Q2 2020 Allegheny Technologies Inc Earnings Call
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Good morning, and welcome to the Allegheny Technologies incorporated second quarter 2020 results conference call.
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I would now like to turn the conference over to Scott lender, Vice President Treasurer, and Investor Relations. Please go ahead Sir.
Thank you Chad good morning, and welcome to the Allegheny Technologies second quarter 2020 conference call, it's called being broadcast on our website at 80 I'd metal Dot com.
Participating in the call today, or Bob Wetherbee, President and Chief Executive Officer, and Don Newman, Senior Vice President and Chief Financial Officer.
We have connected to this call via the Internet you should see slides on your screen for those of you dialed in slides are available on our website.
After our prepared remarks, we will open the line for question.
During the Q and eight session. Please limit yourself to two question, we will attempt to get everyone in the queue within the allotted call time.
Please note that all forward looking statements are subject to various assumptions and caveats as noted in the earnings release and shown on this slide now I will turn the call over to Bob.
Thanks Scott.
Good morning.
Let's get right to it.
The urgency of the situation created by the global pandemic required significant and comprehensive action.
You may recall, the discussion of our leadership priorities as part of our first quarter earnings call.
They continue to focus our actions as we work to maintain a solid foundation to ensure long term profitability and growth.
And emerge from this global crisis, a stronger more focused company.
Beating our employees safe was and still is our foremost concern.
The team has done a great job doing that.
Less than 1% fewer than 50 of our co workers have tested positive for coated.
Across our global footprint, our employees are being personally diligent and monitoring their health.
Where necessary they continue to work collaboratively through quarantines aggressive cleaning protocols periods of uncertainty and operational disruption.
Kept themselves as well as their co workers safe.
This has enabled us to stay focused on delivering for our customers.
This has banned and remains an unprecedented challenge that led to a continuing unprecedented positive response.
Hi, Thanks to the entire team for what we've accomplished together their actions speak to the strength of our commitment to our value for safety.
Preserving cash and maintaining liquidity is high on the priority list.
We entered the quarter in a strong position and took action to make it even better.
These efforts along with our free cash flow generation overtime will ensure that 18 has the ability to invest for profitable top line growth. Despite the downturn.
I'll leave the details of our actions for down to discuss in his portion of today's review.
The other three priorities focused our actions and have led to the second quarter results were reporting today.
Prepared us to weather the storm of even lower aerospace demand in the next two quarters in.
Physician dose for improved results and 2021.
Driven by significant drops and near term customer order levels, we have been aggressively adjusting crewing levels and work schedules across the system.
Many locations have been completely idled with employees for a load for multiple years.
We have reduced salaries and benefits, we've implemented permanent layoffs and operations, where we expect a significant period of time before recovery.
We've also reduced staffing administrative functions.
We have delayed capital investments and are actively managing our maintenance spend.
We proactively curtailed melting operations to accelerate the alignment of our inventories with a new demand expectations.
All of these actions, we're thoughtful deliberate and necessary.
As we took these immediate actions we did so with full recognition that the commercial aerospace market will recover.
Fundamentally we believe its growth deferred not growth loss.
It may take a few years to get back to 2019 levels, but we're confident we'll get there.
As such it's imperative that we retain an appropriate cadre of skilled operators to respond to the previously announced aerospace market share gains.
At the began in 2021.
We kept this firmly in mind is future crewing levels were set.
We're committed to strong execution in the near term and will be recovery ready when the market accelerates.
So let's move to slide four and look at our second quarter revenues by market and our forward expectations for our core aerospace and defense markets as well as the differentiated applications we supply.
Starting with our view on the jet engine market several of our major customers gave updates last week and our view is consistent with those both in terms of market conditions near term demand and the continued potential cobot resurgence caveat.
You May recall, we saw initial leap engine order rate reductions starting in late 2019 triggered by the 737 Max production stuff.
The reductions accelerated through the second quarter as the impact of the pandemic became evident.
Subsequently sales in the quarter were significantly below prior year.
Stabilization of the forward order book for engines appears to be on the horizon.
We expect a low point in demand to stretch from the second half of 2020.
Into early 2021.
Before improving in the second half of a 21.
Thus, we're projecting for more quarters to realign the supply chain to real demand levels.
At that point accounting for the order lead time lag between delivery of our product and the delivery of the Oems engine.
We expect our order levels to more closely track increases and underlying engine production.
As mentioned earlier, we've worked proactively to adjust our mail schedules and institute short duration facility idlings to minimize stranded and or excess inventory in our operations.
Regarding demand for materials, we provide to the airframe supply chain Destocking was apparent in our second quarter results, but at a slower pace compared to the jet engine market.
Airframe Destocking is expected to accelerate in 2021.
Until the grounded 737, Max fleet returns to service, it's going to be difficult to predict one order levels on the air France supply chains.
