the initial deliveries are expected in 2006. The Boeing 77 is in development, with initial delivery expected in 2008. As a reminder, shipments of our products lead the aerospace build schedules by approximately 12 to 18 months.

We expect demand for our titanium and nickel-based superalloys to continue at robust levels. ATI is a leader in the aerospace market. We have the technical capabilities to develop new alloys. As an example, we are encouraged by the interest and acceptance of our proprietary 718 plus alloy, a new nickel-based superalloy that increases the temperature capability of the commonly used 718 alloy. 718 plus alloy has significant potential in the next generation of aeroengines and for spare parts and engine rebuilds.

Turning to our Flat-Rolled Products segment, our service center sheet business remains solid. In general, our service center customers report continued strong demand and anticipate a solid year in 2005. Demand from the construction market remains strong. As an example, demand for our stainless steel products for sinks, window channel, high-efficiency gas furnaces, flexible gas hose and other components of residential construction and remodeling is strong. We expect a recovery in demand in 2005 from the nonresidential construction and infrastructure markets.

Our automotive emission control business is expected to grow in 2005, as a result of the capabilities of our low-cost continuous automated finishing line in Midland, and a richer product mix. We expect our shipments to grow even though we believe the overall automotive build rate is likely to be flat in 2005 compared to 2004. In addition, automotive growth continues for our precision-rolled strip products, primarily from greater use of multilayered stainless steel gaskets and flexible connectors. Exports of our precision-rolled steel products also look very good in 2005.

Demand for our flat-rolled nickel alloy and specialty stainless steel products is strong, particularly from the power generation market in Asia and from oil and gas markets in Europe. Domestic and global project quoting activity is very busy. With the lower-value dollar, we are even more competitive in all global markets.

ATI is well-positioned to benefit in 2005 from these strong markets. We have new capabilities -- an upgraded stainless steel melt shop in Brackenridge and the recently-acquired, low-cost commodity melt shop in Midland, Ohio; the recently-acquired low-cost continue (ph) automated finishing line in Midland; and the specialty finishing facility in Louisville; the expanded High Performance Metals long products rolling mill and straight lengths in our Richburg facility.

We have an improved cost structure, and we have established a 2005 cost reduction goal of approximately $100 million before the effects of inflation. This will include certain synergies and cost reductions from the J&L asset acquisition and the new labor agreement in our stainless steel business. We have now an improved balance sheet, which enables us to take advantage of growth opportunities.

Summarizing these comments today, in 2004, ATI transitioned to profitability. The J&L asset integration is on schedule, on track and executing well. The transition to our new progressive labor agreement in our stainless steel business is on schedule, and is rapidly changing the Allegheny Ludlum cost structure. The aerospace market is strong. We have significantly improved our balance sheet in 2004, and we remain optimistic for our future in 2005 and beyond.

This concludes my comments, and we will now open the call to questions.

(OPERATOR INSTRUCTIONS). Brett Levy, Jefferies & Co.

Can you talk a little bit about some of the metrics for 2005, to the extent you're comfortable with them, and Q1? I also wanted to know, from a backlog perspective, especially on the alloy side, if you can give a little bit of color on that. And then, the last part of the question relates to raw materials. In light of the improved demand, is there anything or any particular area, whether it's nickel or anything else, where you are having a difficult time procuring it, especially further out?

Let me start on that one, and Rich can put any color on this he would like to. First of all, on the idea of the first quarter, our schedules are full through January/February, and we are now booking and finalizing our March commitments. Many of our operating segments in the precision strip, in the standard strip, in the high-value alloys, in the high nickel-based products at Allegheny Ludlum and at Wah Chang are now closed out for the first quarter into the second quarter and beyond. So I would say that business remains robust for the first quarter, if that answers your questions about projections into the first quarter.

In terms of our ability to price products or look at products going forward, we are still in a position that we have been able to differentiate ourselves from many of our competitors, in terms of our ability to decouple our specialty products from our more commodity products, and we are realizing the benefits of those price increases now going forward.

In terms of raw materials, we have our supply contracts in place. We do not have a problem with physical supply of any element that we need. And we do use the surcharge mechanism to pass those costs along on our products.

Rich, do you want to --?

Brad, just to echo what Pat said on the raw material availability standpoint, as I think you know, we have very long-term, long-standing relationships with a variety of suppliers of the key raw materials. And at this point, availability has not been nor is it expected to be a problem. The prices have obviously been very volatile through all of '04 and remain that today, but the margin protection is afforded through the indices and surcharges.

