ATI Inc. (Allegheny Technologies Incorporated) — Q2 2012 Form 10-Q Summary
Business context and reporting period
ATI is a diversified specialty-metals producer serving aerospace and defense, oil and gas, chemical processing, electrical energy, medical, automotive, construction, mining, and other markets. The filing covers the unaudited quarter and six months ended June 30, 2012, compared primarily with the corresponding 2011 periods. Operations comprise High Performance Metals, Flat-Rolled Products, and Engineered Products.
Key financial metrics
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Sales | $1,357.4 million | $1,351.6 million | $2,709.9 million | $2,579.0 million |
| Income before taxes | $89.7 million | $100.3 million | $173.8 million | $194.1 million |
| Net income attributable to ATI | $56.4 million | $64.0 million | $112.6 million | $120.3 million |
| Diluted EPS | $0.50 | $0.59 | $1.00 | $1.13 |
| Income before tax margin | 6.6% | 7.4% | 6.4% | 7.5% |
| Segment operating profit | $159.9 million | $173.4 million | $323.1 million | $335.8 million |
| Segment operating margin | 11.8% | 12.8% | 11.9% | 13.0% |
Six-month operating cash flow was $59.8 million, compared with cash used in operations of $72.0 million in the prior-year period. Working capital absorbed $205.4 million, including increases in receivables and inventories. Capital expenditures were $165.7 million, and cash used in investing activities was $164.8 million. Financing activities used $65.3 million, including $38.2 million of dividends and $22.4 million of taxes on share-based compensation.
Cash and cash equivalents were $210.3 million at June 30, 2012, down from $380.6 million at December 31, 2011. Total debt was $1,501.4 million, versus $1,509.3 million at year-end 2011. Net debt was $1,291.1 million, and net debt to total capitalization was 33.4%, compared with 31.3% at year-end. The company had not borrowed under its $400 million domestic credit facility; approximately $7 million supported letters of credit. A separate letter-of-credit facility had $32 million outstanding. The domestic facility leverage ratio was 2.05 versus a maximum of 3.25, and interest coverage was 5.58 versus a minimum of 2.0.
Material changes versus the prior comparable period
- Q2 sales increased less than 1%, while first-half sales increased 5%. Growth was concentrated in High Performance Metals and Engineered Products.
- High Performance Metals Q2 sales increased 14% to $566.2 million and operating profit increased 10% to $102.2 million. Aerospace demand, ATI Ladish integration, higher nickel-alloy shipments, and cost reductions supported results.
- Flat-Rolled Products Q2 sales declined 10% to $657.4 million and operating profit declined 40% to $44.5 million. Lower raw-material surcharges, lower base prices, project delays, and reduced titanium shipments were significant factors.
- Engineered Products Q2 sales increased 5% to approximately $133.8 million and operating profit increased 94% to $13.2 million, supported by construction, mining, oil and gas, and cost-reduction activity.
- Profitability declined despite lower corporate expenses and interest expense. Retirement benefit expense increased to $30.6 million in Q2 from $19.4 million and to $61.2 million for the first half from $38.7 million.
- Q2 results included approximately $11 million of higher raw-material costs that were not aligned with surcharges, partially offset by a $7.1 million LIFO inventory valuation benefit. The prior-year quarter included $18.8 million of ATI Ladish acquisition-related costs, including inventory accounting charges.
- Inventory increased to $1,512.5 million from $1,384.3 million at year-end, while accounts receivable increased to $744.3 million and accounts payable decreased to $451.7 million.
Guidance, outlook, risks, and unusual items
Management expected 2012 sales of approximately $5.3 billion to $5.4 billion, with segment operating profit as a percentage of sales similar to the first-half 2012 level. Management expected sales and earnings to trough in the third quarter because of seasonal summer slowdowns, slower U.S. and Chinese growth, European uncertainty, U.S. fiscal and regulatory uncertainty, aggressive inventory management, and falling raw-material costs.
Management continued to expect long-term growth in aerospace, oil and gas, chemical processing, electrical energy, and medical markets, and identified nearly $2 billion of potential annual revenue growth over five years from new manufacturing capabilities and products. The approximately $1.1 billion Hot-Rolling and Processing Facility was reported on schedule and on budget, with construction expected to finish by the end of 2013 and commissioning in the first half of 2014. Full-year 2012 capital expenditures were expected to be approximately $485 million.
- Key exposures include volatile nickel, ferrous scrap, energy, and foreign-currency prices; surcharges may not fully or promptly offset raw-material changes.
- At June 30, 2012, hedges covered approximately 13% of annual nickel requirements, about 75% of 2012 domestic natural-gas requirements, and approximately 10% of forecast international sales through 2014 for foreign-currency exposure.
- Defined benefit pension and postretirement obligations remained material. The company reported $496.1 million of pension liabilities and $473.3 million of accrued postretirement benefits. Management stated that no required cash contribution to the U.S. pension plan was expected for 2012 based on then-current regulations and actuarial studies.
- Environmental remediation reserves totaled approximately $16 million, with reasonably possible costs exceeding recorded reserves by as much as $2 million. Additional contamination, remediation requirements, or third-party recovery issues could increase costs materially.
- Pending litigation includes product liability, patent, commercial, employment, benefits, tax, environmental, health and safety, occupational disease, and stockholder matters. Management did not believe currently pending matters were likely to materially affect financial condition or liquidity, but individual periods could be materially affected.
- Management concluded that disclosure controls and procedures were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the expected Q3 trough and $5.3 billion to $5.4 billion 2012 sales outlook were achieved or subsequently revised.
- Progress, final cost, funding, and expected returns for the Hot-Rolling and Processing Facility and other major capital projects.
- Flat-Rolled Products pricing, titanium shipment recovery, raw-material surcharge timing, and the sustainability of cost reductions.
- Working-capital conversion, inventory levels, operating cash flow, and the effect of planned approximately $485 million of 2012 capital expenditures on liquidity.
- Debt maturities, covenant compliance, available credit capacity, and the effect of cash held by foreign subsidiaries on parent-company liquidity.
- Pension asset performance, discount-rate changes, required or voluntary contributions, and the potential effect of pension expense on earnings.
- Updates to environmental reserves, legal contingencies, derivative positions, and raw-material and energy hedge effectiveness.