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Management's Discussion of Results of Operations (Excerpts)

For purposes of readability, Zenith attempts to strip out all tables in excerpts from the Management Discussion. That information is contained elsewhere in our articles. The idea of this summary is simply to review how well we believe Management does its reporting. Also, this highlights what Management believes is important.

In our Decision Matrix at the end of each article, a company with 0 to 2 gets a "-1", and 3 to 5 gets a "+1."

On a scale of 0 to 5, 5 being best, Zenith rates this company's Management's Discussion as a 3.



Overview

Our Business

Arconic (“Arconic” or the “Company”) is a global leader in lightweight metals engineering and manufacturing. Arconic’s innovative, multi-material products, which include aluminum, titanium, and nickel, are used worldwide in aerospace, automotive, commercial transportation, building and construction, industrial applications, defense, and packaging.
Results of Operations
Earnings Summary:
Sales. Sales were $3,559 in the third quarter of 2019 compared to $3,524 in the third quarter of 2018 and $10,791 in the nine months ended September 30, 2019 compared to $10,542 in the nine months ended September 30, 2018. The increase of $35, or 1%, in the third quarter of 2019 and $249, or 2%, in the nine months ended September 30, 2019, was primarily due to volume growth in the aerospace, commercial transportation, packaging, and industrial end markets; favorable product pricing and mix in the Global Rolled Products (GRP) segment; and favorable product pricing in the Engineered Products and Forgings (EP&F) segment (formerly named the Engineered Products and Solutions segment) when fulfilling volume above contractual share, renewing contracts, and selling non-contractual spot business; partially offset by lower aluminum prices; lower sales of $44 and $177 in the third quarter and nine months ended September, 30, 2019, respectively, related to the completed ramp down of Arconic's North American packaging operations (in December 2018) and the divestitures of the extrusions business in Latin America (divested in April 2018) and the forgings business in Eger, Hungary (divested in December 2018); and unfavorable foreign currency movements. The nine months ended September 30, 2018 was also impacted by costs incurred of $38 related to settlements of certain customer claims primarily related to product introductions.
Cost of goods sold (COGS). COGS as a percentage of Sales was 78.7% in the third quarter of 2019 compared to 81.8% in the third quarter of 2018 and 79.3% in the nine months ended September 30, 2019 compared to 81.1% in the nine months ended September 30, 2018. The decrease in the third quarter and nine months ended September 30, 2019 was primarily due to lower raw material costs including aluminum prices, favorable product pricing, and net cost savings, partially offset by unfavorable product mix, and costs related to a fire at a fasteners plant of $4 and $8 in the third quarter and nine months ended September 30, 2019, respectively. The nine months ended September 30, 2019 also included the following costs: a charge for environmental remediation at Grasse River of $25; the impairment of energy business assets of $9; and a charge of $9 primarily for a one-time signing bonus for employees associated with the collective bargaining agreement negotiation. In June of 2019 the Company and the United Steelworkers reached a tentative three-year labor agreement covering approximately 3,400 employees at four U.S. locations; the previous labor agreement expired on May 15, 2019. The tentative agreement was ratified on July 11, 2019. The nine months ended September 30, 2018 included the following costs that did not recur in 2019: costs of $38 related to settlements of certain customer claims noted above and a charge of $23 related to a physical inventory adjustment at one plant in the GRP segment (this plant was previously included in the EP&F segment prior to the transfer of the aluminum extrusions operations from EP&F to GRP in the first quarter of 2019). In the second quarter of 2019, the Company sustained a fire at a fasteners plant in France and recorded a charge of $4 for equipment and inventory damage, as well as higher operating costs. The Company recorded a charge of $4 in the third quarter of 2019 for repairs, cleanup, and higher operating costs related to the fire. The Company anticipates a charge of approximately $10 to $15 in the fourth quarter of 2019, with additional impacts in subsequent quarters as the business continues to recover from the fire. The Company has insurance with a deductible of $10.
Selling, general administrative, and other expenses (SG&A). SG&A expenses were $167 in the third quarter of 2019 compared to $134 in the third quarter of 2018 and $523 in the nine months ended September 30, 2019 compared to $464 in the nine months ended September 30, 2018. The increase of $33, or 25%, in the third quarter of 2019 and $59, or 13%, in the nine months ended September 30, 2019, was primarily due to costs associated with the planned separation of Arconic of $25 and $44 in the third quarter and nine months ended September 30, 2019, respectively, and higher annual incentive compensation accruals and executive compensation costs, partially offset by lower costs driven by overhead cost reductions. The nine months ended September 30, 2019 was also impacted by $6 in strategy and portfolio review costs.
