Business Context and Reporting Period
Allegheny Technologies Incorporated (ATI) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2014. ATI is a specialty materials and components producer operating through High Performance Materials & Components and Flat Rolled Products. The filing renamed the former High Performance Metals segment without changing its composition or reporting structure.
Key Financial Metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Sales | $1,119.0 million | $1,056.8 million | $2,106.3 million | $2,155.8 million |
| Income before interest, other income and taxes | $23.8 million | $20.6 million | $26.3 million | $48.7 million |
| Income (loss) from continuing operations attributable to ATI | $(3.8) million | $3.7 million | $(21.9) million | $13.4 million |
| Net income (loss) attributable to ATI | $(4.0) million | $4.4 million | $(24.0) million | $14.4 million |
| Diluted EPS | $(0.03) | $0.04 | $(0.22) | $0.13 |
| Segment operating profit | $65.2 million | $70.2 million | $108.7 million | $147.7 million |
| Segment operating margin | 5.8% | 6.6% | 5.2% | 6.9% |
- Q2 sales increased approximately 6% year over year; first-half sales decreased approximately 2%.
- High Performance Materials & Components generated Q2 operating profit of $85.1 million, or 16.6% of sales, versus $69.0 million, or 13.7%, in the prior-year quarter.
- Flat Rolled Products reported a Q2 operating loss of $19.9 million, or 3.3% of sales, compared with $1.2 million of operating profit in Q2 2013. First-half operating loss was $45.5 million versus $3.7 million of profit in the prior-year period.
- Six-month operating cash flow was an outflow of $37.5 million versus $58.0 million of cash provided in the prior-year period.
- Cash used in investing activities was $188.3 million, including $97.9 million of capital expenditures and $92.5 million for acquisitions.
- Cash used in financing activities was $445.9 million, primarily reflecting $403.4 million of debt repayments and $38.6 million of dividends.
- Cash and cash equivalents were $355.1 million at June 30, 2014, compared with $1,026.8 million at December 31, 2013.
- Total debt was $1,538.1 million, down from $1,947.3 million at year-end 2013. Net debt to ATI total capital increased to 29.1% from 24.1% because cash declined more than debt.
- The company paid its remaining $397.5 million of convertible notes on June 2, 2014; $5.0 million was converted into 120,476 shares before maturity.
- The company declared dividends of $0.18 per common share in the quarter.
Material Changes Versus the Prior Comparable Period
- Profitability deteriorated despite higher Q2 revenue, primarily because of higher inventory costs, strategic project costs, lower selling prices and lower raw-material surcharges.
- Q2 2014 included approximately $28.9 million of LIFO inventory valuation reserve charges, largely offset by a $26.0 million reversal of net realizable value reserves. Q2 2013 included a $24.4 million LIFO benefit.
- First-half results included $37.9 million of LIFO charges, a $35.0 million reversal of net realizable value reserves and $13.1 million of industrial titanium inventory valuation charges.
- HRPF start-up costs were $4.0 million in Q2 and $6.3 million for the first half. Rowley titanium sponge qualification costs were $11.4 million in Q2 and $26.2 million for the first half.
- Net interest expense increased to $28.5 million in Q2 and $57.6 million for the first half, versus $13.9 million and $28.3 million, respectively, primarily because of reduced capitalized interest and higher debt levels.
- Retirement benefit expense decreased to $24.1 million in Q2 and $48.0 million for the first half, from $32.5 million and $65.0 million, respectively, primarily due to a higher discount rate.
- ATI acquired 85% of Dynamic Flowform for $72.9 million and acquired Hanard Machine for $20.2 million. Both businesses were added to High Performance Materials & Components.
- Discontinued operations, including the planned closure of the iron castings business, produced a $0.2 million Q2 loss and a $2.1 million first-half loss, compared with profits in the prior-year periods.
Guidance, Outlook, Risks and Unusual Items
- Management expected improving end-market conditions and improved third-quarter operating results before start-up, qualification and inventory valuation items.
- Third-quarter HRPF start-up costs were expected to be approximately $12 million, compared with $4.0 million in Q2. Full-year 2014 HRPF start-up costs were expected at $30 million to $35 million.
- Approximately $6 million of Rowley qualification costs was expected in Q3. Management stated that the qualification process remained on schedule but expected Rowley-related costs and higher raw-material costs to adversely affect results throughout 2014.
- Based on forecasted raw-material costs, management expected approximately $19 million of LIFO inventory valuation charges in each of Q3 and Q4, without offsetting net realizable value benefits.
- 2014 capital expenditures were expected to be approximately $300 million. The $1.2 billion HRPF project remained on schedule and budget, with hot commissioning expected to finish in Q4 2014 and benefits expected to begin in 2015.
- ATI stated that cash on hand, internally generated funds and available credit were expected to meet foreseeable liquidity needs, including HRPF completion. The company had no borrowings under its $400 million domestic credit facility, although approximately $5 million supported letters of credit.
- At June 30, 2014, ATI was in compliance with its credit covenants; leverage was 2.06 versus a maximum of 4.0, and interest coverage was 4.61 versus a minimum of 2.0. The facility’s leverage limits tighten beginning in 2015.
- Environmental remediation reserves were approximately $16 million, with reasonably possible additional costs of up to $11 million for recorded matters. The company noted that future environmental developments could materially affect results.
- Other key risks include raw-material and energy price volatility, aerospace and industrial demand, pension funding and asset performance, project execution, litigation, labor negotiations and cybersecurity. Approximately 2,400 employees were covered by collective bargaining agreements expiring June 30, 2015.
- The company’s disclosure controls and procedures were evaluated as effective, with no reported material change in internal control over financial reporting.
Most Important Facts to Verify
- Whether HRPF commissioning remains on schedule and within the $1.2 billion project budget, and whether expected 2015 operating benefits materialize.
- The actual timing and cost of Rowley titanium sponge qualification and the effect of using higher-cost ATI-produced sponge.
- Whether projected LIFO charges of approximately $19 million in each of Q3 and Q4 occur and whether further inventory write-downs are required.
- Cash generation and working-capital requirements, particularly inventory and receivables, given the first-half operating cash outflow.
- Compliance with increasingly restrictive credit-facility leverage covenants and the renewal or replacement of the STAL joint-venture credit facility.
- Progress in winding down the iron castings business and the related estimated $1.7 million of cash exit costs.
- Environmental, litigation, labor and cybersecurity exposures that could create costs beyond recorded reserves.