ARCONIC CORPORATION

ARNC
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HOWMET AEROSPACE : Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-Q)

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05/07/2020 | 09:17 am


(dollars in millions, except per share amounts; shipments in thousands of metric
tons [kmt])
Overview
On April 1, 2020, Howmet Aerospace Inc. (formerly known as Arconic Inc)
("Howmet" or the "Company") completed the previously announced separation of its
business into two independent, publicly-traded companies (the "Arconic Inc.
Separation Transaction"). Following the Arconic Inc. Separation Transaction,
Arconic Corporation holds the Global Rolled Products businesses (global rolled
products, aluminum extrusions, and building and construction systems) previously
held by the Company. The Company retained the Engineered Products and Forgings
businesses (engine products, fastening systems, engineered structures, and
forged wheels).
The Company's Board of Directors approved the completion of the Arconic Inc.
Separation Transaction on February 5, 2020, which was effected by the
distribution (the "Distribution") by the Company of all of the outstanding
common stock of Arconic Corporation on April 1, 2020 to the Company's
stockholders who held shares as of the close of business on March 19, 2020 (the
"Record Date"). In the Distribution, each Company stockholder of record as of
the Record Date received one share of Arconic Corporation common stock for every
four shares of the Company's common stock held as of the Record Date. The
Company did not issue fractional shares of Arconic Corporation common stock in
the Distribution. Instead, each stockholder otherwise entitled to a fractional
share of Arconic Corporation common stock received cash in lieu of fractional
shares.
On March 31, 2020, in connection with the Arconic Inc. Separation Transaction,
the Company entered into several agreements with Arconic Corporation that govern
the relationship between the Company and Arconic Corporation following the
Distribution, including the following: a Separation and Distribution Agreement,
Tax Matters Agreement, Employee Matters Agreement, Transition Services Agreement
and certain Patent, Know-How, Trade Secret License and Trademark License
Agreements.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations includes the historical results of Arconic Corporation, as
the Arconic Inc. Separation Transaction did not take place until April 1, 2020,
after the most recent period reported in this Form 10-Q. In future filings, the
historical results of the businesses that comprise Arconic Corporation will be
presented as discontinued operations in the Company's Consolidated Financial
Statements. As a result of the Arconic Inc. Separation Transaction, the
information in this Management's Discussion and Analysis of Financial Condition
and Results of Operations is not necessarily indicative of the post-separation
Company's future financial position, results of operations or cash flows.
COVID-19
The Company derives a significant portion of its revenue from products sold to
the aerospace end-market, including 71% of our Engineered Products and Forgings
reportable segment. As a result of COVID-19 and its impact on the aerospace
industry to-date, the possibility exists that there could be a sustained impact
to our operations and our financial results. Certain original equipment
manufacturer ("OEM") customers have suspended manufacturing operations in North
America
and Europe on a temporary basis. These suspensions, the duration of
which is uncertain, are impacting operations at certain of our facilities
resulting in the temporary closure of a small number of manufacturing
facilities. As a result, the Company is taking a series of actions to address
the financial impact, including announcing certain headcount reductions and
reducing certain cash outflows, by suspending our dividends and reducing the
levels of our capital expenditures to preserve cash and maintain liquidity.
Although the impact of COVID-19 on the Company's 2020 outlook remains highly
uncertain, we expect this situation to have an adverse impact on its 2020
financial performance and has withdrawn the 2020 guidance and assumptions that
were provided in February 2020. For additional information regarding the risks
of COVID-19 on our business, see the section entitled "Item 1A. Risk Factors-
Our business, results of operations, financial condition and/or cash flows could
be materially adversely affected by the effects of widespread public health
epidemics/pandemics, including COVID-19, that are beyond our control."