I will reflect real demand.
As we approach year end, if and as net needed will adjust our operations to align with lower 2021 order levels for airframe materials.
As a reminder, in both the jet engine and airframe markets, we have significant new business share gains in March margin enhancement actions that will began early next year.
While the magnitude of the positive benefits from these wins will be muted in 2021 due to the lower industry demand levels, the impact will be magnified as the market recovery gains momentum in 2022.
Our defense business continues to post solid year over year growth.
This strength is broad based across many subsectors is led by demand expansion for naval nuclear dealer materials in support of our customer VW XT and ultimately the United States Navy.
Additionally, our missile component sales continued to increase as the demand for our titanium armor plate materials used for land based vehicles.
We expect our defense revenues to expand in the second half the year as the programs, we supply remain mostly insulated from negative cobot impacts.
We continue to work directly with the armed forces research and development labs in the large defense prime contractors to develop next generation applications that perform better with 18 material science and advanced process technologies.
Leading to meaningful growth opportunities in the future.
As for electronics, primarily served by our China based precision rolled strip business on a stall.
Second quarter volumes modestly exceeded expectations as domestic demand improved faster than expected.
Looking ahead to the second half of the year, we expect this market to experienced modest demand growth in support of anticipated year end holiday sales.
Today, China's economic recovery continues.
But a significant regional or global cobot resurgence has the potential to negatively impact second half demand given the worldwide reliance on China sourced consumer electronics.
In the energy markets, the coed impact has been significant.
Based on the well publicized supply demand imbalance and related price declines.
Drilling and exploration activities were severely curtailed.
Production, both on and offshore was greatly reduced.
Our customers are de stocking inventories as they focus on repair work.
Although offshore oil and gas applications drive 80 ice largest energy submarket.
Add from other areas was markedly better including specialty alloy products for industrial pollution control systems.
Civilian nuclear refueling and land based gas turbines, particularly in Asia.
Looking ahead oil and gas prices have started to improve as producers reduced supply.
Demand is solely began to recover we continue to expect overall energy demand to be soft in the second half the year.
With potential upside from government sponsored ultra deepwater projects that require high value nickel alloy materials.
These projects are expected to be awarded late this year for shipments in 2021.
Turning to the medical markets second quarter sales declined after first quarter growth anticipated return of elective surgeries and the need for diagnostic EMR eyes were delayed due to the resurgence pandemic.
We expect second half 2020 sales to remain moderately depressed due to lingering concerns about visiting medical facilities for non critical procedures in this environment.
With that I'll turn the call over to Don to cover in more detail, our second quarter financial results and our outlook for the balance of the year I'll be back to at the end offer a few final thoughts before we open the line for your questions Don pre thanks, Bob turning to slide five continued delays and 737 Max per day.
Option and strong macro headwinds driven by coal that significantly impacted our Q2 results.
Expected to create continued challenges in the near term as well.
And the team we remain focused on what we can control.
Keeping our employees, helping de risking our business by managing costs and staying in lock step with current demand and by being recovery ready.
Before I cover the results by segment there were a couple of the significant non cash charges at the corporate level. These charges were driven by the current economic environment.
And were required by generally accepted accounting principles or GAAP rules.
First we took a $287 million charge for a partial goodwill write down at our board forged products business, which remains profitable.
And with good long term growth prospects.
The second charge totaling approximately $100 million is related to valuation allowances for our deferred tax assets, including net operating loss carry forwards or handle wells.
The valuation reserve was triggered under GAAP rules, largely due to the goodwill impairment charge.
The valuation reserve does not impact cash taxes paid.
We have substantial tax attributes, including at a wells, which we expect to provide a tax shield from us federal taxes for years to come as we returned to profitability.
These charges did not reflect the positive long term growth and profitability potential we've seen any underlying business.
We also recognized pre tax charges for debt extinguishment for the partial redemption of our 2022 convertible notes and for further restructuring and severance actions.
In aggregate these totaled approximately $40 million.
Excluding these charges adjusted EPS was a loss of two cents per share.
This is better than our prior guidance range for an adjusted EPS loss of seven cents to 17 cents.
While business conditions deteriorate with revenues down nearly 30% year over year, we work diligently to controller cost and deliver already melted materials from inventory.
Moving onto our segment results announces second quarter revenues were down 14% versus prior year.
Declines in commercial aerospace and energy were partially offset by growth in defense electronics, and HRP up conversion services.
From a business unit perspective sales grew modestly in our specialty alloys and components business declined somewhat better stalls JV and were meaningfully lower and our specialty rolled and standard stainless products businesses.
And Thats segment operating profit declined in the second quarter versus prior year as the impact of lower volumes that are SRP and triple S. P businesses caused cost under absorption challenges.
Lower raw material price has created a negative surcharge timing mismatch.
And stainless scrap prices decline, causing a decrease in related inventory values.
