Howmet Aerospace Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Amounts are in U.S. dollars unless otherwise stated. Howmet completed its separation from Arconic Corporation on April 1, 2020, retaining Engine Products, Fastening Systems, Engineered Structures, and Forged Wheels. Prior-period operating results were recast to exclude Arconic Corporation as discontinued operations; cash flows and certain equity and comprehensive-income items were not segregated, which limits direct comparability.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Sales | $1,134 million | $1,794 million | $4,021 million | $5,364 million |
| Operating income | $73 million | $256 million | $405 million | $294 million |
| Continuing-operations income after tax | $36 million | $58 million | $105 million | $8 million |
| Diluted EPS, continuing operations | $0.08 | $0.13 | $0.23 | $0.01 |
| Cash from operations | Not separately stated | Not separately stated | $(142) million | $17 million |
| Capital expenditures | $36 million | $127 million | $220 million | $532 million |
Q3 cost of goods sold was 79.4% of sales, versus 73.4% a year earlier. Operating margin was approximately 6.4%, compared with 14.3%. Nine-month operating margin was approximately 10.1%, versus 5.5%; the comparison reflects substantially lower restructuring charges in 2020, including the prior-year impairment charge.
Q3 net income was $36 million, compared with $95 million, including $37 million from discontinued operations in Q3 2019. Nine-month net income was $155 million versus $161 million, including discontinued-operations income of $50 million and $153 million, respectively. Q3 2020 continuing results included a $48 million income-tax benefit, including a $41 million discrete benefit; pretax continuing operations recorded a $12 million loss.
Balance sheet, debt, and liquidity
- At September 30, cash and cash equivalents were $1.365 billion; current assets were $3.600 billion and current liabilities were $1.577 billion.
- Total debt was approximately $5.081 billion: $384 million short-term and $4.697 billion long-term. Gross debt less reported cash was approximately $3.716 billion.
- Cash, cash equivalents, and restricted cash decreased by $335 million during the first nine months to $1.368 billion. The company used $142 million in operating cash and $339 million in financing activities; investing activities provided $152 million.
- The company amended its revolving credit facility in June, reducing commitments to $1.0 billion and providing covenant relief through December 31, 2021. No borrowings were outstanding at quarter-end, and the company reported compliance with covenants. The maximum net-debt-to-EBITDA ratio rises to 5.00x for quarters through December 2020, then steps down to 4.00x by December 2021 and 3.50x thereafter.
- Credit ratings were S&P BB+ (negative outlook), Moody’s Ba3 (negative outlook), and Fitch BBB- (stable outlook).
Material changes and segment trends
- Sales fell 37% in Q3 and 25% year to date, primarily from lower commercial aerospace and commercial transportation volumes related to COVID-19, plus Boeing 737 MAX production declines. Favorable pricing and growth in defense aerospace and industrial gas turbines partly offset declines.
- All four segments reported lower Q3 sales and operating profit year over year. Q3 sales and segment operating profit were: Engine Products $485 million and $39 million; Fastening Systems $271 million and $33 million; Engineered Structures $206 million and $10 million; Forged Wheels $172 million and $35 million.
- Q3 restructuring and other charges were $22 million, versus $56 million; nine-month charges were $166 million, versus $572 million. 2020 charges included layoffs and pension settlement accounting. The company reported 3,772 employee separations year to date and expected remaining layoff-reserve payments by the end of Q3 2021.
- Interest expense was $305 million year to date, up from $256 million, including $59 million of premiums paid on early debt redemptions. Debt actions included issuing $1.2 billion of 6.875% notes due 2025 and redeeming or tendering portions of existing notes.
Outlook, risks, and unusual items
- Management provided no specific company-wide financial guidance in the supplied filing text. It expected lower 737 MAX production to continue weighing on performance for the remainder of 2020. The company anticipated approximately $5 million to $10 million of charges in Q4 related to fires at two plants, with further effects as recovery continued. A $10 million partial insurance settlement had been received.
- COVID-19 remained a major uncertainty: aerospace represented approximately 70% of year-to-date revenue, and General Electric represented 11%. Management cited customer production reductions, uncertain demand, potential facility disruptions, and possible future impairment of goodwill and other assets. All manufacturing facilities were operating at quarter-end; the company had experienced temporary closures at a small number of facilities.
- Common dividends were suspended to preserve cash, and capital spending was reduced. The company repurchased $51 million of common stock in Q3; credit-agreement limits apply to dividends and repurchases during the covenant-relief period.
- Engineered Structures goodwill was tested in Q1; estimated fair-value headroom declined from approximately 60% to 15%, but no impairment was recorded. Management reported headroom above 20% in Q2 and Q3 and warned that materially worse results or market factors could require impairment.
- Contingencies include a Spanish tax assessment estimated at $181 million, with Howmet’s recorded reserve of $63 million partly offset by $52 million of indemnification receivables. A Supreme Court of Spain decision was expected before year-end 2020. Grenfell Tower-related proceedings and investigations remain uncertain; Arconic Corporation agreed to indemnify Howmet for specified related liabilities. Management could not estimate a possible loss range for these matters.
- Howmet disclosed non-material prior-period presentation corrections: a cash-flow classification revision and corrections to tax/equity presentation. Investors should distinguish these from changes in reported operating performance.
Important facts for investors to verify
- Whether aerospace and commercial transportation demand, especially commercial aerospace and 737 MAX-related demand, stabilizes or deteriorates further.
- Cash generation, working-capital movements, and access to receivables programs and the $1.0 billion revolving facility, including covenant headroom as EBITDA changes.
- Progress on restructuring, facility-fire recovery and insurance proceeds, and any resulting additional costs or asset impairments.
- Resolution and potential financial exposure from the Spanish tax matter and litigation or investigations associated with Grenfell Tower, including the scope and enforceability of indemnities.
- Whether the suspended common dividend and capital-spending reductions continue, and how debt repayment and any share repurchases comply with credit-agreement restrictions.