ATI Inc: Form 10-Q for the period ended Jun 30, 2023

Overview

ATI is a global manufacturer of technically advanced specialty materials and complex components. Our largest markets are aerospace & defense, representing 57% of sales for the six months ended June 30, 2023, led by products for jet engines. Additionally, we have a strong presence in the energy markets, including oil & gas, downstream processing, and specialty energy, as well as the medical and electronics markets. In aggregate, these markets represent more than 80% of our 2023 revenue. ATI is a market leader in manufacturing differentiated products that require our materials science capabilities and unique process technologies, including our new product development competence. Our capabilities range from cast/wrought and powder alloy development to final production of highly engineered finished components, including those used in next-generation jet engines and 3D-printed aerospace products.

Second quarter 2023 sales increased 9% to $1.05 billion, compared to sales of $959.5 million for the second quarter of 2022, primarily due to a significant recovery in demand for commercial aerospace products. Total aerospace and defense sales were 58% of total sales for the second quarter 2023. Our gross profit for the second quarter of 2023 was $209.1 million, or 20.0% of sales, compared to $175.3 million, or 18.3% of sales, for the second quarter 2022. This $33.8 million increase in gross profit, reflects strong results for our HPMC segment as well as the benefits of our ongoing transformation focused on the key growth markets of aerospace and defense, and our streamlined value-add production capabilities. Second quarter 2023 gross profit includes $4.5 million of start-up related costs and $2.8 million of other charges primarily related to asset write-offs for the closure of our Robinson, PA operations.

Second quarter 2023 results include a $0.6 million loss on the sale of our Northbrook, IL operations and second quarter 2022 results include a $115.9 million loss on the sale of the Sheffield, UK operations, both of which are reported in loss on asset sales and sales of businesses, net. Restructuring charges were $2.7 million for the second quarter of 2023 primarily related to severance for involuntary reductions across ATI’s domestic operations in conjunction with our continued transformation, while the second quarter of 2022 included $1.3 million of restructuring-related credits primarily related to lowered severance-related reserves based on changes in planned operating rates and revised workforce reduction estimates. Both the losses on sales and restructuring charges/credits are excluded from segment results. Also, nonoperating income for the second quarter of 2022 included a $9.9 million benefit from the A&T Stainless joint venture’s settlement of Section 232 claims, which is included in

AA&S segment results. In addition, nonoperating retirement benefit expense increased to $16.9 million in the second quarter of 2023 compared to $6.6 million in the second quarter of 2022.

Our pre-tax income was $82.8 million in the second quarter of 2023, compared to a loss of $30.9 million in the prior year period. Income tax expense for the second quarters of 2023 and 2022 was $3.7 million and $3.4 million, respectively, primarily related to our Asian precision rolled strip business. ATI continues to maintain a valuation allowance on its U.S. deferred tax assets. Net income attributable to ATI was $76.0 million, or $0.52 per share, in the second quarter of 2023, compared to a loss of $38.0 million, or ($0.31) per share, for the second quarter of 2022.

Adjusted EBITDA was $149.8 million, or 14.3% of sales, for the second quarter 2023, and $143.1 million, or 14.9% of sales, for the prior year second quarter. EBITDA and Adjusted EBITDA are measures utilized by ATI that we believe are useful to investors because these measures are commonly used to analyze companies on the basis of operating performance, leverage and liquidity. Furthermore, analogous measures are used by industry analysts to evaluate operating performance. EBITDA and Adjusted EBITDA are non-GAAP measures and are not intended to represent, and should not be considered more meaningful than, or as alternatives to, a measure of operating performance as determined in accordance with U.S. generally accepted accounting principles (U.S. GAAP). We categorically define EBITDA as income from continuing operations before interest and income taxes, plus depreciation and amortization, goodwill impairment charges and debt extinguishment charges. We categorically define Adjusted EBITDA as EBITDA excluding significant non-recurring charges or credits, restructuring charges/credits, strike related costs, long-lived asset impairments and other postretirement/pension curtailment and settlement gains and losses. EBITDA and Adjusted EBITDA are not intended to be measures of free cash flow for management’s discretionary use, as they do not consider certain cash requirements such as interest payments, tax payments and capital expenditures. See the Liquidity and Financial Condition section of Management’s Discussion and Analysis for a reconciliation of amounts reported under U.S. GAAP to these non-GAAP measures.

Compared to the second quarter 2022, sales increased 33% in the HPMC business segment and decreased 8% in the AA&S business segment. In aggregate, ATI’s aerospace & defense markets sales increased 39% to $607 million in the second quarter 2023, compared to $436 million the second quarter 2022, reflecting increasing demand for commercial aerospace jet engine and airframe products. In the HPMC segment, second quarter 2023 sales of aerospace and defense products increased 38% compared to the prior year period. The decline in the AA&S segment reflects recessionary softness in general industrial end markets and lingering COVID impacts associated with our Asian precision rolled strip business. In the AA&S segment, second quarter 2023 sales of commercial aerospace products increased 49% compared to the prior year period.

