Business context and reporting period
Arconic Inc.’s Form 10-K reports the fiscal year ended December 31, 2019; the quarterly supplement also gives fourth-quarter results. The company manufactured lightweight-metal products for aerospace, automotive, transportation, building, industrial, defense, and packaging markets. Its two reportable segments were Engineered Products and Forgings (EP&F) and Global Rolled Products (GRP). The 2019 results cover both segments, before the planned separation. Arconic expected to rename the continuing EP&F company Howmet Aerospace Inc. and distribute GRP as Arconic Corporation on April 1, 2020, subject to conditions.
Financial performance and position
Amounts below are in millions of dollars, except per-share data and ratios.
| Metric | 2019 | 2018 |
|---|---|---|
| Sales | $14,192 | $14,014 |
| Operating income | $1,035 | $1,325 |
| Net income | $470 | $642 |
| Diluted EPS | $1.03 | $1.30 |
| Cash provided by operations | $406 | $217 |
| Capital expenditures | $586 | $768 |
| Cash and cash equivalents at year-end | $1,648 | $2,277 |
| Total debt | $5,940 | $6,330 |
- Sales rose 1%; management attributed growth to volume gains in aerospace, packaging, commercial transportation, and industrial markets and favorable pricing, partly offset by lower aluminum prices, divestitures, and unfavorable currency movements.
- Cost of goods sold was 79.1% of sales, versus 81.3% in 2018. Operating margin was approximately 7.3%, versus 9.5%; net margin was approximately 3.3%, versus 4.6% (calculated from reported figures).
- Total segment operating profit increased 27% to $2,015. EP&F segment profit was $1,390, up 26%; GRP segment profit was $625, up 30%.
- Net cash used in financing was $1,568, including $1,150 of share repurchases and repayment of approximately $403 of convertible notes. Investing activities provided $583, substantially reflecting $995 of cash receipts from sold receivables. Capital spending exceeded operating cash flow.
- Year-end current assets were $5,842 and current liabilities $4,126. Cash included $414 held by non-U.S. subsidiaries. The company reported a $3,000 unsecured revolving facility, with no borrowings outstanding under it at year-end; it was in compliance with debt covenants.
- Common dividends declared were $0.12 per share for 2019, down from $0.24 in 2018. The quarterly dividend was reduced from $0.06 to $0.02 beginning after the first quarter.
Material changes versus the prior year
- Net income fell by $172 despite higher sales and segment profit. The main reported pressures were restructuring and other charges of $620, up from $9, and higher SG&A, including $78 of separation-related costs. Lower interest expense, cost savings, pricing, and volume growth partly offset these impacts.
- The $620 of restructuring and other charges included a $428 impairment of the Disks asset group, other asset impairments, and layoff costs associated with approximately 1,310 employees. The impairment followed a decline in forecast financial performance; the company reported no goodwill impairment in 2019.
- Operating cash flow increased $189, reflecting better operating results and lower pension contributions, partly offset by a $112 unfavorable working-capital change.
- Debt declined $390, principally following repayment of the convertible notes. Cash declined $629 over the year.
- The company realigned reporting segments in 2019 for the planned separation and divested several businesses. Prior-period segment data was recast to the new presentation.
Outlook, risks, contingencies, and unusual items
- Management expected 2020 commercial aerospace demand to remain strong excluding the 737 MAX, with defense growth, weaker commercial transportation demand, and continued cost savings and favorable pricing. GRP expectations included higher automotive demand, continued commercial transportation headwinds, growth from the Tennessee industrial ramp-up, and continued BCS growth and margin expansion.
- The company estimated the 737 MAX production suspension would reduce 2020 sales by approximately $400, with a corresponding negative segment operating profit impact; it did not quantify that profit impact. The timeline for production resumption was uncertain.
- Management forecast 2020 effective tax of 26.5%–28.5% and capital expenditures below 4% of sales. It stated operating cash flow and financing capacity should cover operational and business needs over the following 12 months.
- A fire at a French fasteners plant caused $26 of 2019 costs; the company received a $25 partial insurance settlement and expected approximately $10–$15 of additional charges in first-quarter 2020, with later impacts also expected to be insured. A February 2020 fire at the Barberton, Ohio forged-wheels plant had an unknown extent and financial impact; insurance carried a $10 deductible.
- Grenfell Tower-related investigations and litigation remained unresolved. The company no longer sold Reynobond PE for architectural use on buildings and said it could not reasonably estimate the likelihood or range of potential losses. A separate Spanish tax assessment was estimated at $172 including interest; the Spanish Supreme Court was reviewing the case. The year-end recorded reserve was $59, with a $29 indemnification receivable from Alcoa Corporation.
- Environmental remediation reserves were $230 at year-end, including $171 for the Grasse River project, expected to be completed in 2022. Management noted that project costs may change as remediation proceeds.
- The planned separation involved execution costs, potential disruption, and tax and financing uncertainties. A $600 offering of 6.125% second-lien notes due 2028 for the GRP successor closed in February 2020; proceeds were held in escrow pending separation conditions.
- Key broader risks include cyclical end markets, competition, customer and supplier concentration, manufacturing interruptions, raw-material and currency exposure, pension funding, regulatory and environmental obligations, and the possibility that separation benefits or projected savings may not be achieved. Moody’s affirmed Ba2 but changed its outlook to negative in January 2020; S&P affirmed BBB- with a stable outlook.
Most important facts for investors to verify
- Whether the planned separation was completed on the expected terms and date, including the distribution ratio, tax treatment, and each successor’s debt, liquidity, and credit ratings.
- Whether the $620 of 2019 restructuring charges, particularly the Disks impairment, signals continuing operating weakness or further capital needs.
- The realized financial impact of the 737 MAX suspension and the Barberton plant fire, along with insurance recoveries and recovery timelines.
- Cash conversion and liquidity quality, including reliance on receivables-sale proceeds, working-capital trends, pension contributions, and debt maturities.
- Developments in Grenfell-related proceedings, the Spanish tax appeal, and environmental remediation, for which material exposures or loss ranges were not clearly estimable in the filing.
- Whether management’s 2020 tax, capital-spending, demand, and productivity expectations were achieved.