Notes to the Combined Financial Statements (unaudited)
(dollars in millions)
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A.
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The Separation and Basis of Presentation
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The interim Combined Financial Statements of Arconic Rolled Products Corporation (“Arconic Corporation” or the “Company”) are unaudited. These Combined Financial Statements include all adjustments, consisting only of normal recurring adjustments, considered necessary by management to fairly state the Company’s results of operations, financial position, and cash flows. The results reported in these Combined Financial Statements are not necessarily indicative of the results that may be expected for the entire year. The 2019 year-end balance sheet data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America (GAAP). This Form 10-Q report should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 31, 2019, which includes all disclosures required by GAAP.
Our operations and financial results have been, and are expected to continue to be, adversely affected by the current coronavirus (COVID-19) pandemic. As a result of, among other things, uncertainty regarding the COVID-19 pandemic’s duration and its impact on the Company’s customers, suppliers and operations, Arconic Corporation is not currently able to estimate with certainty the specific future impact on its operations or financial results. Since Arconic’s launch as a standalone company on April 1, 2020, market conditions have been changing rapidly and unpredictably. As a result of the COVID-19 pandemic, several of our automotive and aerospace customers have temporarily suspended operations. Arconic derives approximately 35% of its revenue from ground transportation end markets and 18% from aerospace end markets, including approximately 13% of its revenue from Ford, our largest customer. We cannot predict with certainty the duration of these shutdowns. Due to the impacts of COVID-19 on our customers, we are experiencing, and expect to continue experiencing, lower demand and volume for our products. These trends may lead to charges, impairments and other adverse financial impacts over time. The duration of the current disruptions to our customers and related financial impact to us has been estimated, but remains highly uncertain at this time. Should such disruption continue for an extended period of time, the impact will have a material adverse effect on our business, results of operations, financial condition and/or cash flows.
As a result of these developments, Arconic Corporation has announced several measures to mitigate the impacts of COVID-19 on the Company’s results of operations, financial position, and cash flows:
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•
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deferred initiating a dividend on common stock;
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•
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reduced the CEO’s salary and the Board of Directors’ cash compensation by 30%;
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•
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reduced salaries for senior-level management by 20% and for all other salaried employees by 10%;
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•
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restructuring of the salaried workforce, targeting a 10% reduction;
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•
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idling of various production facilities based on market conditions within the regions where the Company operates;
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•
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decreased production and operating with a reduced labor force through shortened work weeks, shift reductions, layoffs, and the elimination of temporary workers and contractors at U.S.-based rolling and extrusion facilities;
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•
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modified schedules, adjusted work hours, lower costs, and delayed raises at all rolling mill facilities in Europe, China and Russia;
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•
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suspended the 401K match program for U.S. salaried employees; and
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•
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reducing capital expenditures by approximately $50, or approximately 30%.
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References in these Notes to (i) “ParentCo” refer to Arconic Inc., a Delaware corporation, and its consolidated subsidiaries (through March 31, 2020, at which time it was renamed Howmet Aerospace Inc.), and (ii) “2016 Separation Transaction” refer to the November 1, 2016 separation of Alcoa Inc., a Pennsylvania corporation, into two standalone, publicly-traded companies, Arconic Inc. and Alcoa Corporation.
The Separation. On February 8, 2019, ParentCo announced that its Board of Directors approved a plan to separate into two standalone, publicly-traded companies (the “Separation”). The spin-off company, Arconic Corporation, will include the rolled aluminum products, aluminum extrusions, and architectural products operations of ParentCo, as well as the Latin America extrusions operations sold in April 2018, (collectively, the “Arconic Corporation Businesses”). The existing publicly traded company, ParentCo, will continue to own the engine products, engineered structures, fastening systems, and forged wheels operations (collectively, the “Howmet Aerospace Businesses”).
The Separation was subject to a number of conditions, including, but not limited to: final approval by ParentCo’s Board of Directors (see below); receipt of an opinion of legal counsel (received on March 31, 2020) regarding the qualification of the distribution, together with certain related transactions, as a “reorganization” within the meaning of Sections 335 and 368(a)(1)
(D) of the U.S. Internal Revenue Code (i.e., a transaction that is generally tax-free for U.S. federal income tax purposes); and the U.S. Securities and Exchange Commission (the “SEC”) declaring effective a Registration Statement on Form 10, as amended, filed with the SEC on February 13, 2020 (effectiveness was declared by the SEC on February 13, 2020).
On February 5, 2020, ParentCo's Board of Directors approved the completion of the Separation by means of a pro rata distribution by ParentCo of all of the outstanding shares of common stock of Arconic Corporation to ParentCo common shareholders of record as of the close of business on March 19, 2020 (the “Record Date”). At the time of the Separation, ParentCo common shareholders will receive one share of Arconic Corporation common stock for every four shares of ParentCo common stock (the “Separation Ratio”) held as of the Record Date (ParentCo common shareholders will receive cash in lieu of fractional shares).
In connection with the Separation, as of March 31, 2020, Arconic Corporation and Howmet Aerospace entered into several agreements to implement the legal and structural separation between the two companies; govern the relationship between Arconic Corporation and Howmet Aerospace after the completion of the Separation; and allocate between Arconic Corporation and Howmet Aerospace various assets, liabilities, and obligations, including, among other things, employee benefits, environmental liabilities, intellectual property, and tax-related assets and liabilities. These agreements included a Separation and Distribution Agreement, Tax Matters Agreement, Employee Matters Agreement, and certain Patent, Know-How, Trade Secret License and Trademark License Agreements. The Separation and Distribution Agreement identifies the assets to be transferred, the liabilities to be assumed, and the contracts to be transferred to each of Arconic Corporation and Howmet Aerospace as part of the Separation, and provides for when and how these transfers and assumptions will occur.
On April 1, 2020 (the “Separation Date”), the Separation was completed and became effective at 12:01 a.m. Eastern Daylight Time. To effect the Separation, ParentCo undertook a series of transactions to separate the net assets and certain legal entities of ParentCo, resulting in a cash payment of approximately $730 to ParentCo by Arconic Corporation from a portion of the aggregate net proceeds of previously executed financing arrangements (see Note L). In connection with the Separation, 109,021,376 shares of Arconic Corporation common stock were distributed to ParentCo stockholders. “Regular-way” trading of Arconic Corporation’s common stock began with the opening of the New York Stock Exchange on April 1, 2020 under the ticker symbol “ARNC.” Arconic Corporation’s common stock has a par value of $0.01 per share.
ParentCo incurred costs to evaluate, plan, and execute the Separation, and Arconic Corporation was allocated a pro rata portion of these costs based on segment revenue (see Cost Allocations below). ParentCo recognized $38 in the 2020 first quarter and $3 in the 2019 first quarter for such costs, of which $18 and $1, respectively, was allocated to Arconic Corporation. The allocated amounts were included in Selling, general administrative, and other expenses on the accompanying Statement of Combined Operations.
Basis of Presentation. The Combined Financial Statements of Arconic Corporation are prepared in conformity with GAAP. In accordance with GAAP, certain situations require management to make estimates based on judgments and assumptions, which may affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements. These estimates are based on historical experience and, in some cases, assumptions based on current and future market experience, including considerations related to COVID-19. We have made our best estimates using all relevant information available at the time, but it is possible that our estimates will differ from our actual results and affect the Combined Financial Statements in future periods and potentially require adverse adjustments to the recoverability of goodwill and long-lived assets, the realizability of deferred tax assets and other judgments and estimations and assumptions that may be impacted by COVID-19.
