Business Context and Reporting Period
Allegheny Technologies Incorporated (ATI) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2016. ATI produces specialty materials and components, operating through High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP). Results were materially affected by the USW work stoppage and return-to-work costs, production idling, weak industrial demand, and lower raw-material surcharges.
Key Financial Metrics
| Metric | Three months ended June 30, 2016 | Three months ended June 30, 2015 | Six months ended June 30, 2016 | Six months ended June 30, 2015 |
|---|---|---|---|---|
| Sales | $810.5 million | $1,022.5 million | $1,568.0 million | $2,148.0 million |
| Gross profit | $48.2 million | $77.0 million | $15.0 million | $186.5 million |
| Gross margin | 5.9% | 7.5% | 1.0% | 8.7% |
| Operating income (loss) | $(12.1) million | $4.6 million | $(116.9) million | $51.0 million |
| Operating margin | (1.5)% | 0.4% | (7.5)% | 2.4% |
| Net loss attributable to ATI | $(18.8) million | $(16.4) million | $(120.0) million | $(6.4) million |
| Loss per share | $(0.18) | $(0.15) | $(1.12) | $(0.06) |
| Net interest expense | $30.3 million | $26.8 million | $58.6 million | $53.5 million |
Six-month cash used in operating activities was $33.6 million, compared with $91.5 million of cash provided in the prior-year period. Capital expenditures were $145.3 million, primarily related to the Hot-Rolling and Processing Facility. Financing activities provided $349.6 million. Cash and cash equivalents were $322.3 million at June 30, 2016, compared with $149.8 million at December 31, 2015.
Total debt, excluding debt issuance costs, was $1,895.6 million at June 30, 2016, versus $1,505.2 million at year-end 2015. Net debt to ATI total capital increased to 44.1% from 39.4%, and total debt to ATI total capital increased to 48.7% from 42.0%.
Material Changes Versus Prior Comparable Period
- Second-quarter sales declined 20.7%; six-month sales declined 27.0%.
- FRP second-quarter sales fell 39% to $312.1 million, with an operating loss of $31.8 million versus a $23.2 million loss in the prior-year quarter. Six-month FRP sales fell 47% to $576.6 million, and the operating loss widened to $141.4 million from $30.0 million.
- HPMC second-quarter sales declined 2.5% to $498.4 million, and operating profit declined to $38.8 million from $44.4 million. Six-month operating profit declined to $67.9 million from $117.3 million.
- Aerospace and defense represented 51% of six-month sales, up from 37%, while oil and gas, chemical and hydrocarbon-processing sales declined to 8% from 18%.
- ATI recorded $10.0 million of restructuring charges, including $9.0 million for eliminating more than 250 FRP salaried positions and $1.0 million for HPMC severance.
- Second-quarter and six-month results included approximately $22 million and $48 million, respectively, of work-stoppage and return-to-work costs. FRP also recorded approximately $43 million of non-recurring operating costs in the first half.
- Commodity stainless-steel and GOES operations were idled at Midland, Pennsylvania and Bagdad, Pennsylvania. Restart depends on future demand and acceptable returns.
- The Company issued $287.5 million of 4.75% convertible senior notes due 2022 and added a $100.0 million term loan. The convertible notes have an initial conversion price of $14.45 per share and could result in approximately 19.9 million shares upon conversion.
Guidance, Outlook, Risks and Unusual Items
- Management expected HPMC operating levels to increase through 2016, driven primarily by commercial aerospace, and expected HPMC operating margins to return to low double-digit levels in the second half of 2016.
- Management expected FRP operating losses to decline in the third quarter, although planned maintenance and equipment upgrades were expected to increase costs. Management continued to believe FRP could be modestly profitable in the fourth quarter of 2016.
- Full-year 2016 capital expenditures were expected to be less than $240 million.
- Management expected average annual contributions to the ATI Pension Plan to exceed $100 million for the next several years. ATI made a $115 million pension contribution in July 2016 using proceeds from the convertible notes.
- ATI did not meet the ABL fixed-charge coverage ratio at June 30, 2016. Consequently, approximately $62.5 million of remaining ABL availability was inaccessible until compliance is achieved. The Company reported approximately $325 million of additional ABL liquidity and no revolving borrowings at quarter-end, with $10.8 million used for letters of credit.
- The ABL 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 repayment or refinancing.
- The S&P downgrade to B+ increased the 2023 notes’ interest rate to 7.875%, adding approximately $1.3 million of annual interest expense.
- Environmental remediation reserves were approximately $14 million; reasonably possible costs could exceed recorded reserves by as much as $17 million. Management stated that pending litigation was not expected to materially affect financial condition or liquidity, although individual periods could be materially affected.
- Potential impairment indicators remained for the Rowley, Utah titanium sponge facility and certain higher-cost titanium operations. No interim goodwill impairment trigger was identified at June 30, 2016.
- Other risks include substantial indebtedness, pension funding uncertainty, raw-material and energy-price volatility, weak end-market demand, labor disruptions, foreign exchange exposure, and uncertainty related to Brexit. The filing also noted a preliminary U.S. Commerce Department determination concerning countervailing duties on certain Chinese stainless-steel sheet and strip imports.
Investor Verification Checklist
- Verify whether HPMC achieved the projected low-double-digit margin in the second half of 2016.
- Verify whether FRP reduced losses and reached modest profitability in the fourth quarter, including the effects of idled facilities and planned maintenance.
- Monitor compliance with the ABL fixed-charge coverage covenant and access to the restricted $62.5 million of availability.
- Assess refinancing and liquidity plans for the $350.0 million of 9.375% senior notes due 2019 and the $100.0 million term loan due November 2017.
- Track pension contributions, plan-asset performance, mortality assumptions, and the effect of the July 2016 $115 million contribution.
- Evaluate potential dilution from the convertible notes and the effect of future share-price changes on conversion and liquidity obligations.
- Review whether titanium sponge utilization, inventory valuation charges, environmental matters, or asset impairment indicators create additional charges.