Howmet Aerospace Inc. (then Arconic Inc.) — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. The filing identifies the registrant as Arconic Inc.; it is not filed under the Howmet Aerospace name. Amounts are in millions of dollars except per-share data.
Business context and financial results
Arconic manufactured lightweight metal products for aerospace, automotive, commercial transportation, building and construction, and industrial markets. Its reportable segments were Engineered Products and Solutions (EP&S), Global Rolled Products (GRP), and Transportation and Construction Solutions (TCS).
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Sales | $3,524 | $3,236 | $10,542 | $9,689 |
| Operating income | $345 | $310 | $1,002 | $913 |
| Net income | $161 | $119 | $424 | $653 |
| Net income attributable to common shareholders | $160 | $101 | $422 | $600 |
| Diluted EPS | $0.32 | $0.22 | $0.86 | $1.31 |
| Interest expense | $88 | $100 | $291 | $398 |
Q3 sales grew 9% year over year, and operating income rose 11%. Approximate operating margin was 9.8% versus 9.6%; net margin was 4.6% versus 3.7%. For the nine-month period, sales rose 9% and operating income rose 10%, while net income declined 35%; net margin was approximately 4.0% versus 6.7%.
Cash flow and liquidity: Nine-month operating cash flow was a use of $209, compared with a use of $373. Capital expenditures were $497, implying negative operating cash flow less capex of approximately $706. Investing activities provided $211 and financing activities used $609. Cash and cash equivalents were $1,535 at September 30, 2018, down from $2,150 at year-end 2017. Current assets were $6,132 and current liabilities $3,014 (current ratio approximately 2.0).
Debt: Debt totaled $6,357 at September 30, 2018, comprising $42 short-term debt and $6,315 long-term debt, down from approximately $6,844 at year-end 2017. The $3,000 revolving credit facility had no borrowings outstanding; the company reported compliance with its covenants. The maximum leverage covenant was scheduled to tighten from 4.50:1 to 4.00:1 at year-end 2018.
Changes versus comparable periods
- Revenue growth reflected higher volumes across markets, especially aerospace, automotive, commercial transportation, industrial, and building and construction, plus higher aluminum prices. Foreign currency also benefited the nine-month comparison. Divestitures partly offset growth.
- Q3 earnings improved on volume growth, lower SG&A, interest and restructuring charges. Cost of goods sold increased to 81.8% of sales from 80.1%, pressured by aluminum prices, mix, transportation costs and manufacturing inefficiencies.
- Nine-month earnings were lower largely because 2017 included $351 in gains on sales of Alcoa Corporation shares and a $167 debt-for-equity exchange gain, neither repeated in 2018. Current-period pressures also included aerospace mix, higher aluminum prices, operating shortfalls, $38 of customer-claim settlements and a $23 inventory adjustment.
- Nine-month restructuring charges were $20 versus $118 in 2017, which included the $60 loss on the Fusina rolling-mill sale. Q3 2018 reported a net restructuring benefit of $2, including a $28 postretirement curtailment benefit.
- Average basic shares outstanding rose to 483 million in Q3 from 442 million; diluted shares rose to 502 million from 462 million.
Outlook, commentary, risks and unusual items
- No specific consolidated numerical earnings or revenue guidance is provided in the supplied filing text. Management expected strong commercial aerospace demand and defense growth, continued automotive and commercial transportation demand, and growth in building and construction; industrial gas turbine demand was expected to decline.
- Management cited higher input and transportation costs, pricing pressure, aerospace mix, and challenges in rings, disks and Engineered Structures. A Cleveland forging press suffered a hydraulic leak in late October; it was not expected back in service in Q4, and the financial impact had not been determined.
- The company began a sale process for its Building and Construction Systems business; no final decision to sell had been made. Subsequent to quarter-end, it sold the Texarkana rolling mill and cast house for $302 cash plus possible contingent consideration, with an estimated rolling-mill gain of $150–$165; the cast-house gain was to be deferred under failed-sale-leaseback accounting.
- Arconic recorded a $59 reserve for a Spanish tax assessment after an adverse court decision and a $29 receivable for Alcoa Corporation’s 49% indemnification share. The company intended to seek review by Spain’s Supreme Court. Tax reform accounting remained provisional.
- Other material exposures include environmental remediation reserves of $280, including $208 for the Grasse River project, and litigation related to Reynobond PE and the Grenfell Tower fire. The company said loss outcomes for that litigation could not be reasonably estimated.
- For Q4 2018, pension settlement charges were expected to be $70–$85. The company also cited aluminum-price and currency movements, sanctions affecting Russian aluminum supplier Rusal, market conditions, execution, product quality and safety, and litigation and environmental liabilities as risks.
Investor verification points
- Confirm the issuer and historical reporting basis: this 2018 filing is by Arconic Inc., not Howmet Aerospace Inc.
- Review the sources of nine-month earnings decline, particularly the nonrecurring 2017 gains, and assess underlying segment profitability and cost pressures.
- Monitor the Cleveland press outage, its production and customer effects, and any related financial impact.
- Track the Spanish tax appeal and reserve, Reynobond PE litigation, and environmental remediation estimates.
- Verify completion and accounting effects of the Texarkana transaction and any decision on the Building and Construction Systems sale.
- Assess cash conversion, capital spending, pension contributions, debt maturities, and compliance as the leverage covenant tightens.