ATI Inc (ATI) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2014 ATI earnings conference call. My name is Kathryn, and I will be your operator for today.

(Operator Instructions)

As a reminder, this call is being recorded for replay purposes. And now, I'd like to turn the call over to Mr. Dan Greenfield, Vice President Investor Relations and Corporate Communications. Please proceed, sir.

Thank you, Kathryn. Good morning, and welcome to the Allegheny Technologies' earnings conference call for the second-quarter 2014. This conference call is being broadcast on our website at www.ATImetals.com. Members of the media have been invited to listen to this call.

Participating in the call today are Rich Harshman, Chairman, President and Chief Executive Officer, and Pat DeCourcy, Senior Vice President, Finance and Chief Financial Officer. All reference to net income and earnings in this conference call mean net income and earnings from continuing operations attributable to ATI.

If you have connected to this call via the internet, you should see slides on your screen. For those who have dialed in, slides are available on our website. After some initial comments, we will ask for questions. During the question-and-answer session, please limit yourself to two questions to be considerate of others on the line. As always, we will make every attempt to reach everyone in the question-and-answer queue within the allotted conference call time.

Please note that all forward-looking statements this morning are subject to various assumptions and caveats, as noted in the earnings release and on this slide. Actual results may differ materially.

Here is Rich Harshman.

Thank you, Dan.

It's been five years since ATI's previous strong growth cycle ended abruptly with the 2008 financial crisis. It now appears that the decline and trough is behind us as most of our markets showed improved demand in the second-quarter 2014.

In addition, we are on the verge of a major aerospace upcycle that, if not interrupted for a geopolitical crisis or a financial crisis, is expected to last at least into the next decade. We have been preparing for this business cycle improvement through strategic capital investments and acquisitions that have significantly expanded our manufacturing capabilities to meet the current and expected demand growth from ATI's targeted end markets, including aerospace, oil and gas, chemical process industry, electrical energy, and medical markets.

Most of our capital investments are now qualified to produce next-generation alloys, parts and components that are expected to grow faster than the aerospace market growth because we have earned greater content on next-generation airplanes and engines, compared to legacy models. ATI's technical talent has developed new products that have either been fully qualified or are nearing qualification for the next generation of jet engine and airframe applications.

These new products include: the nickel-based super alloys ATI 718Plus and Rene 65, which are used in the hot section of next-generation as well as legacy jet engines; ATI 425 alloy, which is a high-strength titanium alloy that can be cold rolled at long lengths; ATI's nickel super alloy and titanium alloys powder metals are being used in next-generation jet engine forgings, as well as additive manufacturing applications.

In addition, ATI Flowform Products, a business that we acquired earlier this year, has significant growth opportunities in several end markets, including aerospace, and oil and gas. And more new products are in the development pipeline. We believe that the investments we have made over the last several years are on the precipice of creating value for our stockholders, as demand for ATI products grows over the next three to five years.

Some highlights of our second-quarter 2014: While we are not satisfied with our results, positive signs and momentum continue to build. ATI sales increased 13% compared to the first-quarter 2014, and nearly 6% compared to the second-quarter 2013. Demand from the jet engine market is improving for both newbuilds and aftermarket spares. And it appears that we are at, or close to, the end of the aerospace inventory destocking of the past few years. The oil and gas supply chain appears to be in better balance, and we're seeing demand improvement. We are tracking new projects, both oil and gas, and chemical process industry, that are beginning to move forward.

Lead times are extending for most of our products. Both the April and June 6% cold rolled stainless price increases are in effect in the market. These price increases have had an immediate impact on non-contract business. We expect to see the full effect of the price increases as we move through 2014 into 2015.

The headwinds created by continued falling raw material prices over the last few years appear to have ended. In fact, most raw material prices are increasing. The trade actions implemented against countries that have been illegally dumping product into the US market have stabilized grain-oriented electrical steel prices in the US. This comes after five years of declining prices.

Our balance sheet remains solid, with cash on hand of $355 million at the end of the second quarter. In June, our $402.5-million convertible notes matured; $5 million of the notes were converted, the rest was paid in cash. There were no borrowings outstanding under our $400-million unsecured domestic credit facility. And we continue to expect 2014 capital expenditures to be approximately $300 million, of which $98 million was spent in the first half.

Before I discuss our major end markets and our strategic investments in more detail, I'd like Pat DeCourcy, ATI's Chief Financial Officer, to discuss the second-quarter financial results. Pat?

Thanks, Rich.

