ATI Inc. (Allegheny Technologies Incorporated) — First-Quarter 2019 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2019, compared with the three months ended March 31, 2018. ATI manufactures advanced specialty materials and technically complex components, primarily through High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP). Aerospace and defense represented 52% of consolidated sales, and high-value products represented 87%.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Sales | $1,004.8 million | $979.0 million |
| Gross profit / margin | $131.1 million / 13.0% | $148.6 million / 15.2% |
| Operating income / margin | $63.1 million / 6.3% | $81.5 million / 8.3% |
| Income before taxes | $17.1 million | $65.5 million |
| Net income attributable to ATI | $15.0 million | $58.0 million |
| Diluted EPS | $0.12 | $0.42 |
| Cash used in operating activities | $(130.0) million | $(47.1) million |
| Capital expenditures | $23.5 million | $41.6 million |
| Cash and equivalents at period-end | $217.0 million | $109.9 million |
HPMC sales increased 7.2% to $601.2 million, while segment operating profit declined to $72.6 million from $85.5 million. FRP sales decreased 4% to $403.6 million, and segment results shifted to a $10.9 million operating loss from $10.9 million of operating profit. Consolidated segment operating profit was $61.7 million, or 6.1% of sales, versus $96.4 million, or 9.8%, in the prior-year quarter.
Total debt was $1,552.3 million excluding debt issuance costs, compared with $1,552.5 million at December 31, 2018. Net debt was $1,335.3 million. Debt to trailing-twelve-month EBITDA increased to 3.41 from 3.07 at year-end 2018. The company had no borrowings under the revolving ABL facility, approximately $360 million of additional ABL liquidity, and $35.3 million of letters of credit outstanding.
Material changes versus the prior comparable period
- Sales increased 2.6%, led by aerospace and defense growth of 14% to $525.6 million and HPMC growth; FRP sales declined because of weaker commodity stainless demand and lower oil and gas sales.
- Profitability deteriorated materially. Gross profit declined $17.5 million, while income before taxes fell $48.4 million and ATI-attributable net income fell $43.0 million.
- HPMC was affected by third-party nickel-powder billet supply disruptions, qualification and ramp-up costs for internal nickel-powder production, cobalt-price-related margin compression, and elevated energy costs.
- FRP was affected by weaker Chinese demand and higher costs at the STAL joint venture, U.S. customer inventory destocking, finishing-operations inefficiencies, and a $3.3 million loss from the A&T Stainless joint venture.
- Retirement benefit expense increased to $18.3 million from $8.3 million. Corporate expenses increased to $16.6 million from $13.2 million.
- Q1 2018 included a nonrecurring $15.9 million pretax gain from the deconsolidation of A&T Stainless; no comparable gain was recorded in Q1 2019.
- Operating cash use increased to $130.0 million, primarily due to a $121.0 million increase in managed working capital, a $25.1 million pension contribution, and annual incentive compensation payments. Managed working capital rose to 35.6% of annualized sales from 31.6% at year-end.
Outlook, commentary, risks and unusual items
Management characterized the HPMC and FRP operational issues as short-term headwinds that were not expected to significantly affect future periods. Management expected FRP oil and gas sales to improve as production begins for a $45 million Latin American pipeline project. No formal consolidated earnings or revenue guidance was provided in the filing.
Management expected approximately $145 million of U.S. qualified pension contributions in each of fiscal 2019 and 2020, including $25 million contributed in the first quarter, and approximately $100 million of average annual contributions in subsequent years. Management stated that cash on hand, internally generated funds and ABL availability were expected to satisfy liquidity needs.
A&T Stainless will remain subject to a 25% tariff on imported semi-finished stainless slab from Indonesia after its tariff-exclusion request was denied on April 24, 2019. Environmental remediation reserves were approximately $20 million, with possible additional costs of up to $15 million above recorded reserves based on currently available information. The company also faces litigation from US Magnesium concerning a supply agreement; the case was in early discovery and the outcome could not be predicted.
Other key risks include aerospace cyclicality, production-rate changes including the announced temporary Boeing 737 Max slowdown, raw-material price and availability volatility, energy costs, pension funding requirements, labor disruptions, equipment outages, international trade policy and tariffs, and customer demand weakness. The company adopted ASC 842 lease accounting on January 1, 2019, recognizing $51.7 million of operating lease right-of-use assets and $55.6 million of lease liabilities without a material effect on earnings or cash flow.
Important facts for investors to verify
- Whether nickel-powder supply constraints, cobalt-price timing effects and related HPMC costs normalize as management expects.
- Whether FRP demand, STAL profitability and U.S. finishing efficiency recover, particularly after the A&T Stainless tariff decision.
- Ability to fund approximately $145 million of pension contributions in each of 2019 and 2020 while reducing working capital and preserving liquidity.
- Refinancing or repayment plans for the $500 million of 5.95% senior notes due 2021 and compliance with the ABL liquidity requirement beginning before that maturity.
- Progress toward converting the $2.59 billion backlog into revenue; approximately 80% was expected to be fulfilled within 12 months, but backlog excludes variable consideration.
- Potential exposure from environmental matters and the US Magnesium litigation, for which ultimate costs or outcomes remain uncertain.