Principles of Combination. The Combined Financial Statements of Arconic Corporation are prepared from ParentCo’s historical accounting records and are presented on a standalone basis as if the Arconic Corporation Businesses have been conducted independently from ParentCo. Such Combined Financial Statements include the historical operations that are considered to comprise the Arconic Corporation Businesses, as well as certain assets and liabilities that have been historically held at ParentCo’s corporate level but are specifically identifiable or otherwise attributable to Arconic Corporation. ParentCo’s net investment in these operations is reflected as Parent Company net investment on the accompanying Combined Financial Statements. All significant transactions and accounts within Arconic Corporation have been eliminated. All significant intercompany transactions between ParentCo and Arconic Corporation are included within Parent Company net investment on the accompanying Combined Financial Statements.
Cost Allocations. The Combined Financial Statements of Arconic Corporation include general corporate expenses of ParentCo that were not historically charged to the Arconic Corporation Businesses for certain support functions that are provided on a centralized basis, such as expenses related to finance, audit, legal, information technology, human resources, communications, compliance, facilities, employee benefits and compensation, and research and development activities. These
general corporate expenses are included on the accompanying Statement of Combined Operations within Cost of goods sold, Selling, general administrative and other expenses, and Research and development expenses. These expenses have been allocated to Arconic Corporation on the basis of direct usage when identifiable, with the remainder allocated based on the Arconic Corporation Businesses’ segment revenue as a percentage of ParentCo’s total segment revenue, as reported in the respective periods.
All external debt not directly attributable to Arconic Corporation has been excluded from the accompanying Combined Balance Sheet. Financing costs related to these debt obligations have been allocated to Arconic Corporation based on the ratio of capital invested by ParentCo in the Arconic Corporation Businesses to the total capital invested by ParentCo in both the Arconic Corporation Businesses and the Howmet Aerospace Businesses, and are included on the accompanying Statement of Combined Operations within Interest expense.
The following table reflects the allocations described above:
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First quarter ended March 31,
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2020
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2019
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Cost of goods sold(1)
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$
|
—
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|
|
$
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3
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|
Selling, general administrative, and other expenses(2)
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25
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24
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|
Research and development expenses
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—
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5
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Provision for depreciation and amortization
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1
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|
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2
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Restructuring and other charges (E)
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2
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(9
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)
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Interest expense
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28
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28
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Other (income), net (F)
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(5
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)
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(8
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)
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_____________________
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(1)
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For all periods presented, amount principally relates to an allocation of expenses for ParentCo’s retained pension and other postretirement benefit obligations associated with closed and sold operations.
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(2)
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In the first quarter of 2020, amount includes an allocation of $18 for costs incurred by ParentCo associated with the separation transaction (see The Separation above).
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Management believes the assumptions regarding the allocation of ParentCo’s general corporate expenses and financing costs are reasonable.
Nevertheless, the Combined Financial Statements of Arconic Corporation may not include all of the actual expenses that would have been incurred and may not reflect Arconic Corporation’s combined results of operations, financial position, and cash flows had it been a standalone company during the periods presented. Actual costs that would have been incurred if Arconic Corporation had been a standalone company would depend on multiple factors, including organizational structure, capital structure, and strategic decisions made in various areas, including information technology and infrastructure. Transactions between Arconic Corporation and ParentCo, including sales to the Howmet Aerospace Businesses, have been presented as related party transactions in these Combined Financial Statements and are considered to be effectively settled for cash at the time the transaction is recorded. The total net effect of the settlement of these transactions is reflected on the accompanying Statement of Combined Cash Flows as a financing activity and on the accompanying Combined Balance Sheet as Parent Company net investment.
Cash management. Cash is managed centrally with certain net earnings reinvested locally and working capital requirements met from existing liquid funds. Accordingly, the cash and cash equivalents held by ParentCo at the corporate level were not attributed to Arconic Corporation for any of the periods presented. Only cash amounts specifically attributable to Arconic Corporation are reflected in the accompanying Combined Balance Sheet. Transfers of cash, both to and from ParentCo’s centralized cash management system, are reflected as a component of Parent Company net investment on the accompanying Combined Balance Sheet and as a financing activity on the accompanying Statement of Combined Cash Flows.
ParentCo has an arrangement with several financial institutions to sell certain customer receivables without recourse on a revolving basis. The sale of such receivables is completed through the use of a bankruptcy-remote special-purpose entity, which is a consolidated subsidiary of ParentCo. In connection with this arrangement, in all periods prior to January 1, 2020, certain of Arconic Corporation’s customer receivables were sold on a revolving basis to this bankruptcy-remote subsidiary of ParentCo; these sales were reflected as a component of Parent Company net investment on the accompanying Combined Balance Sheet. As of December 31, 2019, the amount of Arconic Corporation’s outstanding customer receivables sold to ParentCo’s subsidiary was $281. Effective January 2, 2020, in preparation for the Separation, ParentCo's arrangement was amended to no longer
include customer receivables associated with the Arconic Corporation Businesses in this program, as well as to remove previously included customer receivables related to the Arconic Corporation Businesses not yet collected as of January 2, 2020. Accordingly, uncollected customer receivables of $281 related to the Arconic Corporation Businesses were removed from the program and the right to collect and receive the cash from the customer was returned to Arconic Corporation. The Company is evaluating whether to enter into a similar arrangement of its own subsequent to the Separation Date.
ParentCo participates in several accounts payable settlement arrangements with certain vendors and third-party intermediaries. These arrangements provide that, at the vendor’s request, the third-party intermediary advances the amount of the scheduled payment to the vendor, less an appropriate discount, before the scheduled payment date and ParentCo makes payment to the third-party intermediary on the date stipulated in accordance with the commercial terms negotiated with its vendors. In connection with these arrangements, certain of Arconic Corporation’s accounts payable are settled, at the vendor’s request, before the scheduled payment date; these settlements are reflected as a component of Parent Company net investment on the accompanying Combined Balance Sheet. As of both March 31, 2020 and December 31, 2019, the amount of Arconic Corporation’s accounts payables settled under such arrangements that have yet to be extinguished between ParentCo and third-party intermediaries was $1.
Related Party Transactions. Transactions between the Arconic Corporation Businesses and the Howmet Aerospace Businesses have been presented as related party transactions on the accompanying Combined Financial Statements. In the first quarter of 2020 and 2019, sales to the Howmet Aerospace Businesses from the Arconic Corporation Businesses were $35 and $52, respectively.
Earnings Per Share. For all periods presented, the earnings per share included on the accompanying Statement of Combined Operations was calculated based on the 109,021,376 shares of Arconic Corporation common stock distributed on April 1, 2020 in connection with the completion of the Separation (see above). This was determined by applying the Separation Ratio to the 436,085,504 shares of ParentCo’s outstanding common stock as of the Record Date. The same number of shares was used to calculate both basic and diluted earnings per share as Arconic Corporation did not have any common share equivalents in the periods presented.
Goodwill. During the first quarter of 2020, the equity value of Arconic Corporation’s peer group companies, and the overall U.S. stock market 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 ground transportation and aerospace 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, the Company performed a qualitative assessment to evaluate whether it is more likely than not that the fair value of any of its reporting units is less than the respective carrying values. As a result of this assessment, the Company concluded that no further analysis was required and no impairment exists. If Arconic Corporation’s actual results or external market factors further decline significantly, future goodwill impairment charges may be necessary and could be material.
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B.