Results of Operations
Earnings Summary:
Sales. Sales were $3,209 in the first quarter of 2020 compared to $3,541 in the
first quarter of 2019. The decrease of $332, or 9%, in the first quarter of
2020, was primarily due to lower volumes in the commercial transportation,
automotive, and aerospace end markets driven by COVID-19 and 737 MAX production
declines; a decrease in sales of $66 from the divestitures of the hard alloy
extrusions plant in South Korea (March 2020), the aluminum rolling mill in
Itapissuma, Brazil ( February 2020), and the forgings business in the United
Kingdom
(December 2019); and lower aluminum prices, partially offset by
favorable product mix and higher volumes in the industrial end market.
Cost of goods sold ("COGS"). COGS as a percentage of Sales was 77.2% in the
first quarter of 2020 compared to 79.6% in the first quarter of 2019. The
decrease in the first quarter of 2020 was primarily due to net cost savings and
lower aluminum prices, partially offset by lower volumes, impairment costs
related to facilities closures of $3, and costs related to fires at two plants
of
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$11. The Company anticipates charges of approximately $10 to $15 in the second
quarter of 2020, with additional impacts in subsequent quarters as the
businesses continue to recover from the fires. The Company has insurance with a
deductible of $10 for each plant.
Selling, general administrative, and other expenses ("SG&A"). SG&A expenses were
$169 in the first quarter of 2020 compared to $178 in the first quarter of 2019.
The decrease of $9, or 5%, in the first quarter of 2020 was primarily due to
lower costs driven by overhead cost reductions, a decrease of $6 in strategy and
portfolio review costs, and a decrease of $2 in legal and other advisory costs
related to Grenfell Tower, partially offset by higher costs associated with the
Arconic Inc. Separation Transaction of $35.
Research and development expenses ("R&D"). R&D expenses were $15 in the first
quarter of 2020 compared to $22 in the first quarter of 2019. The decrease of
$7, or 32%, in the first quarter of 2020 was primarily due to the consolidation
of the Company's primary R&D facility in conjunction with ongoing cost reduction
efforts.
Restructuring and other charges. Restructuring and other charges was $21 in the
first quarter of 2020 compared to $12 in the first quarter of 2019.
Restructuring and other charges for the first quarter of 2020 primarily included
severance costs of $22 and charges for asset impairments of $24, partially
offset by the gain on sale of an extrusions plant of $27.
Restructuring and other charges for the first quarter of 2019 primarily included
severance costs of $67, partially offset by a benefit of $58 related to the
elimination of life insurance benefits for U.S. salaried and non-bargained
hourly retirees of the Company and its subsidiaries.
Interest expense. Interest expense was $91 in the first quarter of 2020 compared
to $85 in the first quarter of 2019. The increase of $6, or 7%, in the first
quarter of 2020 was primarily due to higher debt outstanding resulting from new
debt issued in the first quarter of 2020. See Note N to the Consolidated
Financial Statements.
Other expense, net. Other expense, net was $17 in the first quarter of 2020
compared to $32 in the first quarter of 2019. The decrease of $15, or 47%, in
the first quarter of 2020 was primarily due to the impacts of deferred
compensation arrangements of $16 related to investment performance which were
favorable in the first quarter of 2020 but unfavorable of $10 in the first
quarter of 2019, and lower non-service related net periodic benefit cost,
partially offset by unfavorable foreign currency and lower interest income.
Provision for income taxes. The tax rate including discrete items was 26.1% in
the first quarter of 2020 compared to 27.2% in the first quarter of 2019. A
discrete tax benefit of $8 was recorded in the first quarter of 2020 compared to
a discrete tax charge of $1 in the first quarter of 2019. The estimated annual
effective tax rate, before discrete items, applied to ordinary income was 27.9%
in the first quarter of 2020 compared to 25.9% in the first quarter of 2019. See
Note G to the Consolidated Financial Statements.