Results for the first six months of 2023 were sales of $2.08 billion and income before tax of $159.3 million, compared to sales of $1.79 billion and income before tax of $9.2 million for the first six months of 2022. Our results for the first half of 2023 reflect the ongoing recovery across many of our key end markets, most notably jet engine materials and components, compared to the prior year period. Our gross profit was $402 million, or 19.3% of sales, a $58 million or 16.7% increase compared to the first six months of 2022. Second quarter 2023 gross profit includes $5.7 million of start-up related costs and $2.8 million of other charges primarily related to asset write-offs for the closure of our Robinson, PA operations. Results in the first six months of 2022 include $34.3 million of benefits from management actions to access available grants and other forms of COVID-19 relief available from previously-enacted U.S. legislation. These benefits included a $16.8 million grant under the Aviation Manufacturing Jobs Protection (AMJP) program for our operations in the HPMC segment, and $17.5 million in employee retention credits applicable across all of ATI’s domestic operations, largely for preserving jobs throughout the global pandemic-related economic downturn.

The six month 2023 results include a $0.6 million loss on the sale of our Northbrook, IL operations. The six month 2022 results include a $141.0 million loss on the sale of the Sheffield, UK operations, of which $25.1 million was recorded in the first quarter of 2022 primarily for the impairment of long-lived assets. Loss on asset sales and sales of businesses, net, for the first six months of 2022 also included a $6.8 million gain from the sale of assets from our Pico Rivera, CA operations as part of the strategy to exit standard stainless products. Restructuring charges were $2.7 million for the six months of 2023 primarily related to severance for the involuntary reductions across ATI’s domestic operations in conjunction with our continued transformation, while the six months of 2022 included $2.4 million of restructuring-related credits primarily related to lowered severance-related reserves based on changes in planned operating rates and revised workforce reduction estimates. Both the losses on sales and restructuring charges/credits are excluded from segment results. Other nonoperating income for the first six months of 2022 includes a $9.9 million benefit from the A&T Stainless joint venture’s settlement of Section 232 claims, which is included in AA&S segment results, and $8.6 million of expense for a litigation reserve. In addition, nonoperating retirement benefit expense increased to $33.7 million in the six months of 2023 compared to $12.4 million in the prior year period.

Our pre-tax income was $159.3 million in the first six months of 2023, compared to $9.2 million in the prior year period. Net income attributable to ATI was $146.1 million, or $1.01 per share, in the first six months of 2023, compared to a net loss attributable to ATI of $7.1 million, or ($0.06) per share, for the first six months of 2022.

Compared to the first six months of 2022, sales increased 35% in the HPMC business segment and 3% in the AA&S business segment. Sales to the aerospace & defense markets in the HPMC segment were 45% higher than the first six months of 2022, due to improvements in the commercial aerospace market. AA&S sales reflect a 53% increase in the aerospace & defense markets and 20% increase in the energy market, partially offset by recessionary softness in general industrial end markets and lingering COVID impacts associated with our Asian precision rolled strip business.

Comparative information regarding our overall revenues (in millions) by end market and their respective percentages of total revenues for the three and six month periods ended June 30, 2023 and 2022 is shown below.

For the second quarter 2023, international sales of $478 million, or 46% of total sales, increased from $391 million in the second quarter 2022. ATI’s international sales are mostly to the aerospace, energy, electronics, automotive and medical markets.

Comparative information regarding our major products based on their percentages of revenues are shown below. HRPF conversion service sales in the AA&S segment are excluded from this presentation.

Segment EBITDA for the second quarter 2023 was $171.3 million, or 16.4% of sales, compared to segment EBITDA of $164.9 million, or 17.2% of sales, for the second quarter of 2022. Segment EBITDA for the first six months of 2023 was $324.1 million, or 15.6% of sales, compared to segment EBITDA of $308.3 million, or 17.2% of sales, for the first six months of 2022. Our measure of segment EBITDA, which we use to analyze the performance and results of our business segments, categorically excludes income taxes, depreciation and amortization, corporate expenses, net interest expense, closed operations and other income (expense), charges for goodwill and asset impairments, restructuring and other credits/charges, strike related costs, debt extinguishment charges and gains or losses on asset sales and sales of businesses. Results on our management basis of reporting were as follows (in millions):

As part of managing the performance of our business, we focus on controlling Managed Working Capital, which we define as gross accounts receivable, short-term contract assets and gross inventories, less accounts payable and short-term contract liabilities. We exclude the effects of inventory valuation reserves and reserves for uncollectible accounts receivable when computing this non-GAAP performance measure, which is not intended to replace Working Capital or to be used as a measure of liquidity. We assess Managed Working Capital performance as a percentage of the prior three months annualized sales to evaluate the asset intensity of our business. At June 30, 2023, Managed Working Capital increased as a percentage of annualized total ATI sales to 39.0% compared to 30.1% at December 31, 2022. The Managed Working Capital increase was impacted by increased inventory levels in the second quarter of 2023 as a result of additional melt capacity coming on line, increased production levels, and a strategic nickel purchase to ensure continuity of supply, which was funded by a $50 million draw on our ABL credit facility. Days sales outstanding, which measures actual collection timing for accounts receivable, worsened by 2% as of June 30, 2023 compared to year end 2022. Gross inventory turns decreased 12% as of June 30, 2023 compared to year end 2022.

The computations of Managed Working Capital at June 30, 2023 and December 31, 2022, reconciled to the financial statement line items as computed under U.S. GAAP, were as follows.

(In millions)

Business Segment Results

High Performance Materials & Components Segment

Second quarter 2023 sales were $527.1 million, increasing 33% compared to the second quarter 2022, reflecting increasing commercial aerospace demand. Sales to the commercial aerospace market increased 40%, reflecting a 38% increase in commercial jet engines. Overall aerospace and defense market sales were 83% of total HPMC sales in the second quarter of 2023.