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Recently Adopted and Recently Issued Accounting Guidance
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Adopted
On January 1, 2020, Arconic Corporation adopted changes issued by the Financial Accounting Standards Board (FASB) to credit losses. This guidance added a new impairment model (known as the current expected credit loss (CECL) model), which is based on expected losses rather than incurred losses. Under this model, an entity is required to recognize an allowance equivalent to its estimate of expected credit losses. The CECL model applies to most debt instruments, trade receivables, lease receivables, financial guarantee contracts, and other loan commitments. This model does not have a minimum threshold for recognition of impairment losses and requires the measurement of expected credit losses on assets that have a low risk of loss. The adoption of this guidance did not have a material impact on the Combined Financial Statements. This guidance will need to be considered in future assessments of credit losses.
Issued
In March 2020, the FASB issued amendments that provide optional guidance to ease the potential burden of reference rate reform on financial reporting. Under the amendments, expedients and exceptions are provided for applying GAAP to contracts, hedging relationships, and other transactions affected by the reform, if certain criteria are met, and apply only to those transactions which reference LIBOR or another reference rate that is expected to be discontinued. These amendments are effective immediately and may be applied prospectively to contract modifications made and hedging relationships entered into or evaluated on or before December 31, 2022. Management is currently evaluating the potential impact of these changes on the Combined Financial Statements.
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C.
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Revenue from Contracts with Customers
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The following table disaggregates revenue by major end market served.
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First quarter ended March 31,
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Rolled
Products
|
|
Extrusions
|
|
Building and
Construction
Systems
|
|
Arconic Corporation
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
Ground Transportation
|
|
$
|
499
|
|
|
$
|
30
|
|
|
$
|
—
|
|
|
$
|
529
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|
Building and Construction
|
|
35
|
|
|
—
|
|
|
256
|
|
|
291
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|
Aerospace
|
|
225
|
|
|
75
|
|
|
—
|
|
|
300
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|
Industrial Products
|
|
275
|
|
|
23
|
|
|
—
|
|
|
298
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|
Packaging
|
|
178
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|
|
—
|
|
|
—
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|
|
178
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|
Other
|
|
10
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|
|
5
|
|
|
—
|
|
|
15
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|
Total end-market revenue
|
|
$
|
1,222
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|
|
$
|
133
|
|
|
$
|
256
|
|
|
$
|
1,611
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2019
|
|
|
|
|
|
|
|
|
|
|
|
|
Ground Transportation
|
|
$
|
651
|
|
|
$
|
31
|
|
|
$
|
—
|
|
|
$
|
682
|
|
Building and Construction
|
|
49
|
|
|
—
|
|
|
281
|
|
|
330
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|
Aerospace
|
|
246
|
|
|
74
|
|
|
—
|
|
|
320
|
|
Industrial Products
|
|
248
|
|
|
32
|
|
|
—
|
|
|
280
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|
Packaging
|
|
210
|
|
|
—
|
|
|
—
|
|
|
210
|
|
Other
|
|
7
|
|
|
12
|
|
|
—
|
|
|
19
|
|
Total end-market revenue
|
|
$
|
1,411
|
|
|
$
|
149
|
|
|
$
|
281
|
|
|
$
|
1,841
|
|
|
|
D.
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Segment and Related Information
|
The operating results of Arconic Corporation’s reportable segments were as follows (differences between segment totals and Arconic Corporation’s combined totals are in Corporate):
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
First quarter ended March 31,
|
|
Rolled
Products
|
|
Extrusions
|
|
Building and
Construction
Systems
|
|
Total
|
2020
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
Third-party sales-unrelated party
|
|
$
|
1,201
|
|
|
$
|
119
|
|
|
$
|
256
|
|
|
$
|
1,576
|
|
Third-party sales-related party
|
|
21
|
|
|
14
|
|
|
—
|
|
|
35
|
|
Intersegment sales
|
|
7
|
|
|
—
|
|
|
—
|
|
|
7
|
|
Total sales
|
|
$
|
1,229
|
|
|
$
|
133
|
|
|
$
|
256
|
|
|
$
|
1,618
|
|
Segment operating profit
|
|
$
|
125
|
|
|
$
|
6
|
|
|
$
|
28
|
|
|
$
|
159
|
|
Supplemental information:
|
|
|
|
|
|
|
|
|
Provision for depreciation and amortization
|
|
$
|
46
|
|
|
$
|
6
|
|
|
$
|
4
|
|
|
$
|
56
|
|
Restructuring and other charges (E)
|
|
9
|
|
|
(31
|
)
|
|
1
|
|
|
(21
|
)
|
2019
|
|
|
|
|
|
|
|
|
Sales:
|
|
|
|
|
|
|
|
|
Third-party sales-unrelated party
|
|
$
|
1,376
|
|
|
$
|
132
|
|
|
$
|
281
|
|
|
$
|
1,789
|
|
Third-party sales-related party
|
|
35
|
|
|
17
|
|
|
—
|
|
|
52
|
|
Intersegment sales
|
|
7
|
|
|
—
|
|
|
—
|
|
|
7
|
|
Total sales
|
|
$
|
1,418
|
|
|
$
|
149
|
|
|
$
|
281
|
|
|
$
|
1,848
|
|
Segment operating profit
|
|
$
|
91
|
|
|
$
|
(4
|
)
|
|
$
|
22
|
|
|
$
|
109
|
|
Supplemental information:
|
|
|
|
|
|
|
|
|
Provision for depreciation and amortization
|
|
$
|
47
|
|
|
$
|
7
|
|
|
$
|
5
|
|
|
$
|
59
|
|
Restructuring and other charges (E)
|
|
6
|
|
|
—
|
|
|
5
|
|
|
11
|
|
The following table reconciles total segment operating profit to combined income before income taxes:
|
|
|
|
|
|
|
|
|
|
First quarter ended March 31,
|
|
2020
|
|
2019
|
Total segment operating profit
|
|
$
|
159
|
|
|
$
|
109
|
|
Unallocated amounts:
|
|
|
|
|
|
|
Cost allocations (A)
|
|
(26
|
)
|
|
(34
|
)
|
Restructuring and other charges (E)
|
|
19
|
|
|
(2
|
)
|
Other
|
|
—
|
|
|
7
|
|
Combined operating income
|
|
152
|
|
|
80
|
|
Interest expense
|
|
(35
|
)
|
|
(28
|
)
|
Other (expenses) income, net (F)
|
|
(26
|
)
|
|
14
|
|
Combined income before income taxes
|
|
$
|
91
|
|
|
$
|
66
|
|
|
|
E.
|
Restructuring and Other Charges
|
In the first quarter of 2020, Arconic Corporation recorded a net benefit of $19 in Restructuring and other charges, which were comprised of the following components: a $31 gain on the sale of an extrusions plant in South Korea (see Note M); a $6 loss on the sale of an aluminum rolling mill in Brazil (see Note M); and a $6 net charge for other items.
In the first quarter of 2019, Arconic Corporation recorded a net charge of $2 in Restructuring and other charges, which were comprised of the following components: an $11 charge for layoff costs, including the separation of approximately 155 employees (all within the Rolled Products and Building and Construction Systems segments) and a $9 net benefit for an allocation of ParentCo’s corporate restructuring activity (see Cost Allocations in Note A).
As of March 31, 2020, approximately 270 of the 480 employees associated with 2019 restructuring programs were separated. The remaining separations for the 2019 restructuring programs are expected to be completed during the remainder of 2020. In the first quarter of 2020, Arconic Corporation made cash payments of $4 against layoff reserves related to 2019 restructuring programs.