Net income. Net income was $215 in the first quarter of 2020, or $0.49 per
diluted share, compared to $187 in the first quarter of 2019, or $0.39 per
diluted share. The increase of $28 in the first quarter of 2020 was primarily
due to net cost savings, lower Other expense, net, SG&A, Provision for
depreciation and amortization, and R&D expenses, partially offset by lower
volumes, and higher Restructuring and other charges, Interest expense, and
Provision for income taxes.
Segment Information
Segment performance under the Company's management reporting system is evaluated
based on a number of factors; however, the primary measure of performance is
Segment operating profit. The Company's definition of Segment operating profit
is Operating income excluding Special items. Special items include Restructuring
and other charges and Impairment of goodwill. Segment operating profit may not
be comparable to similarly titled measures of other companies. Differences
between segment and consolidated totals are in Corporate.
In the third quarter of 2019, the Company realigned its operations by
eliminating its Transportation and Construction Solutions ("TCS") segment and
transferring the Forged Wheels business to its Engineered Products and Forgings
("EP&F") segment and the Building and Construction Systems ("BCS") business to
its Global Rolled Products ("GRP") segment, consistent with how the Chief
Executive Officer was assessing operating performance and allocating capital in
conjunction with the Arconic Inc. Separation Transaction (see Note R to the
Consolidated Financial Statements in Part I Item 1 of this Form 10-Q). Prior
period financial information has been recast to conform to current year
presentation.
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The Company produces aerospace engine parts and components, aerospace fastening
systems, and aluminum sheet and plate products for Boeing 737 MAX airplanes. The
temporary reduction in the production rate of the 737 MAX airplanes that was
announced by Boeing in April 2019 did not have a significant impact on the
Company's sales or segment operating profit in 2019. In late December 2019,
Boeing announced a temporary suspension of production of the 737 MAX airplanes.
This decline in production had a negative impact on sales and segment operating
profit in the EP&F and GRP segments in the first quarter of 2020. The Company
expects the reduction in 737 MAX production rates to continue to have a negative
impact on 2020 financial performance throughout the year
Engineered Products and Forgings
First quarter ended
March 31,
2020 2019
Third-party sales $ 1,631 $ 1,756
Segment operating profit 339 313


Third-party sales for the Engineered Products and Forgings segment decreased
$125, or 7%, in the first quarter of 2020 compared to the first quarter of 2019,
primarily due to lower volumes in the commercial transportation and aerospace
end markets driven by COVID-19 and 737 MAX production declines and a decrease in
sales of $32 from the divestiture of the forgings business in the U.K. (December
2019) (see Note P to the Consolidated Financial Statements in Part I Item 1
of this Form 10-Q).
Segment operating profit for the Engineered Products and Forgings segment
increased $26, or 8%, in the first quarter of 2020 compared to the first quarter
of 2019, primarily due to net cost savings, lower raw material costs, and price
increases, partially offset by lower volumes as noted above.
Global Rolled Products
First quarter ended
March 31,
2020 2019
Third-party sales $ 1,578 $ 1,784
Intersegment sales 35 52
Total sales $ 1,613 $ 1,836
Segment operating profit 169 135
Third-party aluminum shipments (kmt) 312 331


Third-party sales for the Global Rolled Products segment decreased $206, or 12%,
in the first quarter of 2020 compared to the first quarter of 2019, primarily
due to lower volumes in the automotive, commercial transportation, and aerospace
end markets driven by COVID-19 and 737 MAX production declines, lower aluminum
prices, and a decrease in sales of $34 from the divestitures of the aluminum
rolling mill in Itapissuma, Brazil (February 2020) and the hard alloy extrusions
plant in South Korea (March 2020) (see Note P to the Consolidated Financial
Statements in Part I Item 1 of this Form 10-Q), partially offset by increased
industrial volumes as a result of the Tennessee transition to industrial
products.
Segment operating profit for the Global Rolled Products segment increased $34,
or 25%, in the first quarter of 2020 compared to the first quarter of 2019,
primarily due to net cost savings, aluminum prices, and favorable volumes in the
industrial end market, partially offset by lower volumes noted above.
