Howmet Aerospace Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. On April 1, 2020, the company completed its separation from Arconic Corporation, retaining Engine Products, Fastening Systems, Engineered Structures and Forged Wheels. Prior-period income statement and segment results exclude Arconic Corporation and are presented as discontinued operations; prior-period cash flows and equity were not segregated, limiting some comparisons.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Sales | $1,253m | $1,818m | $2,887m | $3,570m |
| Operating income (loss) | $74m | $(176)m | $332m | $38m |
| Continuing-operations income (loss), after tax | $(84)m | $(136)m | $69m | $(50)m |
| Net income (loss), including discontinued operations | $(96)m | $(121)m | $119m | $66m |
| Diluted EPS from continuing operations | $(0.19) | $(0.31) | $0.15 | $(0.11) |
- Q2 sales fell 31% year over year; first-half sales fell 19%. Management attributed the declines principally to COVID-19-driven lower commercial aerospace and commercial transportation volumes, 737 MAX production declines, and the U.K. forgings divestiture. Defense aerospace, industrial gas turbines and pricing partly offset the declines.
- Q2 cost of goods sold was 73.7% of sales versus 73.4% a year earlier; first-half cost of goods sold was 72.9% versus 73.6%. Q2 gross margin was approximately 26.3%. Operating income included $105m of restructuring and other charges; Q2 2019 included $472m of such charges, including a $428m impairment.
- Q2 interest expense rose to $144m from $86m, largely reflecting debt redemption premiums. First-half interest expense was $228m versus $171m.
- Cash used for operations was $260m in the first half, versus $152m used in 2019. Capital expenditures were $101m, making operating cash flow less capital expenditures negative $361m (calculated from reported figures). Cash and cash equivalents were $1,281m at June 30, down from $1,577m at year-end.
- Debt was $5,086m: $391m short-term and $4,695m long-term. The company issued $1.2bn of 6.875% notes due 2025 and redeemed or tendered other notes, including the $1.0bn 2020 notes. The revolving facility was undrawn; its commitment was reduced to $1.0bn. An additional $250m of facilities expire at various dates in the second half of 2020.
Material changes and management commentary
- The separation transferred the Global Rolled Products businesses to Arconic Corporation. Howmet distributed one Arconic Corporation share for every four Howmet shares held by eligible shareholders.
- Segment operating profit in Q2 was $105m for Engine Products, $70m for Fastening Systems, $19m for Engineered Structures and $6m for Forged Wheels. Forged Wheels was particularly pressured: sales declined 56% and segment profit 92% year over year.
- The company recorded $105m of Q2 restructuring and other charges, including $64m for pension settlements and $54m of layoff costs; approximately 2,521 employees were separated in the quarter. First-half charges were $144m and included layoffs affecting approximately 2,981 employees.
- Management said all manufacturing facilities were operating at quarter-end, though a small number had temporarily closed. It suspended common dividends and reduced capital spending and headcount to conserve cash. The filing provides no formal full-year financial guidance.
Outlook, risks and contingencies
- Management expected reduced 737 MAX production to continue to negatively affect performance for the rest of 2020. It anticipated approximately $5m–$15m of charges in Q3 related to fires at two plants, with further impacts possible in subsequent quarters; Q2 fire-related costs were $14m, with a partial insurance settlement of $10m.
- The June credit amendment provided covenant relief through December 2021, with maximum net-debt-to-EBITDA thresholds ranging from 5.00x to 5.25x through 2021, then returning to 3.50x. Howmet reported covenant compliance at June 30. Credit ratings included Moody’s Ba3 and negative outlook; S&P rated the debt BBB- with negative outlook.
- COVID-19 demand uncertainty, customer production cuts, potential customer payment delays, market volatility and possible further credit-rating pressure could affect cash flow, liquidity, pension obligations and asset values. The filing warns future goodwill or other asset impairments may be material if actual results or market conditions worsen. Engineered Structures’ goodwill fair-value cushion was reported at over 20% at quarter-end, after declining to approximately 15% in Q1.
- Grenfell Tower-related investigations and litigation remain unresolved; the company says it cannot reasonably estimate potential loss. Arconic Corporation agreed to indemnify Howmet for specified Grenfell-related liabilities. A Spanish tax assessment is estimated at $174m including interest; Howmet’s reserve was $60m and related indemnification receivables totaled $50m at June 30.
Investor verification points
- Confirm the impact and comparability effects of the April separation, particularly since historical cash flows were not separated.
- Track aerospace and commercial transportation demand, 737 MAX production, customer concentration and subsequent recovery assumptions.
- Monitor operating cash flow, working capital, available liquidity, debt maturities, covenant headroom and credit ratings.
- Verify delivery of announced cost reductions and the cash and earnings effects of restructuring, pension settlements and plant-fire costs.
- Follow goodwill impairment assumptions, the Grenfell proceedings and indemnities, and the Spanish tax case and related recoveries.