Turning to slide 5, looking at the second-quarter results from continuing operations, sales were $1.1 billion for the second-quarter 2014, or 13.3% higher than the first-quarter 2014. Over 77% of our sales in the first half were of high-value products, and international sales represented 38% of our year-to-date sales. The segment operating profit was $65.2 million, or 5.8% of sales in the second quarter, compared to $43.5 million in the first-quarter 2014. Results from continuing operations was a net loss of $3.8 million, or $0.03 per share, compared to a net loss of $18.1 million, or $0.17 per share, in the first-quarter 2014.

Turning to slide 6, high-performance materials and component segment sales were $514 million, which was 6.1% higher than the first-quarter 2014. The segment operating profit was $16 million higher than the first-quarter 2014 at $85 million, or 16.6% of sales. The segment operating profit benefited $27 million from the reversal of our remaining LIFO-related net realizable value reserves. These reserves were recorded in the fourth quarter of 2013, when the carrying value of our inventory, as valued on a LIFO basis, exceeded the replacement cost.

The segment results continued to be negatively impacted by low operating rates at our Rowley, Utah, titanium sponge facility, and by our strategic decision to use ATI-produced titanium sponge rather than lower-cost titanium units to manufacture certain titanium products. This is expected to continue throughout 2014, until we complete premium qualification, or PQ, process at Rowley.

Flat-rolled product sales were $605 million, which was 20.3% higher than the first quarter of 2014. The segment had an operating loss of $19.9 million, which was $5.7 million better than the first-quarter 2014. Results were impacted by a $29.9-million LIFO inventory valuation charge, and a $4-million charge related to the HRPF startup.

In addition, the second-quarter 2014 included a major portion of the higher costs related to the Rowley titanium sponge facility PQ qualification process. This includes charges for the market-based valuation of industrial titanium products, as well as higher raw material costs due to our strategic decision to use ATI-produced titanium sponge rather than lower-cost titanium units. We expect approximately $12 million in start-up costs related to the HRPF in the third-quarter 2014, as we accelerate the hot commissioning process. We continue to expect $30 million to $35 million in HRPF start-up expenses for the full-year 2014.

Slide 7 provides a summary of the 2014 HRPF and Rowley start-up and qualification costs by quarter. This information shows the impact to segment operating profit and income before taxes, while these two strategic projects are in the start-up and qualification phases. These costs are expected to continue throughout the HRPF commissioning, which is expected to be completed by the end of 2014, and the Rowley premium quality, or PQ, qualification program, which is expected to be completed in 2015. Once completed, both of these growth capital projects are positioned to earn their expected returns on capital.

The majority of ATI inventory is valued using the LIFO method. The charges noted here primarily resulted from the rapid rise in nickel and certain other raw materials during the first half of 2014. Looking back in history, a rapid recovery in raw material costs is usually the result of improved demand, and often indicates the end of a trough and the beginning of a new cycle. The LIFO charges are based upon our current assumptions for the year and prices of raw materials included in our market basket, such as nickel, titanium, chromium, et cetera.

Now I'll turn the call back over to Rich.

Thank you, Pat.

Turning to slide 8, the aerospace and defense market continues to be our largest end market, representing 34% of first-half 2014 sales. We expect that the commercial aerospace market will be a significant driver of our profitable growth over the next five years. ATI's first-half 2014 sales into the aerospace and defense market were $717 million.

We attended the Farnborough Airshow last week, and I'd like to share some thoughts with you. My six years of attending the annual Farnborough or Paris airshows has followed the transformation of ATI from a leading mill product supplier to a strategic integrated supplier of mill products, forgings, castings, and fully machined, ready-to-install components. I believe ATI is viewed today more as a tier 2 supplier than ever before. ATI is better positioned to grow content on the next-generation air frames and jet engines due to our new alloys and products: powder metals, near-net shape and net shape mill products, and highly engineered forged investment cast and flow-formed machine parts and components. With our focus on creating value through relentless innovation, we're positioned to work directly with the OEMs on the development of future generation technologies and products, including new alloys, powder metals, isothermal and hot dye forged parts and components, titanium investment cast parts and components, flow-formed parts, and advanced and additive manufacturing solutions.

During the air show, the airframe and jet engine OEMs added to their already record backlogs. They are forecasting further production rate ramps to become even more meaningful in 2015, and extend to the latter part of this decade, and perhaps into the next decade. The OEMs want to be sure that we are ready, and we are.

As part of our continued focus on enhancing ATI's position as an integrated supplier of parts and components, in addition to mill products, in June we completed our second strategic acquisition of the year: Hanard Machine Inc. of Salem, Oregon. This business, which performs precision final machining on parts and components made from titanium alloys, nickel-based alloys and super alloys, aluminum, specialty steel, and other ferrous and non-ferrous metals, now operates as ATI Cast Products Salem operations.