Activity and reserve balances for restructuring charges were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Layoff costs
|
|
Other costs
|
|
Total
|
Reserve balances at December 31, 2018
|
$
|
1
|
|
|
$
|
3
|
|
|
$
|
4
|
|
Cash payments
|
(12
|
)
|
|
(3
|
)
|
|
(15
|
)
|
Restructuring charges
|
30
|
|
|
2
|
|
|
32
|
|
Other(1)
|
1
|
|
|
(1
|
)
|
|
—
|
|
Reserve balances at December 31, 2019
|
20
|
|
|
1
|
|
|
21
|
|
Cash payments
|
(4
|
)
|
|
—
|
|
|
(4
|
)
|
Restructuring charges
|
—
|
|
|
—
|
|
|
—
|
|
Other(1)
|
(1
|
)
|
|
—
|
|
|
(1
|
)
|
Reserve balances at March 31, 2020(2)
|
$
|
15
|
|
|
$
|
1
|
|
|
$
|
16
|
|
_____________________
|
|
(1)
|
Other includes reversals of previously recorded restructuring charges and the effects of foreign currency translation.
|
|
|
(2)
|
The remaining reserves are expected to be paid in cash during the remainder of 2020.
|
|
|
F.
|
Other Expenses (Income), Net
|
|
|
|
|
|
|
|
|
|
|
First quarter ended March 31,
|
|
2020
|
|
2019
|
Interest income
|
|
(2
|
)
|
|
(5
|
)
|
Foreign currency losses (gains), net
|
|
13
|
|
|
(14
|
)
|
Non-service costs - Pension and OPEB (G)
|
|
21
|
|
|
—
|
|
Other, net
|
|
(6
|
)
|
|
5
|
|
|
|
$
|
26
|
|
|
$
|
(14
|
)
|
|
|
G.
|
Pension and Other Postretirement Benefits
|
Certain employees of the Arconic Corporation Businesses participate in ParentCo-sponsored defined benefit pension plans (“Shared Pension Plans”) and health care and life insurance postretirement benefit plans (“Shared OPEB Plans,” and, collectively with the Shared Pension Plans, the “Shared Plans”), which include ParentCo corporate participants and participants of the Howmet Aerospace Businesses, as well as eligible U.S. retired employees and certain retirees from foreign locations.
Pension benefits under the Shared Pension Plans generally depend on length of service, job grade, and remuneration. Substantially all benefits are paid through pension trusts that are sufficiently funded to ensure that all plans can pay benefits to retirees as they become due. Most salaried and non-bargaining hourly U.S. employees hired after March 1, 2006 participate in a defined contribution plan instead of a defined benefit plan. Additionally, effective April 1, 2018, benefit accruals for future service and compensation under all ParentCo’s qualified and non-qualified defined benefit pension plans for salaried and non-bargaining hourly U.S. employees ceased. Furthermore, effective February 1, 2019, benefit accruals for future service and compensation under ParentCo’s defined benefit pension plans for all employees in the United Kingdom ceased.
Generally, ParentCo’s health care plans are unfunded and pay a percentage of medical expenses, reduced by deductibles and other coverage. Life benefits are generally provided by insurance contracts. ParentCo retains the right, subject to existing agreements, to change or eliminate these benefits. All salaried and certain non-bargaining hourly U.S. employees hired after January 1, 2002 and certain bargaining hourly U.S. employees hired after July 1, 2010 are not eligible for postretirement health care benefits. Additionally, all salaried and certain hourly U.S. employees that retire on or after April 1, 2008 are not eligible for postretirement life insurance benefits. Furthermore, ParentCo initiated the following actions between the second half of 2018 and the first half of 2019: (i) effective December 31, 2018, ParentCo terminated all pre-Medicare medical, prescription drug, and vision coverage for current and future salaried and non-bargaining hourly U.S. employees and retirees of ParentCo and its subsidiaries, (ii) effective May 1, 2019, ParentCo eliminated the life insurance benefit for salaried and non-bargaining hourly U.S. retirees of ParentCo and its subsidiaries, and (iii) effective December 31, 2019, ParentCo eliminated certain health care subsidies for salaried and non-bargaining hourly U.S. retirees of ParentCo and its subsidiaries.
Arconic Corporation accounts for the portion of the Shared Plans related to its employees as multiemployer benefit plans. Accordingly, Arconic Corporation does not record an asset or liability to recognize the funded status of the Shared Plans. However, the related pension and other postretirement benefit expenses attributable to Arconic Corporation are based primarily on pensionable compensation of active Arconic Corporation participants and estimated interest costs, respectively.
The accompanying Combined Financial Statements also include an allocation of pension and other postretirement benefit expenses for the Shared Plans attributable to ParentCo corporate participants as well as to closed and sold operations (see Cost Allocations in Note A).
Certain ParentCo plans that are specific only to Arconic Corporation employees (“Direct Plans”) are accounted for as defined benefit pension and other postretirement plans in the accompanying Combined Financial Statements. Accordingly, the funded status of each Direct Plan is recorded in the accompanying Combined Balance Sheet. Actuarial gains and losses that have not yet been recognized in earnings are recorded in Accumulated other comprehensive income until they are amortized as a component of net periodic benefit cost. The determination of benefit obligations and recognition of expenses related to Direct Plans are dependent on various assumptions, including discount rates, long-term expected rates of return on plan assets, and future compensation increases. Management develops each assumption using relevant company experience in conjunction with market-related data for each of the plans.
In preparation for the Separation, effective January 1, 2020, certain U.S. pension and other postretirement benefit plans previously sponsored by ParentCo (the “U.S. Shared Plans” - see above) were separated into standalone plans for both Arconic Corporation (the “New Direct Plans,” and, collectively with the Direct Plans, the “Cumulative Direct Plans”) and Howmet Aerospace. Accordingly, on January 1, 2020, Arconic Corporation recognized an aggregate liability of $1,920, of which $60 was current, reflecting the combined net unfunded status of the New Direct Plans, comprised of a benefit obligation of $4,255 and plan assets of $2,335, as well as $1,752 (net of tax impact) in Accumulated other comprehensive loss. In 2020, Arconic Corporation expects to recognize approximately $100 in combined net periodic benefit cost, of which approximately $25 is service cost. In the 2020 first quarter, Arconic Corporation recognized $26 of combined net periodic benefit cost, of which $6 was service cost, for the New Direct Plans. Prior to January 1, 2020, Arconic Corporation recorded its share of expense related to the U.S. Shared Plans as multiemployer expense for participants of the Arconic Corporation Businesses and as an allocated expense for both ParentCo corporate participants and former employees of ParentCo’s closed and sold operations, totaling $28 in the 2019 first quarter. Also, in 2020, Arconic Corporation expects to make approximately $255 in pension contributions and $55 in other postretirement benefit payments, related to the New Direct Plans.
