ATI - Q2 2023

Transcript

David Weston (VP of Investor Relations)

Thank you. Good morning, welcome to ATI's Second Quarter, 2023 Earnings Call. Today's discussion is being broadcast on our website. Participating in today's call to share key points from our second quarter are Bob Wetherbee, Board Chair and CEO, and Don Newman, Executive Vice President and CFO. Before starting our prepared remarks, I would like to draw your attention to the supplemental presentation that accompanies this call. Those slides provide additional color and details on our results, and all can be found on our website at atimaterials.com. After our prepared remarks, we'll open the line for questions. As a reminder, all forward-looking statements are subject to various assumptions and caveats. These are noted in the earnings release and in the slide presentation. Now I'll turn the call over to Bob.

Bob Wetherbee (Board Chair and CEO)

Thanks, Dave. Let me begin by welcoming you to the ATI team. We're really happy to have you with us, and we're seeing the impact of your presence already, so thanks for being here. We reported another strong quarter with sequential top-line growth and margin expansion. We've accomplished a lot, and I'll use my time this morning to focus your attention on the three highlights about the quarter that I think are most important. First, our core aerospace and defense markets are strong. We continue to grow in A and D, both in absolute dollars and as a percentage of our total revenue and income. Why is this so important? Q2 A and D sales increased 5% over the prior quarter and 39% over Q2 of 2022. Specifically, in defense markets, sales surpassed $100 million in the second quarter.

This is up 7% from the prior quarter and 25% year-over-year. There's sustained demand in materials for military ground vehicles, rotorcraft, and naval applications. Looking longer term, we're playing a key role in the advancement of hypersonic technologies, an area with significant growth opportunity for our highly differentiated materials. Demand continues to accelerate. Our order backlog is up more than 20% from the beginning of the year, reaching $3.5 billion at the end of June. When you put it all together, strong sequential top-line growth in sales, increasing productivity, a very healthy backlog. We're at a very robust part of the cycle with the best still ahead of us. Our percentage of ATI overall revenue attributed to aerospace and defense is now 58%. Just a year ago, that number was 46%.

We're making rapid progress toward our A&D sales goal of 65%. Highlight number two, our strategic transformation continues to deliver greater and greater benefits. Our High Performance Materials & Components segment is hitting its stride. Sales in this segment grew 12% quarter-over-quarter and 33% year-over-year, driven by ramping commercial aerospace production and robust defense demand. Equally important, HPMC EBITDA margins increased 350 basis points sequentially to 20.5% of sales. This increase was driven by improved overall pricing, mix, and volume. All three are enabled by the continued realization of efficiencies in our operations. Our operating teams are doing great work, continuing to improve efficiencies and debottleneck our critical production flow paths. The team also recognizes that we're not done improving. We still have work to do to improve the velocity of inventory through our system.

We're not where we want to be on managed working capital as a percentage of sales, and for a variety of reasons that Don will provide color on shortly. I'm confident we'll see tangible improvement in this metric in the second half of the year. Highlight number three, ATI adjusted earnings per share was $0.59, landing at the top end of our guidance range. It all starts with doing what we say we will do and delivering on our commitments to our customers and our shareholders. We did this in the face of challenges, including continued recessionary headwinds in the industrial markets served by our Advanced Alloys & Solutions segment. Our Asian precision rolled strip business is stabilizing, but not yet in recovery, and we're experiencing continuing late deliveries of direct-forged billet supplied by third parties. Q2 was a strong, very productive quarter for ATI.

It's one more chapter. There's more of this story to come. I'm excited to talk about how we see this quarter's results leading us into a strong second half of 2023 and beyond. I'll provide more on that in a moment. First, Don will share his take on these results and our guidance for the second half. I'll be back after that to share my perspective on ATI's future and take us into questions.

