ATI Inc. (Allegheny Technologies Incorporated) — Third-Quarter 2012 Form 10-Q
Business Context and Reporting Period
Filed November 2, 2012, for the quarter and nine months ended September 30, 2012. ATI is a diversified specialty-metals producer serving aerospace and defense, oil and gas, chemical processing, electrical energy, medical, automotive, construction and mining markets. The filing presents unaudited interim results compared with the corresponding 2011 periods.
Key Financial Metrics
| Metric | Three Months Ended September 30 | Nine Months Ended September 30 |
|---|---|---|
| Sales | $1,220.5 million vs. $1,352.6 million | $3,930.4 million vs. $3,931.6 million |
| Income before income taxes | $54.1 million vs. $95.4 million | $227.9 million vs. $289.5 million |
| Net income attributable to ATI | $35.3 million vs. $62.3 million | $147.9 million vs. $182.6 million |
| Diluted EPS | $0.32 vs. $0.56 | $1.32 vs. $1.68 |
| Segment operating profit | $119.5 million vs. $161.8 million | $442.6 million vs. $497.6 million |
| Segment operating margin | 9.8% vs. 12.0% | 11.3% vs. 12.7% |
| Income before-tax margin | 4.4% vs. 7.1% | 5.8% vs. 7.4% |
| Income tax rate | 31.1% vs. 32.7% | 32.3% vs. 34.7% |
For the nine months, cash provided by operating activities was $245.8 million, compared with $107.5 million in 2011. Capital expenditures were $245.6 million, versus $168.8 million, and investing cash use was $244.1 million, versus $515.0 million, primarily reflecting the absence of 2011 acquisition spending. Financing activities used $101.3 million, including $57.3 million of dividends.
Cash and cash equivalents were $281.0 million at September 30, 2012, down from $380.6 million at December 31, 2011. Total debt was $1,479.3 million, down from $1,509.3 million. Net debt was $1,198.3 million, and net debt to ATI total capitalization was 31.2%. The company had no borrowings under its $400 million domestic credit facility, although approximately $4 million supported letters of credit. An additional letters-of-credit facility had $32 million outstanding.
Working capital increased to $1.9 billion, or 39.1% of annualized sales, from 37.8% at year-end 2011. Inventory was $1,460.2 million, up from $1,384.3 million, while accounts payable declined to $409.3 million from $490.7 million.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales declined 10%, while nine-month sales were essentially unchanged.
- Third-quarter net income attributable to ATI fell 43% and diluted EPS declined 43%. Nine-month net income declined 19% and diluted EPS declined 21%.
- Flat-Rolled Products was the principal weakness: third-quarter sales declined 19% and operating profit declined 55% to $26.2 million; nine-month sales declined 13% and operating profit declined 40% to $117.5 million.
- High Performance Metals third-quarter sales increased 1%, but operating profit declined 12% to $84.5 million. Nine-month sales increased 18% and operating profit increased 6% to $290.8 million, partly reflecting the ATI Ladish acquisition and stronger aerospace and oil-and-gas demand.
- Engineered Products third-quarter sales declined 6%, while operating profit increased 21% to $8.8 million. Nine-month sales increased 5% and operating profit increased 25% to $34.3 million.
- Results were pressured by lower raw-material surcharges and base prices, weaker titanium shipments, project delays, softer industrial demand, unfavorable product mix, and raw-material costs that did not align with surcharges.
- Retirement benefit expense increased to $30.6 million in the quarter from $19.2 million and to $91.8 million year to date from $57.9 million, primarily due to a lower discount rate and lower-than-expected asset returns. The quarterly after-tax impact was $7.5 million, or $0.07 per share; the nine-month impact was $22.3 million, or $0.19 per share.
- Lower corporate expenses, lower interest expense, and the absence of 2011 ATI Ladish acquisition-related charges partially offset operating pressure. Third-quarter results also included a $22.1 million LIFO inventory valuation reserve benefit.
Guidance, Outlook, Risks, and Unusual Items
Management expected challenging fourth-quarter conditions, including soft demand and aggressive customer inventory management, and expected fourth-quarter results to be lower than third-quarter results. Full-year 2012 guidance was sales of $5.0 billion to $5.1 billion and segment operating profit of approximately 10.5% of sales. Management cited longer-term growth opportunities in aerospace, oil and gas, electrical energy and medical markets, including nearly $2 billion of potential annual revenue from new manufacturing capabilities and products over five years.
Capital expenditures were expected to total approximately $410 million in 2012. The approximately $1.1 billion Hot-Rolling and Processing Facility was described as on schedule and on budget, with construction completion expected by the end of 2013 and commissioning in the first half of 2014.
Key risks include global economic and industry weakness, raw-material and energy-price volatility, delays between cost changes and customer surcharges, pension funding and asset-performance changes, project cost overruns, execution and integration risks, litigation, environmental liabilities, and demand weakness in major end markets. Environmental remediation reserves were approximately $15 million, with reasonably possible costs exceeding reserves by as much as $2 million based on currently available information. Management stated that pending litigation was not expected to materially affect financial condition or liquidity, although individual periods could be materially affected.
At September 30, 2012, the U.S. qualified pension plan was approximately 84% funded at December 31, 2011, and no 2012 cash contribution was required under then-current rules. A 0.50 percentage-point change in the pension discount rate was estimated to affect pension liabilities by approximately $150 million and annual pension expense by approximately $10 million.
Investor Verification Priorities
- Verify the sustainability of the 2012 guidance, particularly the expected fourth-quarter decline and approximately 10.5% full-year segment margin.
- Monitor Flat-Rolled Products pricing, titanium shipments, project timing, customer inventories and the performance of the Hot-Rolling and Processing Facility.
- Assess the cash requirements and returns associated with approximately $410 million of 2012 capital expenditures and the longer-term $1.1 billion facility.
- Reconcile operating cash flow with the $112.4 million increase in managed working capital and elevated inventory balances.
- Evaluate pension sensitivity, funding requirements and the effect of discount rates and asset returns on future earnings and liabilities.
- Review exposure to nickel, scrap, natural gas, electricity and foreign-currency movements, including hedge coverage and surcharge pass-through timing.
- Review environmental reserves, potential additional remediation costs, litigation matters and debt covenant compliance.