The following table summarizes the total expenses recognized by Arconic Corporation related to the pension and other postretirement benefits described above:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension benefits
|
|
Other postretirement
benefits
|
|
|
|
|
First quarter ended March 31,
|
|
First quarter ended March 31,
|
Type of Plan
|
|
Type of Expense
|
|
2020
|
|
2019
|
|
2020
|
|
2019
|
Cumulative Direct Plans
|
|
Net periodic benefit cost
|
|
$
|
21
|
|
|
$
|
1
|
|
|
$
|
6
|
|
|
$
|
—
|
|
Shared Plans
|
|
Multiemployer contribution
|
|
—
|
|
|
16
|
|
|
—
|
|
|
5
|
|
Shared Plans
|
|
Cost allocation
|
|
(1
|
)
|
|
5
|
|
|
—
|
|
|
1
|
|
|
|
|
|
$
|
20
|
|
|
$
|
22
|
|
|
$
|
6
|
|
|
$
|
6
|
|
The components of net periodic benefit cost for defined benefit plans classified as Cumulative Direct Plans were as follows:
|
|
|
|
|
|
|
|
|
|
First quarter ended March 31,
|
|
2020
|
|
2019
|
Pension benefits
|
|
|
|
|
Service cost
|
|
$
|
5
|
|
|
$
|
—
|
|
Interest cost
|
|
26
|
|
|
1
|
|
Expected return on plan assets
|
|
(40
|
)
|
|
(1
|
)
|
Recognized net actuarial loss
|
|
30
|
|
|
1
|
|
Net periodic benefit cost*
|
|
$
|
21
|
|
|
$
|
1
|
|
|
|
|
|
|
Other postretirement benefits
|
|
|
|
|
Service cost
|
|
$
|
1
|
|
|
$
|
—
|
|
Interest cost
|
|
4
|
|
|
—
|
|
Recognized net actuarial loss
|
|
2
|
|
|
—
|
|
Amortization of prior service benefit
|
|
(1
|
)
|
|
—
|
|
Net periodic benefit cost*
|
|
$
|
6
|
|
|
$
|
—
|
|
__________________
|
|
*
|
Service cost was included within Cost of goods sold and all other cost components were included in Other expenses (income), net on the accompanying Statement of Combined Operations.
|
Arconic Corporation’s year-to-date tax provision is comprised of the most recent estimated annual effective tax rate applied to year-to-date pretax ordinary income. The tax impacts of unusual or infrequently occurring items, including changes in judgment about valuation allowances and effects of changes in tax laws or rates, are recorded discretely in the interim period in which they occur. In addition, the tax provision is adjusted for the interim period impact of non-benefited pretax losses.
For the first quarter of 2020 and 2019, the estimated annual effective tax rate (the “ETR”) before discrete items, applied to ordinary income was 28.6% and 36.4%, respectively. The ETR for 2020 was higher than the U.S. federal statutory rate of 21.0% primarily due to nondeductible transaction costs, the state tax impact of domestic taxable income, and foreign income taxed in higher rate jurisdictions. The ETR for 2019 was higher than the U.S. federal statutory rate of 21.0% primarily due to estimated U.S. tax on Global Intangible Low-Taxed Income, the state tax impact of domestic taxable income, nondeductible transaction costs, and foreign income taxed in higher rate jurisdictions. Including discrete items, the tax rate for the first quarter of 2020 and 2019 was 34.1% and 37.9%, respectively.
The tax provisions for the first quarter ended March 31, 2020 and 2019 were comprised of the following components:
|
|
|
|
|
|
|
|
|
|
First quarter ended March 31,
|
|
2020
|
|
2019
|
Pretax income at estimated annual effective income tax rate before discrete items
|
|
$
|
26
|
|
|
$
|
24
|
|
Interim period treatment of operational losses in foreign jurisdictions for which no tax benefit is recognized*
|
|
1
|
|
|
(1
|
)
|
Other discrete items
|
|
4
|
|
|
2
|
|
Provision for income taxes
|
|
$
|
31
|
|
|
$
|
25
|
|
__________________
|
|
*
|
The interim period impact related to operational losses in foreign jurisdictions for which no tax benefit is recognized will reverse by the end of the calendar year.
|
|
|
I.
|
Accumulated Other Comprehensive (Loss) Income
|
The following table details the activity of the two components that comprise Accumulated other comprehensive (loss) income for Arconic Corporation (such activity for noncontrolling interest was immaterial for all periods presented):
|
|
|
|
|
|
|
|
|
|
First quarter ended March 31,
|
|
2020
|
|
2019
|
Pension and other postretirement benefits (G)
|
|
|
|
|
|
|
Balance at beginning of period
|
|
$
|
(43
|
)
|
|
$
|
(32
|
)
|
Establishment of defined benefit plans
|
|
(1,752
|
)
|
|
—
|
|
Other comprehensive income:
|
|
|
|
|
Unrecognized net actuarial loss and prior service cost/benefit
|
|
2
|
|
|
(1
|
)
|
Tax expense
|
|
(1
|
)
|
|
—
|
|
Total Other comprehensive income (loss) before reclassifications, net of tax
|
|
1
|
|
|
(1
|
)
|
Amortization of net actuarial loss and prior service cost/benefit(1)
|
|
31
|
|
|
1
|
|
Tax expense(2)
|
|
(7
|
)
|
|
—
|
|
Total amount reclassified from Accumulated other comprehensive loss, net of tax(4)
|
|
24
|
|
|
1
|
|
Total Other comprehensive income
|
|
25
|
|
|
—
|
|
Balance at end of period
|
|
$
|
(1,770
|
)
|
|
$
|
(32
|
)
|
Foreign currency translation
|
|
|
|
|
Balance at beginning of period
|
|
$
|
338
|
|
|
$
|
282
|
|
Foreign currency translation(3)
|
|
(22
|
)
|
|
57
|
|
Net amount reclassified to earnings from Accumulated other comprehensive income(3)(4)
|
|
22
|
|
|
—
|
|
Other comprehensive income
|
|
—
|
|
|
57
|
|
Balance at end of period
|
|
$
|
338
|
|
|
$
|
339
|
|
Accumulated other comprehensive (loss) income
|
|
$
|
(1,432
|
)
|
|
$
|
307
|
|
_____________________
|
|
(1)
|
These amounts were included in the non-service component of net periodic benefit cost for pension and other postretirement benefits (see Note G).
|
|
|
(2)
|
These amounts were included in Provision for income taxes on the accompanying Statement of Combined Operations.
|
|
|
(3)
|
In all periods presented, there were no tax impacts related to rate changes. In the first quarter of 2020, the net amount reclassified to earnings was included in Restructuring and other charges on the accompanying Statement of Combined Operations related to the sale of certain foreign subsidiaries.
|
|
|
(4)
|
A positive amount indicates a corresponding charge to earnings and a negative amount indicates a corresponding benefit to earnings. These amounts were reflected on the accompanying Statement of Combined Operations in the line items indicated in footnotes 1 through 3.
|
|
|
|
|
|
|
|
|
|
|
March 31, 2020
|
|
December 31, 2019
|
Finished goods
|
$
|
259
|
|
|
$
|
237
|
|
Work-in-process
|
738
|
|
|
738
|
|
Purchased raw materials
|
72
|
|
|
85
|
|
Operating supplies
|
68
|
|
|
69
|
|
|
1,137
|
|
|
1,129
|
|
LIFO reserve
|
(293
|
)
|
|
(309
|
)
|
|
$
|
844
|
|
|
$
|
820
|
|
At March 31, 2020 and December 31, 2019, the portion of Inventories subject to the last-in, first-out (LIFO) inventory accounting method was $764, or 67%, and $753, or 67%, respectively, of total inventories before LIFO adjustments.
Arconic Corporation leases certain land and buildings, plant equipment, vehicles, and computer equipment, which have been classified as operating leases. Operating lease cost, which includes short-term leases and variable lease payments and approximates cash paid, was $15 and $16 for the first quarter ended March 31, 2020 and 2019, respectively.
Right-of-use assets obtained in exchange for operating lease obligations in the first quarter ended March 31, 2020 were $9.