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Reconciliation of Total segment operating profit to Consolidated income before
income taxes
First quarter ended
March 31,
2020 2019
Total segment operating profit $ 508 $ 448
Unallocated amounts:
Restructuring and other charges (21) (12)
Corporate expense (88) (62)
Consolidated operating income $ 399 $ 374
Interest expense (91) (85)
Other expense, net (17) (32)
Consolidated income before income taxes $ 291 $ 257


See Restructuring and other charges, Interest expense, and Other expense, net
discussions above under Results of Operations for reference.
Corporate expense increased $26, or 42%, in the first quarter of 2020 compared
to the first quarter of 2019, primarily due to higher costs associated with the
Arconic Inc. Separation Transaction of $35 and impairment costs related to
facilities closures of $3, partially offset by a decrease of $6 in strategy and
portfolio review costs, and a decrease of $2 in legal and other advisory costs
related to Grenfell Tower.
Environmental Matters
See the Environmental Matters section of Note Q to the Consolidated
Financial Statements in Part I Item 1 of this Form 10-Q.
Subsequent Events
See Note N to the Consolidated Financial Statements in Part I Item 1 of this
Form 10-Q for details of both the issuance and early redemption of debt and
changes to the Company's credit facilities.
See Note R to the Consolidated Financial Statements in Part I Item 1 of this
Form 10-Q for updates on the Arconic Inc. Separation Transaction.
Liquidity and Capital Resources
Operating Activities
Cash used for operations was $291 in the three months ended March 31, 2020,
compared to $258 in the three months ended March 31, 2019. The decrease of $33,
or 13%, was primarily due to higher working capital of $68 and an unfavorable
change in noncurrent liabilities of $19, partially offset by higher operating
results of $54. The components of the change in working capital included
unfavorable changes of $280 in accounts payable and $104 in accrued expenses,
partially offset by favorable changes of $279 in receivables and $43 in taxes,
including income taxes.
Financing Activities
Cash provided from financing activities was $1,145 in the three months ended
March 31, 2020 compared to Cash used for financing activities of $741 in the
three months ended March 31, 2019. The change of $1,886, or 255%, was primarily
due to debt issued for Arconic Corporation in connection with the Arconic Inc.
Separation Transaction (see Note N to the Consolidated Financial Statements
in Part I Item 1 of this Form 10-Q) of $1,200, and a decrease in repurchases of
common stock of $700.
The Company maintains a Five-Year Revolving Credit Agreement (the "Credit
Agreement") with a syndicate of lenders and issuers named therein. In addition
to the Credit Agreement, the Company has a number of other credit agreements.
See Note N to the Consolidated Financial Statements in Part I Item 1 of this
Form 10-Q for reference.
The Company's costs of borrowing and ability to access the capital markets are
affected not only by market conditions but also by the short- and long-term debt
ratings assigned to the Company by the major credit rating agencies.
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The Company's credit ratings from the three major credit rating agencies are as
follows:
Long-Term Debt Short-Term Debt Outlook Date of Last Update
Standard and Poor's BBB- A-3 Negative April 22, 2020
Moody's Ba3 Speculative Grade Liquidity-2 Negative April 23, 2020
Fitch BBB- B Stable April 22, 2020


Investing Activities
Cash provided from investing activities was $94 in the three months ended
March 31, 2020 compared to $42 in the three months ended March 31, 2019. The
increase of $52, or 124%, was primarily due to a decrease in capital
expenditures of $99, an increase in proceeds from the sale of assets and
business of $110 (see Note N to the Consolidated Financial Statements in
Part I Item 1 of this Form 10-Q), partially offset by a decrease in sales of
investments of $47 and a decrease in cash receipts from sold receivables of
$112.
