ATI Inc. (formerly Allegheny Technologies Incorporated) — 2Q 2019 Form 10-Q Summary
Business Context and Reporting Period
Quarterly report for the three and six months ended June 30, 2019. ATI manufactures specialty materials and complex components, primarily serving aerospace and defense, oil and gas, energy, medical, and automotive markets. Operations are organized into High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP). Aerospace and defense represented 53% of consolidated sales in both the quarter and year-to-date period.
Key Financial Metrics
| Metric | Q2 2019 | Q2 2018 | Six Months 2019 | Six Months 2018 |
|---|---|---|---|---|
| Sales | $1,080.4 million | $1,009.5 million | $2,085.2 million | $1,988.5 million |
| Gross profit | $177.7 million | $173.7 million | $308.8 million | $322.3 million |
| Gross margin | 16.4% | 17.2% | 14.8% | 16.2% |
| Operating income | $110.0 million | $111.0 million | $173.1 million | $192.5 million |
| Income before taxes | $84.3 million | $80.5 million | $101.4 million | $146.0 million |
| Net income attributable to ATI | $75.1 million | $72.8 million | $90.1 million | $130.8 million |
| Diluted EPS | $0.54 | $0.52 | $0.66 | $0.94 |
| Segment operating profit | $114.5 million | $124.0 million | $176.2 million | $220.4 million |
Second-quarter sales increased 7.0%, while income before taxes increased 4.7% and diluted EPS increased 3.8%. Six-month sales increased 4.9%, but income before taxes declined 30.5% and diluted EPS declined 29.8%. Segment operating margin was 10.6% in the quarter versus 12.3% in the prior year, and 8.5% year-to-date versus 11.1%.
- HPMC second-quarter sales rose 8.5% to $642.4 million; operating profit increased to $98.9 million from $97.9 million, but margin declined to 15.4% from 16.5%.
- FRP second-quarter sales rose 5.0% to $438.0 million; operating profit declined to $15.6 million from $26.1 million, with margin falling to 3.6% from 6.3%.
- HPMC aerospace and defense sales increased 17% in the quarter, including 40% growth in commercial airframes and 32% growth in government aerospace and defense.
- High-value products represented 88% of quarterly sales and 87% of year-to-date sales, compared with 85% in both comparable 2018 periods.
Cash Flow, Liquidity, Debt and Balance Sheet
- Operating cash flow was negative $104.4 million for the first six months of 2019, compared with positive $35.0 million in 2018. The outflow primarily reflected $158.8 million of higher managed working capital, $53.0 million of pension contributions, incentive compensation payments, and $36 million of advances to A&T Stainless.
- Investing cash flow was positive $11.4 million, including $62.8 million of proceeds from non-core asset sales and property disposals. Capital expenditures were $51.3 million.
- Cash declined to $281.2 million at June 30, 2019 from $382.0 million at December 31, 2018.
- Total debt, excluding debt issuance costs for management leverage measures, was $1,557.6 million. Debt to EBITDA increased to 3.39x from 3.07x at year-end 2018; net debt was $1,276.4 million.
- The company had no borrowings under the revolving portion of its $400 million ABL facility, approximately $360 million of additional ABL liquidity, and $35.3 million of letter-of-credit usage. ATI was in compliance with its fixed-charge coverage covenant.
- The ABL facility requires at least $700 million of liquidity beginning 91 days before the January 2021 maturity of the 5.95% senior notes and thereafter until those notes are paid or refinanced.
- Managed working capital increased to $1,470.3 million, or 34.0% of annualized sales, from $1,311.5 million, or 31.6%, at December 31, 2018.
Material Changes Versus the Prior Comparable Period
- Revenue growth was led by aerospace and defense and increased sales of high-value products, but profitability was pressured by raw-material price declines, manufacturing-cycle timing, nickel powder billet shortages, higher retirement costs, and operating costs.
- Six-month gross profit decreased $13.5 million despite higher sales. Retirement benefit expense increased $17 million year over year.
- FRP profitability weakened because of lower commodity stainless demand, higher retirement expense, and a $4.0 million second-quarter loss from ATI’s share of A&T Stainless, compared with $1.1 million of income in the prior-year quarter.
- 2018 benefited from a $15.9 million gain on the deconsolidation of A&T Stainless; no comparable gain was recorded in 2019.
- Corporate expenses increased to $18.0 million in the quarter from $12.9 million, primarily due to company-owned life insurance and non-core transaction costs.
Guidance, Outlook, Risks and Unusual Items
- Management expected approximately $145 million of U.S. qualified pension contributions in each of 2019 and 2020; $53 million had been contributed in the first six months of 2019. Longer-term annual funding was expected to average approximately $100 million, subject to asset values and discount rates.
- Management expected to exit the three-year cumulative U.S. loss condition at year-end 2019 and potentially recognize a fourth-quarter income tax benefit of approximately $25 million to $35 million from releasing valuation allowances. This benefit was not included in the 2019 effective tax rate and remained subject to analysis.
- ATI completed the sale of two non-core forging facilities for net cash proceeds of $33.4 million and recorded a $7.7 million pretax loss. It also recorded a $29.3 million gain on the sale of a portion of its New Mexico oil and gas rights.
- After quarter-end, ATI completed the sale of its Cast Products business for net proceeds of $123 million and expected a pretax gain of $7 million to $10 million, subject to final adjustments. ATI also expected an approximately $62 million pretax gain from selling the remaining New Mexico oil and gas rights.
- The 25% Section 232 tariff continued to pressure A&T Stainless after its tariff-exclusion request was denied. ATI had provided $43.8 million of working-capital advances to the joint venture; no impairment was recorded at June 30, 2019.
- Environmental remediation reserves were approximately $19 million, with reasonably possible costs exceeding recorded reserves by as much as $15 million. The company also disclosed ongoing litigation involving US Magnesium and ATI Titanium; outcomes could not be predicted.
- Key operating risks include commercial aerospace cyclicality, the Boeing 737 MAX production slowdown, raw-material price and availability volatility, international tariffs and trade policy, pension funding requirements, equipment outages, labor disruptions, and potential impairment of retained Salem assets following the Cast Products sale.
Important Facts for Investors to Verify
- Whether aerospace growth and backlog conversion offset margin pressure from nickel billet availability, raw-material pricing, and production costs.
- The timing and final amounts of the expected third-quarter gains from the Cast Products and New Mexico oil-and-gas-rights sales.
- Progress toward refinancing or repaying the $500 million of senior notes due in 2021 and compliance with the $700 million liquidity requirement.
- Actual pension contributions, discount-rate changes, and any related effect on cash flow or liabilities.
- The sustainability of A&T Stainless and the potential impact of continued Section 232 tariffs on ATI’s working-capital advances and equity-method investment.
- Whether the projected $25 million to $35 million tax benefit is realized and how changes in valuation allowances affect future tax rates.