Comparative information for our HPMC segment revenues (in millions) by market and their respective percentages of the segment’s overall revenues for the three month periods ended June 30, 2023 and 2022 is as follows:

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International sales represented 58% of total segment sales for the second quarter 2023, compared to 55% in the prior year period. Comparative information for the HPMC segment’s major product categories, based on their percentages of revenue for the three months ended June 30, 2023 and 2022, is as follows:

Segment EBITDA in the second quarter 2023 increased to $108.1 million, or 20.5% of total sales, compared to $60.3 million, or 15.2% of total sales, for the second quarter 2022. Strength in the HPMC segment continues to be driven by content on next-generation commercial aerospace platforms. Results in the second quarter 2022 included $5.6 million of benefits from AMJP program grants.

Sales for the first six months of 2023 were $998.2 million, increasing 35% compared to the first six months of 2022, reflecting increasing commercial aerospace demand. Sales to the commercial aerospace market increased 51%, reflecting a 47% increase in commercial jet engines. Sales to the energy markets decreased 30%, mainly due to lower oil and gas sales.

Comparative information for our HPMC segment revenues (in millions) by market and their respective percentages of the segment’s overall revenues for the six month periods ended June 30, 2023 and 2022 is as follows:

International sales represented 58% of total segment sales for the first six months of 2023. Comparative information for the HPMC segment’s major product categories, based on their percentages of revenue for the six months ended June 30, 2023 and 2022, is as follows:

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Segment EBITDA in the first six months of 2023 increased to $188.2 million, or 18.9% of total sales, compared to $128.4 million, or 17.4% of total sales, for the first six months of 2022. Strength in the HPMC segment continues to be driven by content on next-generation commercial aerospace platforms. Results in the first half of 2022 included $27.5 million of benefits from the AMJP program and employee retention credits.

HPMC results for the first half of 2023, which include the highest quarterly EBITDA margins for the second quarter of 2023 since prior to the COVID-19 pandemic, reflect improving operating leverage from higher production volumes as the aerospace and defense markets continue to grow. We are seeing an ongoing improvement in demand in many of our key end markets, most notably jet engine materials and components. Increasing demand for travel benefits ATI, and we believe we are well positioned to capture this growth in the future. We are investing in additional capacity to meet growing demand, including our recently announced expansion in Richland, Washington, so that we are well-positioned to capitalize on market opportunities.

Advanced Alloys & Solutions Segment

Second quarter 2023 sales were $518.9 million, decreasing 8% compared to the second quarter of 2022, primarily due to recessionary softness in general industrial end markets and lingering COVID impacts associated with our Asian precision rolled strip business. Sales of commercial aerospace products increased by nearly 50% compared to the prior year period, due in part to a significant increase in commercial airframe demand for various flat-rolled product forms.

Comparative information regarding our AA&S segment revenues (in millions) by market and their respective percentages of the segment’s overall revenues for the three month periods ended June 30, 2023 and 2022 is shown below.

International sales represented 33% of total segment sales for the second quarter 2023, compared to 31% in the prior year’s second quarter. Comparative information regarding the AA&S segment’s major product categories, based on their percentages of revenue for the three months ended June 30, 2023 and 2022, are presented in the following table. HRPF conversion service sales are excluded from this presentation.

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Segment EBITDA was $63.2 million, or 12.2% of sales, for the second quarter 2023, compared to segment EBITDA of $104.6 million, or 18.6% of sales, for the second quarter 2022. Reduced deliveries of nickel based alloys and precision rolled strip products in the second quarter 2023 were only partially offset by increases in titanium plate deliveries. Higher retirement benefit costs negatively impacted 2023 operating margins compared to 2022. Second quarter 2022 AA&S results included a $9.9 million benefit from the A&T Stainless joint venture’s settlement of Section 232 tariff claims.

Sales for the first six months of 2023 were $1.09 billion, increasing 3% compared to the first six months of 2022. Sales to the aerospace & defense markets increased 53%, with a 60% increase in sales of commercial aerospace products, due in part to a significant increase in commercial airframe demand for various flat-rolled product forms. Sales to the energy markets were 20% higher than the prior year period, with both oil & gas and specialty energy markets seeing stronger demand. These favorable trends were partially offset by recessionary softness in general industrial end markets and lingering COVID impacts associated with our Asian precision rolled strip business.

Comparative information regarding our AA&S segment revenues (in millions) by market and their respective percentages of the segment’s overall revenues for the six month periods ended June 30, 2023 and 2022 is shown below.

International sales represented 32% of total segment sales for the first six months of 2023. Comparative information regarding the AA&S segment’s major product categories, based on their percentages of revenue for the six months ended June 30, 2023 and 2022, are presented in the following table. HRPF conversion service sales are excluded from this presentation.

Segment EBITDA was $135.9 million, or 12.5% of sales, for the first six months of 2023, compared to segment EBITDA of $179.9 million, or 17.0% of sales, for the first six months of 2022. A stronger mix of nickel and titanium mill products was offset by weaker demand for precision rolled strip products and higher retirement benefit expense, which contributed to the margin decline year over year. First half 2022 segment EBITDA includes a $9.9 million benefit from the A&T Stainless joint venture’s settlement of Section 232 tariff claims and $6.8 million of employee retention credits.