Future minimum contractual operating lease obligations were as follows:
|
|
|
|
|
|
|
|
|
|
March 31, 2020
|
|
December 31, 2019
|
2020
|
$
|
30
|
|
|
$
|
38
|
|
2021
|
32
|
|
|
29
|
|
2022
|
25
|
|
|
22
|
|
2023
|
18
|
|
|
17
|
|
2024
|
14
|
|
|
14
|
|
Thereafter
|
37
|
|
|
38
|
|
Total lease payments
|
$
|
156
|
|
|
$
|
158
|
|
Less: imputed interest
|
28
|
|
|
29
|
|
Present value of lease liabilities
|
$
|
128
|
|
|
$
|
129
|
|
The weighted-average remaining lease term and weighted-average discount rate for Arconic Corporation’s operating leases at March 31, 2020 and December 31, 2019 was 6.3 years and 6.7 years, respectively, and 5.9% and 6.0%, respectively.
In connection with the capital structure to be established at the time of the Separation, Arconic Corporation secured $1,200 in third-party indebtedness. The Company used a portion of the net proceeds from the aggregate indebtedness to make a payment to ParentCo on April 1, 2020 to fund the transfer of certain net assets from ParentCo to Arconic Corporation in connection with the completion of the Separation (see Note A). The payment to ParentCo was calculated as the difference between (i) the $1,168 of net proceeds from the aggregate indebtedness and (ii) the difference between a beginning cash balance at the Separation Date of $500 and the amount of cash held by Arconic Corporation Businesses at March 31, 2020 ($60 – the sum of this amount and the aggregate indebtedness in (i) equals the sum of Cash and cash equivalents and Restricted cash on the accompanying Combined Balance Sheet as of March 31, 2020). Descriptions of this aggregate indebtedness are set forth below.
144A Debt—On February 7, 2020, Arconic Corporation completed a Rule 144A (U.S. Securities Act of 1933, as amended) debt offering for $600 of 6.125% Senior Secured Second-Lien Notes due 2028 (the “2028 Notes”). The Company received $593 in net proceeds from the debt offering reflecting a discount to the initial purchasers of the 2028 Notes. The discount to the initial purchasers, as well as costs to complete the financing, was deferred and is being amortized to interest expense over the term of the 2028 Notes. Interest on the 2028 Notes will be paid semi-annually in February and August, commencing August 15, 2020. The net proceeds from the 2028 Notes were held in escrow until the satisfaction of the escrow release conditions, including the substantially concurrent completion of the Separation. Accordingly, the $593 of escrowed cash was included in Restricted cash on the accompanying Combined Balance Sheet at March 31, 2020.
Arconic Corporation has the option to redeem the 2028 Notes on at least 10 days, but not more than 60 days, prior notice to the holders of the 2028 Notes under multiple scenarios, including, in whole or in part, at any time or from time to time after February 14, 2023 at a redemption price specified in the indenture (up to 103.063% of the principal amount plus any accrued and unpaid interest in each case). At any time prior to February 15, 2023, the Company may redeem all or a part of the notes at a redemption price equal to 100% of the principal amount of the notes redeemed plus a “make-whole” redemption price determined as the greater of (1) 1.0% of the principal amount of such notes and (2) the excess, if any, of (a) the present value at the date of redemption of (i) 103.063% of the principal amount of such notes plus (ii) all required interest payments due on such notes (excluding accrued but unpaid interest to the date of redemption) through February 15, 2023, computed using a discount rate equal to, generally, the yield to maturity of United States Treasury securities with a constant maturity as of the date of redemption plus 50 basis points, over (b) the principal amount of such notes, as of, and accrued and unpaid interest, if any, to, but excluding, the date of redemption. Also, at any time prior to February 15, 2023, Arconic Corporation may, on one or more occasions, redeem up to 40% of the aggregate principal amount of the notes at a redemption price equal to 106.125% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date, with the net cash proceeds of certain equity offerings, if at least 60% of the original aggregate principal amount of the notes remains outstanding immediately after such redemption and the redemption occurs within 120 days of the date of such equity offering. Additionally, the 2028 Notes are subject to repurchase upon the occurrence of a change in control repurchase event (as defined in the indenture) at a repurchase price in cash equal to 101% of the aggregate principal amount of the 2028 Notes repurchased, plus any accrued and unpaid interest on the 2028 Notes repurchased.
The 2028 Notes are senior secured obligations of Arconic Corporation and do not entitle the holders to any registration rights pursuant to a registration rights agreement. The Company does not intend to file a registration statement with respect to resales of or an exchange offer for the 2028 Notes. The 2028 Notes are guaranteed on a senior secured basis by Arconic Corporation and its subsidiaries that are guarantors (the “subsidiary guarantors” and, together with Arconic Corporation, the “guarantors”) under the Credit Agreement (see below). Each of the subsidiary guarantors will be released from their 2028 Notes guarantees upon the occurrence of certain events, including the release of such guarantor from its obligations as a guarantor under the Credit Agreement.
The 2028 Notes indenture includes several customary affirmative covenants. Additionally, the 2028 Notes indenture contains several negative covenants, that, subject to certain exceptions, limit the Company’s ability to, among other things, (i) make investments, loans, advances, guarantees, and acquisitions, (ii) pay dividends on or make other distributions in respect of capital stock and make other restricted payments and investments (as defined in the 2028 Notes), (iii) sell or transfer certain assets, and (iv) create liens on assets to secure debt.
The 2028 Notes rank equally in right of payment with all of Arconic Corporation’s existing and future senior indebtedness, including the facilities under the Credit Agreement (see below); rank senior in right of payment to any future subordinated obligations of Arconic Corporation; and are effectively subordinated to Arconic Corporation’s existing and future secured indebtedness that is secured on a first priority basis, including the facilities under the Credit Agreement, to the extent of the value of property and assets securing such indebtedness.
Credit Agreement—On March 25, 2020, Arconic Corporation entered into a credit agreement, which provides a $600 Senior Secured First-Lien Term Loan B Facility (variable rate and seven-year term) (the “Term Loan”) and a $1,000 Senior Secured First-Lien Revolving Credit Facility (variable rate and five-year term) (the “Credit Facility”), with a syndicate of lenders and issuers named therein (the “Credit Agreement”) (see Refinancing below). The Company received $575 in net proceeds from Term Loan B reflecting upfront fees and costs to enter into the financing arrangement. These upfront fees and costs, as well as other costs to complete the financing, were deferred and are being amortized to interest expense over the term of Term Loan B.
The variable interest rate with respect to the Term Loan is currently based on LIBOR for the relevant interest period plus an applicable margin of 2.75% and the variable commitment fee for undrawn capacity related to the Credit Facility is 0.35%. The provisions of the Term Loan require a mandatory 1% repayment of the initial $600 borrowing each annual period during the seven-year term. The Term Loan and the Credit Facility are guaranteed by certain of Arconic Corporation’s wholly-owned domestic subsidiaries. Each of the Term Loan, the Credit Facility, and the related guarantees are secured on a first-priority basis by liens on certain assets of Arconic Corporation and the guarantors, as defined therein.