We are now integrated in the production of titanium investment castings, from titanium sponge to precision machined finished parts. We have identified significant growth opportunities for ATI's integrated titanium investment casting business with our goal to at least double the revenue and profitability of ATI Cast Products within the next five years.

In addition, we are nearing completion of expanding and consolidating into one building our two ATI forged products Connecticut machining centers. This expansion and enhancement of our machining capabilities and capacities is in response to the OEMs approach of simplifying and streamlining their supply chain with strategic suppliers that are fully integrated, from raw materials to machine part or component that's ready to be installed on an airframe or an engine.

Turning to slide 9, at the Farnborough Airshow, we displayed parts that are currently being used in next-generation engines. These products are expected to grow significantly over the next five to seven years. Pictured on the slide from left to right are: our Rene 65 hot dye forging. Rene 65 is a unique GE-developed nickel-based super alloy that can sustain the higher temperatures and pressures required by the next generation of jet engines. ATI was selected by GE Aviation to develop Rene 65 into a wrought product.

The middle picture is nickel-based super alloy forging made from powders, which are then isothermal forged into a part. ATI is one of the few qualified integrated producers of this high-growth product. And the picture on the right is a titanium investment jet casting jet engine part. Demand for fully machined investment castings continues to grow, as OEMs require more near-net shape products.

Moving to slide 10, ATI is driven by relentless innovation. We will never be satisfied with the status quo. Even though we have growing content of new alloys, products and components on next-generation and legacy airframes and jet engines, we are focused on expanding our product portfolio to help our customers meet their ever-increasing and demanding needs, and to create value for ATI's stockholders.

For example, on display at the air show were ATI Flowform products that use an innovative process to reduce buy-to-fly ratios, and the time it takes to make a component that is ready to go directly on the airframe or jet engine. On display were Flowform products for jet engine shafts and landing gear components.

Also, ATI is a leader in developing wire and powders for additive manufacturing, such as 3-D printing, powder bed systems, direct deposition of powder, and direct deposition of wire. Some ask if we consider additive manufacturing to be a threat to our Business. Rather, we see innovation by our customers as an opportunity, and we believe we are a development leader in these future generation processes.

As depicted on the chart on slide 11, the projected demand increases from the aerospace market are being driven by unprecedented build rates of commercial aircraft. The near parabolic black line shown above represents the next-generation aircraft growth, and best depicts ATI's projected aerospace market growth trajectory.

As one would expect, the increase in airframe build rates results in a corresponding increase in jet engine demand. There are now over 20,000 large jet engines on firm order. This figure is as of June 30, 2014, and does not include orders taken at the Farnborough Airshow. ATI enjoys strong positions on most of the legacy programs, and we're gaining content on future next-generation jet engines.

Turning to slide 13, our second-largest end market is the oil and gas chemical process industry, which represented over $370 million, or 17%, of our first-half 2014 sales. ATI's second-quarter sales to the oil and gas market increased over 30% compared to the first-quarter 2014, primarily due to demand from small- and medium-sized products for both upstream and downstream applications, using our nickel-based alloy and duplex alloy products. Orders for similar sized projects continue to be booked.

In addition, some major projects are beginning to appear in the oil and gas market. We expect to win significant orders associated with these projects in the second half of 2014, which are expected to result in increased sales in 2015. Also, we are tracking several large petrochemical projects that are nearing the tendering phase for the anticipated US chemical process industry renaissance that is expected to result from abundant, reliable and affordable supplies of domestic natural gas.

Turning to slide 14, our flat-rolled product segment's hot rolling and processing facility, or HRPF, continues to progress as expected, with cold commissioning in the first quarter of 2014 progressing to hot commissioning and the start of operational integration in the second-quarter 2014.

As you see on slide 15, we have successfully hot rolled trial coils, including 200, 300 and 400 stainless grades, as well as grain-oriented electrical steel and carbon steel coils. Additionally, we have processed a number of these coils through our finishing plants, and the results thus far have been very good.

As we move through the rest of 2014, we will accelerate the commissioning process on all 140 plus ATI flat-rolled products, fine tune the HRPF equipment, and complete the training and operational integration process. While much work remains, we continue to expect to complete the hot commissioning training and operational integration process in the fourth quarter of 2014.

We continue to view the HRPF as a game-changing investment designed to significantly enhance ATI's flat-rolled products capabilities across alloy systems, enhance ATI's flat-rolled products market position, reduce manufacturing cycle times for all of our flat-rolled products, and significantly reduce production and overhead costs. We believe that the HRPF investment, in combination with our continued focus on cost reduction and enhancing our market position for both standard-grade and high-value flat-rolled products, enables the successful transformation of our flat-rolled products business into a global leader that can sustain profitable growth through business cycles.