Research and development expenses (R&D). R&D expenses were $16 in the third quarter of 2019 compared to $25 in the third quarter of 2018 and $55 in the nine months ended September 30, 2019 compared to $77 in the nine months ended September 30, 2018. The decrease of $9, or 36%, in the third quarter of 2019 and $22, or 29%, in the nine months ended September 30, 2019, 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 $119 in the third quarter of 2019 compared to a net benefit of $2 in the third quarter of 2018 and $630 in the nine months ended September 30, 2019 compared to $20 in the nine months ended September 30, 2018. The increase of $121 in the third quarter of 2019 and $610 in the nine months ended September 30, 2019, was primarily due to charges of $59 and $43 primarily related to non-cash impairments of the net book value of the Company’s aluminum rolling mill in Brazil and its forgings business in the U.K., respectively, associated with agreements reached during the quarter to sell these businesses. The nine months ended September 30, 2019 was also impacted by a charge for impairment of a long-lived asset group of $428 (see Note M to the Consolidated Financial Statements); an increase in layoff charges of $81, and a charge for impairment of a trade name intangible asset and properties, plants, and equipment of $24; partially offset by a credit of $58 related to the elimination of life insurance benefits for U.S. salaried and non-bargaining hourly retirees of the Company and its subsidiaries. The nine months ended September 30, 2018 was also impacted by a postretirement curtailment benefit of $28. See Note D to the Consolidated Financial Statements.
Interest expense. Interest expense was $86 in the third quarter of 2019 compared to $88 in the third quarter of 2018 and $256 in the nine months ended September 30, 2019 compared to $291 in the nine months ended September 30, 2018. The decrease of $2, or 2%, in the third quarter of 2019 and $35, or 12%, in the nine months ended September 30, 2019, was primarily due to lower debt outstanding. The nine months ended September 30, 2018 was also impacted by a charge of $19 related to the premium paid on the early redemption of the Company’s then outstanding 5.72% Senior Notes due 2019.
Other expense, net. Other expense, net was $31 in the third quarter of 2019 compared to $8 in the third quarter of 2018 and $92 in the nine months ended September 30, 2019 compared to $69 in the nine months ended September 30, 2018. The increase of $23, or 288%, in the third quarter of 2019 and $23, or 33%, in the nine months ended September 30, 2019, was primarily due to a benefit of $29 from establishing a tax indemnification receivable reflecting Alcoa Corporation’s 49% share of a Spanish tax reserve in 2018 that did not recur in 2019 and an increase in deferred compensation arrangements related to investment performance. The nine months ended September 30, 2019 was also impacted by favorable foreign currency movements.
Provision for income taxes. The tax rate including discrete items was 54.5% in the third quarter of 2019 compared to 35.3% in the third quarter of 2018. A discrete tax charge of $10 was recorded in the third quarter of 2019 compared to a discrete tax charge of $26 in the third quarter of 2018. The estimated annual effective tax rate, before discrete items, applied to ordinary income was 43.9% in the third quarter of 2019 compared to 26.5% in the third quarter of 2018. See Note G to the Consolidated Financial Statements.
Net income. Net income was $95 in the third quarter of 2019, or $0.21 per diluted share, compared $161 in the third quarter of 2018, or $0.32 per diluted share, and $161 in the nine months ended September 30, 2019, or $0.35 per diluted share, compared to $424 in the nine months ended September 30, 2018, or $0.86 per diluted share. The decrease of $66 in the third quarter of 2019 and $263 in the nine months ended September 30, 2019, was primarily due to higher Restructuring and other charges, higher Income taxes, higher SG&A expenses, and higher Other expense, net, partially offset by volume growth, favorable product pricing, net cost savings, lower Interest expense, and lower R&D expenses.
Segment Information
Segment performance under Arconic’s management reporting system is evaluated based on a number of factors; however, the primary measure of performance is Segment operating profit. Arconic’s definition of Segment operating profit is Operating income excluding Special items. Special items include Restructuring and other charges. Segment operating profit includes the impact of LIFO inventory accounting, metal price lag, intersegment profit eliminations, and derivative activities. Segment operating profit may not be comparable to similarly titled measures of other companies. Differences between segment totals and consolidated Arconic 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 EP&F segment and the Building and Construction Systems business to its GRP segment, consistent with how the Chief Executive Officer is assessing operating performance and allocating capital in conjunction with the planned separation of the Company (see Note S to the Consolidated Financial Statements). The Latin American extrusions business, which was formerly part of the Company's TCS segment until its sale in April of 2018 (see Note Q to the Consolidated Financial Statements), was moved to Corporate. In the first quarter of 2019, management transferred its aluminum extrusions operations from its Engineered Structures business unit within the EP&F segment to the GRP segment, based on synergies with GRP including similar customer base, technologies, and manufacturing capabilities. Prior period financial information has been recast to conform to current year presentation.
Arconic 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 revenues or segment operating profit in the third quarter. A significant reduction in the production rate could have a negative impact on revenues and segment operating profit in the fourth quarter of 2019 in the EP&F and GRP segments.


