ATI Inc. 2018 Third-Quarter Form 10-Q Summary
Business Context and Reporting Period
Allegheny Technologies Incorporated, now ATI Inc., is a global manufacturer of specialty materials and complex components serving aerospace and defense, oil and gas, automotive, electrical energy, medical, and other markets. The filing covers the quarter and nine months ended September 30, 2018. ATI operates through High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP).
Aerospace and defense represented 49% of third-quarter sales and 48% of nine-month sales. High-value products represented 84% of total sales in both periods.
Financial Performance and Key Metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Sales | $1,020.2 million | $869.1 million | $3,008.7 million | $2,615.2 million |
| Gross profit | $160.4 million | $105.3 million | $482.7 million | $354.4 million |
| Gross margin | 15.7% | 12.1% | 16.0% | 13.5% |
| Operating income (loss) | $94.9 million | $(73.7) million | $287.4 million | $52.5 million |
| Income (loss) before taxes | $62.5 million | $(121.3) million | $208.5 million | $(86.9) million |
| Net income (loss) attributable to ATI | $50.5 million | $(121.2) million | $181.3 million | $(93.6) million |
| Diluted EPS | $0.37 | $(1.12) | $1.31 | $(0.87) |
Third-quarter operating margin was approximately 9.3% and net margin was approximately 5.0%. Nine-month operating margin was approximately 9.6% and net margin was approximately 6.0%.
- HPMC third-quarter sales increased 14.2% to $585.5 million, with segment operating profit of $76.0 million, or 13.0% of sales, compared with $61.7 million, or 12.0%, in the prior-year quarter.
- FRP third-quarter sales increased 22.1% to $434.7 million. Segment operating profit improved to $29.5 million, or 6.8% of sales, from a $7.3 million operating loss in the prior-year quarter.
- Nine-month segment operating profit was $325.9 million, or 10.8% of sales, compared with $195.2 million, or 7.5%, in 2017.
- Net interest expense declined to $24.8 million in the quarter and $75.8 million for nine months, primarily because ATI redeemed its 9.375% senior notes in the fourth quarter of 2017.
Cash Flow, Balance Sheet, Debt, and Liquidity
- Cash provided by operating activities was $116.6 million for the first nine months of 2018, compared with cash used of $53.8 million in the prior-year period.
- Capital expenditures were $101.3 million, and cash used in investing activities was $109.1 million, including the $10.0 million Addaero acquisition.
- Cash and cash equivalents were $153.5 million at September 30, 2018, up from $141.6 million at December 31, 2017.
- Total debt, excluding debt issuance costs for management's capital calculations, was $1,563.0 million; net debt was $1,409.5 million.
- Net debt to ATI total capital improved to 41.6% from 44.8% at year-end 2017. Total debt to total capital improved to 44.1% from 47.2%.
- There were no borrowings under the revolving portion of the $400 million ABL facility; $35.1 million was used for letters of credit. Management reported approximately $360 million of additional ABL liquidity.
- ATI was in compliance with its fixed-charge coverage covenant at September 30, 2018. The ABL facility also requires at least $700 million of specified liquidity beginning 91 days before the January 2021 senior-notes maturity and thereafter until repayment or refinancing.
- Managed working capital increased $99.4 million from year-end to $1,485.0 million, reflecting higher receivables, contract assets, and inventory, partially offset by contract liabilities.
Material Changes Versus the Prior Comparable Period
- Sales increased 17.4% in the third quarter and 15.0% for the first nine months, driven by stronger aerospace demand, higher high-value product sales, improved FRP utilization, and higher pricing and surcharges.
- Profitability improved substantially. The comparable 2017 quarter included a $114.4 million noncash goodwill impairment charge related to ATI Cast Products; no comparable impairment was recorded in 2018.
- FRP returned to profitability in the third quarter, benefiting from stronger demand, improved asset utilization, and better matching of raw-material surcharges with input costs.
- ATI recognized a $15.9 million pretax gain in the first quarter from forming and deconsolidating the A&T Stainless joint venture with Tsingshan. ATI retained a 50% interest and now accounts for the venture under the equity method.
- ATI adopted ASC 606 revenue recognition on January 1, 2018 using the modified retrospective method, increasing opening retained earnings by $15.5 million. The adoption created contract assets and liabilities and changed the timing of revenue recognition for certain HPMC contracts.
- Retirement benefit presentation was changed retrospectively, moving non-service components to nonoperating retirement benefit expense. The change affected operating income presentation but did not affect pretax or net income.
- ATI acquired Addaero Manufacturing for $10.0 million in July 2018, adding additive-manufacturing capabilities to HPMC. The purchase allocation included $2.0 million of technology intangible assets and $6.0 million of tax-deductible goodwill.
Guidance, Outlook, Commentary, and Risks
- Management reiterated full-year 2018 segment operating-margin improvement of approximately 300 basis points versus 2017 for HPMC and 150 to 300 basis points for FRP.
- HPMC expected continued fourth-quarter revenue and operating-profit growth from aerospace demand, higher jet-engine build rates, and improved asset utilization.
- FRP expected weaker fourth-quarter results because declines in certain raw-material prices could create a short-term mismatch with surcharge-based pricing. Management nevertheless expected U.S. operations to remain profitable.
- Management expected strong fourth-quarter cash generation and zero borrowings under the ABL revolving facility at year-end.
- Raw-material volatility remains significant. ATI estimated that a $1.00 per pound change in nickel prices could affect annual costs by approximately $100 million, while a $1.00 per MMBtu change in natural-gas prices could affect annual costs by approximately $8 million to $10 million.
- The A&T Stainless joint venture remained exposed to a 25% Section 232 tariff on imported Indonesian stainless slabs. ATI had requested an exclusion, but no assurance of approval was provided; third-quarter results were negatively affected by the tariffs.
- Pension funding was approximately $40 million for 2018, with $15 million contributed through September 30. Management expected average annual funding requirements of approximately $100 million for the next several fiscal years, subject to asset values, discount rates, and other assumptions.
- Environmental remediation reserves were approximately $15 million, and reasonably possible costs could exceed recorded reserves by as much as $16 million. The company cautioned that future environmental, litigation, product-liability, labor, trade, supply, and equipment risks could materially affect results.
- The company continued to maintain valuation allowances on U.S. federal and state deferred tax assets because of a three-year cumulative loss condition. Accounting for the Tax Act transition tax remained provisional; the remaining estimated liability was $5.9 million, payable over eight years.
Important Facts for Investors to Verify
- Whether aerospace demand and next-generation jet-engine programs continue to support HPMC growth and margins.
- Whether FRP's surcharge mechanisms offset raw-material volatility and whether the expected fourth-quarter margin pressure materializes.
- The status and economic impact of the A&T Stainless Section 232 tariff-exclusion request.
- Progress toward year-end zero revolving ABL borrowings and compliance with future liquidity requirements tied to the 2021 notes.
- Actual pension contributions, asset performance, discount-rate changes, and the projected approximately $100 million annual funding burden.
- Final accounting for the Tax Act transition tax and the realizability of deferred tax assets and tax attributes.
- Working-capital conversion, inventory growth, LIFO expense, and the remaining $6.2 million NRV inventory reserve.
- Potential environmental remediation, litigation, product-liability, labor, trade-policy, and equipment-outage exposures not fully quantified in the filing.