Moving to slide 16, the premium quality, or PQ, qualification program at our Rowley titanium sponge facility remains on schedule. We have produced all of the sponge required as part of the qualification process, and the sponge is now being melted into mill products for further processing into bar product. As we have said, this qualification program is done in coordination with jet engine OEMs, and requires ATI to not only produce a certain volume of titanium sponge specifically for the qualification program, but also requires that the qualification program sponge be melted using all of our melt technologies: electron beam, vacuum arc remelt, and plasma arc melt, and then produce the output from the melts into a defect-free round bar product. We are well into this qualification program, and we remain on track to successfully complete the program in 2015, or sooner if possible.

In the meantime, we continue to produce high-quality titanium sponge at the facility. The sponge is being used to produce standard-grade titanium products. While the industrial titanium market is showing signs of improved demand and pricing, we continue to operate the facility well below capacity, resulting in inefficiencies and higher-cost titanium units. This is expected to continue throughout 2014, until we complete the PQ process.

The Rowley facility and the capability of producing premium-quality titanium sponge is an important part of our long-term titanium products growth strategy. The facility is expected to provide ATI with a reliable, safe and secure supply of high-quality, competitive titanium sponge. Recent geopolitical events reinforce the importance of this strategy.

As we look ahead to the third quarter of 2014, we expect business conditions to continue to improve, resulting in improved operating results, before taking into account expected HRPF start-up and Rowley qualification costs, and the net inventory valuation charges that Pat discussed earlier. As Pat indicated, HRPF start-up costs in the third quarter are expected to increase to approximately $12 million pre-tax, as we accelerate the commissioning process. We expect the third quarter to be impacted by approximately $6 million of costs associated with the PQ qualification program at Rowley, which is less than the costs identified in both the first and second quarters of 2014.

And in addition, based on the current year-end forecast for raw material costs, we expect net LIFO net realizable value valuation reserve charge of approximately $19 million pre-tax. Excluding these costs and inventory valuation charges, we expect pre-tax operating results from continuing operations to improve by $15 million to $20 million in the third-quarter 2014 compared to the second-quarter 2014.

In closing, the investments we have made over the last several years are on the precipice of creating value for our stockholders and customers. We believe this value creation will be realized. As the global demand for our products grows, we become a more fully integrated supplier of value-added parts and components, our cost structure continues to improve, our major capital spending ends, the strategic growth projects are commissioned and qualified, and begin to earn their expected rates of return.

Operator, may we have the first question, please?

(Operator Instructions)

Julie Yates, Credit Suisse.

In rev performance, it looks like titanium shipments were flat sequentially with the first quarter, and then modestly down year-on-year. At what point in the year do you expect to see sequential and year-on-year increases in the titanium volumes in high performance?

I think, as you know, some of that is product mix related. Can be and was impacted by having more value added product and less ingot, which is actually part of the strategy. So I think we look at it from the standpoint of titanium revenues in terms of total titanium product, as well as operating margins.

One thing I can say is that the order book, as we look out, has the longest visibility from the standpoint of backlogs and lead times than in the titanium product line than we've had in the last three or four years as we enter the third quarter, and actually looking into the fourth quarter. So, lead times are pushing out, capacity utilization is improving.

I think it's mainly driven by the aerospace market. The industrial market is still challenged, quite frankly, in terms of lack of demand. And the projects that are out there are intensely competitive, although, some of the recent industrial projects we've realized increases in base prices that are not insignificant. So I think that that's a positive. But I think the titanium growth profile as we move through the second half of 2014 and into 2015, is pretty much on track with what we believe is happening in aerospace. And medical remains a healthy market as well.

(technical difficulty) think about the opportunity for ATI on the a330neo that you guys have a nice relationship with Rolls through the Ladish acquisition?

Yes, I think that we do have a strategic relationship with Rolls, and that should -- as well is with GE and Snecma and Pratt. So, we like all of our relationships with all of the jet engine manufacturers.

But, the Rolls-Royce is the engine for the a330neo. And I think that will present some opportunities, not only in the traditional product we make but also in the powder arena. So, I think that's a good development. Quite frankly, it would have been a good development for ATI regardless of who would have won the engine program.

Richard Safran, Buckingham Research.

So I wanted to ask you a couple questions about cost reduction. First is, you looked like generally continuing your run rate. It looks like you're going to exceed your $100 million cost reduction target. Just want to know a couple of things.

Is there anything in the back half that would cause that to slow? Should we be thinking about a sustainably higher run rate for cost reduction here? And I guess, if you could also comment on what inning do you think we're in here? Do you still have meaningful costs to take out here, or is the low hanging fruit gone?

