ATI Inc. (Allegheny Technologies Incorporated) — Q1 2014 Form 10-Q
Business context and reporting period
The filing covers the three months ended March 31, 2014. ATI is a specialty materials and components producer serving aerospace and defense, oil and gas/chemical processing, electrical energy, medical, automotive, construction and other markets. Operations comprise High Performance Materials & Components and Flat Rolled Products. The former High Performance Metals segment was renamed during the quarter without changing its composition or reporting methodology.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Sales | $987.3 million | $1,099.0 million | Down 10% |
| Income before interest, other income and taxes | $2.5 million | $28.1 million | Down $25.6 million |
| Income (loss) from continuing operations attributable to ATI | $(18.1) million | $9.7 million | Turned to loss |
| Net income (loss) attributable to ATI | $(20.0) million | $10.0 million | Turned to loss |
| Diluted EPS | $(0.19) | $0.09 | Down $0.28 |
| Cash used in operating activities | $(56.9) million | $(57.4) million | Similar outflow |
| Capital expenditures | $39.6 million | $86.9 million | Down $47.3 million |
| Cash and cash equivalents | $837.7 million | $1,026.8 million at Dec. 31, 2013 | Down $189.1 million |
Consolidated cost of sales was $917.1 million, and selling and administrative expense was $67.7 million. Income before tax from continuing operations was $(26.0) million versus $14.8 million in the prior-year quarter. ATI recorded a $10.0 million income tax benefit, including a $2.2 million discrete benefit, but management could not reliably estimate the annual effective tax rate.
- Segment operating profit was $43.5 million, or 4.4% of sales, versus $77.5 million, or 7.1%, in Q1 2013.
- High Performance Materials & Components sales declined 10% to $484.4 million; operating profit declined to $69.1 million from $75.0 million, while margin improved to 14.3% from 13.9%.
- Flat Rolled Products sales declined 10% to $502.9 million; the segment reported a $25.6 million operating loss versus $2.5 million of profit, with margin deteriorating to negative 5.1% from positive 0.4%.
- Key markets represented 67% of sales, led by aerospace and defense at 35%, oil and gas/chemical processing at 16%, electrical energy at 11%, and medical at 5%.
Material changes versus the prior comparable period
- Lower shipment volumes, lower base selling prices, and lower raw-material surcharge and index pricing reduced sales and profitability. Total titanium mill product shipments declined 15%.
- Flat Rolled Products results included an $8.3 million inventory valuation charge for industrial titanium products and $2.3 million of Hot-Rolling and Processing Facility start-up costs.
- ATI incurred $5.0 million of closed-company and other expenses, up from $3.4 million, primarily because of higher environmental expenses.
- Net interest expense more than doubled to $29.1 million from $14.4 million, primarily because of reduced capitalized interest and higher debt levels.
- Retirement benefit expense declined to $23.9 million from $32.5 million, principally because of a higher discount rate.
- ATI acquired 85% of Dynamic Flowform Corp. for $73.1 million of cash consideration, including $71.1 million paid during the quarter. The acquisition added $47.0 million of preliminary goodwill and created a $12.2 million redeemable noncontrolling interest.
- Discontinued operations generated a $1.9 million net loss versus $0.3 million of income. ATI subsequently decided to close its iron castings business; the wind-down was expected to be completed by the end of Q3 2014 with approximately $3 million of cash exit costs.
Debt, liquidity and cash flow
Total debt was $1,946.8 million at March 31, 2014, broadly unchanged from $1,947.3 million at year-end. Net debt increased to $1,109.1 million from $920.5 million because cash declined. Net debt to ATI total capital rose to 27.9% from 24.1%; total debt to total ATI capital was 40.4%.
The $402.5 million of 4.25% Convertible Senior Notes matured June 1, 2014 and could be settled through conversion into approximately 9.6 million shares at the initial conversion price of approximately $41.795 per share. ATI represented that cash on hand, internally generated funds and available credit were adequate for foreseeable needs, including this maturity and the HRPF project.
No borrowings were outstanding under the $400 million domestic revolving credit facility, although approximately $7 million supported letters of credit. The company was in compliance with its covenants: leverage ratio 1.91 versus a maximum of 4.0 and interest coverage ratio 5.57 versus a minimum of 2.0. Separate letters of credit totaled $32 million. Planned 2014 capital expenditures were approximately $300 million.
Operating cash flow was pressured by a $68.5 million investment in managed working capital, including higher inventory and receivables. Managed working capital increased to $1.515 billion, although it declined to 35.6% of annualized sales from 39.4% at year-end.
Guidance, outlook, risks and unusual items
- Management reported improving conditions during the quarter, a $1.8 billion backlog at a two-year high, improving jet-engine demand, better oil and gas supply-chain balance, and improving flat-rolled markets.
- ATI expected continuing operations to be at or near break-even in Q2 2014, excluding HRPF start-up costs.
- HRPF hot commissioning was on schedule for completion in October 2014. Expected HRPF start-up costs were approximately $5 million in Q2 and $30 million to $35 million for full-year 2014; the project budget was approximately $1.2 billion excluding capitalized interest.
- Management expected the Rowley, Utah titanium sponge strategy to continue negatively affecting operating results throughout 2014 while premium-quality qualification continued.
- Major risks include specialty metals demand and pricing, raw-material and energy volatility, timing and benefits of strategic projects and acquisitions, pension funding and asset performance, litigation, environmental obligations, and execution of cost reductions.
- Environmental remediation reserves were approximately $15 million, with reasonably possible costs exceeding recorded reserves by as much as $8 million. Future environmental developments could materially affect a period’s results.
- Energy, nickel and foreign-exchange hedges reduce but do not eliminate market exposure. Nearly all debt was fixed rate, limiting current interest-rate exposure.
Most important facts for an investor to verify
- Whether the expected Q2 break-even result and broader 2014 demand recovery materialized.
- The repayment, refinancing or equity conversion of the $402.5 million convertible notes due June 1, 2014.
- HRPF commissioning progress, final project cost, start-up costs and expected 2015 operating benefits.
- Whether Flat Rolled Products returned to profitability after titanium inventory charges and weak pricing.
- Cash generation, working-capital normalization and the ability to fund approximately $300 million of 2014 capital expenditures.
- Actual costs and timing of the iron castings wind-down and other discontinued operations.
- Changes in environmental reserves, contingent liabilities, pension obligations and credit-facility covenant headroom.