The Credit Agreement includes financial covenants requiring the maintenance of a Consolidated Total Leverage Ratio and a Consolidated Interest Coverage Ratio, as defined in the Credit Agreement. The Consolidated Total Leverage Ratio is the ratio of Consolidated Debt to Consolidated EBITDA for the trailing four fiscal quarters, as defined in the Credit Agreement, and may not exceed a ratio of 2.50 to 1.00 for each fiscal quarter commencing with the fiscal quarter ending on June 30, 2020 through and including the fiscal quarter ending on March 31, 2021, and 2.25 to 1.00 for each fiscal quarter thereafter. The Consolidated Interest Coverage Ratio is the ratio of Consolidated EBITDA to Consolidated Interest Expense for the trailing four fiscal quarters, as defined in the Credit Agreement, and may not fall below a ratio of 3.00 to 1.00 for any fiscal quarter during the term of the Credit Agreement, commencing with the fiscal quarter ending on June 30, 2020. In addition, the Credit Agreement requires pro forma compliance with these financial covenants at each instance of borrowing under the Credit Facility, which may limit the Company’s ability to draw the full amount of the Credit Facility.
On April 2, 2020, Arconic Corporation borrowed $500 under the Credit Facility (see Refinancing below). This borrowing was a proactive measure taken by the Company to bolster its liquidity and preserve financial flexibility in light of uncertainties resulting from the COVID-19 outbreak (see Note A).
Fair Value—Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (i) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (ii) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
|
|
•
|
Level 1—Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
|
|
|
•
|
Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
|
|
|
•
|
Level 3—Inputs that are both significant to the fair value measurement and unobservable.
|
As of March 31, 2020, the combined carrying value and fair value of the 2028 Notes and Term Loan were $1,175 and $1,217, respectively. The fair value was based on quoted market prices for public debt and on interest rates that are currently available to Arconic Corporation for issuance of debt with similar terms and maturities for non-public debt. The fair value amounts for the 2028 Notes and Term Loan were classified in Level 2 of the fair value hierarchy.
Refinancing
In order to provide improved financial flexibility, Arconic Corporation executed a refinancing of its existing Credit Agreement. Arconic Corporation used the net proceeds from the new indebtedness, together with cash on hand, to prepay in full the obligations outstanding under both the Term Loan ($600) and Credit Facility ($500) and to terminate in full the commitments under the Credit Agreement. Descriptions of the new aggregate indebtedness are set forth below.
144A Debt—On May 13, 2020, Arconic Corporation completed a Rule 144A (U.S. Securities Act of 1933, as amended) debt offering for $700 of 6.000% Senior Secured First-Lien Notes due 2025 (the “2025 Notes”). The Company received $691 in net proceeds from the debt offering reflecting a discount to the initial purchasers of the 2025 Notes. The discount to the initial purchasers, as well as costs to complete the financing, was deferred and is being amortized to interest expense over the term of the 2025 Notes. Interest on the 2025 Notes will be paid semi-annually in May and November, commencing November 15, 2020.
Arconic Corporation has the option to redeem the 2025 Notes on at least 10 days, but not more than 60 days, prior notice to the holders of the 2025 Notes under multiple scenarios, including, in whole or in part, at any time or from time to time after May 14, 2022 at a redemption price specified in the indenture (up to 103.000% of the principal amount plus any accrued and unpaid interest in each case). At any time prior to May 15, 2022, the Company may redeem all or a part of the notes at a redemption price equal to 100% of the principal amount of the notes redeemed plus a “make-whole” redemption price determined as the greater of (1) 1.0% of the principal amount of such notes and (2) the excess, if any, of (a) the present value at the date of redemption of (i) 103.000% of the principal amount of such notes plus (ii) all required interest payments due on such notes (excluding accrued but unpaid interest to the date of redemption) through May 15, 2022, computed using a discount rate equal to, generally, the yield to maturity of United States Treasury securities with a constant maturity as of the date of redemption plus 50 basis points, over (b) the principal amount of such notes, as of, and accrued and unpaid interest, if any, to, but excluding, the date of redemption. Also, at any time prior to May 15, 2022, Arconic Corporation may, on one or more occasions, redeem up to 40% of the aggregate principal amount of the notes at a redemption price equal to 106.000% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest, if any, to, but excluding, the redemption date, with the net cash proceeds of certain equity offerings, if at least 60% of the original aggregate principal amount of the notes remains outstanding immediately after such redemption and the redemption occurs within 120 days of the date of such equity offering. Additionally, the 2025 Notes are subject to repurchase upon the occurrence of a change in control repurchase event (as defined in the indenture) at a repurchase price in cash equal to 101% of the aggregate principal amount of the 2025 Notes repurchased, plus any accrued and unpaid interest on the 2025 Notes repurchased.
The 2025 Notes are senior secured obligations of Arconic Corporation and do not entitle the holders to any registration rights pursuant to a registration rights agreement. The Company does not intend to file a registration statement with respect to resales of or an exchange offer for the 2025 Notes. The 2025 Notes are guaranteed on a senior secured basis by Arconic Corporation and its subsidiaries that are guarantors (the “subsidiary guarantors” and, together with Arconic Corporation, the “guarantors”) under the ABL Credit Agreement (see below). Each of the subsidiary guarantors will be released from their 2025 Notes guarantees upon the occurrence of certain events, including the release of such guarantor from its obligations as a guarantor under the ABL Credit Agreement.
The 2025 Notes indenture includes several customary affirmative covenants. Additionally, the 2025 Notes indenture contains several negative covenants, that, subject to certain exceptions, limit the Company’s ability to, among other things, (i) pay dividends on or make other distributions in respect of capital stock and make other restricted payments and investments (as defined in the 2025 Notes), (ii) sell or transfer certain assets, (iii) incur indebtedness, and (iv) create liens on assets to secure debt.
The 2025 Notes are secured on a first priority basis by certain defined collateral (generally consisting of the Company’s and the Guarantors’ equipment, material owned U.S. real property, intellectual property, certain stock, and other tangible and intangible personal property, in each case, subject to certain exceptions) and on a second priority basis by certain other assets (generally consisting of substantially all of the accounts receivable, inventory, deposit accounts, securities accounts, commodities accounts, and cash assets of the Company and the Guarantors, and the proceeds thereof).
ABL Credit Agreement—Also on May 13, Arconic Corporation entered into a credit agreement with a syndicate of lenders named therein and Deutsche Bank AG New York Branch, as administrative agent (the “ABL Credit Agreement”). The ABL Credit Agreement provides for a senior secured asset-based revolving credit facility in an aggregate principal amount of $800, including a letter of credit sub-facility and a swingline loan sub-facility (the “ABL Credit Facility”). In addition, the ABL Credit Facility includes an accordion feature allowing the Company to request one or more increases to the revolving commitments in an aggregate principal amount up to $350. Availability under the ABL Credit Facility is subject to a borrowing base calculation, generally based upon a set percentage of eligible accounts receivable and inventory, less customary reserves (provided that for a period ending on the earlier of (a) the date of receipt by the administrative agent of the initial inventory appraisal and field examination and (b) 90 days following the date of entry into the ABL Credit Facility, the borrowing base will be deemed to be equal to $500).
The ABL Credit Facility is scheduled to mature on May 13, 2025, unless extended or earlier terminated in accordance with the ABL Credit Agreement. Under the provision of the ABL Credit Agreement, Arconic Corporation will pay a quarterly
commitment fee ranging from 0.250% to 0.375% (based on Arconic Corporation’s leverage ratio) per annum on the unused portion of the ABL Credit Facility, which will be determined based on the Company’s average daily utilization. The ABL Credit Facility was undrawn as of May 15, 2020.