With the AA&S business transformation and footprint consolidation nearly complete, we believe we are well positioned for continued future growth. With our titanium melt shop in Albany, Oregon planning to be fully operational in the third quarter of 2023, we are well positioned to capitalize on the aerospace ramp. Sales of commercial airframe flat-form products in the AA&S segment are projected to increase over the longer term due in part to the repositioning of the commercial aerospace supply chain in response to the Russia/Ukraine conflict. While availability of raw materials for our melting processes remains adequate during the ongoing Russia/Ukraine conflict, changes in raw material prices may cause variability in profit margins based on the timing of index pricing mechanisms.

Corporate Items

Corporate expenses for the second quarter of 2023 were $18.1 million, compared to $16.7 million for the second quarter 2022. For the six months ended June 30, 2023, corporate expenses were $35.4 million, compared to $33.7 million for the six months ended June 30, 2022.

Closed operations and other expense for the second quarter 2023 was $3.4 million, compared to $5.1 million for the second quarter 2022. For the six months ended June 30, 2023, closed operations and other expense was $6.2 million, compared to $6.5 million for the six months ended June 30, 2022. These decreases reflect changes in foreign currency remeasurement impacts primarily related to ATI’s European Treasury operation partially offset by higher costs in 2023 associated with insurance matters at closed operations and increased retirement benefit expense.

The following table shows depreciation & amortization for the relevant periods by each business segment. Depreciation expense in the second quarter and six months ended June 30, 2023 includes $0.8 million of accelerated depreciation on fixed assets for the closure of our Robinson, PA operations.

Interest expense, net of interest income, in the second quarter 2023 was $21.3 million, compared to $23.4 million for the second quarter 2022. On a year-to-date basis, net interest expense was $41.2 million for the first six months of 2023 compared to $47.0 million for the first six months of 2022. Capitalized interest reduced interest expense by $3.3 million in the second quarter 2023 and $0.4 million in the second quarter 2022. For the six months ended June 30, 2023 and 2022, capitalized interest was $6.7 million and $0.6 million, respectively.

Restructuring and other charges of $9.2 million for the second quarter ended June 30, 2023 include $2.7 million of severance-related restructuring charges for the involuntary reduction of approximately 40 employees across ATI’s domestic operations in conjunction with our continued transformation, as well as $4.5 million of start up costs and $2.0 million primarily for asset write-offs for the closure of our Robinson, PA operations, both of which are included within cost of sales on the consolidated statements of operations. Restructuring and other charges of $10.4 million for the six months ended June 30, 2023 also include $1.2 million of additional start-up costs related to the Company’s titanium operations in Albany, OR, which are included within cost of sales on the consolidated statements of operations. Restructuring charges for the second quarter ended June 30, 2022 were a credit of $1.3 million, for a reduction in severance-related reserves related to approximately 30 employees based on changes in planned operating rates and revised workforce reduction estimates. Restructuring and other charges for the six months ended June 30, 2022 were $6.2 million, as an $8.6 million charge for a litigation reserve relating to our indefinitely idled Rowley, UT titanium sponge production facility was partially offset by a $2.4 million restructuring credit for a reduction in severance-related reserves related to approximately 50 employees based on changes in planned operating rates and revised workforce reduction estimates. These items were excluded from segment EBITDA. Cash payments associated with prior restructuring programs were $0.8 million in the first six months of 2023. Of the $11.7 million of remaining reserves associated with these restructuring actions as of June 30, 2023, $7.2 million are expected to be paid within the next year.

Loss on asset sales and sales of businesses, net, for the second quarter and six months ended June 30, 2023 is related to a $0.6 million loss on the sale of the Company’s Northbrook, IL operations for which no proceeds were received but $0.3 million of transaction costs were paid and reported as an investing activity on the consolidated statement of cash flows. Loss on asset sales and sales of businesses, net, for the second quarter of 2022 was $115.9 million for the loss on the sale of the Company’s Sheffield, UK operation. Loss on asset sales and sales of businesses, net, for the first six months of 2022 was $134.2 million, including a $141.0 million loss on the sale of the Company’s Sheffield, UK operations, of which $25.1 million was recorded in the first quarter of 2022 primarily for the impairment of long-lived assets, and a $6.8 million gain from the sale of assets from our Pico Rivera, CA operations. These items are excluded from segment EBITDA.

Income Taxes

The provision for income taxes for the second quarter and six months ended June 30, 2023 was $3.7 million and $8.0 million, respectively. The provision for income taxes for the second quarter and six months ended June 30, 2022 was $3.4 million and $8.3 million, respectively. Tax expense in both periods is mainly attributable to our foreign operations and was based on an estimated annual effective tax rate calculation which included foreign, non-valuation allowance operations combined with the U.S. jurisdiction. The 2022 calculation excluded the results related to our Sheffield, UK operations, which was sold in the second quarter of 2022.

In the second quarter 2020, we entered into a three-year cumulative loss within the United States, limiting our ability to utilize future projections when analyzing the need for a deferred tax asset valuation allowance, therefore limiting sources of income as part of the analysis. We continue to maintain valuation allowances on our U.S. federal and state deferred tax assets, as well as for certain foreign jurisdictions.

Liquidity and Financial Condition

We have an Asset Based Lending (ABL) Credit Facility, which is collateralized by the accounts receivable and inventory of our operations. The ABL facility also provides us with the option of including certain machinery and equipment as additional collateral for purposes of determining availability under the facility. The ABL facility, which matures in September 2027, includes a $600 million revolving credit facility, a letter of credit sub-facility of up to $200 million, a $200 million term loan (Term Loan), and a swing loan facility of up to $60 million. The Term Loan has an interest rate of 2.0% above adjusted Secured Overnight Financing Rate (SOFR) and can be prepaid in increments of $25 million if certain minimum liquidity conditions are satisfied. In addition, we have the right to request an increase of up to $300 million in the maximum amount available under the revolving credit facility for the duration of the ABL.

