ATI Inc. Form 10-Q Summary
Business context and reporting period
Allegheny Technologies Incorporated (ATI) filed its Form 10-Q for the quarter and nine months ended September 30, 2016. ATI operates through High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP), serving aerospace and defense, oil and gas, electrical energy, automotive, medical, construction and other markets.
Management continued restructuring and portfolio rationalization. The Rowley, Utah titanium sponge facility was indefinitely idled because externally sourced sponge was available at lower cost, while commodity stainless steel and grain-oriented electrical steel facilities were being reduced or idled.
Financial metrics
| Metric | Q3 2016 | Q3 2015 | First nine months 2016 | First nine months 2015 |
|---|---|---|---|---|
| Sales | $770.5 million | $832.7 million | $2,338.5 million | $2,980.7 million |
| Gross profit (loss) | $50.2 million | $(28.7) million | $65.2 million | $157.8 million |
| Operating loss | $(498.9) million | $(91.2) million | $(615.8) million | $(40.2) million |
| Net loss attributable to ATI | $(530.8) million | $(144.6) million | $(650.8) million | $(151.0) million |
| Loss per share | $(4.95) | $(1.35) | $(6.07) | $(1.41) |
| Net interest expense | $32.6 million | $27.5 million | $91.2 million | $81.0 million |
Q3 sales declined 7.5% year over year, while nine-month sales declined 21.5%. The Q3 gross margin was approximately 6.5%, compared with negative 3.4% in the prior-year quarter. The Q3 operating loss was dominated by restructuring charges.
- Q3 restructuring and other charges were $499.9 million pretax, including $471.3 million of long-lived asset impairment, $11.3 million of titanium sponge inventory valuation charges, and $17.3 million of shutdown, idling and employee costs.
- The Rowley impairment charge was approximately $470.8 million, reducing the facility’s carrying value to an estimated fair value of $15.0 million.
- The Q3 tax benefit was $4.3 million and included a $173.1 million valuation allowance charge against U.S. federal deferred tax assets. The effective tax rate excluding the valuation allowance and other discrete charges was 34.1%.
- Nine-month segment operating loss was $47.3 million, compared with segment operating profit of $14.3 million in the prior-year period. Q3 segment operating profit was $26.2 million, compared with a $73.0 million loss in Q3 2015.
Cash flow, balance sheet and liquidity
- Cash used in operating activities was $111.7 million for the first nine months, compared with $108.9 million of cash provided in the prior-year period. The 2016 amount included a $115.0 million U.S. pension contribution.
- Capital expenditures were $174.9 million, compared with $99.5 million in the prior-year period. Management estimated full-year 2016 capital expenditures of approximately $215 million and 2017 capital expenditures of approximately $120 million.
- Cash and cash equivalents were $188.4 million at September 30, 2016, up from $149.8 million at December 31, 2015. Approximately $91.0 million was held by foreign subsidiaries, including $49.2 million at the STAL joint venture.
- Total debt, excluding debt issuance costs for leverage calculations, was $1.894 billion, up from $1.505 billion at year-end 2015. Net debt was $1.705 billion.
- Net debt to ATI total capital increased to 53.7% from 39.4%; total debt to ATI total capital increased to 56.3% from 42.0%.
- The ABL facility had a $400 million revolving commitment and a new $100 million term loan due November 2017. There were no revolving borrowings at quarter-end, although $10.8 million supported letters of credit. Management reported approximately $325 million of additional available liquidity.
- ATI did not meet the ABL fixed-charge coverage ratio at September 30, 2016 and therefore could not access approximately $62.5 million, or 12.5%, of the facility until the required ratio was met.
- The company issued $287.5 million of 4.75% convertible senior notes due 2022 and used $115 million of proceeds for the pension contribution. The initial conversion price was $14.45 per share, representing approximately 19.9 million potential shares.
Material changes versus prior comparable periods
- HPMC Q3 sales decreased 2.7% to $461.8 million, but segment operating profit increased to $47.0 million from $18.8 million. Aerospace and defense represented 77% of HPMC sales and benefited from next-generation aircraft and engine programs.
- FRP Q3 sales decreased 14% to $308.7 million, while its operating loss improved to $20.8 million from $91.8 million. Nine-month FRP sales fell 39% to $885.3 million and its operating loss widened to $162.2 million from $121.8 million.
- Aerospace and defense represented 51% of total nine-month sales, up from 39%. Oil and gas, chemical and hydrocarbon processing sales fell to 9% from 16%.
- Nine-month FRP results included approximately $43 million of non-recurring costs associated with the labor stoppage, return to work and related operating inefficiencies. Total first-nine-month costs associated with the stoppage and return to work were approximately $48 million.
- Inventory declined to $1.079 billion from $1.272 billion at year-end 2015, while managed working capital declined $39.0 million and fell to 43.0% of annualized sales from 46.2%.
- The four-year USW labor agreement froze defined benefit pension plan entry for new employees and eliminated defined benefit retiree healthcare for new employees. ATI expected approximately $8 million of lower retirement benefit expense during March through December 2016.
Guidance, outlook, risks and unusual items
- Management expected HPMC operating margins to improve further in Q4 2016 and continue improving in 2017 and beyond.
- Rowley shutdown and related consolidation actions were expected to improve operating earnings by approximately $50 million beginning in 2017. Approximately $10 million of additional Rowley closure costs were expected in Q4 2016, including costs related to eliminating approximately 150 positions.
- After quarter-end, ATI announced permanent closure of the Midland, Pennsylvania commodity stainless facility and Bagdad, Pennsylvania GOES finishing operation. Q4 2016 charges were expected to range from $11 million to $21 million for employee benefit costs and other obligations, with approximately $4 million to $14 million of contract termination costs, approximately $3 million of pension and postretirement termination benefits, and approximately $2 million of supplemental unemployment benefits.
- Management expected these FRP actions to improve 2017 segment operating profit by approximately $10 million and expected FRP to be profitable in 2017, although fourth-quarter market conditions were expected to remain challenging.
- Management expected average pension funding requirements to exceed $100 million annually for the next several years. Funding needs remain sensitive to mortality assumptions, discount rates and pension asset performance.
- Key risks include substantial indebtedness, covenant compliance and refinancing needs, weak or volatile end-market demand, excess global stainless and titanium capacity, raw material and energy price volatility, labor disputes, pension obligations, environmental remediation, litigation, foreign exchange exposure and uncertainty related to Brexit.
- Environmental remediation reserves were approximately $14 million, with possible costs exceeding recorded reserves by as much as $17 million based on currently available information.
Investor verification points
- Verify the company’s ability to restore ABL covenant compliance and access the restricted $62.5 million of availability.
- Assess cash generation, pension contributions and refinancing requirements against approximately $1.9 billion of debt.
- Evaluate whether Rowley and FRP restructuring savings are achieved and whether additional closure costs exceed estimates.
- Review the sustainability of HPMC aerospace growth and the timing of recovery in FRP and other weak end markets.
- Monitor the realizability of U.S. deferred tax assets after the $173.1 million valuation allowance.
- Track pension funding requirements, changes in discount rates and mortality assumptions, and asset performance.
- Reconcile reported results with restructuring, impairment, inventory, labor-stoppage and tax items when assessing underlying margins and earnings.