Well, I think the low hanging fruit has probably been long picked. We've been at this for a long time, as you know, and I think the big -- so the run rate through the first half of 2014, we count each cost reduction project as a cost reduction for 12 consecutive months. So some do drop off, and some new ones add on. Because as we identify a cost reduction opportunity, we formalized it. We measure it. We agree on how it's going to be measured to make sure that it really is a cost reduction and not going out the door.

In strong markets, you're able to, net of inflation, you're able to realize all of that cost reduction that drops to the bottom line in some cases. In other cases, we have formal agreements. Especially on the aerospace side with some of the aerospace -- under the aerospace long-term agreements. Where, we have formal cost reduction programs that are, because of fixed manufacturing flow paths that are negotiated and identified with the customer, and we share in those cost reductions. So, we would report that as part of our overall gross cost reduction. But half of it, for example, would go to the customer from a value add proposition there.

So, I don't know that we'll continue and realize $140 million in 2014. I think that's probably unrealistic. I think going forward in 2015, quite frankly, the big cost reduction driver will be HRPF. There is a big component of cost reduction associated with the HRPF coming online, and the old hot strip mill being idle then coming off line, as well as another breakdown mill that we have. So that will be a big driver and opportunity for us in 2015.

We have been targeting for the last several years gross cost reductions to the tune of about $100 million, and I see no reason to change that. That's the level that I think is appropriate. And it requires us to get creative, and it requires us to improve yields, and improve productivity. And be better buyers of our product that we buy from our suppliers. So all of that goes into the equation, Rich.

Just quickly, on your target or your guidance for the HRPF $150 million to $250 million. I wonder if you could just maybe comment, now given how far afield you are in bringing that facility online, can you comment at all, do think there's maybe upside to that guidance range here now?

Yes, my instinct is yes. Specifically how, we haven't yet identified. I think to the extent that -- I was just out at the facility yesterday for our monthly meeting with the team, with the flat rolled products leadership team and the project team. And we've been discussing for a long time that as we get into 2015 and begin operating this, we'll be better at realizing the true benefits of the HRPF at the end of 2015 than we will be at the beginning of 2015. And consequently, we'll be better in 2016 than we will be in 2015.

There will be a continual period of learning and realizing what the real opportunity set is because of the -- this is a very unique asset. And a very unique capability that can produce products that the market needs that we can't produce today, and produce them in a cost and cost structure and at a quality level of significantly improved quality that may in fact be above and beyond what we anticipated and estimated in the development of the project itself.

So, is there upside to that number? I believe so, not only in the cost reduction side, but also on the market growth side. Will we realize all of that in 2015? We'll try. But my honest answer will be probably not, because I think we'll identify new opportunities as we continue to learn and grow with the facility.

Sal Tharani, Goldman Sachs.

A couple of things on HRPF. You showed some pictures of rolled products, including carbon steel. I was just wondering, as you are close to hot commissioning or completing hot commissioning, are you in talks for tolling or a joint venture on the excess capacity you will have over there as was talked about in the past?

Yes, we are in discussions. I would say it's early stages of discussions. The first part is actually running product across the HRPF, which we have begun to do, as you saw. Our approach, quite frankly, is this. You'd like to do everything in parallel, but when you're bringing a facility like this online, you have to prioritize. So our prioritization, our number one prioritization, is ATI's products. Because we intend to idle the old 65-year-old hot mill in early 2015, so that becomes our number one emphasis.

At the same time, we have in our commissioning schedule a variety of HRPF products from more than, or I'm sorry carbon steel products from more than one carbon steel producer. So we will run that and commission that on the mill at the same time, and continue to have dialogue. So that we can move as quickly as possible into a desired state of a partnership of some sort with a carbon steel producer.

And on the destocking, as you mentioned in your prepared remarks, that you are at or close to destocking the aerospace supply chain. How does the Boeing titanium supply chain look to you at the moment? Do think it's pretty destocked?

Yes, I think it looks pretty good. I think though that it looks to us like their demand is continuing to grow. And we're at levels in shipments, and we will be in 2014, that we haven't seen in a number of years. Both from a pure volume standpoint, as well as a product mix standpoint. So that's good.

I think the continued rate ramps across the variety of their platforms will continue to draw down the rest of that inventory. I think there may be certain product forms that they have in the inventory that they have more of than they want, and other product forms that they need that are more of an emergent demand with a very quick turnaround. So, I think as we get into 2015, my sense is that as we exit 2014 and move into 2015, that it will be very well in balanced.

Timna Tanners, Bank of America.

My first question, I want to look into stainless and electrical little bit more. So, on the stainless side, we were hearing that the June price hike was struggling a bit in the market. And so, if you could comment a bit more on that. And then help us understand on the electrical, the timing of the benefit of higher spot prices. I know you sell more contract, so is that really a 2015 benefit, or can we see anything there earlier?

