Business context and reporting period
This is Arconic Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2017. The supplied filing is for Arconic, not a company identified as Howmet Aerospace Inc. Arconic reported three segments: Engineered Products and Solutions, Global Rolled Products, and Transportation and Construction Solutions. Alcoa Corporation had separated from Arconic effective November 1, 2016; its 2016 results are presented as discontinued operations, but its cash flows remain included in the comparative cash-flow statement.
Financial results and key metrics
Amounts are in millions except per-share data. Comparisons are with the corresponding 2016 periods.
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Sales | $3,261 | $3,234 | $6,453 | $6,289 |
| Operating income | $281 | $283 | $526 | $553 |
| Income from continuing operations | $212 | $53 | $534 | $163 |
| Net income attributable to Arconic | $212 | $135 | $534 | $151 |
| Diluted EPS, continuing operations | $0.43 | $0.08 | $1.07 | $0.29 |
| Combined segment Adjusted EBITDA | $556 | $568 | $1,105 | $1,092 |
- Margins: Gross margin, calculated as sales less cost of goods sold, was 20.8% in Q2 versus 21.7% a year earlier; operating margin was 8.6% versus 8.8%. The filing reports COGS at 79.2% and 78.3% of sales, respectively.
- Cash flow: Cash used for operations was $83 in the first half, versus $98 used in 2016. Capital expenditures were $229; operating cash flow less capex was therefore negative $312. Investing activities provided $904, while financing activities used $903. Cash ended the period at $1,785, down from $1,863 at year-end 2016.
- Debt and liquidity: Long-term debt was $6,796 and short-term borrowings were $48, compared with total debt of $8,048 at year-end 2016. Current assets were $6,033 and current liabilities $2,658; the current ratio was approximately 2.27. Cash exceeded short-term borrowings by $1,737.
- Segments: Q2 sales and Adjusted EBITDA were $1,484 and $310 for Engineered Products and Solutions; $1,268 third-party sales and $164 EBITDA for Global Rolled Products; and $501 and $82 for Transportation and Construction Solutions.
Material changes versus the prior period
- Sales rose 1% in Q2 and 3% for the first half, reflecting higher volumes and aluminum prices, partly offset by lower product pricing and the Tennessee packaging business ramp-down and toll-processing arrangement.
- Reported earnings rose substantially, but included material investment-related gains: $167 from the debt-for-equity exchange in Q2 and, for the first half, an additional $351 gain from selling part of the Alcoa Corporation investment. These gains should be distinguished from operating performance.
- Operating income was slightly lower in Q2 and down for the first half. Segment EBITDA was lower in Q2, despite modest first-half growth. Aerospace pricing/mix and ramp-up costs weighed on Engineered Products and Solutions; Transportation and Construction Solutions improved.
- Interest expense increased to $183 in Q2 from $124, including $76 of costs primarily related to early debt redemptions. Total debt declined by about $1.25 billion from year-end.
- Restructuring and other charges were $26 in Q2 and $99 for the first half, including a $60 loss on the Fusina, Italy mill sale and employee-reduction costs. The company reported approximately 680 employee separations associated with 2017 programs.
Outlook, commentary, risks, and unusual items
- No consolidated numerical earnings or revenue guidance is stated in the supplied text. Management’s segment outlook was qualitative: commercial aerospace demand expected to remain strong, with pricing, destocking, and engine ramp-up challenges; automotive demand expected to grow; commercial airframe and packaging demand expected to weaken; and building/construction and some commercial transportation markets expected to grow. Cost savings were expected to continue.
- Three purported securities class actions were filed in July 2017 following the Grenfell Tower fire, involving allegations concerning Reynobond PE cladding disclosures. Arconic said it would contest the cases; it could not estimate the likelihood or range of loss. Regulatory investigations were also ongoing.
- Environmental remediation reserves totaled $301 at June 30, including $224 for the Grasse River project. The filing describes fieldwork as expected to take about four years. A Spanish tax dispute involved combined assessments of $283, with a favorable court decision on one assessment but further proceedings pending; outcome was not predictable.
- Arconic remained subject to guarantees for Alcoa Corporation obligations, including maximum potential guarantees of $314 related to project financing and guarantees with an estimated present value of up to $1,600 for energy supply agreements; liability is contingent on Alcoa Corporation payment default. The company also reported $46 of other bank guarantees, $133 of letters of credit, and $127 of surety bonds.
- On July 31, 2017, Arconic agreed to separation terms for former CEO Klaus Kleinfeld, including a $5 million cash payment, continued benefits, and a prorated 2017 bonus subject to release and other conditions.
- The interim financial statements were reviewed by the independent auditor, not audited. Management reported disclosure controls as effective and no material second-quarter change in internal control over financial reporting.
Important facts for investors to verify
- Confirm the filing issuer and period: this source is Arconic’s Q2 2017 10-Q, notwithstanding the request metadata naming Howmet Aerospace.
- Separate recurring operating results from the $351 investment-sale gain, $167 debt-for-equity gain, $60 Fusina loss, and debt-redemption charges when assessing earnings quality.
- Review cash conversion and working-capital needs, particularly the negative first-half operating cash flow and increased inventories and receivables.
- Assess the potential financial exposure from Grenfell-related litigation and investigations, environmental obligations, and the Spanish tax assessments; the filing does not provide a clear loss estimate for these matters.
- Track execution of segment outlook assumptions, restructuring savings and costs, debt reduction, and Alcoa-related guarantee exposure.