And can you talk a little bit about backlog, especially for sort of some of the high-end alloys?

Backlog is basically up about 40 percent, in terms of dollars.

And what is absolute level?

It's up 40 percent.

Robert LaGaipa, CIBC World Markets.

Very good quarter. I just had several questions. One, I was hoping you could maybe provide a little bit more color on the contract price increases. Obviously, you have talked about the aerospace contracts, for example, the three-year duration of those, the fact that they were negotiated successfully this past fall. Also, the decoupling of the commodity versus the specialty -- can you give us some sort of range, in terms of the way you think about the price increases? I mean, are they up 10 percent, 20 percent, 30 percent? You mentioned the stainless business, the base pricing being up roughly 30 percent. Can you provide maybe a little bit more color there?

Well, first of all, let's just go back. About 65 percent of our business is transactional business, and about 35 percent of our business is in either under one-year to longer-term contracts. Out of that portion of our business that was under contract, all but 4 percent of the total business matured in 2004, and all of those contracts have been renegotiated with new pricing and with also surcharge mechanisms in place.

Many of those contracts were into the double digits, some with a 20 percent type of increases moving into 2005. Our transactional business is on a spot basis but, as you noted, on our commodity products, our conversion price on 304 standard commodity stainless steel was up 28 percent. As we factor in our specialty commodities and then special alloys going forward, the increases are higher.

And on the cost side, you have also talked about, obviously, the benefits of the Brackenridge upgrade, the rolling mill which it appears is now up to full utilization, given the idling prior for the expansion. The $200 million related to the J&L synergies and also the labor contract. Now, that $100 million for 2005, in terms of the cost reduction goal -- how does that relate to the original $200 million? Can you help reconcile that?

Sure. Let's just go back and all get based on the same timeframe. If we go back to June of 2004, we said that we had a $200 million synergy with combining the J&L assets into the Allegheny Ludlum assets. When that integration was completed, $70 million of that 200 million was realized in the integration of J&L into the Allegheny Ludlum business.

In addition to that, about $75 million has been realized in labor, operating and procurement savings in 2004, most of that accomplished in the fourth quarter of 2004, as our agreements and labor changes came into effect. So if you take the 70 million that we have from the integration of the Company and the 75 million I'm talking about, most of which came into play in the fourth quarter of 2004, that brings our total to about $145 million of the 200 million. We have a balance, then, of around $55 million that will be realized in 2005 and 2006, most of it in 2005.

This is tied into our cost reduction program. So, as you see our fourth-quarter cost reductions accelerating to over $140 million, part of this is what I'm talking about with the J&L acquisition coming on board. In our approximate $100 million planned for 2005, then approximately $25 to $30 million of that 100 million would be further synergisms with the J&L assets. Does that give you a flavor for where we are?

No, that's very helpful. The last question, if I could -- maybe, Rich, you could help us out with this -- is also the tax rate. You had mentioned the net operating carryforwards, which appear to still be in place for 2005. What would be the appropriate tax rate for 2005? How should we think about that number?

It obviously depends on what our taxable income ends up being in 2005. And that, because of the differences between book and tax, there are substantial differences there. I think the best way to look at it is what we said in our news release, is that because of the valuation allowance that we recorded on most of our net deferred tax assets in the fourth quarter of '03, we are in the unique position of really not providing either a provision on income or, in the past, earlier this year, a benefit on losses because of that net deferred tax valuation allowance.

So, heading into 2005, that fact situation is there. And then you have to look at whether or not you will be a cash-basis taxpayer on the federal income tax side in '05, and we have a substantial net operating loss carryforward of estimated of at least $140 million on the taxable income side. So we would have to generate in excess of $140 million of taxable income in '05 before we would begin to look at being a cash-basis taxpayer.

So, without getting into projecting or predicting what our taxable income would be, I think it's suffice to say that at this point, we don't expect a significant cash payment for federal income taxes in 2005.

Terrific. Thank you very much. Good quarter.

John Hill, Smith Barney.

Good day, everyone, and congratulations on a strong quarter. Just to follow up on the cost-cutting program question a little bit, we see a lot of similar programs across various companies, and many times they are difficult to capture or characterize because of the starting points and, obviously, because there are a lot of other moving parts in the cost structure, as you highlight in the press release on inflation.

I'm just curious -- on just a benchmark basis, if we cut 100 million in costs next year, how much of that should we see drop to the bottom line? Conventional for the industry would be 20 to 25 percent, with inflation eating the rest of that. Is that a reasonable way to look at this, or do you think you can do better?

I think we will do better John. I think we would look at this more like 50 percent.