Partially offsetting these negatives were lower production and overhead cost.
Both from our aggressive facility idling efforts and from significant back office cost reductions.
We also sustain reduced losses from the AMC stainless JV.
Shifting to the age PMC segment revenues declined nearly 45% year over year.
Primarily driven by commercial aerospace OEM production decreases at both our specialty materials and forged products businesses.
The medical and energy markets declined considerably in response to the cold It pandemic, while defense market sales increased due to demand for naval nuclear and missile materials.
Segment operating profit decreased due to lower volumes and associated manufacturing cost under absorption cost savings efforts largely related to the facility idling schedule and reduced overheads helped to offset the cost inefficiencies and worked down inventory levels.
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Let's turn to slide six for look at current liquidity cash flows and our capital structure.
As a leadership team we spent considerable time working to ensure that AI has the best possible capital structure and ample liquidity to whether any storm.
And even thrive on opportunities to create value are presented.
The second quarter, we continue to take decisive and prudent actions to maximize liquidity levels and preserve our ability to strategically invest and grow our business over time.
In the quarter, we took the opportunity to further managed debt maturities.
Including a small over allotment in July we issued $291 million of new convertible notes, redeeming 230, $203 million or more than 70% of our 2022 convertible notes.
The new convertible notes carry a lower cash interest rate, 3.5% versus 4.75%.
Have a higher conversion price $19 in 76 cents per share versus $14.45 per share.
Provide for more flexible cash settlement options and are callable after three years.
In addition, we exercised a low interest rate 100 million dollar term loan option under our ABL facility.
That would have expired at the end of the second quarter.
These steps all have favorable into packs to our liquidity profile and are part of our continuing efforts to opportunistically improve our debt maturity schedule.
Today, our next significant debt maturity is now three years away.
April 2023.
We ended the second quarter with approximately $1 billion of total liquidity, including approximately $540 million of cash on hand at $460 million available capacity on our Undrawn ABL revolver.
Further we see opportunities to add incremental liquidity by optimizing existing collateral to support the l. borrowing base, even as we convert inventory and receivables into cash through our initiatives.
From a managed working capital standpoint, we made great product great progress in the second quarter.
To that end, we reduced inventory levels by $78 million in the quarter.
Well in some cases that lower cost absorption due to selling from inventory rather than producing.
It was a healthy trade off for cash generation.
We also maintained our disciplined are producing to customer orders to avoid creating stranded inventory.
While we made good progress reducing inventory in Q2.
We expect this favorable managed working capital trend to actually accelerate in the second half of the year.
Now, let's turn to slide seven and talk about Q3, and full year 2020 expectations, along with some initial thoughts on 2021 and beyond.
Similar to my comments on the first quarter call the uncertainty around end market demand, particularly for commercial aerospace and that the pace of recovery makes it very difficult to predict itchy eyes revenues beyond the next quarter with any level of precision.
Therefore, we are still unable to accurately estimated full year 2020 EPS.
We can't however, better predict near term demand and earnings as we have better visibility into from customer orders and understand the timing and impact from our cost savings plans.
The assumption is laid out in our initial 2020 guidance and updated in Maine are still relevant guide close today.
Our current view on these items have evolved over the past three months.
First 737, Max production did restart at a low rate in the second quarter as predicted.
Given the ongoing recertification process and as reported by Boeing last week.
Planes production rate will remain low for the balance of 2020.
Second while nickel prices improved in the second quarter, they're still below our original range of $6 to $6.50 per pound.
When an over the past few weeks average prices have been above $6.
With a likely third quarter 2020 average prices higher than second quarter, but below prior year levels.
Finally, with regards to the impact from Covance.
We've seen significant and continued deterioration in the business conditions as a results of this pandemic.
The current us resurgence and continue to worldwide spread has had and we'll continue likely continue to have a pronounced negative impact on the end markets we serve.
We continue to pursue reductions as we adjust our cost structures to the new demand expectations, while maintaining critical capabilities and remaining recovery Reg.
On our Q1 earnings call, we announced 2020 cost reductions of between 115 and $135 million.
So as a decisive response to a rapid change in demand focus on what we can control.
Those efforts continued in Q2.
And we have increased our 2020 cost savings targets by $25 million or 20%.
This brings our range to between 140 and $160 million for calendar 2020.
Additional plant Idlings employee furloughs, and Severances and tighter cost controls all aligned.
Our low with our lower production requirements drove the increase in the range.
Across both segments, we expect our initial cost savings to ramp up to the full annualized run rate in the third quarter.
The second quarters additional savings amount of $25 million will reach run rate in the fourth quarter.
These will help to mitigate the deteriorating market conditions expected in the back half of 2020.
All of these cost reductions improve decremental margins in the downturn.
But the structural savings also expand margins in the upcycle to that end, we expect 40% to 50% of these cost reductions to become permanent.