On the electrical, I think you're seeing some of it now on the spot market. There isn't a big spot market, because most of it is contracted. To the extent that there is any spot opportunities on GOES, the prices are modestly better, but still a long -- way below where they once were.

On the stainless side, there have been two price increases that were announced, and are in the market, as I stated in my comments. There was a third one that we led that was announced for August. That one, I think it's safe to say, is struggling in the market, and we'll see what happens. But I think for the first two, they've been in the market for a while. And underlying demand in stainless, quite frankly, has remained pretty strong in 2014.

Lead times for us, and I assume for others, are well extended beyond what the normal lead times are in a product like stainless sheet and plate. They're out into the late third quarter, if not into the fourth quarter at this stage. So that's a positive sign.

And I still think imports are a factor in the market. But the industry watches it very closely, and the domestic market does have the advantage of cycle time over imports because of the time on the water. So, two out of three of the price increases this year look good, the third one I would say is at risk.

Okay, that's helpful. I was also really intrigued by your discussion on the oil and gas progress and chemical processing. Can you help us quantify or put some metrics to that? Is that maybe not the highest margin product you do, but a higher margin product? What kind of percent increases might we see, or how much of your mix could that improve to?

Yes, when you think about the -- when we talk about the key global markets, which is aerospace, which is chemical processing, oil and gas, which is energy, some aspects of the electrical energy more from the generation as opposed to a distribution, and the medical. Because of the nature of those applications and those end markets, the quality and the qualification of the supply base is more intense.

Because failure, really, in those end markets for those applications is not an option. And I would include oil and gas in that, even more so today after Deepwater Horizon than before. So with that, you have higher barriers to entry from a technical and quality standpoint, and the competitive landscape is different because the products are harder to make. So that, all in all, lends itself to more demanding application, more demanding market, fewer qualified and capable producers. And therefore, a better margin opportunity, and oil and gas is certainly within that.

I think we view the oil and gas market from a global perspective, and it truly is. It's not a regional market for the products that we have. We have been under Kevin Kramer, who is our Senior VP and Chief Commercial and Marketing Officer. And really, the first Chief Commercial and marketing Officer ATI has ever had. It is focused on coordinating and integrating our whole oil and gas chemical process industry commercial strategy on a global basis.

We've added resources to that, because we think that there are opportunities that are there for us to realize and grow revenue in that market far faster than GDP growth. And I'm talking high single digits, low double digits in terms of our revenue growth, and you saw the 30% revenue growth that I commented on.

We think there are great opportunities in oil and gas. It's one of the reasons, quite frankly, why, not the only reason but one of the reasons why we purchased Dynamic Flowform which is now ATI Flowform Products. And we have a large part of our technical and commercial organization really focused on opportunities there.

Michael Gambardella, JPMorgan.

Hey I want to understand, what percentage of your nickel units do you purchase as virgin nickel units, as opposed to in the form of stainless steel scrap?

We, like most stainless producers, are much heavier scrap users than we are prime.

Right. Is it like 80%, 90% scrap?

We view that as competition sensitive, and have never discussed that. I can't speak for everybody in ATI, but I haven't discussed it.

Okay, because I'm trying to understand the third quarter guidance, a net after unusual items of $15 million to $20 million. I actually thought it would have been higher than that. And I'm trying to understand what's going on. Because nickel, LME nickel is up around 40%, since the Indonesian bans went to the effect of the beginning of the year. Are stainless steel scrap prices just increasing on a percentage basis higher than the LME price of nickel?

Yes, I think it's safe to say, Mike, that if you compare it to a year ago, the discount to the LME for scrap is much less today than it was a year ago. So if you think about it that way, and in answer to your question, yes, scrap is more expensive on a relative basis than it was a year ago, or even three quarters ago.

So, when I was visiting one of your competitors, their melt shop, not quite a year ago, they were saying that the -- because they also buy most of their nickel units in the form of stainless steel scrap. They were saying that the nickel units in scrap they could buy at about a 20% discount to the LME nickel price. And clearly, you charge the customer the LME nickel price and to capture that margin by being able to purchase scrap because you're sitting in a big scrap generating region. So, was that 20% about a year ago or nine months ago, was that what it was ballpark?

That seems a little high, but it was higher then than it is now.

Is it near parity now? Or --?

No. It can get near parity, and it has been near parity as a percent of LME. There are times in the market where it approaches the upper 90% level, and there are times when it doesn't. And you also have -- not all scrap is created equal. Even in an air melt, there some scrap that you have -- it's less efficient to use really dirty scrap in a melt than it is to use cleaner scrap. So it all depends on what you're targeting for your melt costs are.