Don Newman (EVP and CFO)

Thanks, Bob. Following those same headlines, I'll add some more color on our results and financial trajectory. First up, we are increasing A&D content. This is directly in line with our strategy to expand our aerospace and defense leadership. Reaching a near-term high, 58% of ATI's Q2 revenue is driven by A&D. This is up 1,200 basis points year-over-year and up 200 basis points sequentially. With strengthening demand, A&D offers some of our highest margins and projected sustained growth. Our goal for A&D content is 65% or higher of our total business. A&D should continue to drive growth for ATI, and we project it will be greater than 60% of total sales by year-end. Within A&D, sequential jet engine sales increased 10%, and defense sales rose by 7%.

Strong trends we expect to continue. Turning to headline number two, margin performance. ATI's overall adjusted EBITDA margin increased to 14.3%. That's an increase of 150 basis points sequentially, driven by our HPMC segment. Overall, adjusted EBITDA increased by 13% from last quarter and 5% year-over-year. Let's take a closer look at HPMC's Q2 results. 2023 Q2 sales increased $56 million or 12% compared to the first quarter of 2023. Remember, A&D content makes up 83% of total Q2 HPMC sales. It's a key driver in the 33% year-over-year increase in HPMC revenues. Another positive in our HPMC performance was a reduction of our lingering cost inefficiencies from 2022 and Q1, 2023. As expected, that roughly $5 million headwind incurred in Q1 declined this quarter.

The improved mix and efficiencies are clearly visible in HPMC's adjusted EBITDA margins, which improved 350 basis points sequentially to 20.5%. Our 2025 targeted EBITDA margins for HPMC are in the low to mid-20% range. This puts us in line with those 2025 targets. Strength in HPMC offset flatness in our AA&S segment, where we saw a sequential sales decline. That was primarily due to softness in general industrial end markets and lingering economic impacts associated with our Asian precision rolled strip business. We're doing a lot of things well, and it shows in our results. One area that we know there's opportunity for improvement is managed working capital. It's an area of critical focus for ATI and our leadership team.

At the end of the second quarter, managed working capital was $1.6 billion or 39% of sales. This balance drops by 120 basis points when adjusted for a $50 million strategic raw material purchase we made in Q2. That purchase was funded with a draw on our ABL revolver. We expect that strategic inventory largely to be consumed and the ABL draw to be repaid by the end of the year. What else is driving higher working capital? I would point to three things: First, we've put inventory into position for the continuing A&D ramp. As Bob noted, our backlog has grown more than 20% year-to-date, including 9% growth in Q2. Second, our production rates are improving, which can create inventory spikes as we work to solve downstream bottlenecks and constraints.

Third, we have inventory associated with expanding titanium melt capacity ahead of ramping sales. The good news is, all of these drivers lead to higher sales, earnings, and cash generation. We focus on inventory for a purpose. Ramping ahead of new revenue is the best purpose I can think of for near-term inventory increases. We are focused on hitting our 30% managed working capital target by year-end, and we're confident we will deliver. We have equally sharp focus on efficient and strategic capital deployment. Our CapEx for the first half of 2023 was $103 million, which includes $38 million of carryover related to capital expenditures accrued at the end of 2022. Overall, we remain on track in 2023 with our disciplined capital investment plan.

We're holding our previous annual CapEx guidance of $200 million to $240 million. It's important to emphasize this guidance includes expenditures associated with our recently announced titanium melt expansion in Richland, Washington. We're managing the challenges of working capital in concert with prudent and focused capital expenditures. We are holding our annual range of free cash flow at $125 million to $175 million. Expanding on cash management, we generated $68 million of cash from operations in Q2. We ended the quarter with a total liquidity of approximately $770 million. This reflects $267 million in cash and $500 million available under our ABL facility. We remain committed to our balanced capital deployment strategy, which includes returning capital to shareholders.