The applicable interest rate for revolving credit borrowings under the ABL facility includes interest rate spreads based on available borrowing capacity that range between 1.25% and 1.75% for SOFR-based borrowings and between 0.25% and 0.75% for base rate borrowings. The ABL facility contains a financial covenant whereby we must maintain a fixed charge coverage ratio of not less than 1.00:1.00 after an event of default has occurred and is continuing or if the undrawn availability under the ABL revolving credit portion of the facility is less than the greater of (i) 10% of the then applicable maximum loan amount under the revolving credit portion of the ABL and the outstanding Term Loan balance, or (ii) $60.0 million. We were in compliance with the fixed charge coverage ratio as of June 30, 2023. Additionally, we must demonstrate minimum liquidity specified by the facility during the 90-day period immediately preceding the stated maturity date of our 3.5% Convertible Senior Notes due 2025 and the 6.95% Debentures due 2025 issued by our wholly owned subsidiary, Allegheny Ludlum LLC. The ABL also contains customary affirmative and negative covenants for credit facilities of this type, including limitations on our ability to incur additional indebtedness or liens or to enter into investments, mergers and acquisitions, dispositions of assets and transactions with affiliates, some of which are more restrictive, at any time during the term of the ABL when our fixed charge coverage ratio is less than 1.00:1.00 and our undrawn availability under the revolving portion of the ABL is less than the greater of (a) $120 million or (b) 20% of the sum of the maximum loan amount under the revolving credit portion of the ABL and the outstanding Term Loan balance.

As of June 30, 2023, there were $50 million of outstanding borrowings under the revolving portion of the ABL facility, and $39.4 million was utilized to support the issuance of letters of credit. At June 30, 2023, we had $267 million of cash and cash equivalents, and available additional liquidity under the ABL facility of approximately $500 million.

During the second quarter of 2022, $82.5 million of the 2022 Convertible Senior Notes were converted into 5.7 million shares of ATI common stock, with the remaining $1.7 million of outstanding principal balance paid in cash for notes that were not converted. The conversion rate for the 2022 Convertible Notes was 69.2042 shares of ATI common stock per $1,000 principal amount of the 2022 Convertible Notes, equivalent to a conversion price of $14.45 per share.

In the first quarter 2023, the Company made $50 million in voluntary cash contributions to its U.S. qualified defined benefit pension plans to improve the plans’ funded position. Based on current actuarial assumptions, we are not required to make any further contributions to these pension plans during fiscal year 2023, and our prior contributions have generated a credit balance that may be utilized to offset future minimum required contributions. We may elect to contribute additional amounts to these pension plans to improve their funded position, or we may elect to use a portion of our credit balance in lieu of cash contributions based on other capital allocation priorities.

On February 2, 2022, we announced that our Board of Directors authorized the repurchase of up to $150 million of ATI stock. In the six months ended June 30, 2023 and 2022, we used $10.1 million and $89.9 million, respectively, to repurchase 0.2 million and 3.5 million shares, respectively, of our common stock under the $150 million program. In addition, on April 28, 2023, our Board of Directors authorized the repurchase of an additional $75 million of ATI stock. Repurchases under these programs were or may be made in the open market or in privately negotiated transactions, with the amount and timing of repurchases depending on market conditions and corporate needs. Open market repurchases are structured to occur within the pricing and volume requirements of SEC Rule 10b-18. Our ongoing stock repurchase programs do not obligate the Company to repurchase any specific number of shares and may be modified, suspended, or terminated at any time by the Board of Directors without prior notice.

We believe that internally generated funds, current cash on hand and available borrowings under the ABL facility will be adequate to meet our liquidity needs, including currently projected required contributions to our pension plans. We do not expect to pay any significant U.S. federal or state income taxes in 2023. If we needed to obtain additional financing using the credit markets, the cost and the terms and conditions of such borrowings may be influenced by our credit rating. In addition, we regularly review our capital structure, various financing alternatives and conditions in the debt and equity markets in order to opportunistically enhance our capital structure. In connection therewith, we may seek to refinance or retire existing indebtedness, incur new or additional indebtedness or issue equity or equity-linked securities, in each case, depending on market and other conditions. We have no off-balance sheet arrangements as defined in Item 303(a)(4) of SEC Regulation S-K.

In managing our overall capital structure, we focus on the ratio of net debt to Adjusted EBITDA, which we use as a measure of our ability to repay our incurred debt. We define net debt as the total principal balance of our outstanding indebtedness excluding deferred financing costs, net of cash, at the balance sheet date. See the explanations above for our definitions of Adjusted EBITDA and EBITDA, which are non-GAAP measures and are not intended to represent, and should not be considered more meaningful than, or as alternatives to, a measure of operating performance as determined in accordance with U.S. GAAP. Our ratio of net debt to Adjusted EBITDA (Adjusted EBITDA Leverage Ratio) measures net debt at the balance sheet date to Adjusted EBITDA as calculated on the trailing twelve-month period from this balance sheet date.

