Business context and reporting period
Entity note: The supplied filing is Arconic Inc.’s Form 10-Q for the quarter ended June 30, 2018, not a filing under the name Howmet Aerospace Inc. Arconic was a global manufacturer of engineered aluminum, titanium, and nickel products serving aerospace, transportation, construction, and industrial markets. Figures are in millions of dollars except per-share amounts.
Financial performance and liquidity
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Sales | $3,573 | $3,261 | $7,018 | $6,453 |
| Operating income | $324 | $320 | $657 | $603 |
| Net income | $120 | $212 | $263 | $534 |
| Diluted EPS | $0.24 | $0.43 | $0.53 | $1.07 |
Q2 gross profit was $670 (18.8% of sales), versus $712 (21.8%) a year earlier; operating margin was 9.1% versus 9.8%, and net margin was 3.4% versus 6.5%. For the first half, operating margin was 9.4% versus 9.3%, while net margin was 3.7% versus 8.3%. Sales increased 10% in Q2 and 9% year to date, but earnings were lower.
- Cash flow: First-half cash used for operations was $260, compared with $316 used in 2017. Investing provided $146, including $420 in receipts from sold receivables; financing used $577. Capital expenditures were $288, implying approximate free cash flow of negative $548 (operating cash flow less capital expenditures).
- Balance sheet and liquidity: Cash was $1,455 at June 30, down from $2,150 at year-end 2017. Current assets were $6,075 and current liabilities $2,977 (current ratio approximately 2.0). Debt was $6,357, comprising $6,312 long-term debt and $45 short-term debt; cash less total debt was approximately negative $4,902. The $3.0 billion revolving credit facility was undrawn, and the company reported compliance with its covenants.
- Other: Shareholders’ equity was $5,204; dividends were $0.06 per share in Q2. Pension contributions were $237 in the first half.
Material changes versus prior comparable period
- Revenue growth reflected higher volumes across segments, higher aluminum prices, and favorable currency movements. Higher input costs and aluminum prices, unfavorable mix, customer-claim settlements of $38, and a $23 inventory adjustment weighed on costs and profitability.
- Q2 net income fell 43%; first-half net income fell 51%. Comparisons were affected by 2017 gains that did not recur: a $167 debt-for-equity exchange gain in Q2 2017 and, for the first half, a $351 gain from selling Alcoa Corporation shares as well as the $167 exchange gain.
- Segment operating profit declined year to date in Engineered Products and Solutions ($433 versus $497) and Global Rolled Products ($235 versus $269); Transportation and Construction Solutions improved ($164 versus $139). Rings and disks operating shortfalls particularly affected Engineered Products and Solutions.
- Interest expense declined to $89 from $183 in Q2, partly because 2017 included debt-redemption costs and debt outstanding was lower. First-half restructuring charges declined to $22 from $99, including the prior-year $60 loss on the Fusina mill sale.
Outlook, risks, contingencies, and unusual items
- Management expected continued strength in commercial aerospace, defense, automotive, commercial transportation, and building and construction markets, alongside cost savings. It also expected continuing industrial gas-turbine weakness, pricing pressure and operating challenges in rings and disks, unfavorable effects from higher aluminum prices in rolled products, and continued packaging-operation ramp-down. No consolidated numerical earnings guidance is provided in the supplied text.
- The company identified uncertainty around U.S. sanctions affecting Rusal, a supplier of primary aluminum. It did not anticipate interruption at its Samara plant and expected U.S. and European facilities could source metal elsewhere if needed; aluminum prices could remain volatile.
- Q2 included a $21 tax charge related primarily to updated provisional estimates under the 2017 U.S. tax law. A Spanish tax assessment was under appeal; a potential tax charge of up to approximately $59 was identified for Q3, with Alcoa Corporation responsible for 49% of the net liability under the tax agreement. A separate foreign tax matter could produce recognition of a tax benefit of up to approximately $38 in Q3.
- Grenfell Tower-related securities litigation and a derivative action remained unresolved; the company said it could not reasonably estimate the likelihood or potential loss. Environmental remediation reserves were $287, including $211 for the Massena West, New York, project. Other guarantees include a long-term energy-supply guarantee for an Alcoa Corporation facility with an estimated present value of approximately $1,156; management considered payment-default risk remote.
- There was no impairment recorded for the disks operation or Arconic Engines goodwill after interim reviews, but the company warned that weaker forecasts or changed assumptions could lead to a material future non-cash impairment. In July 2018, after quarter-end, Arconic announced a sale process for its Building and Construction Systems business, which had 2017 sales of approximately $1,070.
Most important facts for investors to verify
- Confirm the issuer: this is an Arconic Inc. 2018 filing, despite the Howmet Aerospace metadata.
- Assess whether volume growth and cost savings can offset aluminum/input-cost inflation, customer claims, and rings-and-disks performance issues.
- Review cash conversion and working-capital needs: operating cash flow remained negative, and cash fell materially during the first half.
- Track debt, refinancing needs, and compliance with the revolving-credit leverage covenant as its limit tightens over time.
- Monitor the Spanish tax matter, Grenfell-related litigation, environmental remediation, and guarantees made on behalf of Alcoa Corporation.
- Evaluate execution of the announced Building and Construction Systems sale process and the outlook for the affected segment.