In last quarter's call, we announced the next tranche of share repurchases with a $75 million buyback program. While we did not repurchase shares in Q2, we expect to complete the $75 million program by the end of the year. Our third area to highlight, it was a strong quarter for earnings per share. At $0.59 per share, adjusted EPS was at the high end of our guidance range and $0.03 above the midpoint of the range we provided. The higher performance reflects favorable price and mix tied to A&D growth. This was partially offset by slower industrial demand and moderately lower raw material metal prices. This positive performance builds on our results from the first quarter. This was our fourth consecutive quarter in which revenue exceeded $1 billion.

Our revenue of $1.05 billion represents a 9% increase year-over-year and reinforces the sustained strength and demand. We are confident in our position as a premier aerospace and defense supplier. Now, let's look forward to Q3 and full year guidance. For the third quarter, we expect adjusted EPS to be in the range of $0.51-$0.57. The midpoint of the range, $0.54, is below Q2, driven by planned facility outages in the third quarter. It also reflects our expectation that sales in our Asian precision rolled strip business will continue to be pressured due to China's economic conditions. We are also assuming the slowdown in industrial demand will continue in Q3. We are raising our full year EPS guidance to a range of $2.15-$2.35 per share.

You can use the full year and Q3 EPS guidance to get a sense of how we're thinking about Q4 performance. Assuming Q3 and full year EPS are at the midpoint of the respective ranges, then Q4 EPS would be in the range of $0.63 per share. That'd be a strong finish to a great year and would provide nice momentum as we move into 2024. What would drive an EPS increase in Q4? Continued robust A&D demand, contributions from the restart of the 34th Avenue facility in Albany, Oregon, and continued operational improvements. With that, I will turn the call back over to Bob.

Bob Wetherbee (Board Chair and CEO)

Thanks, Don. We've covered a lot this morning, and I can sum it up in one simple statement: We are confident. You look at markets recovering, demand accelerating, focused and disciplined execution, a stronger backlog than we've had in a long time, if ever. It's a great picture of where we are and a very positive trajectory going forward. We're converting near-term demand into long-term agreements. In June, we announced that we've secured over $1.2 billion in new commitments. That's an average of $200 million in new sales per year from 2024-2029. Of this, roughly 70% is incremental to our announced 2025 targets. Assume a targeted incremental EBITDA margin of 30%-35% on these sales, and the result is an estimated additional $40 million to $50 million of EBITDA per year above our previously announced targets.

The collective commitments encompass nickel and titanium materials for aero-engine and airframe applications and ground vehicle armor. They represent new share positions and support sustained future growth. To meet this rising demand, we continue to increase critical capacity to ensure we can meet the needs of our customers. It starts with getting more from existing assets. Our restarted Albany, Oregon, titanium melt shop is producing at the target levels in the 3rd quarter. That's a key component of delivering the 35% increase in capacity on our 2022 baseline. We're already producing ingots at that location. We'll see the positive financial impact from this capacity as the ingots get shipped as end products starting in Q4. A few quarterly calls ago, we announced even more expansion to deliver incremental titanium melt capacity. Last month, we named our existing operation in Richland, Washington, as the site of that build.

The expansion is well underway. As we shared previously, it will increase ATI's titanium production by an additional 35% over our 2022 baseline. This additional increase is projected to be online by the end of 2024. Additional product qualifications will occur in 2025. We expect revenue and profits to reach their full run rate in 2026. Added together, 35% increase from existing assets, including the Albany restart, +35% from the expansion in Richland. That's 70% more capacity to support $1.2 billion in confirmed commitments. To say the least, we're well positioned for a strong future. It's important to highlight that the expansion in Richland as capabilities in addition to capacity, will have the flexibility to produce both standard and premium quality to serve both airframe and aero-engine demand.

