Howmet Aerospace Inc. quarterly report, Q3 FY2016

Business context and reporting period

This is Arconic Inc.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The supplied filing is for Arconic (formerly Alcoa Inc.), not a filing identified as Howmet Aerospace; the source does not establish that Howmet was the registrant for this period. Results include the businesses later separated into Alcoa Corporation, because the separation took effect November 1, 2016. Arconic said these historical consolidated results are not indicative of its post-separation results. Share and per-share data are retrospectively adjusted for a 1-for-3 reverse stock split.

Financial results and liquidity

Amounts are in millions of dollars, except per-share data. Quarter comparisons are versus Q3 2015; nine-month comparisons are versus the prior-year period.

• Sales declined 6% in Q3 and 11% year to date. Q3 net income attributable to Arconic rose $122; nine-month net income fell $62.
• Gross profit, calculated as sales less cost of goods sold, was $996 in Q3 versus $1,014, and $2,981 for nine months versus $3,624. Gross margin was approximately 19.1% versus 18.2% in Q3 and 19.3% versus 21.0% year to date. Reported cost of goods sold as a share of sales was 80.9% and 80.7%, respectively, compared with 81.8% and 79.0%.
• Cash from operations fell $509 year to date, primarily reflecting lower operating results. Capital expenditures were $814 versus $782. Cash from operations less capital expenditures was negative $606, compared with negative $65 in 2015, a simple calculated cash-flow measure.
• At September 30, cash and cash equivalents were $1,863 and restricted cash was $1,337; the restricted amount principally included escrowed proceeds for the separation-related notes. Current assets were $9,368 and current liabilities $5,500.
• Short-term borrowings were $32; long-term debt was $10,274, including $773 due within one year. Total debt including short-term borrowings was approximately $10,306. Debt issuance and repayment cash flows were largely revolving-credit activity.
• Q3 and nine-month dividends were $0.09 and $0.27 per share. The estimated 2016 annual effective tax rate was 49.0%; reported rates were 44.1% for Q3 and 46.7% year to date.

Material changes and segment performance

• Management attributed Q3 earnings improvement chiefly to productivity gains across segments and asset-sale gains, partly offset by unfavorable midstream/downstream price and product mix and lower alumina prices. The nine-month decline mainly reflected lower aluminum and alumina prices and unfavorable product mix, partly offset by productivity and lower restructuring charges.
• Segment after-tax operating income (ATOI) totaled $395 in Q3 versus $410 and $1,130 for nine months versus $1,633. Q3 Primary Metals ATOI improved to $56 from a $59 loss; Alumina fell to $72 from $212. Nine-month Alumina ATOI fell to $189 from $648; Engineered Products and Solutions rose to $504 from $472.
• Alumina and aluminum prices, production and shipments were lower in several upstream operations, including effects of refinery and smelter closures or curtailments. Engineered Products and Solutions benefited from acquired businesses and productivity, while aerospace pricing pressure and project costs remained headwinds.
• Q3 other income, net was $117, including a $118 gain on sale of the Intalco smelter wharf property. Other notable year-to-date proceeds and gains included redemption of company-owned life insurance policies and sales of investments and assets.

Outlook, significant events, and risks

• The separation was completed November 1, 2016: 80.1% of Alcoa Corporation was distributed to Arconic shareholders, with Arconic retaining 19.9%. Alumina and Primary Metals and certain rolling operations moved to Alcoa Corporation; Arconic retained the remaining rolled products, engineered products, and transportation and construction businesses.
• Management anticipated approximately $800 million to $1 billion of valuation allowances on certain U.S. deferred tax assets following the separation, and approximately $175 million to $200 million of additional separation costs after Q3, including capital expenditures. Management also said a potential impairment of Alcoa Corporation net assets was under evaluation and could be material to fourth-quarter results.
• Outlook was primarily qualitative: management expected stronger automotive sheet demand, aerospace demand improvement alongside pricing pressure and airframe destocking, continued strength in North American industrial gas turbines, and weakness in North American commercial transportation. Alumina and Primary Metals outlooks reflected capacity reductions and expected productivity improvements.
• The amended revolving credit agreement reduced total commitments from $4 billion to $3 billion and introduced a leverage covenant: debt to consolidated EBITDA of 5.50:1, declining to 3.50:1 from December 31, 2019. Moody’s downgraded Arconic’s long-term debt to Ba2 on November 1, citing the separation; its outlook was stable.
• Environmental remediation reserves were $602 at September 30. The filing describes material uncertainties across environmental, tax, and other legal matters, including Spanish tax assessments totaling $296 and a disputed Italian energy-tariff demand with a stated reasonably possible loss range of $0–$97. Saudi joint-venture project-financing guarantees and pension funding obligations are also relevant exposures.
• Other risks identified include aluminum and energy prices, foreign exchange, end-market demand, pension assumptions and returns, execution of restructuring and separation plans, litigation and environmental outcomes, and the ability to achieve expected productivity and cash generation.

Important facts for investors to verify

• Confirm the registrant and security being analyzed: this filing is Arconic/Alcoa Inc. for 2016, not a Howmet Aerospace filing, and it includes businesses subsequently spun off.
• Review the separation, tax, employee-benefit, environmental, and transition agreements to understand which assets, liabilities, costs, and cash flows remained with Arconic after November 1.
• Assess the likely timing and cash impact of the disclosed $800 million–$1 billion tax valuation allowances, remaining separation costs, and any Alcoa Corporation impairment.
• Reconcile the $1,337 restricted-cash balance and note-related escrow release conditions with accessible liquidity and debt maturities.
• Track the leverage covenant, post-separation credit ratings, pension contributions, environmental reserves, and outcomes of the disclosed tax and legal matters.

The interim financial statements were reviewed, not audited; the independent accountant reported no material modifications identified in its review.