Our Debt to Adjusted EBITDA Leverage Ratio in the second quarter of 2023 remained fairly comparable to year end 2022. Our Net Debt to Adjusted EBITDA Leverage ratio worsened in the second quarter of 2023 compared to year end 2022, largely due to a decreased cash balance. The reconciliations of our Adjusted EBITDA Leverage Ratios to the balance sheet and income statement amounts as reported under U.S. GAAP are as follows:

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Cash Flow

For the six months ended June 30, 2023, cash used in operations was $217.1 million, primarily related to higher accounts receivable and inventory balances due to increased operating levels and input costs and a strategic nickel purchase in 2023 to ensure continuity of supply. Working capital balances, and consequently cash from operations, can fluctuate throughout any operating period based upon the timing of receipts from customers and payments to vendors. However, we actively manage our working capital to ensure the required flexibility to meet our strategic objectives. Other significant 2023 operating cash flow items included $50 million in contributions to the U.S. defined benefit pension plans and the payment of 2022 annual incentive compensation. For the six months ended June 30, 2022, cash used in operations was $222.4 million, primarily related to higher accounts receivable and inventory balances, despite improved operating results. Increased operating levels, higher sales, increased raw material values and strategic inventory purchase actions to ensure adequate raw material availability all contributed to these operating cash flow uses. Other significant 2022 operating cash flow items included the payment of 2021 annual incentive compensation.

Cash used in investing activities was $100.8 million in the first six months of 2023, reflecting $103.3 million in capital expenditures primarily related to AA&S transformation projects and various HPMC growth projects. For the six months ended June 30, 2022, cash used in investing activities was $55.7 million, reflecting $54.8 million in capital expenditures. We expect to fund our capital expenditures with cash on hand and cash flow generated from our operations and, if needed, by using a portion of the ABL facility.

Cash provided by financing activities was $1.0 million in the first six months of 2023 and included $50 million of borrowings under the Company’s ABL Credit Facility and $10.1 million of payments for the repurchase of 0.2 million shares of ATI stock under the $150 million repurchase program authorized by our Board of Directors on February 2, 2022. For the six months ended June 30, 2022, cash used in financing activities was $135.6 million and included $89.9 million for repurchase of 3.5 million shares of ATI stock and a $16 million dividend payment to the 40% noncontrolling interest in our PRS joint venture in China.

At June 30, 2023, cash and cash equivalents on hand totaled $267.1 million, a decrease of $316.9 million from year end 2022. Cash and cash equivalents held by our foreign subsidiaries was $110.7 million at June 30, 2023, of which $70.5 million was held by the STAL joint venture.

Critical Accounting Policies

Asset Impairment

We monitor the recoverability of the carrying value of our long-lived assets. An impairment charge is recognized when the expected net undiscounted future cash flows from an asset’s use (including any proceeds from disposition) are less than the asset’s carrying value, and the asset’s carrying value exceeds its fair value. Changes in the expected use of a long-lived asset group, and the financial performance of the long-lived asset group and its operating segment, are evaluated as indicators of possible impairment. Future cash flow value may include appraisals for property, plant and equipment, land and improvements, future cash flow estimates from operating the long-lived assets, and other operating considerations. In the fourth quarter of each year in conjunction with the annual business planning cycle, or more frequently if new material information is available, we evaluate the recoverability of idled facilities.

As of March 31, 2022, our Sheffield, UK operations were classified as held for sale, and the terms of sale resulted in indicators of impairment in the long-lived assets of this disposal group. A $22.3 million long-lived asset impairment charge was recorded in the first quarter 2022, reported as part of the $141.0 million loss on sale of this business for the six months ended June 30, 2022. This long-lived asset impairment charge was determined using the held for sale framework and represents Level 1 information in the fair value hierarchy.

Goodwill is reviewed annually in the fourth quarter of each year for impairment or more frequently if impairment indicators arise. Other events and changes in circumstances may also require goodwill to be tested for impairment between annual measurement dates. At June 30, 2023, we had $227.2 million of goodwill on our consolidated balance sheet. All goodwill relates to reporting units in the HPMC segment.

Management concluded that none of ATI’s reporting units or long-lived assets experienced any triggering event that would have required an interim impairment analysis at June 30, 2023.

Income Taxes

The provision for income taxes includes deferred taxes resulting from temporary differences in income for financial and tax purposes using the liability method. Such temporary differences result primarily from differences in the carrying value of assets and liabilities. Future realization of deferred income tax assets requires sufficient taxable income within the carryback and/or carryforward period available under tax law. On a quarterly basis, we evaluate the realizability of our deferred tax assets.

The evaluation includes the consideration of all available evidence, both positive and negative, regarding historical operating results including recent years with reported losses, the estimated timing of future reversals of existing taxable temporary differences, estimated future taxable income exclusive of reversing temporary differences and carryforwards, and potential tax planning strategies which may be employed to prevent an operating loss or tax credit carryforward from expiring unused. In situations where a three-year cumulative loss condition exists, accounting standards limit the ability to consider projections of future results as positive evidence to assess the realizability of deferred tax assets. Valuation allowances are established when it is estimated that it is more likely than not that the tax benefit of the deferred tax asset will not be realized.

Since the second quarter of 2020, our results reflected a three year cumulative loss from U.S. operations. As a result, we established deferred tax asset valuation allowances in the second quarter of 2020 on our U.S. Federal and state deferred tax assets. In 2023 and 2022, ATI continues to maintain income tax valuation allowances on its U.S. Federal and state deferred tax assets. In addition, we have $70.4 million of valuation allowances on amounts recorded in other comprehensive loss as of June 30, 2023.

