ATI Inc. (formerly Allegheny Technologies Incorporated) — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. The interim financial statements are unaudited and prepared under U.S. GAAP. ATI operates through High Performance Materials & Components (HPMC) and Advanced Alloys & Solutions (AA&S), with aerospace and defense representing approximately 50% of sales.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Sales | $598.0 million | $1,018.7 million | $2,323.8 million | $3,103.9 million |
| Gross profit and margin | $38.1 million; 6.4% | $159.7 million; 15.7% | $247.6 million; 10.7% | $468.5 million; 15.1% |
| Operating income (loss) | $(9.6) million | $94.5 million | $(214.6) million | $267.6 million |
| Income (loss) before taxes | $(46.2) million | $119.0 million | $(339.1) million | $220.4 million |
| Net income (loss) attributable to ATI | $(50.1) million | $111.0 million | $(451.6) million | $201.1 million |
| Diluted EPS | $(0.40) | $0.78 | $(3.57) | $1.44 |
| Adjusted EBITDA | $16.6 million; 2.8% margin | $180.2 million; 17.7% margin | $295.1 million | $529.2 million |
- Q3 sales declined 41% year over year. HPMC sales fell 51% to $221.3 million and AA&S sales fell 34% to $376.7 million.
- Q3 aerospace and defense sales declined 51% to $246.1 million. Commercial aerospace demand was particularly weak; HPMC commercial aerospace sales declined 64%.
- For the first nine months, sales declined 25%, while segment operating profit fell to $101.7 million from $275.4 million. Segment margin declined to 4.4% from 8.9%.
- Cash provided by operating activities was $45.0 million in the first nine months, compared with cash used of $10.0 million in the prior-year period. Capital expenditures were $94.6 million, producing cash used in investing activities of $89.2 million.
- Cash and cash equivalents totaled $572.2 million at September 30, 2020, up from $490.8 million at December 31, 2019.
- Total debt, excluding debt issuance costs and including the equity-classified portion of the convertible notes for management leverage calculations, was $1.605 billion. Net debt was $1.033 billion.
- Debt to adjusted EBITDA increased to 5.44x from 2.67x at December 31, 2019; net debt to adjusted EBITDA increased to 3.50x from 1.74x.
- Reported pension liabilities were $608.9 million and accrued postretirement benefits were $300.2 million at September 30, 2020.
Material changes versus the prior comparable period
- COVID-19-related reductions in commercial aerospace, energy and general industrial demand drove substantially lower sales, plant utilization and margins.
- ATI recorded a $287.0 million second-quarter goodwill impairment charge for the Forged Products reporting unit. Goodwill declined to $238.4 million at September 30, 2020 from $525.8 million at year-end 2019.
- Restructuring charges were $2.3 million in Q3 and $27.0 million year to date, primarily for workforce reductions and voluntary retirement programs. Approximately 800 positions, or about 10% of the workforce, had been eliminated, with expected annualized benefits of approximately $60 million once fully implemented.
- ATI issued $291.4 million of 3.5% convertible senior notes due 2025, repurchased $203.2 million of 4.75% convertible notes due 2022 and recognized a $21.5 million debt extinguishment charge.
- ATI borrowed an additional $100.0 million under its ABL term loan. Cash interest costs were reduced through the refinancing, but the new convertible notes carry an estimated reported interest rate of 8.4% after non-cash amortization and debt issuance costs, compared with a 3.5% cash coupon.
- Prior-year results benefited from $68.2 million of Q3 gains on non-core asset and business sales and $89.8 million for the first nine months; comparable 2020 gains were only $2.5 million year to date.
- A $99.0 million deferred tax asset valuation allowance was recorded in Q2 after ATI entered a three-year cumulative U.S. loss position.
Liquidity, outlook, risks and unusual items
- Management reported approximately $950 million of total liquidity at September 30, 2020, consisting of $572 million of cash and approximately $375 million of additional ABL availability.
- ATI did not meet the ABL fixed-charge coverage ratio at quarter end and consequently could not access the remaining 12.5%, or $87.5 million, of revolving availability until compliance is restored. No borrowings were outstanding under the revolving facility, and $34.8 million supported letters of credit.
- Management expected weak aerospace and energy market conditions, lower utilization and pricing pressure to continue through at least the first half of 2021. Most cost-reduction measures were expected to continue into 2021.
- Fiscal 2020 U.S. qualified pension funding requirements were approximately $130 million; $95 million had been contributed through September 30. Management expected average annual funding requirements of approximately $85 million for the following few years, subject to asset performance and discount rates.
- Backlog was $1.44 billion at September 30, 2020, down from $2.34 billion a year earlier; approximately 70% was expected to be satisfied within 12 months.
- Environmental remediation reserves were approximately $14 million, with reasonably possible costs exceeding recorded reserves by as much as $15 million.
- ATI and ATI Titanium are defendants and counterclaimants in the US Magnesium litigation concerning a supply and operating agreement. Trial was scheduled for mid-2021, and the outcome could not be predicted.
- Key risks include prolonged COVID-19 disruption, commercial aerospace and energy downturns, customer and supply-chain disruption, raw-material and energy price volatility, pension funding requirements, labor issues, credit-rating deterioration and restricted access to capital.
- The A&T Stainless joint venture completed the orderly idling of its DRAP facility in Q3 after Section 232 tariff exclusion requests were denied. ATI recognized a $2.4 million share of related termination charges year to date.
Investor verification priorities
- Verify the recovery timing and production-rate assumptions for commercial aerospace, particularly Forged Products and next-generation jet-engine programs.
- Monitor compliance with the ABL fixed-charge coverage and liquidity provisions and the availability of the restricted $87.5 million tranche.
- Reconcile reported debt, equity-classified convertible-note amounts, cash interest and non-GAAP leverage measures.
- Assess whether the remaining $238.4 million of goodwill and the approximately $1.3 billion HRPF asset group remain recoverable under continuing weak demand.
- Track cash generation, working-capital release, capital expenditures and pension contributions against management’s liquidity expectations.
- Evaluate the realization of U.S. deferred tax assets following the $99.0 million valuation allowance and the company’s inability to estimate a reliable annual effective tax rate.
- Review potential environmental, litigation, pension withdrawal and joint-venture obligations, including the US Magnesium case and possible environmental exposure above recorded reserves.