We gain speed and flexibility in the form of extraordinary chemistry control and the ability to input both recycled and prime materials. We continuously refine and advance the mix of capability and products we deliver for our customers to drive the most value for our shareholders. Our strategic transformation has reduced volatility in our quarterly results related to raw material pricing. It stabilizes the consistency of our quarter-over-quarter performance and fuels strategic growth and value creation. Wrapping it up, what are we confident about? Well, we're confident in our strategy, laser-focused on the strong A&D market. We're confident in our execution. The team is delivering to our customers to meet this ever-growing demand. We're getting stronger every day, unlocking opportunity and operational efficiencies across all of ATI. We're confident in our growth. In a disciplined way, we're adding capacity and capability.

That gives me confidence in our performance today and what we'll achieve long term. We're confident in the shareholder value we provide, doing what we say we will, with a clear path to go beyond. Last but not least, I'm confident in our team. We're working together across the enterprise, constantly pushing ourselves to higher levels of performance. Each new production record we set brings more ideas and drives us to strive for more. We've created a system that leverages collaboration and accelerates improvements. I'm honored to lead this team forward. Our success is a large part of why we were delighted to add the role of president to Kim Fields' responsibilities as Chief Operating Officer. The team is performing and optimizing our business. Now, it's great to take a minute to recognize the impact her leadership is having.

Our customers feel it, our shareholders are certainly seeing it, and our team is responding to it. Titles are first earned and not given, and often, well before they're given, they're earned. Thank you, Kim. We're in a great position to grow. It's one of the things that makes us proven to perform. Operator, we're ready for the first question.

Operator (participant)

Thank you. We'll now enter the Q&A session. If you'd like to ask a question, please press Star, followed by One on your telephone keypad. If you change your mind and would like to revoke your question, please press Star followed by Two. When preparing to ask your question, please ensure that your device is unmuted locally. Our first question comes from Richard Safran from Seaport Research Partners. Richard, the line is now open. Please go ahead.

Richard Safran (Managing Director - Aerospace and Defense)

Thanks. Bob, Don, Dave, good morning. How are you?

Bob Wetherbee (Board Chair and CEO)

Great. Good morning.

Richard Safran (Managing Director - Aerospace and Defense)

Oh, Don, I think this first one may be for you, and then, Bob, if it's okay, I got a quick follow-up. I'd like to get Don, I'd like to ask you if you could expand on those comments you were making at the Paris Air Show, the $1.2 billion in new contracts. I'm kind of wondering if this work is margin accretive and how we also should think about what that does to your 30% to 35% incremental margin comments that you've made? Thanks.

Don Newman (EVP and CFO)

Okay. Let me take a run at that. The short answer is yes, they should be accretive, and let me walk you through the math on that. What we've shared is $1.2 billion of sales commitments over a 6-year period. You spread that out, you expect about $200 million a year. Of that, you know, as we think about our 2025 targets, about 70% of that $200 million in annual revenue is incremental. As you think about the margins on that, Rich, think in terms of 30%-35% for that new business that we're picking up.

Of course, the math on that then indicates we're gonna have probably between $40 million and $50 million of incremental EBITDA that's gonna be generated from that new business. As you think about, well, how does that affect our existing EBITDA margins for targeted 2025, and then those 30%-35% incremental margins for the overall business? The short answer there, yep, this should be incremental.

The way to think about the incremental effect, and I know you're gonna do the math on it, but the math is gonna prove out that it's probably 30-40 basis points of enhancement to our incrementals, which we typically range at 30%-35%, and it would have a similar effect you would expect to the 18%-20% kind of EBITDA margin that we've targeted for 2025.

Richard Safran (Managing Director - Aerospace and Defense)

Okay, thanks for that. Bob, something you've done before, I'd like to ask you again about titanium trends. Specifically, could you talk a bit about share gains orders, where lead times are, and, if possible, pricing because of some of the comments you've made previously, I think about not taking on dilutive work. Any color you could provide on titanium trends would be helpful. Thanks.