Critical Accounting Policies and Estimates
Goodwill. Goodwill is not amortized; instead, it is reviewed for impairment
annually (in the fourth quarter) or more frequently if indicators of impairment
exist or if a decision is made to sell or realign a business. A significant
amount of judgment is involved in determining if an indicator of impairment has
occurred. Such indicators may include deterioration in general economic
conditions, negative developments in equity and credit markets, adverse changes
in the markets in which an entity operates, increases in input costs that have a
negative effect on earnings and cash flows, or a trend of negative or declining
cash flows over multiple periods, among others. The fair value that could be
realized in an actual transaction may differ from that used to evaluate the
impairment of goodwill.
Goodwill is allocated among and evaluated for impairment at the reporting unit
level, which is defined as an operating segment or one level below an operating
segment. For the first quarter of 2020, Howmet had seven reporting units, of
which four were included in the EP&F segment (Fastening Systems, Engineered
Structures, Engine Products, and Forged Wheels), and three were included in the
GRP segment (Global Rolled Products, Aluminum Extrusions, and BCS.)
In reviewing goodwill for impairment, an entity has the option to first assess
qualitative factors to determine whether the existence of events or
circumstances leads to a determination that it is more likely than not (greater
than 50%) that the estimated fair value of a reporting unit is less than its
carrying amount. If an entity elects to perform a qualitative assessment and
determines that an impairment is more likely than not, the entity is then
required to perform the quantitative impairment test (described below),
otherwise no further analysis is required. An entity also may elect not to
perform the qualitative assessment and, instead, proceed directly to the
quantitative impairment test. The ultimate outcome of the goodwill impairment
review for a reporting unit should be the same whether an entity chooses to
perform the qualitative assessment or proceeds directly to the quantitative
impairment test.
Howmet determines annually, based on facts and circumstances, which of its
reporting units will be subject to the qualitative assessment. For those
reporting units where a qualitative assessment is either not performed or for
which the conclusion is that an impairment is more likely than not, a
quantitative impairment test will be performed. Howmet's policy is that a
quantitative impairment test be performed for each reporting unit at least once
during every three-year period.
Under the qualitative assessment, various events and circumstances (or factors)
that would affect the estimated fair value of a reporting unit are identified
(similar to impairment indicators above). These factors are then classified by
the type of impact they would have on the estimated fair value using positive,
neutral, and adverse categories based on current business conditions.
Additionally, an assessment of the level of impact that a particular factor
would have on the estimated fair value is determined using high, medium, and low
weighting. Furthermore, management considers the results of the most recent
quantitative impairment test completed for a reporting unit and compares the
weighted average cost of capital (WACC) between the current and prior years for
each reporting unit.
During the first quarter of 2020, Howmet's market capitalization declined
significantly compared to the fourth quarter of 2019. Over the same period, the
equity value of our peer group companies, and the overall U.S. stock market also
declined significantly amid market volatility. In addition, as a result of the
COVID-19 pandemic and measures designed to contain the spread, sales globally to
customers in the aerospace and commercial transportation industries that are
impacted by COVID-19 have been and are expected to be negatively impacted as a
result of disruption in demand. As a result of these macroeconomic factors, we
performed a qualitative impairment test to evaluate whether it is more likely
than not that the fair value of any of our reporting units is less than its
carrying value. As a result of this assessment, the Company performed a
quantitative impairment test for the Engineered Structures reporting unit and
concluded that though the margin between the fair value of the reporting unit
and carrying value had declined from approximately 60% to approximately 15%, it
was not impaired. Consistent with prior practice, a discounted cash flow model
was used to estimate the current fair value of the reporting unit. The
significant
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assumptions and estimates utilized to determine fair value were developed
utilizing current market and forecast information reflecting the disruption in
demand that has and is expected to negatively impact the Company's sales
globally in the aerospace industry. If our actual results or external market
factors decline significantly from management's estimates, future goodwill
impairment charges may be necessary and could be material.
