ATI Inc. 2018 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
Allegheny Technologies Incorporated (ATI) is a global manufacturer of specialty materials and complex components, serving aerospace and defense, oil and gas, electrical energy, medical, automotive, and other markets. The filing covers the quarter and six months ended June 30, 2018, with comparative periods ended June 30, 2017. ATI operates through High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP).
Key Financial Metrics
| Metric | Q2 2018 | Q2 2017 | Six Months 2018 | Six Months 2017 |
|---|---|---|---|---|
| Sales | $1,009.5 million | $880.2 million | $1,988.5 million | $1,746.1 million |
| Gross profit | $173.7 million | $124.3 million | $322.3 million | $249.1 million |
| Gross margin | 17.2% | 14.1% | 16.2% | 14.3% |
| Operating income | $111.0 million | $59.3 million | $192.5 million | $126.2 million |
| Income before taxes | $80.5 million | $11.3 million | $146.0 million | $34.4 million |
| Net income attributable to ATI | $72.8 million | $10.1 million | $130.8 million | $27.6 million |
| Diluted EPS | $0.52 | $0.09 | $0.94 | $0.25 |
| Segment operating profit | $124.0 million | $70.9 million | $220.4 million | $140.8 million |
| Segment operating margin | 12.3% | 8.1% | 11.1% | 8.1% |
Sales increased 14.7% in the second quarter and 13.9% for the first six months. HPMC sales increased 12% in the quarter and 11% year to date; FRP sales increased 18% in both periods. Aerospace and defense represented 48% of total second-quarter sales, while key markets collectively represented 81%. High-value products represented 84% of sales, compared with 82% in the prior-year periods.
At June 30, 2018, cash and cash equivalents were $122.4 million, down from $141.6 million at December 31, 2017. Total assets were $5.39 billion and total equity was $2.04 billion. Net inventories were $1.25 billion, up from $1.18 billion at year-end, and accounts receivable were $621.9 million, up from $545.3 million.
The consolidated cash flow statement reported $35.0 million of cash provided by operating activities for the first six months, compared with $85.5 million used in the prior-year period. Operating cash flow was pressured by a $127.8 million increase in managed working capital, including inventory builds and contract assets. Capital expenditures were $70.6 million, and investing cash outflow was $69.8 million. Financing activities provided $15.6 million. The company reported a $19.2 million decrease in cash during the period.
Total debt was approximately $1.55 billion before or after differing presentation of debt issuance costs. Management reported debt excluding issuance costs of $1.56 billion, up from $1.55 billion at year-end. Net debt to ATI total capital improved to 42.8% from 44.8%, and total debt to total capital improved to 44.8% from 47.2%.
Material Changes Versus the Prior Comparable Period
- Profitability improved materially, with second-quarter gross profit up $49.4 million and net income attributable to ATI up $62.7 million.
- HPMC operating profit rose to $97.9 million from $68.0 million, with margin increasing to 16.5% from 12.9%, driven by aerospace growth, productivity, and product mix.
- FRP operating profit rose to $26.1 million from $2.9 million, with margin increasing to 6.3% from 0.8%, reflecting stronger high-value product demand, improved operating rates, surcharge matching, and A&T Stainless benefits.
- Net interest expense declined to $25.5 million in the quarter and $51.0 million year to date, primarily following redemption of the 9.375% senior notes due 2019 in the fourth quarter of 2017.
- ATI adopted ASC 606 using the modified retrospective method, increasing opening retained earnings by $15.5 million and recording contract assets. The new standard reduced second-quarter sales by $5.1 million and cost of sales by $4.2 million relative to the former method.
- ATI formed the A&T Stainless joint venture, sold a 50% interest for $17.5 million, and recognized a $15.9 million pretax gain in the first quarter. The remaining $5.5 million purchase price was due in the fourth quarter.
- Retirement benefit presentation was changed retrospectively, moving non-service costs outside operating income without changing pretax income or segment operating profit. A $5.4 million unfavorable capitalization impact was recorded in the first quarter from the related accounting change.
Guidance, Outlook, Risks, and Unusual Items
- Management raised HPMC 2018 guidance to revenue growth of 10% to 12% and a 300-basis-point year-over-year improvement in segment operating margin.
- Management raised FRP guidance to revenue growth of 14% to 16% and operating-margin improvement of 150 to 300 basis points.
- Management expects strong second-half cash generation and intends to end 2018 with zero borrowings under the ABL revolving facility.
- ATI expects approximately $40 million of 2018 pension contributions and approximately $85 million annually for the next few years, subject to asset values and discount rates.
- Raw-material inflation, particularly nickel, cobalt, and molybdenum, is expected to create a moderate LIFO expense headwind in the second half. Management projected an additional $27.5 million of LIFO expense, partially offset by reversal of the remaining $8.2 million NRV reserve.
- The A&T Stainless joint venture imports Indonesian stainless slabs potentially subject to a 25% Section 232 tariff. ATI’s exclusion request remained pending; results through June 30 did not include tariff-affected slabs.
- The company recognized a $5.9 million second-quarter transition-tax expense, offset by a $5.9 million discrete tax benefit related to amended prior-period returns. The Tax Cuts and Jobs Act accounting remained provisional.
- On July 12, 2018, ATI acquired Addaero Manufacturing’s assets for $10 million in cash to expand additive-manufacturing capabilities for aerospace and defense.
- Environmental remediation reserves were approximately $15 million, with reasonably possible costs exceeding recorded reserves by as much as $16 million. Future environmental adjustments could materially affect results.
- The ABL facility had no revolving borrowings at June 30, $41.2 million of letters of credit utilization, and approximately $355 million of available additional liquidity. ATI was in compliance with its fixed-charge coverage covenant.
- Additional risks include aerospace production execution, raw-material and energy-price volatility, trade policy and tariffs, pension funding, labor disruptions, equipment outages, foreign currency exposure, and market demand.
Important Facts for Investors to Verify
- Whether aerospace production ramps and next-generation jet-engine demand support the increased HPMC guidance.
- Whether FRP margins sustain the guided 150-to-300-basis-point improvement amid raw-material inflation and tariff uncertainty.
- The timing and amount of working-capital recovery and whether operating cash flow improves in the second half.
- Finalization of the Tax Cuts and Jobs Act transition-tax accounting and the company’s ability to use NOLs and tax credits.
- The outcome of the A&T Stainless Section 232 tariff exclusion request and the joint venture’s funding and operating ramp.
- Actual 2018 and future pension contributions, including sensitivity to plan-asset performance and discount rates.
- The effect of LIFO expense and NRV-reserve reversals on second-half earnings.
- Potential environmental, litigation, trade, and other contingent liabilities beyond recorded reserves.
- The impact of the July 2018 ABL amendment, including the lower term-loan base rate and related $50 million interest-rate swap.