Engineered Products and Forgings
	

Third-party sales for the Engineered Products and Forgings segment increased $111, or 7%, in the third quarter of 2019 compared to the third quarter of 2018 and $289, or 6%, in the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily as a result of higher aerospace and commercial transportation volumes and favorable product pricing, partially offset by unfavorable foreign currency movements and the absence of sales of $7 and $26 in the third quarter and nine months ended September 30, 2019, respectively, from the forgings business in Eger, Hungary (divested in December 2018).
Segment operating profit for the Engineered Products and Forgings segment increased $79, or 28%, in the third quarter of 2019 compared to the third quarter of 2018 and $199, or 24%, in the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, due to higher volumes as noted previously, favorable product pricing, net cost savings, and lower raw material costs, partially offset by the unfavorable impact of new product introductions in aerospace engines and unfavorable product mix.
On December 31, 2018, as part of the Company’s ongoing strategy and portfolio review, Arconic completed the sale of its Eger, Hungary forgings business to Angstrom Automotive Group LLC.
In the fourth quarter of 2019 compared to the fourth quarter of 2018, demand in the commercial aerospace end market is expected to remain strong, driven by the ramp-up of new aerospace engine platforms. Demand in the defense end market is expected to continue to grow due to the ramp-up of certain aerospace programs, while the commercial transportation end market is expected to be down. Net cost savings and favorable pricing are expected to continue.
Global Rolled Products
															
Third-party sales for the Global Rolled Products segment decreased $76, or 4%, in the third quarter of 2019 compared to the third quarter of 2018 and $53, or 1%, in the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, primarily as a result of lower aluminum prices; the absence of sales of $37 and $126 in the third quarter and nine months ended September 30, 2019, respectively, from the completed ramp down of Arconic's North American packaging operations (completed in December 2018); and unfavorable foreign currency movements; partially offset by higher volumes in the packaging, aerospace, and industrial end markets; and favorable product pricing and mix.
Segment operating profit for the Global Rolled Products segment increased $54, or 50%, in the third quarter of 2019 compared to the third quarter of 2018 and $87, or 22%, in the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, due to favorable pricing adjustments on industrial and commercial transportation products, higher volumes as noted previously, favorable aluminum price impacts, and net cost savings, partially offset by operational challenges at one plant in the Aluminum Extrusions business and the Tennessee plant transition to industrial production. The nine months ended September 30, 2018 was also impacted by a charge related to a physical inventory adjustment at one plant incurred in 2018 that did not recur in 2019.
In the fourth quarter of 2019 compared to the fourth quarter of 2018, demand from the commercial airframe end market is expected to be up, while the automotive end market is expected to be down. Demand in the North American commercial
transportation end market is expected to be down, while growth is anticipated in the industrial market with the Tennessee transition from packaging. Favorable pricing and net productivity improvements are also anticipated to continue.
	