Okay. That would be a very strong performance. Turning to the commodity flat-rolled business, it looked like for a number of quarters your pricing had been above, let's just say, the 304 (ph) benchmark price. And in Q4, it lagged little bit. Does that have anything to do with sort of the extreme price volatility seen in the market late in the quarter, or are there some other lag effects we should understand there?

I think, John, what you are seeing is, as we brought the J&L business into the total company, some of that business is automotive-related, the 409 products and other products that may have had a little lower base. So what you might be seeing is a mix effect versus our pricing effect in the total tons shipped.

So you would characterize it as more of a mix effect rather than a pricing lag?

As we said before, we can pick up up to $400 million in new sales at J&L's existing business, and part of that would be at more of a commodity -- more commodity tons than the mix that was in place at Allegheny Ludlum.

Great answer. And just last, very briefly, we have seen some very strong margin performance across the business, and that's always great to see. Flat-rolled products -- a bit of a laggard there, but certainly not unique to Allegheny. I was just wondering if you could provide some perspective on the ability of your companies and others in similar businesses to drive operating margins in Flat-Rolled Products -- in this case, 5.5 percent looking somewhat flat from Q3? Can you see that going to a 7 or 8 percent number in 2005, or is there some kind of structural impediment that prevents that part of the business from delivering margin gains?

John, when you look at those quarters quarter on quarter, what is affecting that is our LIFO reserve. We had $24 million -- something like that, I think is the number -- $24 million in the Flat-rolled Products segment of LIFO reserve, in addition to the -- that was reserved with the $26 million performance. You put those two together, if you say that -- if you believe that raw material prices have now reached their levels, and they are going to flatten out in 2005 -- which is our opinion -- what we have, then, is the equilibrium coming up on the LIFO side. If you add the LIFO reserve to the performance, I don't necessarily agree that we have not been able to bring better margins to the Flat-Rolled Products segment. And in fact, we might say that we are looking at a 10 percent gain.

So you would say that, X the LIFO effects, you have seen a significant upturn and expect to see an upturn in conversion premiums?

Absolutely.

Thanks, and congrats again.

Mark Parr, Keybanc Capital Markets.

The one thing I was curious -- you had talked in your release about the vast majority of your product line experiencing base price increases heading into '05. Can you give a little more color on that, in terms of helping us to quantify the magnitude?

Well, let's just take the performance in the fourth-quarter over the third-quarter results demonstrate a significant movement in our transactional pricing. You can look and see that we had some additional price increases in the fourth quarter on a transactional basis, especially in tooled steel and some of our other specialty products.

Now, what you have not seen in the fourth quarter is the long-term contracts that expired at the end of 2004, and new pricing that went into effect January 1, 2005. And that runs at around 35 percent of our business, and I commented earlier than 31 percent of that 35 all had price increases. And I also commented that on that 31 percent, they were all double-digit increases. Does that give you a flavor for some pricing changes?

Yes, that's a good help. And you've talked about the cost reduction plan, and you have also talked about the pension in the release. I was wondering, Rich, is there any sense of what sort of tax rate that we should be using for '05 at this point?

No. Mark, as I said to an earlier question, the tax rate is really going to be driven by the amount of cash taxes that we are required to pay, and that is going to be driven by taxable income, as opposed to GAAP income. And at this point, we don't expect to have a significant cash payment for federal income taxes in 2005 because of the $140 million NOL carryforward that we estimate is in place at the end of 2004.

Just for frame of reference there, the 35 million in pretax that you had in the fourth quarter -- how much of that was taxable, for cash tax purposes?

None of it. If it were taxable for -- if we were a cash-basis taxpayer, we would have likely have provided a provision in the fourth quarter, but we have no provision.

No, I recognize that you are not a tax cash payer right now, but if you had no NOLs, how much of that fourth-quarter earnings, theoretically, would have been taxable?

Well, none of it, because we actually, on a cash -- on the taxable income side for 2005, we had a tax laws. 2004, we had a tax loss. So even without a valuation allowance that would have been established, we still would have had zero taxes due on the federal side in 2004.

I'm not asking the question the way I would like to, but I'll try it again and call you back. I have one other thing I wanted to ask. You guys have talked about a fair amount of visibility, as far as first quarter shipments, et cetera. I'm just wondering if, given all the visibility that you have got in your end markets right now, when you would be in a position to give some guidance on first-quarter earnings?

Mark, we really are not going to give guidance at this time. We try to give a little bit of guidance when things change materially, but we think that with the release that we have given you today in this conference call, there is a lot of information out there as to what could be expected from this company in the first quarter.