If you want to get poor yields and have to do more prime adds because you're off chemistry, you can get really cheap dirty scrap. But we look at it from the standpoint of what's the actual total real melt cost and the yield, and that's really what drives our blends. But scrap on a relative basis, 20% discount to LME, no, it wasn't that high, but it was higher then than it is today.

Steve Levenson, Stifel Nicholas.

Just in relation to the LIFO data you gave us for third quarter, would you expect additional LIFO reserves in the fourth quarter? Or would nickel have to move or scrap prices move much away from the current levels for that to happen?

No, we -- remember how we book LIFO or at least with the process is, we project year-end FIFO inventory levels and we project year-end raw material costs and labor costs and overhead costs to get our indices for the current year. And then we calculate what the LIFO reserve needs to be or is expected to be at the end of the year, and then we book that ratably. So using that methodology, which most do, by the way, because that is GAAP, when you change your estimates either up or down, then you have a cumulative catch-up. So at midyear, you have to be booked 50% of what you think the provision is going to be for the full year, and that's where we are.

And then, the rest of the -- if all of the estimates remain the same, whatever the second half is you book ratably in the third and fourth quarter. Now having said all that, we update our estimates every quarter, actually several times a quarter. And we'll do that as well as we head into the third quarter. So there is a possibility that the $19 million that we're projecting will be -- it could be more than that, it could be less than that, at all depends upon what the costs are, the raw material costs are really in the fourth quarter. Because based on our inventory turns, that's the relevant costs that are in our FIFO inventory at the end of the year.

Got it. Thank you for the detail on that. Then, you've been mentioning mix in different alloys. Can you talk about standard alloys in the past like 6-4 titanium and 718 nickel, and if those will still represent more than half of your respective titanium and nickel sales? Or are you moving more towards the more exotic alloys?

No, I still think the big workhorses in the market, in the aerospace market, is still 6-4. Now, there are a whole range of boutique-ish alloys that are more highly alloyed for very specific components in a jet engine or an airframe. And those are also important products for us.

It's the whole portfolio that we have, and it's really the same on nickel. On the nickel side, on the jet engine, 718 is still the workhorse alloy, although, there are inroads being made by Ti aluminides, for example. There are inroads being made by ATI 718Plus, which is a differentiated product. There's a 720 grade that's more high cobalt. There is the powders, which are beginning to make inroads. There's the near powders like Rene 65, et cetera. But the real workhorse remains on the nickel super alloy side 718.

Gautam Khanna, Cowen and Company.

So, Rich, I wanted to just explore a couple things. One, you made an important comment about how the gross cost reductions are shared in some instances with the customers. And I just want to make sure I'm properly calibrated on the HRPF cost improvement we should expect next year.

Should we expect the net cost tailwind is maybe below that range we've discussed, the $150 million to $250 million and then it ramps from there in 2016 and beyond? Or should we start the year off assuming it's $150 million? How should we --

No. Remember what we've talked about in the past, of what are the components of the range of $150 million to $250 million? It's really cost reductions and it's margin growth, because we can make product that the market wants and needs with the HRPF that we can't make today.

So therefore, you have sales growth. So there's really -- if you think about it, there are three components. There's the benefit that you get by growing your revenue, that hopefully derives and gives you a net contribution margin and a positive pretax margin on revenue that we don't have today, because we can't make the product. So that's number one.

Number two, there's an inherent -- when you do that and you produce and you have more volume running across, not only your primary facilities but also your finishing facilities, because were not operating at capacity, your cost absorption is better. So all the products you make benefit from that.

And then there's the third component that's really unique and an enabler by the HRPF investment, that is a pure cost reduction from our method of producing the product today to what the method will be using the new HRPF. More productivity, better yields, less scrap, less quality costs to rework.

And by the way, on the quality side, even at the early stages of hot commissioning, we are seeing evidence of that even before we've turned on the automation for the HRPF. What we're doing right now is really running it manually, and we haven't turned on all the automated sensors in full. And we're producing a quality product off the HRPF in the initial runs that is really impressive. So, those are the three components that make up the $150 million to $250 million. Pat, do you agree with that?

I agree.

And, Pat and Rich, the last driver you mentioned, just the pure costs out if you will. Can you size that for us? Is that half of the $150 million? Just proportionality would be helpful.

I think we've said in the past that at the lower end, it's probably more than 50%. At the higher end, it's less than 50%.

Got it.

Of the $150 million to $250 million range.

Okay, thank you. We've seen -- just to follow up on pricing, we've seen --

And I would also, if I could just interrupt. I would also suggest that the cost reduction will be greater in the second half of 2015 than it will be in the first half of 2015. Just from the natural learning curve and learning and fine tuning that will take place throughout 2015 on the HRPF.

