ATI Inc. 2019 Form 10-K Summary
Business context and reporting period
Allegheny Technologies Incorporated (ATI) filed its Form 10-K for the fiscal year ended December 31, 2019, filed February 25, 2020. ATI manufactures specialty materials and complex components through two segments: High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP). Aerospace and defense represented approximately 52% of 2019 sales, while oil and gas and energy were other significant end markets. International sales were approximately 40% of total revenue.
HPMC represented 58% of sales and is heavily exposed to commercial aerospace, including next-generation jet engines, forgings, titanium, nickel alloys and metallic powders. FRP represented 42% of sales and serves oil and gas, aerospace, automotive, energy, industrial and consumer markets.
Key financial metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Sales | $4,122.5 million | $4,046.6 million | Up 2% |
| Gross profit | $637.8 million | $630.3 million | Up 1% |
| Gross margin | 15.5% | 15.6% | Down 0.1 point |
| Income before taxes | $241.6 million | $247.7 million | Down 2% |
| Net income attributable to ATI | $257.6 million | $222.4 million | Up 16% |
| Diluted EPS | $1.85 | $1.61 | Up 15% |
| Operating cash flow | $230.1 million | $392.8 million | Down $162.7 million |
| Cash and equivalents | $490.8 million | $382.0 million | Up $108.8 million |
| Total debt, excluding issuance costs | $1,411.2 million | $1,552.5 million | Down $141.3 million |
Segment operating profit was $380.7 million, or 9.2% of sales, compared with $413.2 million, or 10.2%, in 2018. HPMC operating profit increased 2% to $343.1 million, with a 14.3% margin. FRP operating profit fell 52% to $37.6 million, with a 2.2% margin.
Working capital management improved: managed working capital declined to 30.0% of annualized sales from 31.6% at year-end 2018. Capital expenditures were $168.2 million, compared with $139.2 million in 2018. Cash provided by investing activities was $81.7 million, including $250.1 million of proceeds from non-core asset sales.
Material changes versus the prior comparable period
- Aerospace and defense revenue increased $164.9 million, or 8%, to $2.13 billion and rose to 52% of total sales from 49% in 2018.
- HPMC sales rose 3%, despite a 4% negative impact from divestitures. Airframe and government defense sales increased 17% and 28%, respectively, while commercial jet-engine sales declined 3% because of product mix and temporary customer order-pattern changes.
- FRP sales increased 1%, but profitability deteriorated materially because of higher retirement benefit expense, Section 232 tariffs affecting A&T Stainless, weaker standard stainless demand and operating inefficiencies.
- ATI sold two non-core forging facilities for $33.0 million of net proceeds and sold its Cast Products titanium investment castings business for $125.1 million of net proceeds. ATI also received approximately $92 million from selling oil and gas rights.
- ATI issued $350 million of 5.875% senior notes due 2027 and used the proceeds and cash on hand to redeem $500 million of 5.95% notes due 2021. The transaction reduced debt by approximately $150 million but generated a $21.6 million debt extinguishment charge.
- Operating cash flow declined from $392.8 million to $230.1 million, primarily reflecting $145 million of pension contributions in 2019 versus $40 million in 2018, as well as working-capital and joint-venture funding effects.
Guidance, outlook, management commentary and unusual items
Management expects commercial aerospace demand, particularly for next-generation aircraft, jet engines, powder alloys, isothermal forgings and additive manufacturing, to support HPMC growth for the next several years. Year-end backlog was approximately $2.3 billion, versus $2.2 billion in 2018; approximately 80% was expected to be filled in 2020. The filing does not provide formal consolidated revenue or earnings guidance.
ATI extended or expanded important long-term agreements, including GE Aviation agreements expected to generate $2.5 billion of revenue beginning in 2021, a Rolls-Royce agreement extended through 2029, and a 6.5-year extension with BWX Technologies. The Cudahy, Wisconsin isothermal press and heat-treating expansion was expected to enter service and begin customer qualification in mid-2020.
A&T Stainless remained subject to a 25% tariff on Indonesian stainless slab imports after its tariff-exclusion request was denied. A new request filed in October 2019 remained pending, and idling the Midland, Pennsylvania facility was considered probable if a near-term exclusion was not obtained. ATI recorded an $11.4 million impairment charge and had $36.8 million of net receivables from the joint venture at year-end, including a $4.3 million collectability reserve.
Other significant 2019 items included a $91.7 million gain on oil and gas rights, an $8.1 million loss on the forging-facility sale, a $6.2 million gain on the Cast Products sale, a $4.5 million restructuring charge for approximately 70 salaried positions, and a $41.9 million discrete tax benefit primarily from releasing deferred-tax valuation allowances. ATI expects future effective tax rates of approximately 23% to 25%, although U.S. cash taxes are expected to remain limited for several years because of net operating loss carryforwards.
Liquidity was supported by $491 million of cash and approximately $450 million of additional ABL availability at year-end. The ABL facility was extended to 2024, with a $500 million revolving facility, a $100 million term loan and potential delayed-draw capacity. ATI was in compliance with its applicable financial covenant.
Principal risks and contingencies
- Dependence on cyclical commercial aerospace and oil and gas markets, including exposure to the Boeing 737 MAX production suspension and changing aircraft build rates.
- FRP exposure to global stainless overcapacity, pricing pressure, Section 232 tariffs and the potential idling of A&T Stainless.
- Raw-material, energy and foreign-exchange volatility. A $1.00 per pound change in nickel prices would affect annual costs by approximately $105 million before surcharges, hedges or pricing actions.
- Substantial debt, including $291.5 million of scheduled principal payments in 2022 and $502.7 million in 2023, and a 7.875% current effective rate on the 2023 notes.
- U.S. qualified pension plans were approximately 73% funded. Expected 2020 pension contributions were approximately $130 million, with average annual contributions of approximately $85 million thereafter for the next few years.
- Environmental reserves were approximately $18 million, with reasonably possible additional costs of up to $16 million based on currently available information.
- Approximately 1,500 union-represented employees were covered by collective bargaining agreements expiring February 29, 2020, creating potential labor-disruption risk.
- ATI and ATI Titanium were defendants in litigation brought by US Magnesium concerning a supply agreement; the filing states that the outcome could not be predicted.
- The filing also identifies cyber-security, supply-chain, energy availability, government-contract, litigation and global health-crisis risks, including potential disruption to the Shanghai joint venture.
Important facts for investors to verify
- Reconcile reported net income and EPS with the $41.9 million discrete tax benefit and other non-recurring gains and charges.
- Assess the sustainability of HPMC aerospace growth, backlog conversion and the timing of GE Aviation, Rolls-Royce and other long-term agreements.
- Monitor A&T Stainless tariff-exclusion proceedings, facility-idling decisions and collectability of ATI receivables.
- Review debt maturities, convertible-note dilution potential, interest costs and ABL covenant and liquidity requirements.
- Validate pension funding needs, asset performance and the sensitivity of liabilities to discount-rate changes.
- Track raw-material pricing, surcharge recovery, LIFO/NRV inventory effects and FRP margin recovery.
- Review subsequent filings for developments related to COVID-19, labor negotiations, litigation, environmental matters and the 2020 operating outlook.