Bob Wetherbee (Board Chair and CEO)

All right. Well, thanks, Rich. Certainly dominating our lives these days as we ramp up and increase our capacity and the bottleneck. Actually, because of the improvements we've been making, we've actually been able to, I call it, lower the bar in terms of what's accretive, right? We actually have more access to more accretive business going forward because of the improvements that we've made. Some of the historical paradigms have actually moved away from us, opening up a bigger access. To your point, let's use the $1.2 billion that we announced as kind of a baseline for share gains. I would say, the split of that is about 2/3 titanium and 1/3 nickel, roughly, the $1.2 billion.

The titanium is clearly a result of taking share based on the world's adjustments post-Ukrainian invasion by Russia, right? That's the lion's share of it. The other third in nickel is actually share we picked up through the quality and performance versus our customers, but you were asking more about the titanium side. Share gains, pretty aggressive. We are seeing benefits then in 2023, but we're not quantifying it. By 2024, we'll see a pretty big start there with the titanium share gains. In terms of lead times it's kind of reflective of our backlog, the 20% rise we've seen in the backlog.

I would say, we said a couple of quarters ago that if you knew anybody who was trying to order titanium in the long term, they should get their contracts in, and that's what we've seen, a heavy contract load. Like titanium bar orders are out, you know, Q4 2024. Titanium plate, probably depending on the customer and these commitments that we've picked up in titanium, Q3 2024, maybe even into 2025 for some products. If you wanted just some transactional business, maybe we have some opportunities in Q2 2024, but that's kind of where the market is. It's, it's extended and, you know, as we start up with 34th Avenue, Albany facility, we've got a few slots left in late 2023, but they're, they're starting to be pretty sparse.

I think from a lead time perspective, that helps on titanium, and then on a pricing side, you know, I think it's definitely been a seller's market. I think people are trying to get their supply secure and reliable. I do think we're getting value for the reliability and quality, but in terms of pricing, I would say, we're seeing, you know, appropriate increases for where we are in the states and the market. I think that was your list, but there's always, like, six questions in there, Rich, so hopefully, hopefully, I got them all.

Don Newman (EVP and CFO)

You, you did. I just like to go for efficiency. Thanks, Bob.

Bob Wetherbee (Board Chair and CEO)

All right, that's good. We do too. Thank you.

Operator (participant)

Thank you. Our next question comes from Seth Seifman from JPMorgan. Seth, your line is now open. Please go ahead.

Seth Seifman (Executive Director)

Hey, thanks very much, and good morning. For our first question, wanted to ask about HPMC and the strong margin we saw in the quarter and the degree to which, you know, mix may have played a role there. I saw the engine sales look like they picked up again sequentially. Are there particular products that you started to sell in the quarter that contributed to the profitability in Q2, and how does that factor in going forward, if it did, in fact, have any impact?

Bob Wetherbee (Board Chair and CEO)

That's a good question, Seth. Good morning. I think that from a mix perspective, I would say, you know, our comment about hitting our stride is, is probably the biggest issue. It probably had a slightly larger mix of ingot, billet, and bar, which are some of our great products. I think we're also seeing some of the isothermal forgings kinda picking up. I wouldn't say we've seen the start of the wide-body recovery per se, but, you know, those are the kind of products that end up, you know, heading towards the wide-body market. I would say, modest mix. I would say a lot of it is volume revenue and efficiencies that come with that, and, certainly the price with these contract upgrades have been positive. Yeah, I think those are probably the big ones.

Don, did you have any color you wanted to add on that one?

Don Newman (EVP and CFO)

Yeah, I think for context, Seth, you know, as you think about the $28 million increase in our sequential EBITDA and that nice expansion on the margin, as you, as you look at it, Bob's absolutely right. It was really all about volume, and it was price slash mix. If you want to get a sense as to which of those two really drove, you know, it's kind of probably, 2/3 price mix driven and about a third related to volume. Really nice overall contribution to that growth from demand, really.

