Howmet Aerospace Inc. quarterly report, Q2 FY2019

Business context and reporting period

This is Arconic Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2019—not a filing by Howmet Aerospace Inc. Arconic said it planned to separate into two public companies: Howmet Aerospace, comprising Engineered Products and Forgings, and Arconic Corporation, comprising Global Rolled Products. Completion was targeted for the second quarter of 2020 and remained subject to approvals and other conditions.

Financial performance and position

Sales increased 3% year over year in both periods. Q2 reported operating margin was approximately -2.2% and net margin -3.3%; six-month margins were approximately 4.1% and 0.9%, respectively. Cost of goods sold was 79.6% of sales in both 2019 periods, versus 81.2% in Q2 2018 and 80.8% in the first half of 2018.

Q2 segment operating profit was $286m for Engineered Products and Solutions (EP&S), $145m for Global Rolled Products (GRP), and $107m for Transportation and Construction Solutions (T&CS), totaling $538m. For the first half, respective segment operating profit was $539m, $252m, and $194m, totaling $985m. These are management-defined measures, not consolidated operating income.

At June 30, cash and cash equivalents were $1,357m, current assets $6,018m, and current liabilities $3,621m. Short-term debt was $434m and long-term debt $5,901m. The company had a $3,000m revolving credit facility with no borrowings outstanding. Cash fell $922m from year-end, primarily reflecting $900m of share repurchases. Capital expenditures were $304m in the first half.

Material changes versus the prior comparable period

• Q2 shifted from $120m net income to a $121m net loss. The principal driver was $499m of restructuring and other charges, versus $15m a year earlier; this included a $428m impairment of the Disks asset group.
• Despite the consolidated loss, total segment operating profit rose 25% in Q2 and 18% in the first half. Management cited higher aerospace volume and pricing, GRP pricing and volume, and cost savings.
• First-half sales growth reflected volume and pricing/mix gains, partly offset by lower aluminum prices, foreign exchange, divestitures, and the completed North American packaging operations ramp-down.
• First-half cash used in operations improved by $108m year over year, though working-capital requirements remained significant. First-half interest expense declined to $170m from $203m.
• The company repurchased $900m of shares through accelerated repurchase agreements, receiving approximately 45.5m shares. Shares outstanding were 440m at June 30, versus 483m a year earlier.

Outlook, risks, contingencies, and unusual items

• No numeric full-year earnings or revenue guidance is provided in the supplied filing text. Management expected strong commercial aerospace demand in the second half, continued defense growth, and ongoing pricing and cost savings. GRP expected continued packaging demand and favorable productivity; T&CS anticipated slower growth in commercial transportation and building and construction.
• Management warned that a significant reduction in Boeing 737 MAX production could weigh on EP&S and GRP results in the second half; the production-rate reduction announced in April had not materially affected Q2.
• A fire at a French fasteners plant generated a Q2 charge of $4m. Management anticipated another $5m–$10m charge in Q3 and further impacts during recovery; insurance has a $10m deductible.
• Environmental remediation reserves were $275m at June 30, including $210m for the Grasse River project, expected to be completed in 2022. The company increased that reserve by $25m in Q2 following remedial-design changes.
• Arconic disclosed Grenfell Tower-related litigation and investigations. It said it could not reasonably estimate the likelihood or amount of any potential loss. It stated it would no longer sell Reynobond PE for architectural use on buildings.
• A Spanish tax dispute had an estimated revised assessment of $173m, including interest; the company carried a $60m tax reserve and a $29m indemnification receivable from Alcoa Corporation.
• The planned separation incurred $16m in Q2 and $19m in first-half SG&A costs. The transaction could be abandoned or changed and faced tax, financing, regulatory, and execution conditions.

Most important facts to verify

1. Whether separation milestones, financing, tax-free treatment, and the targeted Q2 2020 timing remain achievable.
2. The recoverability assumptions behind the $428m Disks impairment and any further impairment exposure.
3. Cash conversion and working-capital trends, alongside the effect of continued capital spending and share repurchases on liquidity.
4. Second-half aerospace exposure, including potential 737 MAX production changes, and the recovery costs and insurance recovery related to the plant fire.
5. Developments in the Grenfell litigation and investigations, environmental remediation, and the Spanish tax appeal, for which outcomes or potential losses remain uncertain.