(dollars in millions, except per share amounts; shipments in thousands of metric tons [kmt]) Overview OnApril 1, 2020 ,Howmet Aerospace Inc. (formerly known asArconic 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 theArconic 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 theArconic Inc. Separation Transaction onFebruary 5, 2020 , which was effected by the distribution (the "Distribution") by the Company of all of the outstanding common stock of Arconic Corporation onApril 1, 2020 to the Company's stockholders who held shares as of the close of business onMarch 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. OnMarch 31, 2020 , in connection with theArconic 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 theArconic Inc. Separation Transaction did not take place untilApril 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 theArconic 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 inNorth America andEurope 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 inFebruary 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 inSouth Korea (March 2020 ), the aluminum rolling mill in Itapissuma,Brazil (February 2020 ), and the forgings business in theUnited 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 25 --------------------------------------------------------------------------------$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 toGrenfell Tower , partially offset by higher costs associated with theArconic 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 forU.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. 26 -------------------------------------------------------------------------------- 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 inApril 2019 did not have a significant impact on the Company's sales or segment operating profit in 2019. In lateDecember 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 theU.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 theTennessee transition to industrial products. Segment operating profit for the Global Rolled Products segment increased$34 , or 25%, in the first quarter of 2020 compared to the first quarter of 2019, primarily due to net cost savings, aluminum prices, and favorable volumes in the industrial end market, partially offset by lower volumes noted above. 27 -------------------------------------------------------------------------------- Reconciliation of Total segment operating profit to Consolidated income before income taxes First quarter ended March 31, 2020 2019 Total segment operating profit$ 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 theArconic 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 toGrenfell 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 theArconic Inc. Separation Transaction. Liquidity and Capital Resources Operating Activities Cash used for operations was$291 in the three months endedMarch 31, 2020 , compared to$258 in the three months endedMarch 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 endedMarch 31, 2020 compared to Cash used for financing activities of$741 in the three months endedMarch 31, 2019 . The change of$1,886 , or 255%, was primarily due to debt issued for Arconic Corporation in connection with theArconic 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. 28 -------------------------------------------------------------------------------- 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 endedMarch 31, 2020 compared to$42 in the three months endedMarch 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 EstimatesGoodwill .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 overallU.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 29 -------------------------------------------------------------------------------- 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 withU.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 endedDecember 31, 2019 and other reports filed with theU.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. 30
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