Seth Seifman (Executive Director)

Great. Great, thank you. Then, maybe as a follow-up, just, looking at A&S and thinking about, some of the non-A&D demand headwinds, that the segment faces in the end markets. How do we think about where that is? Did you kind of end the quarter where things or where the demand signals were still kind of on the way down? How did you account for that in terms of the EBITDA that you expect from A&S for the rest of the year? Or are we looking at something that's a little bit more stable?

Bob Wetherbee (Board Chair and CEO)

Yes, good question. Something we are looking at all the time. We go back to really about 15% of the segment, give or take, mostly the industrial markets you're talking about. I would say we'll see a little bit more decline in Q3, stabilizing into Q4 before recovering in Q1. It's a transitory issue, I think, driven by 2 things, 3 things, perhaps. One is obviously the industrial markets, you know, appliances, some of the food and beverage type stuff that we supply into, and then some of the remnant automotive businesses we have. Those kinds of things, it's really the industrial markets being down. We also tend to see a lot of these products or some of these products going through the distribution channel.

If you're familiar with the distribution channel, when OEMs take a breath just to make sure the economy is going in the right place, the distribution channel tends to take 2 breaths and exacerbate some of that decline. We do see it solid, you know, through or stabilizing in the back half and then moving up in Q1 of next year. It's also we're seeing a little on the energy side. If you go back to May, when the oil prices dropped quickly, nickel prices followed. They've now recovered. When that happens, the EPCs or OEMs take a breath as well and say, "Well, let's just wait and see." You know, we expect those, those are kind of chunky program or project orders. They'll come back, you know, later in the year for probably H1 of 2024 shipments.

It's the generally industrial markets the chunkiness of energy with a little volatility there. The bottom line is the solid business that we have there, heavy and increasing Aerospace and Defense, certainly mid-to-high teens EBITDA by 2025 is definitely our target, and we see the runway to be there. I think we're just going through what everyone else is seeing. Even the reports you guys put out, we actually read them, and it looks like this is kind of different spots and different channels where the economics are floating around and giving people pause. I think it is stabilizing in Q4 and then come back in Q1.

Seth Seifman (Executive Director)

Cool. Excellent. That, that's helpful. Thanks very much.

Operator (participant)

Thank you. Our next question comes from David Strauss from Barclays. David, your line is now open. Please go ahead.

Josh Corn (Managing Director)

Hi, good morning. This is actually Josh Korn on for David. Wanted to ask how, how you're thinking about nickel pass-through and pension relative to the longer-term 2025 targets. Thanks.

Don Newman (EVP and CFO)

Sure, sure. What I would say is, as you think about those 2025 targets, we shape those targets assuming flat metal prices. That answers kind of the pass-through assumption that you're talking about. Right now, and we saw this in 2022 as well, we've seen some elevated metal prices, which have elevated pass-through and surcharges. When it comes to those 2025 targets, we're not assuming that those higher metal prices and that higher pass-through revenue are gonna continue to be with us. At the moment, a bit of a headwind to our margins, but we don't expect that that headwind is gonna continue to be with us, you know, out to 2025.

In terms of pension, the simplest way to think about it is that we saw overall about a $36 million increase in pension expense. This is non-cash, but a $36 million increase in pension expense in 2024. I've shared with you guys in the past, I do not expect that that additional expense is gonna be with us in the long term. It is not assumed to be in those 2025 targets. You know, that would indicate I don't expect it to be with us in out to 2025. That will help you as you're thinking about bridging from current performance to 2025 with the increased profitability as well as expanding margins. Does that answer your question?

Josh Corn (Managing Director)

Okay. Yes, thank you. Did the recent drop in nickel prices over the last couple of months negatively impact the results in AA&S at all in the quarter?

Don Newman (EVP and CFO)

Yes. The short answer is, is yes. There was a modest pullback on metal prices and the way our business is constructed and contracted. When metal prices go up, generally, that's a good guy for us. When metal prices go the other direction, it's generally a headwind for us. As you think about the AA&S business in terms of those headwinds, it was probably $2.5 million to EBITDA, something like that, $2 million to $3 million. Sorry to get super precise on that, but it's probably $2 million to $3 million of headwind in Q2 that we would expect would turn around.