Congratulations on a great turnaround, and hope it continues for you.

John Tumazos, Prudential.

Could you explain a little more the alloy 718 plus? It sounded very interesting. Does it have the same 3 percent cobalt, 57 percent nickel content, et cetera -- or 3 percent moly with alloying, et cetera? Or is the same metallics treated a little differently so it has better performance?

Well, let me give you a very high-level answer about the alloy, and then Dr. Jack Shilling is with us, and if you have more questions, he can give you a more technical answer. But basically, this is a product that is a proprietary, patented product for ATI. It will perform at 100 degrees hotter temperatures, at 1200 to 1300 degrees. As you know, as you get faster gaseous state in a jet engine, you get more power out of it. So it's a higher performing product. It appears to have some traction going forward for new engines, and it has about 9 percent cobalt in it. So it's someplace in between the 718 and the washvaloy (ph) alloy that has more cobalt, only this alloy performs better, gives the engine maker the performance that they are looking for, in terms of the gaseous state, it's more formable, and it's easier to manufacture. So we think it's got a lot of potential.

(OPERATOR INSTRUCTIONS). Jeff Feinberg, JLF Asset Management.

Two quick questions -- the first is, on the price increases that you are achieving on the contract business, approximately for a $1 increase in price, how much of that should flow through to the pretax line, if not all of it?

Well, it should flow through to the pretax line offset by any inflation that we have in our business, less the cost savings from that inflation. So we expect to see some improvement of profitability in those products. And of course, when you look at our performance in 2003, moving into 2004, we need to have improved performance in these sectors.

Just to make sure I am understanding correctly, so for $1 of increased price, at least two-thirds of that then should flow through, sort of on an incremental basis, to pretax profits?

Based on what we are seeing in our cost reduction programs and our improvements that we have, we are hoping to flow through at least two-thirds of it, maybe more.

I just wanted to make sure I was following the conversation on the call, as it relates to both the pricing benefits and the NOL. If I understand correctly, you are running at roughly 775 million a quarter of revenue, and you have been able to implement these approximate 20 percent price increases on there. That's 31 percent of the business, I think you mentioned. That would get you about 50 million of incremental revenue, and just for argument's sake, if two-thirds of that was passed through, that would be another 30 million or 30 cents a share per quarter of additional profitability. If that were to be the case, based on the base that you reported this quarter, where you made 35 cents, if you were at a run rate of 65 cents or so quarter, I think you would eat through the entire NOL of 140 million, by approximately mid-year. That's where there's a point of confusion for me.

Rich, you can go ahead and answer that question.

You are probably oversimplifying the differences between book and tax and taxable income across the board, in terms of depreciable life and depreciation expense and retirement benefit expenses, as well as LIFO. The LIFO approach for tax purposes is significantly different than it is for book purposes. So we are really not going to put ourselves in the position of projecting not only GAAP income but also taxable income. Suffice it to say that we are comfortable that at this point, we don't expect to have a significant cash expenditure in 2005 for taxes.

Can I just ask you how much income could you have, on a pretax basis, without having to have material taxes, just to keep it simple?

Well, to keep it simple, you'd have to have more taxable income than the NOL of $140 million, on a simplistic basis.

And just to make sure I am understanding -- is that another way of saying that if, for argument's sake, you were to make $200 million, then that statement would not be correct?

$200 million on the taxable income side?

Yes.

If we were in the position of having taxable income of $200 million in 2005, and you compare that to the NOL -- the estimated NOL that exists at the end of 2004 that is available to carry forward -- the other opportunities that we have to further reduce taxable income are various tax planning strategies, which would include or could include, for example, a further contribution to the defined benefit trust, which would generate a tax deduction that would offset any taxable income.

And what is the magnitude of the opportunity of that contribution?

It's virtually unlimited.

So I guess the bottom line is you cannot take the NOL and say -- one should not assume you're going to make less than X because of the NOL, because you could simply offset it through that contribution? You can actually make a couple hundred million dollars and still not pay taxes?

That's correct.

Sir, it appears those are all the questions we have at this time.

We would like to thank everyone for joining us today. We thank you for your continued interest in ATI and your continuing support for this company. We have had what we believe is a very good quarter. We remain optimistic about moving ahead in 2005, and the management team is committed to continue to make the changes that we have made to keep this company on track, on schedule and moving ahead to accelerating profitability. Thank you very much.

Ladies and gentlemen, thank you for joining today's conference. This concludes your presentation. You may now disconnect. Good day.