ATI Inc. (formerly Allegheny Technologies Incorporated) — First Quarter 2017 Form 10-Q
Business context and reporting period
ATI is a global manufacturer of specialty materials and complex components serving aerospace and defense, oil and gas, electrical energy, medical, automotive, and industrial markets. The filing covers the three months ended March 31, 2017, compared with the three months ended March 31, 2016.
Operations comprise High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP). Aerospace and defense accounted for $417.2 million, or 48% of consolidated sales, and international sales accounted for 39% of total sales.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Sales | $865.9 million | $757.5 million |
| Gross profit (loss) | $112.8 million | $(33.2) million |
| Gross margin | 13.0% | (4.4)% |
| Operating income (loss) | $53.3 million | $(104.8) million |
| Income (loss) before taxes | $23.1 million | $(132.3) million |
| Net income (loss) attributable to ATI | $17.5 million | $(101.2) million |
| Diluted EPS | $0.16 | $(0.94) |
| Segment operating profit (loss) | $69.9 million | $(80.5) million |
| Cash used in operating activities | $(110.2) million | $(61.5) million |
| Capital expenditures | $24.8 million | $69.5 million |
HPMC sales increased 3.5% to $510.4 million, with segment operating profit rising to $50.9 million, or 10.0% of sales, from $29.1 million. FRP sales increased 34% to $355.5 million, and the segment returned to profitability with $19.0 million of operating profit, or 5.3% of sales, versus a $109.6 million loss.
Cash and cash equivalents were $159.8 million at March 31, 2017, down from $229.6 million at December 31, 2016. Total debt, excluding debt issuance costs, was $1.961 billion, compared with $1.894 billion at year-end. Net debt to ATI total capitalization increased to 56.4% from 55.1%.
Current assets were $1.763 billion and current liabilities were $795.6 million. Net inventory was $1.052 billion, accounts receivable were $504.6 million, and ATI stockholders’ equity was $1.394 billion.
Material changes versus the prior comparable period
- Sales increased 14%, while gross profit improved by $146.0 million.
- The company returned to operating and net profitability, primarily reflecting stronger aerospace demand, restructuring benefits, improved operating performance, and the absence of 2016 work-stoppage and severance costs.
- Q1 2016 included approximately $26 million of work-stoppage and return-to-work costs, a $9 million FRP severance charge, and $10 million of titanium inventory valuation charges.
- FRP benefited from higher shipment volumes and prices, improved raw-material cost recovery, cost reductions, exit from the grain-oriented electrical steel market, and a $6 million benefit from a change in the ferrochrome surcharge calculation.
- Interest expense increased to $33.5 million from $28.3 million because of the 2022 convertible notes and term loan issued in 2016, partly offset by lower average ABL borrowings.
- Operating cash flow declined despite the return to profitability, largely because of a $135 million U.S. pension contribution and an $11.2 million working-capital use.
- The quarterly dividend was suspended beginning with the fourth quarter of 2016; no dividend was declared or paid in Q1 2017.
Guidance, outlook, risks, contingencies, and unusual items
- Management expects HPMC sales growth of approximately 10% in 2017 and low-double-digit operating profit as a percentage of sales.
- Management expects FRP to sustain profitability at a low-single-digit margin, excluding the effect of the first-quarter ferrochrome surcharge benchmark change.
- Order volumes were described as good entering the second quarter, but visibility into the second half of 2017 remained cautious. Oil and gas conditions remained challenging.
- Management estimated 2017 capital expenditures of $125 million and expects annual capital expenditures beyond 2017 to average no more than $100 million for several years.
- ATI expects no U.S. federal income tax payments in 2017 because of net operating loss carryforwards. The projected annual effective tax rate for Q1 2017 was 14.1%, excluding discrete tax benefits.
- The company does not meet the ABL fixed-charge coverage ratio at March 31, 2017. Consequently, $62.5 million of remaining ABL availability was restricted. Reported cash was approximately $160 million and additional ABL liquidity was approximately $230 million.
- The $100 million ABL term loan was due November 13, 2017. Management expected to finalize an extension to September 2020 in Q2 2017, subject to customary conditions.
- The ABL agreement requires at least $500 million of liquidity beginning 91 days before the June 1, 2019 maturity of the 9.375% senior notes and thereafter until those notes are repaid or refinanced.
- ATI contributed $135 million to its U.S. pension plan in March 2017 and expects average annual contributions of approximately $135 million for the next several years, subject to asset performance, mortality assumptions, and regulatory changes.
- Environmental remediation reserves were approximately $14 million. Management stated that recorded matters could reasonably exceed reserves by as much as $19 million, and future developments could materially affect results.
- Management disclosed a material weakness in internal control over financial reporting related to the calculation and review of deferred tax asset valuation allowances. Remediation was expected by December 31, 2017, but the weakness had not been remediated as of the filing.
- A collective bargaining agreement covering approximately 500 employees expired April 1, 2017 and was extended through June 30, 2017 while negotiations continued.
- Pending accounting changes are expected to materially affect reported operating income presentation for retirement benefit costs beginning in 2018. The company estimated an approximately $5 million unfavorable pre-tax Q1 2018 adoption impact from capitalization changes.
Most important facts for investors to verify
- Whether the ABL term-loan extension was completed and whether the fixed-charge covenant and restricted availability improved after March 31, 2017.
- ATI’s ability to refinance or repay the $350 million of 9.375% senior notes due in 2019 and satisfy the associated $500 million liquidity requirement.
- Actual operating cash generation after the large pension contribution and as working capital increases with higher activity.
- Progress toward the stated HPMC growth and FRP margin objectives, particularly amid cautious second-half visibility and weak oil and gas conditions.
- Remediation of the material tax-control weakness and the effect of deferred tax valuation allowances on future effective tax rates.
- Future pension funding requirements, plan asset performance, and potential changes in mortality or funding assumptions.
- Exposure to raw-material, energy, foreign-currency, labor, environmental, and litigation risks, including the ongoing USW negotiations.