As a result of these poor market conditions, we expect to lose between 62 and 72 cents per share on an adjusted basis in the third quarter.
This estimate assumes marginally higher decremental margins than experienced in Q2, due impart to accelerating jet engine revenue decline rates lower production levels and unfavorable product mix.
We assume zero percent tax rate and the quarter.
Given our significant efforts to reserve cash we are maintaining our 2020 full year free cash flow guide to generate between 110 and $140 million.
This excludes us defined benefit pension contributions.
Looking beyond the third quarter, we expect some modest improvement in the fourth quarter, primarily outside of commercial aerospace.
We also anticipate meaningful improvement in 2021.
Particularly the back half of the year.
This is due to the end of Destocking at our jet engine customers.
Foreigners better aligned to the increasing leap engine production.
The full impact of our cost savings initiatives and improvements from our cost share gains from our share gains new business and margin enhancement actions.
Partially offsetting these improvements it's unlikely continued destocking any airframe.
Supply chain.
We are aligned with our customers on the longer term industry view.
Echoing their belief that commercial aerospace production rates will take three to four years to recover to 2019 levels with narrow bodies, returning more rapidly than wide body aircraft.
However, it is likely a T.I.s other end markets will improve more quickly and in the case of defense continue to grow.
That coupled with the H.T.I.s specific benefits that I outlined a moment ago, well Hopper company to mitigate lingering commercial aerospace softness.
I'll now turn the call back over to bomb to add some closing comments.
Thanks, Doug Thanks for the updates pretty active last hundred 20 days, if I say so.
I will end todays call, where we started these leadership priorities underpin everything we're doing at 18 Guy and leaders defined straightforward solutions to challenging problems and market conditions.
We first focus on the people, who create and drive our success.
From our R&D sciences to production workers and all the supporting team members in between that relentless innovation and commitment sets us apart.
We do our best to delight and serve our customers partnering with them to solve their toughest challenges. This is what leads to long term profitability for 18.
And returns for our shareholders.
And we achieved financial security and preserve the fuel for growth no matter, how choppy the waters were swimming.
By investing our time at efforts on these things we believe they were on the path to being wildly successful in the inevitable recovery.
This is more than a slide for us that is how we leave every day.
So our goal for today it was pretty simple we wanted to provide a complete picture of our current demand environment in our most up to date forward looking views.
To provide a comprehensive look at our actions to adjust to these dynamic conditions and share our expectations for third quarter earnings per share and full year cash flows.
We know that our investors are making important decisions with less than perfect data.
We strive to give you the best possible information on its current state.
And forward outlook.
Now I can't tell you exactly when the code crisis will land or when the 737, Max will be certified to fly globally or when demand levels will ultimately get back to 2019 levels in each of our core or differentiated markets.
But what I can assure you as this.
I will be a stronger more focused and profitable growth company as a result of the actions we're taking during this crisis.
We remain focused on creating long term shareholder value through the combination of material science.
Advanced process technologies, and with our relentless innovative people.
So Scott that few.
Thanks, Bob that concludes our prepared remarks, operator, we're ready for the first question.
Thank you we will begin the question and answer session.
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At this time, we will pause momentarily to assemble our roster.
Yes.
And the first question today will come from sale Gibbs with Keybanc. Please go ahead.
Thank you good morning.
Good morning, though.
A question I had was just on the incremental.
Cost cuts that you announced this morning.
Don I think you said, 40% to 50% of those cost reductions will be structural in nature.
With all the actions that you've done up until this point.
What does that amounts to in terms of an exit rate for 22020.
Sure I'll take that I'll take that question. So in terms of our cost reductions where our target range at 140 to 160 as you as you're thinking about the kind of hitting the run rate, which I think is kind of the core of what you're asking Phil Theres you want us to do is thinking about in two pieces. One is our original guidance was.
115 to 135, and we expect to hit run rate on that.
On that tranche of cost savings by the end of Q3, and I would say probably early Q3 are for.
Cap our capture rate to giving idea in Q2 was probably in the $30 million range.
The second piece is the incremental 25 million that we're adding out of this Q2 discussion the run rate on that piece is going to be in the range of Q4, and and I would say I would think earlier Q4, rather than later Q4.
But we should have full run rate by the end of this year.
So does that does that suggest that the.
All else equal the cost savings on an annualized basis are closer to 250 to 300 million, yes, yes, exactly thats. The way you want to think about its on the as you lay out the build toward that.
Towards that run rate, we would expect to have annualized cost reductions and.
Probably 250 to 75 range in 2021, and then importantly is how much of that a structural and going to stay with us and as I noted, we're expecting between 40 and 50% of.
Those cost reductions to stay with us as permanent reductions.
One thing that I also want to stress as we talk about the cost reductions the team pivoted to this very very quickly I think has done a.