Interest expense, and Other expense, net discussions above under Results of Operations for reference.
Corporate expense increased $31, or 65%, in the third quarter of 2019 compared to the third quarter of 2018 and $59, or 29%, in the nine months ended September 30, 2019 compared to the nine months ended September 30, 2018, due to costs associated with the planned separation of Arconic of $25 and $44 in the third quarter and nine months ended September 30, 2019, respectively, higher annual incentive compensation accruals and executive compensation costs, and costs related to a fire at a fasteners plant of $4 and $8 in the third quarter and nine months ended September 30, 2019, respectively, partially offset by lower costs driven by overhead cost reductions, lower research and development expenses, and a decrease in legal and other advisory costs related to Grenfell Tower. The nine months ended September 30, 2019 also included the following costs: environmental remediation costs for Grasse River of $25; collective bargaining agreement negotiation costs of $9; impairment of energy business assets of $9; and costs associated with the strategy and portfolio review of $6. The nine months ended September 30, 2018 included costs of $38 incurred in the second quarter of 2018 related to settlements of certain customer claims primarily related to product introductions.

Subsequent Events

Liquidity and Capital Resources
Operating Activities
Cash used for operations was $100 in the nine months ended September 30, 2019 compared to $209 in the nine months ended September 30, 2018. The decrease in cash used of $109, or 52%, was primarily due to higher operating results, lower pension contributions of $71, and a favorable change in noncurrent liabilities of $46, partially offset by higher working capital of $166. The components of the change in working capital included an unfavorable change of $376 in accounts payable, partially offset by favorable changes of $92 in inventories, $63 in receivables, and $29 in taxes, including income taxes.

Financing Activities
Cash used for financing activities was $1,144 in the nine months ended September 30, 2019 compared to $609 in the nine months ended September 30, 2018. The increase in cash used of $535, or 88%, was primarily related to the repurchase of $1,100 of common stock (see Note H to the Consolidated Financial Statements); partially offset by a decrease in payments on debt due to the redemption in the first quarter of 2018 of the then outstanding 5.72% Notes due in 2019 with aggregate principal amount of $500; a decrease in dividends paid to shareholders of $41; and premiums paid on early redemption of debt of $17 in 2018.

On October 15, 2019, the 1.63% Convertible Notes (“the Notes”) matured in accordance with their terms and the Company repaid in cash on the maturity date the aggregate outstanding principal amount of the Notes of approximately $403 together with accrued and unpaid interest, pursuant to the terms of the Notes.
Arconic 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, Arconic has a number of other credit agreements. See Note O to the Consolidated Financial Statements in Part I Item 1 of this Form 10-Q for reference.
Arconic’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 Arconic by the major credit rating agencies.
Arconic’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 26, 2019
Moody’s
	
Ba2
	
Speculative Grade Liquidity-2
	
Stable
	
October 9, 2019
Fitch
	
BB+
	
B
	
Positive
	
October 8, 2019
Investing Activities
Cash provided from investing activities was $288 in the nine months ended September 30, 2019 compared to $211 in the nine months ended September 30, 2018. The increase in cash provided of $77, or 36%, was primarily due to the sale of fixed-income securities of $47 in the first quarter of 2019 and lower capital expenditures of $82, partially offset by a decrease in cash receipts from sold receivables of $63.
	
On February 5, 2018, the Company announced that its Board of Directors (the Board) had authorized the repurchase of up to $500 million of the Company's outstanding common stock (the "February 2018 Share Repurchase Program"). There was no stated expiration for the February 2018 Share Repurchase Program, and no shares were repurchased during 2018. On February 8, 2019, the Company announced that the Board had authorized the repurchase of an additional $500 million of the Company's outstanding common stock, effective through the end of 2020. On May 20, 2019, the Company announced that the Board had authorized the repurchase of a further $500 million of the Company's outstanding common stock (the "May 2019 Share Repurchase Program"). There was no stated expiration for the May 2019 Share Repurchase Program.
	
On August 6, 2019, the Company entered into an accelerated share repurchase (ASR) agreement with Goldman Sachs & Co. LLC (“GS”) to repurchase $200 million of its common stock, and received an initial delivery of 6,791,172 shares. The term of the ASR concluded on September 30, 2019, with GS delivering 983,107 additional shares to Arconic on October 3, 2019. A total of 7,774,279 shares, at an average price of $25.73 per share, were repurchased under the agreement.