Business context and reporting period
Registrant: Arconic Inc., the company that planned to rename its retained Engineered Products and Forgings business Howmet Aerospace upon separation. This is Arconic’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2019; it is not a filing under the Howmet Aerospace name.
Arconic reported two segments: Engineered Products and Forgings (EP&F) and Global Rolled Products (GRP). The filing describes a planned separation, targeted for the second quarter of 2020: EP&F would remain with the company renamed Howmet Aerospace, while GRP would become Arconic Corporation. Completion remained subject to approvals and other conditions.
Financial performance and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Sales | $3.559bn | $3.524bn | $10.791bn | $10.542bn |
| Operating income | $326m | $345m | $619m | $1.002bn |
| Net income | $95m | $161m | $161m | $424m |
| Diluted EPS | $0.21 | $0.32 | $0.35 | $0.86 |
| Operating margin | 9.2% | 9.8% | 5.7% | 9.5% |
Sales rose 1% in Q3 and 2% year to date. Management cited volume growth and pricing/mix benefits, partly offset by lower aluminum prices, unfavorable currency, and exited or divested operations. Cost of goods sold fell to 78.7% of sales in Q3 from 81.8%; year-to-date it was 79.3% versus 81.1%.
- Segments: Q3 EP&F sales were $1.794bn and segment operating profit was $363m, up 7% and 28%, respectively. GRP third-party sales were $1.763bn, down 4%, while segment operating profit rose 50% to $161m. Segment profit excludes restructuring and other special items.
- Cash flow: Operating activities used $100m in the first nine months, versus $209m used in 2018. Investing activities provided $288m; financing activities used $1.144bn, including $1.1bn of share repurchases. Cash and cash equivalents were $1.321bn at September 30, down from $2.277bn at year-end 2018.
- Debt and liquidity: The debt note reports $6.309bn of debt before amounts due within one year; the balance sheet reports $1.434bn of short-term debt and $4.905bn of long-term debt. The $3bn revolving credit facility was undrawn. Arconic also had $715m of other credit capacity. On October 15, 2019, it repaid approximately $403m of convertible notes at maturity.
- Balance sheet: Total assets were $17.484bn and total liabilities were $12.774bn. Current assets were $5.908bn versus current liabilities of $4.460bn. Accrued pension and other postretirement benefits totaled $2.630bn.
Material changes versus prior periods
- Year-to-date net income fell $263m to $161m, principally reflecting $630m of restructuring and other charges, higher income taxes and SG&A, and higher other expense. These effects more than offset stronger segment operating profit, pricing, volume, cost savings, and lower interest expense.
- The $630m year-to-date restructuring and other charge included a $428m impairment of the Disks asset group, $102m of impairments tied to agreed sales of Brazilian rolling-mill and U.K. forgings operations, and $97m of layoff costs, partly offset by a $58m benefit from eliminating certain retiree life-insurance benefits.
- Q3 restructuring charges were $119m, including the Brazilian and U.K. business impairments. The filing also records a $25m Grasse River environmental charge and a $9m impairment of energy-business assets during the first nine months.
- Share repurchases totaled $1.1bn in the first nine months. Average basic shares outstanding fell to 451m from 483m year to date, but the decline in earnings outweighed the reduced share count.
Outlook, commentary, and risks
- For Q4, management expected strong commercial aerospace demand and continued growth in defense for EP&F, with commercial transportation weaker. GRP expected commercial-airframe demand to improve, while automotive and North American commercial transportation were expected to decline; industrial demand was expected to grow. The filing gives no consolidated full-year earnings or revenue guidance.
- Management expected pricing and net cost savings/productivity improvements to continue in both segments. A French fasteners-plant fire was expected to generate approximately $10m–$15m of charges in Q4, with further impacts as operations recovered; insurance had a $10m deductible.
- The Boeing 737 MAX production-rate reduction had not significantly affected Q3 results, but management warned a significant further reduction could hurt Q4 revenue and segment operating profit.
- Arconic announced the planned curtailment of its San Antonio GRP plant before year-end 2019; the plant generated approximately $50m in annual revenue, and the company expected a roughly $4m Q4 restructuring charge.
- Material uncertainties include completion, timing, cost, and tax treatment of the proposed separation; environmental remediation at more than 100 locations (reserve: $253m); the Grenfell Tower-related investigations and litigation, for which loss exposure could not be reasonably estimated; and a Spanish tax assessment estimated at $166m, partly subject to a 49% Alcoa Corporation indemnification. The company also disclosed other legal, product-liability, tax, and environmental contingencies.
Most important facts for investors to verify
- Whether the separation proceeded on the targeted timetable and with the disclosed business perimeter, financing, and tax-free treatment.
- Whether the $428m Disks impairment and other restructuring actions indicate sustained deterioration, and whether projected savings materialize.
- Cash generation, working-capital needs, debt repayment and refinancing, and liquidity after the $403m convertible-note repayment and $1.1bn repurchases.
- Exposure to aerospace and 737 MAX production changes, weaker transportation/automotive demand, and recovery costs from the fasteners-plant fire.
- Developments in Grenfell-related proceedings, the Spanish tax case, and environmental remediation costs, including the Grasse River project.