But an incredible job delivering a meaningful change in terms of our cost structure, obviously pointed towards Doug focusing our cost structures to the new demand, but one thing I want make really clear clean in this Phil is that we are in this business for the long run.
We're also aggressively pursuing these these cost savings, but we're not doing it and managing our or mortgaging our future.
We're going to have a goal in mind to firmly maintain our materials science leadership and capabilities and to maintain our our skilled workforce has your thinking about these cost reductions.
Just keep in mind, we are focused on the recovery and being recovery ready so even with delivering these savings we have the long term in mind.
Thanks for that and you provided guidance for the third quarter at this point.
Certainly a big piece, that's going to be due due to revenue stepping down.
But you do have more cost reductions coming through and it sounds like the China business is better how much.
How much of that step down in implied EBITDA sequentially.
Is just due to the fact that you're you're you're blowing through all this networking capital in that obviously has a margin impact so.
That part of its probably a bit temporary as you bleed through that inventory in the back half so trying to understand just how much of this.
Rob.
In profits is due to the fact that you're just under absorbed.
On your assets, yes, it's a it's it's a great question.
Right you know as we're focused on managing down our inventory levels that means we're making decisions to not produce and in that creates under absorption. We haven't talked a great deal about the financial magnitudes of under absorption nothing I would.
Just as a place holder I would think in terms of probably something in that $20 million ish range, maybe impacting Q3.
But it's.
Obviously, a dynamic number based upon a whole lot of assumptions.
No wonder if we're going to continue to stay the course when it comes to Rightsizing, our production levels staying focused on that working capital reduction and and then the cost savings, which in Q3, you're right, it's going to be a contributor in terms of our our.
Ability to to hit the 60 to 72 cents per share and energy with kind of already talked about the run rate around those cost savings. So it will be meaningful but the key to to key thought in terms of Q3 guidance is you know you're seeing effective of the anticipated decline.
In the in the jet engine and aerospace.
Parts of the business hitting in Q3, and we're thinking Q3, and Q4 could be our trough.
Good news is that we do see green shoots of of recovery in 2021 and conditions should improve.
And then lastly, if I could.
Your liquidity improved here sequentially by roughly 100 million based on your current free cash flow guidance for the for the full year I think that implies more free cash in the back half, but how that.
How that men's itself or intermingle is with the B L. Unclear you would know that more than I, but where is the plan to exit the year on on liquidity all all else equal with this free cash flow guidance. Thanks, Yeah. So let me kind of let me kind of answer that question in layers.
So as you look at to Q3 in Q4 to answer one of your questions.
What does it look like from a cash generation standpoint, we would expect to be cash generator. In Q3 in Q4 of course that excludes the impact of of contributions to the pension plan, but we are expecting the pace of of inventory relief our release, rather to pick up in the second half and and.
Then as you think about the interplay between their conversion of inventory into cash and availability under the revolver. What you can expect is we started an initiative and then last 90 days that was really all about taking great.
Great advantage of our Undrawn revolver, it's a 500 million dollar instrument and as we're converting.
Converting inventory into cash were taken those inventory balances down how do we replenished the inventory in a cash efficient way well one way to do that Phil is we have pockets of inventory and accounts receivable that he was just historically not been included in the ABL borrowing base, we are working with our.
Banking group to get those added and so I would expect and we've got some internal targets into the magnitude of what we can do there, but I think it can be meaningful and what's meaningful.
My target is adding.
Upward of something in the range of 100 million to our ABL borrowing base as a result of doing that so so you add up our Q over Q3 Q4 cash generation.
What we're doing around the.
Around the.
The ABL collateral base I, it's my.
Thought is right now that we can be heading toward the end of twentytwenty.
And finding ourselves in a similar position from a liquidity standpoint, as we were at the end of Q2, which of course was about $1 billion of liquidity. So we're managing all the levers and.
And I and I think where we're headed the right direction again looking at 2021 is a bit out there, but I think we're going to enter in a very healthy position.
Thank you and our next question will come from Josh Sullivan with the Benchmark company. Please go ahead.
Hi, good morning.
Hi, Josh.
Just following up on the inventory question, yet how comfortable are you. How lean are you comfortable taking inventory to just looking at that growth and then lead times and what they might be in 21 in 22.
Oh, yeah involved in those fabrication you concerned about will.
You will be plans might go if you conclude.
Great and.
And then how much your contract base is in take or pay structures at this point.
The good morning, Josh on terms of the the inventory situation. The first part of your question.
No as demand has come down.
So our flow times have actually come down as well so we actually have.
Pretty good ability to respond to emerge and demand or near term changes upticks in demand. So I think from how nervous with our customers be I'd say.
I'm not very.
I think we're staying and good touch with them.
Daily in most cases, if not weekly for the other cases.
I think the other issue is that.
We're managing our melt very aggressively.
And as as such.