While we remain in a cumulative loss condition, our ability to evaluate the realizability of deferred tax assets is generally limited to the ability to offset timing differences on taxable income associated with deferred tax liabilities. Therefore, a change in estimate of deferred tax asset valuation allowances for federal, state, or foreign jurisdictions during this cumulative loss condition period will primarily be affected by changes in estimates of the time periods that deferred tax assets and liabilities will be realized, or on a limited basis to tax planning strategies that may result in a change in the amount of taxable income realized.

Retirement Benefits

In accordance with accounting standards, we determine the discount rate used to value pension plan liabilities as of the last day of each year. The discount rate reflects the current rate at which the pension liabilities could be effectively settled. In estimating this rate, we receive input from our actuaries regarding the rate of return on high quality, fixed income investments with maturities matched to the expected future retirement benefit payments. The estimated effect at the year end 2022 valuation date of an increase in the discount rate by 0.50% would decrease pension liabilities by approximately $90 million. The effect on pension liabilities for changes to the discount rate, the difference between expected and actual plan asset returns, and the net effect of other changes in actuarial assumptions and experience are deferred and amortized over future periods in accordance with accounting standards.

For ERISA (Employee Retirement Income Security Act of 1974, as amended) funding purposes, discount rates used to measure pension liabilities for U.S. qualified defined benefit plans are calculated on a different basis using an IRS-determined segmented yield curve, which currently results in a higher discount rate than the discount rate methodology required by accounting standards. Funding requirements are also affected by IRS-determined mortality assumptions, which may differ from those used under accounting standards.

We have certain collective bargaining agreements that include participation in a multiemployer pension plan. Under current law, an employer that withdraws or partially withdraws from a multiemployer pension plan may incur a withdrawal liability to the plan, which represents the portion of the plan’s underfunding that is allocable to the withdrawing employer under very complex actuarial and allocation rules. A subsidiary of the Company participates in the Steelworkers Western Independent Shops Pension Plan (WISPP) for union-represented employees of our primary titanium operations in Albany, OR, which is funded on an hours-worked basis. Manufacturing operations at this facility were idled throughout 2021 and most of 2022, with a limited number of employees that participate in the WISPP remaining active in maintenance and other functions. It is reasonably possible that a significant reduction or the elimination of hours-worked contributions due to changes in operating rates at this facility could result in a withdrawal liability assessment in a future period. A complete withdrawal liability is estimated to be approximately $27 million on an undiscounted basis, based on information for the plan year ended September 30, 2022, which is the most recent information available from the Plan Administrator. If this complete withdrawal liability was incurred, ATI estimates that payments of the obligation would be required on a straight-line basis over a 15-year period.

Other Critical Accounting Policies

A summary of other significant accounting policies is discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note 1 to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2022.

The preparation of the financial statements in accordance with U.S. generally accepted accounting principles requires us to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities. Significant areas of uncertainty that require judgments, estimates and assumptions include the accounting for derivatives, retirement plans, income taxes, environmental and other contingencies, as well as asset impairment, inventory valuation and collectability of accounts receivable. We use historical and other information that we consider to be relevant to make these judgments and estimates. However, actual results may differ from those estimates and assumptions that are used to prepare our financial statements.

Pending Accounting Pronouncements

See Note 1 of the Notes to Consolidated Financial Statements for information on new and pending accounting pronouncements.

Forward-Looking and Other Statements

From time to time, we have made and may continue to make “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Certain statements in this report relate to future events and expectations and, as such, constitute forward-looking statements. Forward-looking statements include those containing such words as “anticipates,” “believes,” “estimates,” “expects,” “would,” “should,” “will,” “will likely result,” “forecast,” “outlook,” “projects,” and similar expressions. Forward-looking statements are based on management’s current expectations and include known and unknown risks, uncertainties and other factors, many of which we are unable to predict or control, that may cause our actual results, performance or achievements to differ materially from those expressed or implied in the forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include: (a) material adverse changes in economic or industry conditions generally, including global supply and demand conditions and prices for our specialty materials and changes in international trade duties and other aspects of international trade policy; (b) material adverse changes in the markets we serve; (c) our inability to achieve the level of cost savings, productivity improvements, synergies, growth or other benefits anticipated by management, from strategic investments and the integration of acquired businesses; (d) volatility in the price and availability of the raw materials that are critical to the manufacture of our products; (e) declines in the value of our defined benefit pension plan assets or unfavorable changes in laws or regulations that govern pension plan funding; (f) labor disputes or work stoppages; (g) equipment outages; (h) the risks of business and economic disruption associated with extraordinary events beyond our control, such as war, terrorism, international conflicts, public health issues, such as epidemics or pandemics, natural disasters and climate-related events that may arise in the future; and (i) other risk factors summarized in our Annual Report on Form 10-K for the year ended December 31, 2022, and in other reports filed with the Securities and Exchange Commission. We assume no duty to update our forward-looking statements.

As part of our risk management strategy, we utilize derivative financial instruments, from time to time, to hedge our exposure to changes in energy and raw material prices, foreign currencies, and interest rates. We monitor the third-party financial institutions which are our counterparties to these financial instruments on a daily basis and diversify our transactions among counterparties to minimize exposure to any one of these entities. Fair values for derivatives were measured using exchange-traded prices for the hedged items including consideration of counterparty risk and the Company’s credit risk. Our exposure to volatility in interest rates is presently not material, as nearly all of our debt is at fixed interest rates.