Recently Adopted and Recently Issued Accounting Guidance
See Note B to the Consolidated Financial Statements in Part I Item 1 of this
Form 10-Q.
Forward-Looking Statements
This report contains statements that relate to future events and expectations
and as such constitute forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Forward-looking statements
include those containing such words as "anticipates," "believes," "could,"
"estimates," "expects," "forecasts," "goal," "guidance," "intends," "may,"
"outlook," "plans," "projects," "seeks," "sees," "should," "targets," "will,"
"would," or other words of similar meaning. All statements that reflect Howmet's
expectations, assumptions or projections about the future, other than statements
of historical fact, are forward-looking statements, including, without
limitation, forecasts and expectations relating to the growth of the aerospace,
automotive, commercial transportation and other end markets; statements and
guidance regarding future financial results or operating performance; statements
regarding future strategic actions; and statements about Howmet's strategies,
outlook, business and financial prospects. These statements reflect beliefs and
assumptions that are based on Howmet's perception of historical trends, current
conditions and expected future developments, as well as other factors Howmet
believes are appropriate in the circumstances. Forward-looking statements are
not guarantees of future performance and are subject to risks, uncertainties,
and changes in circumstances that are difficult to predict, which could cause
actual results to differ materially from those indicated by these statements.
Such risks and uncertainties include, but are not limited to: (a) the impact of
the separation of Arconic Corporation from Howmet on the businesses of Howmet;
(b) deterioration in global economic and financial market conditions generally
including as a result of pandemic health issues (including COVID-19 and its
effects, among other things, on global supply, demand, and distribution
disruptions as the COVID-19 outbreak continues and results in an increasingly
prolonged period of travel, commercial and/or other similar restrictions and
limitations); (c) unfavorable changes in the markets served by Howmet; (d) the
inability to achieve the level of revenue growth, cash generation, cost savings,
improvement in profitability and margins, fiscal discipline, or strengthening of
competitiveness and operations anticipated or targeted; (e) competition from new
product offerings, disruptive technologies or other developments; (f) political,
economic, and regulatory risks relating to Howmet's global operations, including
compliance with U.S. and foreign trade and tax laws, sanctions, embargoes and
other regulations; (g) manufacturing difficulties or other issues that impact
product performance, quality or safety; (h) Howmet's inability to realize
expected benefits, in each case as planned and by targeted completion dates,
from acquisitions, divestitures, facility closures, curtailments, expansions, or
joint ventures; (i) the impact of potential cyber attacks and information
technology or data security breaches; (j) the loss of significant customers or
adverse changes in customers' business or financial conditions; (k) adverse
changes in discount rates or investment returns on pension assets; (l) the
impact of changes in aluminum prices and foreign currency exchange rates on
costs and results; (m) the outcome of contingencies, including legal
proceedings, government or regulatory investigations, and environmental
remediation, which can expose Howmet to substantial costs and liabilities; and
(n) the possible impacts and our preparedness to respond to implications of
COVID-19; and (o) the other risk factors summarized in Howmet's Form 10-K for
the year ended December 31, 2019 and other reports filed with the U.S.
Securities and Exchange Commission
. Market projections are subject to the risks
discussed above and other risks in the market. Howmet disclaims any intention or
obligation to update publicly any forward-looking statements, whether in
response to new information, future events, or otherwise, except as required by
applicable law.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Not material.
Item 4. Controls and Procedures.
(a) Evaluation of Disclosure Controls and Procedures

The Company's Co-Chief Executive Officers and Chief Financial Officer have
evaluated the Company's disclosure controls and procedures, as defined in Rules
13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as of the end of
the period covered by this report, and they have concluded that these controls
and procedures are effective.
(b) Changes in Internal Control over Financial Reporting
There have been no changes in internal control over financial reporting during
the first quarter of 2020 that have materially affected, or are reasonably
likely to materially affect, the Company's internal control over financial
reporting.
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