We're not getting our melt way ahead of what we're working on and looking at those value streams and how they flow we're able to be ready to go and as Don said maintain recovery readiness. So I think how lean can we go when get very lean in terms of.
Our inventory levels than our ability to respond this should be.
As good as it's ever been as as we said earlier, we've made a specific.
Decision to hang on to have as many of our.
Highly trained people as we could and certainly that continuous improvement activities.
In our melting areas and downstream continue so.
Hopefully that helps.
And then on just.
Take or pay structures do.
Is that a meaningful portion or how do you how those look yeah. This is Don I'll take that so.
I, Wouldnt say that take or pays or a meaningful element. We do have do have some but they're certainly not material driver in our contract structures.
Okay.
And then just moving over to the to the strength in the defense portfolio can you dig into that little bit what does the visibility look like deviation in Mary client platforms can that growth carry you through the 2021 as well.
Yes.
Simple answer is yes, so when we look at our defense business. It really breaks down quite simply into things that float things that fly and things that roll, let's easiest way to kind of break it down so the things that float are principally long visibility areas. The navy nuclear programs.
Pretty strong forward look there so that should carriers.
Into 2021 pretty well on the this stuff that's a flying again, we haven't seen any.
You know decline and.
Demand there so I'd say our order visibility is good.
And on the.
On the stuff that rolls I think we continue to see good demand. So I would say into 2021, we do see growth.
You know I think it's got to get a little nervous, but it's probably in the double digit ranges as we go through.
Into 2021 in the strong.
Products, the titanium alloys in particular.
But certainly the navy new killer programs the contract we signed with.
Wjxt.
A few quarters ago. So all those are progressing and we still have a portfolio of new applications that are probably beyond 2021 harder to predict how those will actually come to bear, but we feel pretty strong for 2021 and defense.
So you can find.
Yeah. Thanks, Josh.
Your next question will come from gotten caught up with Cowen. Please go ahead.
Hi, Thanks, guys. Good morning, Hey, good morning.
I was wondering if you could.
Give us some color on you know you guys have the hedging Uncontracted Pauline and.
The only in the I think you will consulted school.
Oh, the minimums and then zone.
Does that have you adjusted down to kind of below the contractual minimums I'm. Just curious now that's played out those or another.
I'd like to fall as we look and compares for 2014.
And that began in particular.
Yes, if we if you take a step back and.
Say, whereas our our airframe demand couple of things going on got them. One is we've been close to the contractual targets you know in 2020.
As you look forward.
You know what I'm confident that those numbers will be sustained in that Destocking will start we've seen a little bit a destocking starting in Q2.
Expect that kind of those levels the balance of the year, where 2021 would be the lower and then we expected to to level out in the sustained for quite a the next two or three years, probably on the airframe side that said you know.
I think we announced last quarter that we're expanding our participation in the air frame business. So we'll pick up some share and some position with other airframe manufacturers and that should help offset some of that probably a half to a third of the problem that we could see coming out of.
The Boeing contract.
As they will start in 2021 and really kick in in 2022.
That's helpful. Appreciate it Bob and then also just as a follow up.
I'm curious.
In terms of de stocking or.
Yes de stocking or just clear demand signals on the engine.
No channel.
Or do you think folks are now all of your various customers are well aligned to.
The the for the production rates.
A and B I mean are you still see like how much longer should we see some de stocking to amplify.
The.
The behind your business may see relative to the underlying.
Production rates.
Yeah.
Yes, that's a question we ask that our customers engaged with them every week every day I would say.
We expect I do believe our engine customers are for the most part aligned with the near term demand. So 2020 2021 is probably where they are today and we expect these stocking in the engine space to really be taking place through the balance of this year into the first half.
Probably the first two quarters of 2021, and then by the time, we get to about mid year, we should see pretty good alignment with true demand correlating with with our orders was always a little bit of a lag that we've talked about with you for ever an ever but I.
I think it's got to take on another couple of quarters, because it was a fairly significant.
The decline in the end market.
And certainly their issues with.
Engines running departures as they as well GE spoke to in last week.
I think we expect them to be in line by mid year, our inventories and their inventories by mid year next year.
Thank you. Our next question will come from Timna Tanners with Bank of America Merrill Lynch. Please go ahead.
Hey, good morning.
Great and high level Hello, Good morning, the high level question wanted to just ask you know how any of your comments might change or not if there were a vaccine and to be early next year.
Well you hear us cheering number one that theres a vaccine I think it would give a lot of impetus to.
Clearly increased air travel, which would lead to no improvement in the spare side and I think for US we feel well positioned for the new builds and I think one other things we've seen in the aerospace industry is that the airlines are retiring the old stuff.
And that positions us well for a I.
I would call at a faster recovery with the vaccine. So we feel with our next generation products on the next generation engines that would be a plus so you know acceleration of spares followed by acceleration of demand for the new stuff. So we would be more will more bullish but once we see a vaccine.