Volatility of Interest Rates. We may enter into derivative interest rate contracts to maintain a reasonable balance between fixed- and floating-rate debt. The Company has a $50 million floating-for-fixed interest rate swap which converts a portion of the Term Loan to a 4.21% fixed rate. The swap matures in June 2024. The Company designated the interest rate swap as a cash flow hedge of the Company’s exposure to the variability of the payment of interest on a portion of its Term Loan borrowings. The ineffectiveness at hedge inception, determined from the fair value of the swap immediately prior to its July 2019 amendment, was amortized to interest expense over the initial Term Loan swap maturity date of January 12, 2021. Any gain or loss associated with this hedging arrangement is included in interest expense. At June 30, 2023, the net mark-to-market valuation of the outstanding interest rate swap was an unrealized pre-tax gain of $1.5 million, all of which is in prepaid expenses and other current assets on the balance sheet.

Volatility of Energy Prices. Energy resource markets are subject to conditions that create uncertainty in the prices and availability of energy resources. The prices for and availability of electricity, natural gas, oil and other energy resources are subject to volatile market conditions. These market conditions often are affected by political and economic factors beyond our control. Increases in energy costs, or changes in costs relative to energy costs paid by competitors, have and may continue to adversely affect our profitability. To the extent that these uncertainties cause suppliers and customers to be more cost sensitive, increased energy prices may have an adverse effect on our results of operations and financial condition. We use approximately 6 to 8 million MMBtu’s of natural gas annually, depending upon business conditions, in the manufacture of our products. These purchases of natural gas expose us to the risk of higher gas prices. For example, a hypothetical $1.00 per MMBtu increase in the price of natural gas would result in increased annual energy costs of approximately $6 to $8 million. We use several approaches to minimize any material adverse effect on our results of operations or financial condition from volatile energy prices. These approaches include incorporating an energy surcharge on many of our products and using financial derivatives to reduce exposure to energy price volatility.

At June 30, 2023, the outstanding financial derivatives used to hedge our exposure to energy cost volatility included natural gas hedges. Approximately 80% of our forecasted domestic requirements for natural gas for the remainder of 2023, approximately 50% for 2024 and 15% for 2025 are hedged. At June 30, 2023, the net mark-to-market valuation of these outstanding natural gas hedges was an unrealized pre-tax loss of $4.0 million, comprised of $0.2 million in prepaid expenses and other current assets, $0.3 million in other long-term assets, $3.6 million in other current liabilities and $0.9 million in other long-term liabilities on the balance sheet. For the three months ended June 30, 2023, natural gas hedging activity increased cost of sales by $2.4 million.

Volatility of Raw Material Prices. We use raw materials surcharge and index mechanisms to offset the impact of increased raw material costs; however, competitive factors in the marketplace can limit our ability to institute such mechanisms, and there can be a delay between the increase in the price of raw materials and the realization of the benefit of such mechanisms. For example, in 2022, we used approximately 70 million pounds of nickel; therefore, a hypothetical change of $1.00 per pound in nickel prices would result in increased costs of approximately $70 million. While we enter into raw materials futures contracts from time-to-time to hedge exposure to price fluctuations, such as for nickel, we cannot be certain that our hedge position adequately reduces exposure. We believe that we have adequate controls to monitor these contracts, but we may not be able to accurately assess exposure to price volatility in the markets for critical raw materials.

The majority of our products are sold utilizing raw material surcharges and index mechanisms. However, as of June 30, 2023, we had entered into financial hedging arrangements, primarily at the request of our customers related to firm orders, for an aggregate notional amount of approximately 8 million pounds of nickel with hedge dates through 2024. The aggregate notional amount hedged is approximately 10% of a single year’s estimated nickel raw material purchase requirements. These derivative instruments are used to hedge the variability of a selling price that is based on the London Metal Exchange (LME) index for nickel, as well as to hedge the variability of the purchase cost of nickel based on this LME index. Any gain or loss associated with these hedging arrangements is included in sales or cost of sales, depending on whether the underlying risk being hedged was the variable selling price or the variable raw material cost, respectively. At June 30, 2023, the net mark-to-market valuation of our outstanding raw material hedges was an unrealized pre-tax loss of $0.9 million, comprised of $1.7 million in prepaid expense and other current assets, $2.1 million in other current liabilities and $0.5 million in other long-term liabilities on the balance sheet.

Foreign Currency Risk. Foreign currency exchange contracts are used, from time-to-time, to limit transactional exposure to changes in currency exchange rates. We sometimes purchase foreign currency forward contracts that permit us to sell specified amounts of foreign currencies expected to be received from our export sales for pre-established U.S. dollar amounts at specified dates. The forward contracts are denominated in the same foreign currencies in which export sales are denominated. These contracts are designated as hedges of the variability in cash flows of a portion of the forecasted future export sales transactions which otherwise would expose the Company to foreign currency risk, primarily the euro. In addition, we may also hedge forecasted capital expenditures and designate cash balances held in foreign currencies as hedges of forecasted foreign currency transactions. At June 30, 2023, we had no significant outstanding foreign currency forward contracts.

(a) Evaluation of Disclosure Controls and Procedures

Our Chief Executive Officer and Chief Financial Officer have evaluated the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of June 30, 2023, and they concluded that these disclosure controls and procedures are effective.

(b) Changes in Internal Controls

There was no change in our internal controls over financial reporting identified in connection with the evaluation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of June 30, 2023 conducted by our Chief Executive Officer and Chief Financial Officer, that occurred during the quarter ended June 30, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.