ATI Inc. (Allegheny Technologies Incorporated) — First-Quarter 2016 Form 10-Q
Business context and reporting period
The filing covers the three months ended March 31, 2016. ATI produces specialty materials and components, including titanium, nickel-based alloys, specialty steels, forgings, castings and related products. Operations are reported in two segments: High Performance Materials & Components (HPMC) and Flat Rolled Products (FRP).
First-quarter results were materially affected by the 2015–2016 USW work stoppage and return-to-work transition. A four-year labor agreement was ratified on March 4, 2016, and employees began returning to work in mid-March.
Financial performance and key metrics
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Sales | $757.5 million | $1,125.5 million |
| Gross profit (loss) | $(33.2) million | $109.5 million |
| Operating income (loss) | $(104.8) million | $46.4 million |
| Income (loss) before taxes | $(132.3) million | $20.6 million |
| Net income (loss) attributable to ATI | $(101.2) million | $10.0 million |
| Diluted EPS | $(0.94) | $0.09 |
| Cash flow from operations | $(61.5) million | $12.0 million |
| Capital expenditures | $69.5 million | $22.6 million |
| Cash and cash equivalents at period-end | $156.9 million | $238.0 million |
Sales declined 32.7% year over year. The gross margin was approximately negative 4.4%, compared with approximately 9.7% in the prior-year quarter. The pretax loss was 17.5% of sales, versus pretax income of 1.8% of sales in Q1 2015. The reported tax benefit was $34.2 million, representing a 25.9% effective rate on the pretax loss; management stated that the rate was below the standard U.S. federal rate because certain state tax attributes could not be recognized.
- HPMC: External sales were $493.0 million, down 9.2%. Segment operating profit was $29.1 million, or 5.9% of sales, versus $72.9 million, or 13.4%, in Q1 2015.
- FRP: External sales were $264.5 million, down 54.6%. Segment operating loss was $109.6 million, or 41.4% of sales, versus a $6.8 million loss, or 1.2%, in Q1 2015.
- Aerospace and defense represented 52% of total sales, up from 36% in the prior-year quarter. Oil and gas/chemical and hydrocarbon processing declined to 7% of sales from 19%.
- FRP shipment volume declined 49% overall, including a 61% decline in standard products and a 34% decline in high-value products.
Liquidity, debt and balance sheet
- Total debt, excluding debt issuance costs, was $1,658.3 million at March 31, 2016, up from $1,505.2 million at December 31, 2015. The increase primarily reflected $150.0 million drawn under the asset-based lending facility.
- Net debt to ATI total capital increased to 42.9% from 39.4%; total debt to ATI total capital increased to 45.4% from 42.0%.
- The company had $156.9 million of cash and approximately $200 million of additional ABL liquidity. The ABL facility had $150 million outstanding and $9.8 million utilized for letters of credit.
- ATI did not meet the ABL fixed-charge coverage ratio at March 31, 2016, restricting access to the remaining 10% or $40 million of facility availability until the ratio is met.
- Minimum pension funding requirements through March 2017 were projected at $31 million and were classified as a current liability. Management expects higher ongoing pension funding requirements in 2017 and later years.
- Management stated that cash on hand, internally generated funds and available ABL borrowings were expected to meet liquidity needs. No significant debt maturities were expected before June 2019.
Material changes versus the prior comparable period
- Revenue fell sharply, driven primarily by the FRP downturn, lower shipment volumes, lower prices and reduced raw-material surcharges.
- FRP was affected by work-stoppage and return-to-work costs of approximately $21 million, while total company work-stoppage-related costs were approximately $26 million.
- ATI recorded a $9.0 million restructuring charge for eliminating more than 250 FRP salaried positions, approximately one-third of the FRP salaried workforce.
- The company completed the idling of standard/commodity stainless operations at Midland, Pennsylvania, and planned to complete idling GOES operations, including the Bagdad, Pennsylvania facility, by the end of April 2016.
- Inventory decreased by $105.3 million from year-end, while accounts receivable increased by $42.1 million and accounts payable decreased by $40.4 million.
- The quarterly dividend was reduced to $0.08 per share from $0.18 per share in the prior-year quarter.
- S&P downgraded ATI’s credit rating from BB- to B+, increasing the interest rate on the 2023 Notes from 7.625% to 7.875% and adding approximately $1.3 million of annual interest expense.
- The USW agreement reduced postretirement obligations by $22.5 million and was expected to reduce retirement-benefit expense by approximately $7.5 million from March through December 2016.
Guidance, outlook, risks and unusual items
- Management expected HPMC operating levels to increase through 2016 as commercial aerospace demand grows and expected HPMC operating margins to return to low double-digit levels in the second half of 2016.
- Management expected FRP to be modestly profitable in the second half of 2016, supported by rightsizing, a higher-value product mix and more than $30 million of annualized salaried-workforce savings beginning to be fully realized in the third quarter.
- Full-year 2016 capital expenditures were expected to be approximately $225 million, including remaining Hot-Rolling and Processing Facility payments and other expansion projects.
- Demand remained weak in commodity stainless, GOES, titanium industrial markets and oil and gas. Global overcapacity, low raw-material prices, imports and uncertain end-market demand remained significant risks.
- ATI disclosed potential impairment risk for the Rowley, Utah titanium sponge facility, which had an approximate carrying value of $490 million, if operating rates or market conditions deteriorate further. No triggering event requiring an interim goodwill impairment analysis was identified at March 31, 2016.
- Environmental remediation reserves were approximately $16 million, with reasonably possible costs exceeding recorded reserves by as much as $17 million. The ultimate timing and cost of remediation remain uncertain.
- Natural gas and raw-material hedges carried significant unrealized losses, including approximately $22.8 million for natural gas and $44.4 million for raw-material hedges at March 31, 2016. The filing also disclosed $72.7 million of total derivative liabilities.
- The NLRB complaint related to the labor dispute was withdrawn after ratification of the USW agreement. Other litigation and environmental matters could still materially affect results in a particular reporting period.
Most important facts for investors to verify
- Whether HPMC achieves the projected operating-margin recovery and whether FRP reaches modest profitability in the second half of 2016.
- Actual realization and timing of the more than $30 million of annualized FRP savings.
- Compliance with ABL covenant and availability restrictions, including the company’s ability to restore access to the restricted borrowing capacity.
- Cash generation after approximately $225 million of planned 2016 capital expenditures and required pension contributions.
- Liquidity and refinancing plans for the $350 million of 9.375% Senior Notes due June 2019, including the ABL requirement to demonstrate at least $500 million of liquidity before maturity.
- Potential impairment of the Rowley titanium sponge facility and the effect of continuing weak titanium, oil and gas, stainless and GOES demand.
- Changes in pension funding requirements, environmental remediation costs, derivative losses and other contingent liabilities.