No clearly at that that'd be positive in a lot of ways I'm just wondering in terms of timing separate considering that there's the de stocking that's going to continue that's for the next four quarters or so in jet engines, and then airframes de stocking and then I'm trying to reconcile all the different end markets in terms of where we are with regard to actual demand.
De stocking so you know automotive, obviously more likely to recover more quickly kind of confused by the construction mining although I know it's small so just wondering if you can go to and and tell us how quickly. Some of these continue that if if things way to recover.
So you mentioned automotive and construction there they're smaller parts of our business today as we deemphasized our role in stainless but I think we're seeing a.
A decent recovery I think Don referred to some green shoots I think in the defense and automotive.
As we get into early 2021, we should feel pretty good about as the Catholic saw it with the capital spending cycle, others consumer confidence, but it appears that the automotive side is recovering relatively quickly we see that in the U.S. and we see it in Asia actually through the precision.
Strip business, we have in China.
So I don't I think the.
Aerospace the jet engine side will probably be.
The four quarters, but I think everything else should we should feel pretty good about recovering in early 2021 in the in the other markets.
Okay. That's it from me. Thank you thanks, Tim Yes.
Your next question is from Paretosh, Misra, where Berenberg capital markets. Please go ahead.
Thank you good morning, Bob and Don So first question on your long term aerospace revenue potential I guess, so when airplane production rate when they do come back to the 2019 run rates, whether it's in three years of 40 years.
Yes, it's fair to say that your sales in the high performance business should be higher than 2019.
Just given the progress in the last 12 months, you know the market share gains new contracts.
Repricing opportunities you've had and just also the higher penetration and I'll be next generation engines.
A simple answer is yes, we do expect the longer term to benefit from a the share gains and the margin enhancement and have a new business. The new positions that we've won I think the other thing is the couples with the defense growth.
We talked about earlier, we see.
Continued long term growth in defense of some great programs coming down the pipe obviously they have to be funded but you know we're bullish on our core being aerospace and defense materials and components. That's that's really where the strengths of 80 I play the best though.
You couple that with the structural cost savings and obviously then if I.
So performance of the company reaches a much better point.
And how sensitive are you to the white body versus narrow body makes I guess the is that.
That change anything.
So in a nutshell you know wide bodies tend to have more metallic content per unit.
Do you look at the narrow bodies, obviously, though the quantity tends to be equally important. So I think it what I would tell you based on our product performance between wide body and narrow body. We're happy with every airplane that gets built anywhere in the world.
And we're going to beyond those engines and almost frame. So we're excited so I'd say less concerned about what gets built just that they are getting built.
Got it and if I could just one quick one.
If you look at your sales to jet engines to airframe typically it's like two to one ratio.
But it was pretty much lower than that in Q1. So how should we think up that in the near term how much would revert back to two to one.
Next year that second half of next year.
Uh huh.
Yeah, I think by the second half of next year I think you know that the jet engine destockings going to make those historical numbers a little funky in the first half a balance of the year just as we work through that but yes, I would think long term, especially with the yeah, I think with a share positions.
It's going to take a little longer I think the de stock the airframe supply chain, just because of where we sit in that supply chain, but I think over time, you're right I think it will return probably the 2022 timeframe we'd be back to historical.
Comps.
Thank you. Our next question will come from David Strauss with Barclays. Please go ahead.
Thanks.
Good morning.
Morning, Hey, good morning.
I know, we've we've been over there.
The difference between the engine side airframe side in terms of de stocking, but Bob can you can you tell us maybe maybe dumb it down me whats the explanation in terms of the difference in the timing around de stocking.
In the versus airframe, where you think airframe is going to extend you'll all the way through 21.
Yes, so I think from a destocking standpoint.
I think the real issue is the engine group has gotten going first you know so they've gotten out ahead. We we saw the disruption that occurred in late Q4, you know with the announcements on the Max and what was going on I think.
The engine guys reacted pretty quick and.
So we saw a major shift and a desire to to get inline much faster very quickly I'll, just say very quickly I think on the they airframe side.
Because of the length of that supply chain, it's taken them longer to understand when is the Max coming back what are the implications of co bid on long term airplane deliveries and they've been working through that and I think.
What we saw starting to happen in Q4 of 2019 on the engine side I think is happening in Q3 in Q4, 2020 and airframe side. So I think that just gotta a late start and as a result will see the pop up in engines in the second half of 2021, because we'll be back to.
More demand I think airline travel be up the spares will be up whereas the airframe is big kind of leveling out we've said I think in previous conversations that one good thing about the airframe builders is over time, they tend to smooth things out.
On the history would say it just takes him a little longer to get there and so that's what we're seeing so to be a quicker down in the quicker up for engines a slower down in the slower upon the frames.