Okay, that's very helpful. Thank you. I want to just skip quickly to base prices. We've seen, obviously, the move higher in standard stainless. I was wondering if you could just give us some flavor of how base prices compare at the high performance titanium and nickel alloy product categories relative to where they were maybe a year ago? Are they up, down? If so, how much? Ballpark?

Compared to a year ago?

Yes.

On average, I would say they're relatively flat. I think there are some opportunities as the market tightens a little bit on the transaction side that the prices are moderately, modestly improving. I think on the LTA side, the long term agreement, the price is the prices. That's the issue of the long term agreements.

I think there are some markets, quite frankly, that have been more competitive. And base prices might be slightly down. So I think when you put all of that together, I would say, on a general response that at this point in time, they're relatively flat. So the improvement initially, and this is not news, this is what happens. What's the first thing that happens when market conditions began to improve? Volume begins to improve, lead times start to push out. The market becomes tighter, and then what follows are base price increases. And I think we're at the very beginning of that process.

Phil Gibbs, KeyBanc Capital Markets.

Rich, my question was largely just on core spread improvement in the flat rolled side of the business. I know you have a lot of contracts running through that business segment, so we've seen incremental upside in a lot of these stainless base prices. But have you really seen the core improvement, or is that really more reserved for 2015?

Yes, I think we've seen some modest improvement. But I think it's more reserved for 2015. The one thing that, and we've seen this on other big -- first of all, we've never had a capital investment project as big as HRPF. But of other big projects, there's a lot of resource requirements across the businesses that inherently create some inefficiencies. And I think we're probably seeing that.

So I think once, there's a lot of reasons for us to complete the HRPF. One is, to really get a better -- some of the guys at HRPF flat rolled products use the term cadence, which I think is a great word to describe it. That it's important for us to complete the HRPF, and begin to really get the cadence of how that's going to be operating. And I think there are very good and strong cost reduction and efficiency opportunities once that project comes on stream, and the facility comes on stream.

I think your question was, is it more impactful, is the base prices more impactful from a benefit standpoint in 2015 then and 2014? Yes, I would say I agree with that.

I was just thinking in terms of you have a piece of your standard stainless business that's contract, you have a piece that's non-contract. I'm just thinking about maybe some of that being realized now. But as these contracts get reset, you get essentially a lift to base pricing in another piece of the business, or is that not accurate?

No, that's very accurate, and that's very true. There's the transaction business, where you get the immediate lift. Some of it is more on a quarterly basis, quite frankly. So when you have a May and a June effective price increase, you really don't begin to see that until you get into the third quarter and fourth-quarter, especially with lead times where they are. So I think it's more important to get the tone of the market there that the demand is tight, base prices should be going up from our perspective. I won't speak for anybody else, but from our perspective. And you build in that higher floor, and you realize the advantages on the next contract.

Okay. And if I could just ask one more -- I just wanted one for clarity, Dan, and it's the titanium costs. Is that all inclusive? Are you including the headwinds on the actual business segments outside of the PQ start up, or is there more actual impacts aside from the [11-4] that you outlined?

What that is, is the impact of operating at 50% or maybe slightly less of capacity. And we've taken as much cost out of that business as we can without jeopardizing the PQ process, which would be self defeating. So the cost per pound of sponge produced is higher than it will be in operating in a normal state, and that's part of that.

And then the other part is, obviously with -- because we can't use that sponge yet on any rotating quality product, and in some cases on medical product, we're limited in its utilization until we can get the PQ approval. So we're driving the usage of that sponge, so we don't build this big inventory. And where we would be buying lower-cost titanium units, mainly scrap, we're using -- we have a richer blend of prime that's a higher cost than scrap. And that's the other component of the number that we disclosed. So both of those really go away whenever the PQ is achieved.

John Tumazos, Very Independent Research.

Concerning the hot strip mill start up in the second half, presumably, the escalation is because you'll be rolling titanium and other less malleable, tougher to roll grades. Are you budgeting for the product that you roll to be scrapped, remelted, and go through the whole process again? Or are you budgeting for the product to be salable?

We are -- John, the intent is to do the commissioning on production orders. But having said that, we also acknowledge that we may not have, as we're starting up this facility, a 100% success rate of that. So some of that may in fact, if not the product of the whole coil, some of the coil may have to be cut and scrapped and then remelted. And all of that is factored into our estimate of what the start up costs will be.

Thank you. I would now like turn the call over to Mr. Dan Greenfield for closing remarks.

This is Rich Harshman, before I turn it over to Dan. Thank you for joining us on the call today, and as always, thank you for your continuing interest in ATI.

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

Thank you for joining today's conference. This concludes the presentation. You may now disconnect, and have a very good day.