We've already seen metal prices, actually recovering in early Q3, and so that should be a good guy for us, as we look out to the rest of the year.

Josh Corn (Managing Director)

Okay, thank you.

Operator (participant)

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

Gautam Khanna (Aerospace and Defense Equity Analyst)

Hi, good morning, guys.

Don Newman (EVP and CFO)

Good morning.

Gautam Khanna (Aerospace and Defense Equity Analyst)

Bob, based on your comments on the new business, you know, the $140-ish million annually, 2/3 of which is titanium. You got about $100 million of new titanium business. I was curious, does that pretty much exhaust all the opportunity of folks switching away from VSMPO, or do you think there's still a lot of headroom left to get, additional share? I'm just curious how your discussions are with largely concluded, or are they still going on?

Bob Wetherbee (Board Chair and CEO)

Yeah. Well, it's a never-ending process, for sure, but I gotta get you to put a new number on your pad. You gotta think about $200 million of new business, of which $140 million is incremental to what we said before, right? Just make sure. I got the same numbers. I think the other part of your question I think that those we're seeing orders against those commitments, is what I would say, which is what's driving our lead times out.

Are all the contract commitments done? I would say no. There's still a couple of big ones that are out there. They don't all expire at the same time, so probably, you know, the next renewal point is probably 2026, you know, orders and beyond. As the wide-body comes back, people are reassessing or assessing where they need to be for the long term. So there's a couple of those. It doesn't exhaust the opportunities. I think, you know, when we see opportunities to pick up for, I would call it lack of performance by other industry participants.

Don Newman (EVP and CFO)

I think that'll be a real concern of the OEMs on the airframe side and definitely on the engine side. I don't think it exhausts the opportunity. I think we're gonna have probably the best titanium capacity situation for the emerging opportunities that come. Not over-capacitized by any stretch, but we still see quite a bit of upside as the wide-body market continues to recover. I think there's probably some new product opportunities there as well. Lastly, we're always using the 80/20 kind of market optimization. Where we have opportunities, we clearly continue to prioritize. I think that's another upside for us in terms of how the mix can still be adjusted. Let's see. Did that answer your question, Don? Did I get them all?

Gautam Khanna (Aerospace and Defense Equity Analyst)

Yeah, I think you did. Just to be clear, so I understand it better, in terms of contract share opportunities, the emergent ones will be against competitors that aren't doing as well. In terms of, like, big opportunities to kind of reset share, is that 2026 for the next big ones? I just wanna make sure I understood that correctly.

Don Newman (EVP and CFO)

We've got the $1.2 billion. We'll start to see the benefit of that in 2024, right? Then the next ones, you were asking if it was exhausted, and I would say, no, it's not exhausted, but the next real opportunity for upscaling would be shipments in 2026, and that's just a matter of the timing of some of the customer schedules and where they sit in their renewal process. I do think there's opportunity.

Gautam Khanna (Aerospace and Defense Equity Analyst)

Very helpful. You guys talked about seasonality, Q3, seasonal maintenance. Could you articulate what the sequential EBIT impact is to HPMC from that? Just if you could reflect on Q1's HPMC performance relative to Q2, 'cause it looked like in Q1, the throughput wasn't as strong as it could have been. It was back-end loaded in the quarter. Did all of those issues kind of resolve, and therefore, we had a very clean Q2, or is there still opportunity that was on the table in Q2?

Don Newman (EVP and CFO)

This is Don, let me take a run at that. First of all, in terms of the, let me answer the second question first. In terms of the Q1 to Q2 performance for HPMC, you know, it was really about volume and price/mix, right? You know, some of the bottlenecks that we were seeing in the business were resolved in Q2 that released, you know, what had been some constraint in HPMC, when we got through Q2. Are there more opportunities for that? Yeah, we believe so, quite strongly, actually.