Okay, Yeah that's helpful.
And then.
As you think about Q3 when the.
The P. S. A number we're looking at can you can you help us out on terms of what that speaks in for a.
Revenue decline on the aerospace side I think you know this quarter between engine and airframe on.
Adjusted for the divestiture or you were down you on the low 40% range. How how much are you baking into your you're down in aerospace in Q3 and that in that EPS number.
Well, we haven't given we haven't given a revenue guidance right. So I'm reticent to to do that math here, but what I can tell you as you can you can do the math or I mean to be cheeky about it. We just don't want to we don't want to be out of putting additional guidance out there.
Clearly one piece of information I think it would be helpful to you and doing your math detrimental margins. So if you think about our decremental margins in Q2, we were sitting at about 32% decremental margins year over year, excluding 20, 19% to up divestiture impacts.
As you look forward in Q3 in Q4, you should expect decremental margins in that 30% to 35% range.
Yes, a little bit a wider the Q2, because you know what the jet engine declines that Bob was talking about and seven some next I expected whiting out, but it's not going to pull off so I think I think in terms of maybe 35%.
If you take earnings guidance any any and you can you can do some modeling that will back into.
You know keep to get you a view on on revenue.
And ER and your you will find with a you know with certainty that our expectations are certainly going to be lower I just had to quantify it publicly.
Okay, Yeah that that's the piece on the decremental margin sides helpful and Dawn I guess last one on on pension and any updated thoughts on.
Oh, you know what you might look like from an expense standpoint in a cash contribution standpoint in 21 at this point.
Yes, it's.
Yes, I said, yeah, and then ending the answer is is kind of so 2021, we I.
I would expect at our expense will be down. Some you know, we we should have about $60 million of expense in 2020.
And I would expect that to drop down modestly based upon what I know right now in terms of contributions in 2021 the guidance that we've given is that between 2021 and 2023, we expected to average of about 85 million of contributions a little bit higher.
During the first couple of years and and dropping down in the third year, but averaging about 85 million. The reality is we won't know with certainty what those numbers look like until we run our actuarial evaluations at the end of the calendar year.
So, but right now I would assume that that's that those figures I. Just gave you will hold and be kind of in the neighborhood for 2021.
Sure that help.
Our next question will come from Matthew fields with Bank of America. Please go ahead.
Hey, guys I'm just a modeling question for me that the one thirtyth pension contribution to this year is not expected to take place in Threeq or Fourq you.
So as you look at the 130, so thats the for the benefit of everyone on the phone that's the estimated deposits into the defined benefit plan in.
2020, so the way to think about that from a cash standpoint, we have contributed about 45 million of the 130 between Q1 in Q2 I would expect in Q3, we're going to contribute probably in the neighborhood of 18 to 20 million, a probably and lower end of that range and.
And the balance will be contributed balances 130, we contributed in Q4.
All right that's helpful.
And then on the liquidity side, you know you've done a good job existing liquidity, so far and I. Appreciate the comments that you expect to end the year at about 1 billion of.
What are the as well.
Is that billion dollar level kind of adequate uncomfortable for you heading into you know another year or two of kind of down results in aerospace or do you think that there's a couple of extra moves you need to make to boost that even further.
Yeah, I mean first of all I feel like we're in a really good really really good spot from a liquidity standpoint, and then of course, our next nearest term maturity isn't until 2023. So so were lined up to to continue to be in a very healthy position and of course, you know what we'll continue to watch the demand.
And we'll pull levers around cost structures capital expenditures and working capital initiatives to continue to to shape, our business to the to the demand.
But I feel I feel very very good about our liquidity position. We did the financing placed a new convert in June that all saw was a healthy good guy for our our liquidity profile as you look out past 2021.
In terms of other moves you know really were opportunistic.
I think what you are bringing up as we've got some 2023 maturities and we'll manage all is in due course, but generally cash needs. In the business are are we should be able to meet those quite easily. We aim to give you a kind of a bookend on on the on the cash needs we wait.
Typically need anywhere from 50 to 100 million a cash in the business. So said with a billion dollars of liquidity and and in a very healthy position that were in is you know is is a good spot to be I feel very very fortunate to be in in the position that we are with our balance sheet in our liquidity.
Ladies and gentlemen, this concludes our question and answer session I would like to turn the conference back over to Bob Wetherbee for any closing remarks.
Thank you for joining us on the call today, clearly, we talked about the commercial aerospace industries reset as it relates to coated.
I also heard US heard you heard us talk about our strong liquidity position the significant significant actions, we've taken to adjust our cost structure as to the new demand reality and certainly our strong product positioning for recovery.
We remain recovery ready and believe 80 I will outpace the industry is that occurs so thank you for your continued interest in Asia.
Thank you Bob Thank you to all the participants and listeners for joining us today that concludes our second quarter 2020 conference call.
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