ATI Inc. (Allegheny Technologies Incorporated) — Q2 2020 Form 10-Q Summary
Business context and reporting period
ATI is a global manufacturer of specialty materials and complex components serving aerospace and defense, energy, automotive, medical, electronics, and other markets. Effective January 1, 2020, the company operated through two segments: High Performance Materials & Components (HPMC) and Advanced Alloys & Solutions (AA&S). The filing covers the quarter and six months ended June 30, 2020; results were materially affected by the COVID-19 pandemic, particularly in commercial aerospace and energy.
Financial performance and key metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Sales | $770.3 million | $1,080.4 million | $1,725.8 million | $2,085.2 million |
| Gross profit / margin | $74.7 million / 9.7% | $177.7 million / 16.4% | $209.5 million / 12.1% | $308.8 million / 14.8% |
| Operating income (loss) | $(273.4) million | $110.0 million | $(205.0) million | $173.1 million |
| Net income (loss) attributable to ATI | $(422.6) million | $75.1 million | $(401.5) million | $90.1 million |
| Diluted EPS | $(3.34) | $0.54 | $(3.18) | $0.66 |
| Adjusted EBITDA | $57.6 million / 7.5% of sales | $149.1 million / 13.8% of sales | $458.7 million | $529.2 million |
- Sales declined 29% year over year in the second quarter and 17% for the first six months. Q2 HPMC sales fell 44% and AA&S sales fell 14%.
- Aerospace and defense represented 47% of Q2 sales, down from 53% in the prior-year quarter. Energy represented 22% of Q2 sales.
- Segment operating profit declined to $27.3 million, or 3.5% of sales, from $114.5 million, or 10.6%, in Q2 2019. HPMC margin was 3.1%; AA&S margin was 3.9%.
- Cash used in operating activities was $14.4 million in the first half of 2020, compared with $104.4 million used in the prior-year period. Capital expenditures were $66.0 million.
- Cash and cash equivalents were $539.1 million at June 30, 2020, compared with $490.8 million at December 31, 2019.
- Accounts receivable were $483.6 million and inventories were $1,103.5 million at June 30, 2020. Managed working capital increased to $1,329.6 million, or 43.2% of annualized sales, from 30.0% at year-end 2019.
- Debt carrying value on the balance sheet was $1,529.7 million, while management’s debt measure excluding debt issuance costs was $1,596.1 million. Net debt was $1,057.0 million. Debt-to-adjusted-EBITDA increased to 3.48 from 2.67 at December 31, 2019; net debt-to-adjusted-EBITDA increased to 2.30 from 1.74.
- Total liquidity was approximately $1.0 billion, consisting of $539 million of cash and approximately $460 million of additional ABL availability. No borrowings were outstanding under the revolving ABL facility at quarter-end; $35.2 million supported letters of credit.
Material changes versus the prior comparable period
- ATI recorded a $287.0 million goodwill impairment charge for the Forged Products reporting unit, reflecting lower projected commercial aerospace demand, revenue, profitability, and cash flow.
- The company recorded $16.7 million of Q2 restructuring charges and $24.7 million for the first six months, primarily related to workforce reductions and voluntary retirement programs. Approximately 550 positions were eliminated in Q2, following approximately 90 positions in Q1.
- ATI issued $285.0 million of 3.5% convertible notes due 2025 and used proceeds to repurchase $203.2 million of 4.75% convertible notes due 2022. The transaction produced a $21.5 million debt extinguishment charge and included a $19.0 million capped-call cost.
- ATI’s share of a $4.8 million termination-benefit charge at the A&T Stainless joint venture was $2.4 million. A&T Stainless continued to face a 25% tariff on imported Indonesian stainless slab and began idling its DRAP facility.
- Q2 2019 included $21.6 million of net gains from non-core asset sales, including a $29.3 million gain on oil and gas rights; Q2 2020 included only $0.5 million of net other income.
- Income taxes included a $99.0 million valuation allowance on U.S. federal and state tax attributes after ATI entered a three-year cumulative U.S. loss position. Management stated that a reliable annual effective tax rate could not be estimated.
- Goodwill declined to $236.4 million from $525.8 million at year-end 2019, while total ATI stockholders’ equity declined to $1,735.3 million from $2,090.1 million.
Guidance, outlook, commentary, risks, and unusual items
- Management expects aerospace and energy market conditions, reduced utilization, cost inefficiencies, and weaker margins to continue at least through the remainder of 2020. Commercial aerospace demand remains the principal concern.
- ATI expects $140 million to $160 million of 2020 cost reductions from workforce actions, temporary idlings, salary and benefit reductions, furloughs, lower capital expenditures, and lower corporate expenses. The announced workforce programs are expected to provide approximately $50 million of annualized benefits once fully implemented.
- Backlog of confirmed orders was $1.51 billion at June 30, 2020, down from $2.38 billion a year earlier; approximately 70% was expected to be fulfilled within 12 months.
- ATI expects approximately $130 million of 2020 contributions to U.S. qualified defined benefit pension plans, of which $28 million had been contributed in the first six months. The company deferred an April contribution under the CARES Act and contributed $17.5 million in July 2020.
- Environmental remediation reserves were approximately $15 million, with reasonably possible additional costs of up to $16 million above recorded reserves. The filing states that environmental and litigation outcomes could materially affect results in a particular period.
- The company is involved in litigation with US Magnesium concerning a supply and operating agreement; the outcome cannot currently be predicted.
- Key risks include prolonged COVID-19 disruption, commercial aerospace and energy weakness, customer production-rate reductions, supply-chain interruptions, pension funding requirements, credit-rating downgrades, refinancing risk, raw-material and energy price volatility, tariffs, labor issues, and potential additional asset impairments.
- The filing reports no material change adversely affecting internal control over financial reporting, and management concluded disclosure controls were effective as of June 30, 2020.
Most important facts for investors to verify
- Whether commercial aerospace demand and ATI’s HPMC utilization rates recover, and whether the remaining $173.4 million of Forged Products goodwill is at risk of further impairment.
- Whether the projected $140 million to $160 million of 2020 cost reductions are achieved and sufficient to offset lower volumes and margins.
- Cash generation, working-capital normalization, pension funding requirements, and continued compliance with ABL covenants.
- The maturity and refinancing requirements for the 2022 convertible notes, 2023 notes, and other debt, including the effect of the 2025 convertible notes’ effective reported interest rate of approximately 8.4%.
- The duration and financial effects of COVID-19, commercial aerospace and energy weakness, A&T Stainless tariffs and facility idling, and other potential restructuring or impairment charges.
- The valuation and recoverability of U.S. deferred tax assets, environmental reserves, and exposures related to pending litigation.