ATI Inc. 2016 Form 10-K Summary
Business context and reporting period
Allegheny Technologies Incorporated (ATI) is a global manufacturer of specialty materials and complex components, serving primarily aerospace and defense, oil and gas, electrical energy, medical, automotive and industrial markets. The filing covers the fiscal year ended December 31, 2016, with comparisons to 2015 and 2014.
ATI operates through High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP). Aerospace and defense represented 51% of 2016 sales, while HPMC generated 62% of external sales and FRP generated 38%.
Key financial metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Sales | $3,134.6 million | $3,719.6 million | Down 16% |
| Gross profit | $162.5 million | $60.3 million | Up 170% |
| Segment operating profit (loss) | $5.7 million | $(84.8) million | Improved $90.5 million |
| Operating income (loss) | $(612.4) million | $(369.4) million | Worsened |
| Loss attributable to ATI | $(640.9) million | $(377.9) million | Worsened |
| Diluted loss per share | $(5.97) | $(3.53) | Worsened |
| Cash flow from operations | $(43.7) million | $131.4 million | Declined |
| Capital expenditures | $202.2 million | $144.5 million | Increased |
| Cash and equivalents | $229.6 million | $149.8 million | Increased |
| Total debt | $1,877.0 million reported balance-sheet debt; $1,894.1 million excluding debt issuance costs | $1,495.7 million reported balance-sheet debt | Increased materially |
Gross margin improved to approximately 5.2% of sales from approximately 1.6% in 2015. The improvement reflected the exit from unprofitable grain-oriented electrical steel and reduced commodity stainless steel volume, despite substantially lower revenue.
HPMC sales were $1,930.4 million, down 3%, while segment operating profit increased 7% to $168.7 million, or 8.7% of sales. FRP sales fell 31% to $1,204.2 million, while its operating loss improved to $163.0 million from $241.9 million.
Material changes versus the prior comparable period
- ATI recorded $538.5 million of pre-tax restructuring and other charges in 2016, including $471.3 million of long-lived asset impairments. The largest item was a $470.8 million impairment related to the indefinite idling of the Rowley, Utah titanium sponge facility.
- ATI permanently closed the Midland, Pennsylvania commodity stainless steel facility and the Bagdad, Pennsylvania grain-oriented electrical steel facility, and eliminated more than 250 FRP salaried positions.
- A seven-month work stoppage ended in March 2016. Related work stoppage and return-to-work costs were approximately $49 million, primarily in FRP.
- Aerospace and defense sales increased 5% overall, including a 16% increase in HPMC commercial jet-engine sales. Oil and gas sales declined 48% company-wide, reflecting weak demand and low oil prices.
- The company issued $287.5 million of 4.75% convertible senior notes due 2022 and added a $100 million term loan. A portion of the convertible-note proceeds funded a $115 million pension contribution.
- Net debt to ATI capital increased to 55.1% from 39.4%, and total debt to ATI capital increased to 58.3% from 42.0%.
- The quarterly dividend was reduced to $0.08 per share for the first three quarters of 2016 and suspended beginning with the fourth quarter.
Liquidity, debt and cash flow
Cash used in operations was $43.7 million, including the $115 million pension contribution. Cash used in investing activities was $200.0 million, primarily for capital expenditures. Financing activities provided $323.5 million, primarily from the term loan and convertible notes.
At December 31, 2016, ATI reported $229.6 million of cash and approximately $310 million of available borrowing capacity under its asset-based lending facility. However, ATI did not meet the facility’s fixed-charge coverage ratio at year-end and therefore could not access approximately $62.5 million of the facility until the required ratio is met. The $100 million term loan matures November 13, 2017, and $350 million of senior notes mature in 2019.
The U.S. qualified defined benefit pension plan was approximately 70% funded. ATI expects a $135 million cash contribution in 2017 and approximately $135 million of average annual contributions for the next several years, subject to actuarial and investment-performance changes.
Guidance, outlook, risks and unusual items
- Management expects 2017 HPMC sales growth of approximately 10% and operating margin in the low teens, supported by commercial aerospace demand, long-term agreements and titanium restructuring benefits.
- Management expects FRP sequential sales growth during the first two quarters of 2017 and a low-single-digit operating margin, but remains cautious about the second half of the year because of excess capacity and difficult market conditions.
- 2017 capital expenditures are expected to be approximately $125 million, including approximately $40 million for the STAL joint venture. Capital expenditures are expected to average no more than $100 million annually after 2017.
- Management expects no U.S. federal cash taxes in 2017 because of net operating loss carryforwards.
- Significant risks include cyclical aerospace and industrial demand, global stainless-steel overcapacity, raw-material and energy price volatility, dependence on foreign suppliers, high leverage, pension funding requirements, environmental liabilities, labor negotiations, litigation, export and trade restrictions, and potential goodwill or long-lived-asset impairments.
- Environmental reserves totaled approximately $16 million, with reasonably possible additional exposure of up to $17 million for active matters. Litigation outcomes cannot be predicted and could materially affect results in a particular period.
- ATI reported a material weakness in internal control over financial reporting related to the calculation and review of deferred tax asset valuation allowances. Management and the auditors concluded that internal controls were not effective at December 31, 2016; the financial statements received an unqualified audit opinion, but the internal-control opinion was adverse.
- Deferred tax asset valuation allowances increased by $171.5 million in 2016, and the year-end valuation allowance totaled $322.2 million, reflecting the company’s cumulative U.S. loss position.
Most important facts for investors to verify
- Whether HPMC aerospace growth and expected low-teens margins materialize in 2017.
- Whether FRP reaches profitability and whether additional restructuring or impairment charges are required.
- ATI’s ability to refinance or repay the $100 million 2017 term loan and 2019 senior notes while meeting ABL liquidity requirements.
- The timing and amount of required pension contributions and the plan’s funded status.
- Progress in remediating the material weakness over deferred tax asset valuation allowances.
- Whether cash generation improves sufficiently to fund capital expenditures, restructuring payments and pension obligations without additional borrowing.
- The effect of aerospace production rates, oil and gas demand, stainless-steel pricing, raw-material costs and trade duties on revenue and margins.