Business Context and Reporting Period
Allegheny Technologies Incorporated (ATI), a diversified specialty-metals producer, filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2010. ATI operates through High Performance Metals, Flat-Rolled Products, and Engineered Products. Key end markets include aerospace and defense, oil and gas, chemical processing, electrical energy, medical, automotive, and transportation.
Financial Results and Position
| Metric | Three Months Ended June 30, 2010 | Three Months Ended June 30, 2009 | Six Months Ended June 30, 2010 | Six Months Ended June 30, 2009 |
|---|---|---|---|---|
| Sales | $1,052.0 million | $710.0 million | $1,951.4 million | $1,541.6 million |
| Income before taxes | $60.6 million | Break-even | $93.6 million | $0.3 million |
| Net income attributable to ATI | $36.4 million | $(13.4) million | $54.6 million | $(7.5) million |
| Diluted EPS | $0.36 | $(0.14) | $0.54 | $(0.08) |
| Segment operating profit | $117.3 million | $53.9 million | $205.5 million | $109.8 million |
| Segment operating margin | 11.2% | 7.6% | 10.5% | 7.1% |
- First-half sales rose 27%; second-quarter sales rose 48%, primarily from higher shipments, selling prices, and raw-material surcharges.
- Operating profit improved in all segments. First-half segment operating margins increased to 19.0% in High Performance Metals, 6.5% in Flat-Rolled Products, and 5.5% in Engineered Products.
- Six-month operating cash flow was negative $193.4 million, versus positive $81.3 million in 2009, principally because working capital increased by $346.8 million as activity and raw-material costs increased.
- Capital expenditures were $97.6 million in the first half, compared with $211.5 million in the prior-year period. Management expected approximately $325 million of capital expenditures for 2010.
- Cash and cash equivalents were $378.7 million at June 30, 2010, down from $708.8 million at December 31, 2009.
- Total debt was $1,070.1 million, broadly unchanged from $1,071.1 million at year-end. Long-term debt was $1,032.1 million and current debt was $38.0 million.
- Net debt to ATI total capitalization increased to 25.2% from 15.3%, primarily because cash declined. Total debt to total capitalization was 34.3%, versus 34.7% at year-end.
- The $400 million domestic credit facility had no borrowings, although approximately $7 million supported letters of credit. A separate letter-of-credit facility had $32 million outstanding. The company reported a leverage ratio of 1.82 and interest coverage ratio of 5.40 for the twelve months ended June 30, 2010.
- Quarterly dividends remained $0.18 per share; first-half dividends were $0.36 per share.
Material Changes Versus the Prior Comparable Period
- ATI returned to profitability, with second-quarter net income attributable to ATI of $36.4 million versus a $13.4 million loss in 2009; first-half earnings were $54.6 million versus a $7.5 million loss.
- High Performance Metals sales increased 7% in the quarter, while Flat-Rolled Products and Engineered Products sales increased 84% and 75%, respectively. First-half High Performance Metals sales declined 9%, offset by 59% growth in Flat-Rolled Products and 46% growth in Engineered Products.
- Engineered Products returned to operating profitability, reporting $7.9 million in the quarter and $9.7 million year to date, versus losses of $9.4 million and $15.5 million, respectively.
- Interest expense increased to $15.4 million in the quarter and $30.0 million year to date, primarily because of debt issued in the second quarter of 2009 and lower capitalized interest.
- Retirement benefit expense declined to $22.4 million in the quarter and $44.9 million year to date, compared with $33.4 million and $70.7 million, respectively.
- Unlike 2009, when falling raw-material costs produced substantial LIFO benefits, 2010 included a $5.5 million LIFO inventory valuation charge for the quarter and first half.
- Gross cost reductions were $35.3 million in the second quarter and $72.3 million for the first half.
Guidance, Outlook, Risks, and Unusual Items
- Management said key markets were performing well, with improving aerospace demand and stronger oil and gas and chemical-processing demand in Asia and the Middle East.
- Management expected High Performance Metals performance to improve approximately 7% to 8% quarter to quarter, subject to normal seasonal adjustments in Engineered Products.
- Flat-Rolled Products was expected to be significantly affected in the third quarter by out-of-phase surcharges following the decline in nickel prices and by lower standard-stainless volumes. Management anticipated a fourth-quarter rebound from supply-chain restocking and stable end-use demand.
- Second-quarter results included $8.9 million of idle-facility and start-up costs, primarily related to titanium sponge operations; first-half costs were $20.4 million. ATI planned to ramp its Rowley, Utah titanium sponge facility during 2010.
- ATI was consolidating its Natrona, Pennsylvania melt shop into Brackenridge. Under an EPA consent decree, the Natrona melt shop was to close before November 30, 2010; total civil penalties were $1.6 million.
- The company was developing a new advanced specialty-metals hot-rolling and processing facility in Brackenridge, estimated to cost approximately $1.16 billion over at least four years, and was expanding zirconium sponge and melting capacity.
- Environmental remediation reserves were approximately $18 million at June 30, 2010. Management did not believe reasonably possible losses beyond recorded amounts would be material in aggregate, but future adjustments could materially affect a reporting period.
- Principal risks include global economic and metals-market conditions, aerospace and other end-market demand, raw-material and energy price volatility, timing of surcharges, project cost overruns, pension-asset performance, legal and environmental matters, and the ability to achieve planned cost savings.
- Foreign currency, raw-material, and energy derivatives had aggregate asset fair values of $48.6 million and liability fair values of $22.8 million. The filing stated that approximately 50% of forecast domestic natural-gas requirements through 2011 and approximately 40% of certain 2011 electricity requirements were hedged.
Important Facts for Investors to Verify
- Whether the substantial increase in receivables and inventories converts into operating cash flow as demand and raw-material prices stabilize.
- The effect of declining nickel prices, out-of-phase surcharges, and LIFO accounting on Flat-Rolled Products margins in the third quarter.
- Progress, remaining costs, and expected returns from the Rowley titanium sponge facility and the Brackenridge expansion.
- Whether projected 2010 capital expenditures of approximately $325 million can be funded while preserving liquidity and debt covenant compliance.
- Future pension funding requirements, retirement-benefit expense, and the sensitivity of earnings to pension-asset returns.
- Environmental remediation, litigation, and the required closure and consolidation of the Natrona facility.
- The sustainability of reported cost reductions and the recovery trajectory in aerospace, standard stainless steel, oil and gas, and chemical-processing markets.