Part of that has to do with the work that's being done around our work management and capital flows, the inventory flows in the business, really improving that throughput, which will have a positive effect on sales and profitability, et cetera. In addition to that, Kim and the operating teams are doing a phenomenal job identifying operational efficiencies, and those are opportunities existing not just for HPMC, but also for the A&S business units. We can see over time that those would be additive to the performance in our business. To answer the question in terms of how to think about the seasonal outages that we talk about for Q3, not much of that is really related to HPMC. I wouldn't expect to see any significant pullback in terms of performance in HPMC in Q3.

That outage, the outages that are scheduled in Q3 in A&S, the way to think about dimensionalizing those, think in terms of probably $8 million to $10 million of effect to the performance. If you do the math on the EPS drop from Q2 to Q3, you'll see that the general direction of that increased spend being reflected in Q3 performance. There's some offset, you'll see it in the math when you run the numbers. You know, obviously, we're expecting the A&D performance to, especially in that HPMC side of the business, to continue to perform well, that helps to offset some of that outage cost.

Then, of course, as you saw in our Q4 indications, we're expecting a nice breakout quarter in Q4 based upon getting out of those outages, continued A&D strength, et cetera, et cetera.

Gautam Khanna (Aerospace and Defense Equity Analyst)

Excellent. Thank you so much.

Don Newman (EVP and CFO)

You bet.

Operator (participant)

Thank you. As a reminder, if you'd like to ask a question, please press star followed by 1 on your telephone keypad. Our next question comes from Timna Tanners from Wolfe Research. Timna, your line is now open.

Timna Tanners (Managing Director, Equity Research)

Thank you, good morning, everyone. I just had 2 questions remaining. I was looking at my past notes, and you had said that you expected that China hit, or the disappointment in China to be a first-half story with the stabilizing or improving in second half. Is this, is this a change to that? What's embedded in your guidance now? Is it just assuming kind of soft conditions continue in China, or anything you can clarify there would be great?

Don Newman (EVP and CFO)

If this lacks clarity, then please let me know, Timna. You're absolutely right. When we were entered into 2023, we saw slowness carried over related to that precision-rolled strip business, and our expectations were that that slowness would recover in the second half. We have not seen recovery in this precision rolled strip business. What we've assumed in the guidance is that the performance in Q2 off of that PRS business will continue through the second half of the year. If there is a recovery, obviously, that's an upside to our guidance.

Timna Tanners (Managing Director, Equity Research)

Okay. Helpful, thank you. A random question perhaps, but I know you used to be a big player in the Electrical steel market, and that's been really, really strong. I would just wondered if it would even be possible to return to producing much Electrical steel, whether it be non-grain or grain-oriented. My understanding is those margins have exploded over the last couple of years, and demand is expected to be strong. Just wondering if it's possible and if you would think about it. Thanks again.

Don Newman (EVP and CFO)

Yeah, fair question. I always like clear, concise answers like you do, Timna, which is. Nope, we're not getting back into that business. We made a decision back in 2015, 2016, based on the assets we had at the time, to devote our capital allocation strategy towards aerospace and defense, and that's what we're still doing. We do see opportunities, I would say, in the magnetic alloys, so alloy differentiation, where there's, we see, you know, very good product opportunities, and we see technology differentiating. In terms of the historical electrical steels or Grain-oriented electrical steel, it's a big, fat nope. We're done.

Timna Tanners (Managing Director, Equity Research)

Okay. Thank you.

Operator (participant)

Thank you. There are no further questions on the line, so I'll now hand back to David Weston for any closing remarks.

David Weston (VP of Investor Relations)

Thanks again for joining us today. This concludes today's ATI second quarter 2023 earnings call. A replay will be available on our website. Thank you. Have a good day.

Operator (participant)

This concludes today's conference call, everybody. Thank you very much for joining. You may now disconnect your line.