ATI Inc. (Allegheny Technologies Incorporated) — Q1 2018 Form 10-Q Summary
Business context and reporting period
ATI is a global manufacturer of technically advanced specialty materials and complex components, operating through High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP). The filing covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017. Aerospace and defense represented approximately 47% of consolidated sales, while key markets collectively represented 81% of sales.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Sales | $979.0 million | $865.9 million | +13.1% |
| Gross profit / margin | $148.6 million / 15.2% | $124.8 million / 14.4% | Margin +80 bps |
| Operating income / margin | $81.5 million / 8.3% | $66.9 million / 7.7% | Improved |
| Income before taxes | $65.5 million | $23.1 million | +184% |
| Net income attributable to ATI | $58.0 million | $17.5 million | +231% |
| Diluted EPS | $0.42 | $0.16 | +163% |
| Segment operating profit / margin | $96.4 million / 9.8% | $69.9 million / 8.1% | Improved |
HPMC sales increased 9.9% to $560.7 million and segment operating profit increased to $85.5 million, or 15.2% of sales, from $50.9 million, or 10.0%. FRP sales increased 17.7% to $418.3 million, but segment operating profit declined to $10.9 million, or 2.6% of sales, from $19.0 million, or 5.3%.
Cash used in operating activities was $47.1 million, compared with $110.2 million used in Q1 2017. Capital expenditures were $41.6 million, producing implied negative operating cash flow less capital expenditures of approximately $88.7 million. Working capital was a significant use of cash, including a $63.1 million increase in managed working capital and $16 million of short-term advances to fund the A&T Stainless joint venture ramp-up.
Cash and cash equivalents were $109.9 million at March 31, 2018, down from $141.6 million at year-end 2017. ATI reported approximately $305 million of additional ABL availability. Debt excluding debt issuance costs was $1.6115 billion, versus $1.5538 billion at year-end; the increase primarily reflected $50 million of ABL borrowings. Net debt to ATI total capital was 44.9%, compared with 44.8% at year-end. ATI was in compliance with its ABL fixed-charge coverage covenant.
Material changes versus the prior comparable period
- Growth was led by aerospace demand, particularly next-generation commercial jet engine products, and higher FRP shipments of nickel-based and specialty alloys for oil and gas projects.
- HPMC commercial jet engine sales increased 23%, while next-generation jet engine product sales increased 65% year over year.
- FRP operating profit declined because of approximately $8 million of unfavorable retirement-benefit capitalization accounting effects, lower foreign-currency hedge gains, and lower raw-material surcharge benefits.
- Net interest expense declined to $25.5 million from $33.5 million, primarily following the redemption of the 9.375% senior notes due 2019 in Q4 2017.
- ATI recognized a $15.9 million pretax gain from selling a 50% interest in and deconsolidating A&T Stainless. This gain was excluded from FRP segment results.
- ASC 606 revenue recognition was adopted using the modified retrospective method, increasing beginning retained earnings by $15.5 million and creating $50.5 million of contract assets at March 31, 2018.
- The retirement-benefit presentation change reclassified non-service costs to nonoperating expense; it did not affect pretax income or net income for the comparative period. The related capitalization change had an unfavorable Q1 2018 pretax impact of $5.4 million, primarily in FRP.
Guidance, outlook, risks and unusual items
- Management expects continued revenue growth and margin improvement in HPMC, with full-year 2018 HPMC margins expected to expand approximately 200 basis points versus 2017, although quarterly results may vary with next-generation product cadence.
- Management cited elevated aerospace order patterns, increasing jet-engine build rates, improved asset utilization and ongoing production-ramp requirements.
- Management expects continued strong FRP end-market demand and benefits from product mix and operational improvements, but the A&T Stainless ramp depends partly on resolution of the Section 232 tariff exclusion request. Without an exclusion, imported Indonesian stainless slabs could be subject to a 25% tariff.
- ATI expects approximately $40 million of 2018 contributions to its U.S. pension plan and approximately $85 million of annual contributions in subsequent years, although estimates are sensitive to asset values and discount rates.
- Environmental remediation reserves were approximately $14 million, with reasonably possible costs exceeding recorded reserves by as much as $16 million. Future environmental, litigation or regulatory developments could materially affect results.
- Other significant risks include specialty-metal and energy-price volatility, raw-material availability, international trade restrictions, foreign exchange, pension funding, labor disruptions, equipment outages and aerospace or other end-market weakness.
- ATI continued to maintain valuation allowances on certain U.S. deferred tax assets because of a cumulative-loss condition. Tax Act amounts remained provisional, with finalization expected by Q4 2018.
- The quarterly dividend remained suspended. Management stated that internally generated funds, cash on hand and available ABL borrowings are expected to meet liquidity needs, including pension funding.
Most important facts for investors to verify
- Whether aerospace demand and next-generation engine production ramps sustain HPMC’s reported 15.2% segment margin and the targeted 200-basis-point full-year improvement.
- Whether FRP margins recover after the retirement-benefit accounting impact, lower hedge gains and weaker surcharge benefits.
- The timing and cash requirements of the A&T Stainless ramp, including the remaining $12.5 million purchase-price installments and the outcome of the Section 232 tariff exclusion request.
- Whether working-capital growth converts into operating cash flow and whether cash generation is sufficient to fund capital expenditures, pension obligations and debt maturities.
- Compliance with ABL liquidity and covenant requirements, particularly the required $700 million liquidity threshold ahead of the 2021 senior-note maturity.
- The potential effect of environmental matters, pension funding assumptions, deferred-tax valuation allowances and unresolved Tax Act accounting on future earnings and cash flow.