The ABL Credit Facility is subject to an interest rate for U.S. dollar borrowings equal to an applicable margin plus, at the Company’s option, of either (a) base rate (“ABR”) determined by reference to the highest of (1) Deutsche Bank AG New York Branch’s “prime rate,” (2) the greater of the federal funds effective rate and the overnight bank funding rate, plus 0.5%, and (3) the one month adjusted LIBO Rate, plus 1% per annum or (b) an adjusted LIBO Rate (which will not be less than 0.75% per annum) (“LIBOR”). The applicable margin for the ABL Credit Facility through June 30, 2021 is (a) 1.25% for ABR loans and (b) 2.25% for LIBOR loans. Thereafter, the applicable margin for the ABL Credit Facility will be (a) 0.75% to 1.25% per annum for ABR loans and (b) 1.75% per annum to 2.25% per annum for LIBOR loans based on the average daily excess availability (as defined under the ABL Credit Agreement). Accordingly, the interest rates for the ABL Credit Facility will fluctuate based on changes in the ABR, LIBOR, and/or future changes in the average daily excess availability.
All obligations under the ABL Credit Facility are unconditionally guaranteed, jointly and severally, by substantially all of the direct and indirect wholly-owned material subsidiaries of the Company that are organized under the laws of the United States, any state thereof or the District of Columbia, subject to certain exceptions (collectively, the “Guarantors”). The Company and the Guarantors entered into a guarantee under the ABL Credit Agreement concurrently with the effectiveness of the ABL Credit Agreement.
Subject to certain limitations, the ABL Credit Facility is secured on a first priority basis by certain defined collateral (generally consisting of substantially all of the accounts receivable, inventory, deposit accounts, securities accounts, commodities accounts, and cash assets of the Company and the Guarantors, and the proceeds thereof) and on a second-priority basis by certain defined collateral under the 2025 Notes (generally consisting of the Company and the Guarantors’ equipment, material owned U.S. real property, intellectual property, certain stock, and other tangible and intangible personal property, in each case, subject to exceptions as defined in the 2025 Notes). The Company and the Guarantors entered into collateral agreements concurrently with the effectiveness of the ABL Credit Agreement.
The ABL Credit Facility contains certain affirmative and negative covenants customary for financings of this type that, among other things, limit the Company’s and its subsidiaries’ ability to incur additional indebtedness or liens, to dispose of assets, to make certain fundamental changes, to enter into restrictive agreements, to make certain investments, loans, advances, guarantees and acquisitions, to prepay certain indebtedness and to pay dividends, to make other distributions or redemptions/repurchases, in respect of the Company’s and its subsidiaries’ equity interests, to engage in transactions with affiliates and to amend certain material documents.
In addition, the ABL Credit Facility contains a financial maintenance covenant applicable to any fiscal quarter in which the excess availability is less than the greater of (a) 10% of the lesser of (x) the aggregate amount of the commitments under the ABL Credit Facility and (y) the borrowing base and (b) $50. In such circumstances, until such time as excess availability shall have exceeded such threshold for at least 30 consecutive days, we would be required to maintain a fixed charge coverage ratio of not less than 1.00 to 1.00. The ABL Credit Facility also requires the Company and its subsidiaries to maintain substantially all of the Company’s cash in accounts that are subject to the control of the agent, which control becomes applicable when (a) an event of default under the facility occurs and is continuing until the first day thereafter on which no event of default shall exist or (b) excess availability is less than the greater of (i) 12.5% of the lesser of (x) the aggregate amount of the commitments under the ABL Credit Facility and (y) the borrowing base or (ii) $62.5 for five consecutive business days until the first day thereafter on which excess availability shall have exceeded such threshold for at least 30 consecutive days.
The ABL Credit Facility contains customary events of default, including with respect to a failure to make payments thereunder, cross-default and cross-acceleration, certain bankruptcy and insolvency events and customary change of control events.
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M.
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Acquisitions and Divestitures
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On February 1, 2020, Arconic Corporation completed the sale of its aluminum rolling mill (specialty foil and sheet products) in Itapissuma, Brazil to Companhia Brasileira de Alumínio for a net $46 in cash, resulting in a loss of $59 (pretax). As a result of entering into an agreement in August 2019 to sell this rolling mill, Arconic Corporation recognized a charge of $53 (pretax) in the 2019 third quarter for the non-cash impairment of the carrying value of the rolling mill’s net assets, primarily properties, plants, and equipment. Additionally, in the 2020 first quarter, Arconic Corporation recognized a charge of $6 (pretax). These charges were recorded in Restructuring and other charges (see Note E) on the Company’s Statement of Combined Operations in the respective reporting periods. This transaction remains subject to certain post-closing adjustments as defined in the agreement. Prior to the divestiture, this rolling mill’s operating results and assets and liabilities were reported in the Rolled Products segment. The rolling mill generated third-party sales of $143, $179, and $162 in 2019, 2018, and 2017, respectively, and, at the time of divestiture, had approximately 500 employees.
On March 1, 2020, Arconic Corporation completed the sale of its hard alloy extrusions plant in South Korea to SeAH Besteel Corporation for a net $55 in cash, resulting in a gain of $31 (pretax), which was recorded in Restructuring and other charges (see Note E) on the accompanying Statement of Combined Operations. The gain is net of a $6 write-off of related goodwill. This transaction remains subject to certain post-closing adjustments as defined in the agreement. Prior to the divestiture, this plant’s operating results and assets and liabilities were reported in the Extrusions segment. The extrusions plant generated third-party sales of $51, $53, and $50 in 2019, 2018, and 2017, respectively, and, at the time of divestiture, had approximately 160 employees.
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N.
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Contingencies and Commitments
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The matters described within this section are those of ParentCo that are associated directly or indirectly with the Arconic Corporation Businesses. For those matters where the outcome remains uncertain, the ultimate allocation of any potential future costs between Arconic Corporation and Howmet Aerospace were addressed in the Separation and Distribution Agreement.
Contingencies
Environmental Matters. ParentCo participates in environmental assessments and cleanups at several locations. These include owned or operating facilities and adjoining properties, previously owned or operating facilities and adjoining properties, and waste sites, including Superfund (Comprehensive Environmental Response, Compensation and Liability Act (CERCLA)) sites.
A liability is recorded for environmental remediation when a cleanup program becomes probable and the costs can be reasonably estimated. As assessments and cleanups proceed, the liability is adjusted based on progress made in determining the extent of remedial actions and related costs. The liability can change substantially due to factors such as, among others, the nature and extent of contamination, changes in remedial requirements, and technological changes.
Arconic Corporation’s remediation reserve balance was $208 (of which $81 and $83, respectively, was classified as a current liability) at both March 31, 2020 and December 31, 2019, respectively, and reflects the most probable costs to remediate identified environmental conditions for which costs can be reasonably estimated for current and certain former Arconic Corporation operating locations. In the first quarter of 2020, the remediation reserve was increased by $1 related to the divestiture of a rolling mill in Brazil (see Note M). This charge was recorded in Restructuring and other charges (see Note E) on the accompanying Statement of Combined Operations. Payments related to remediation expenses applied against the reserve were $2 in the first quarter of 2020, which include expenditures currently mandated, as well as those not required by any regulatory authority or third party. In the first quarter of 2020, the change in the reserve also reflects an increase of $1 due to the effects of foreign currency translation.
The following description provides details regarding the current status of one reserve, which represents the majority of the Company’s total remediation reserve balance, related to a current Arconic Corporation site.
Massena West, NY—Arconic Corporation has an ongoing remediation project related to the Grasse River, which is adjacent to Arconic Corporation’s Massena plant site. Many years ago, it was determined that sediments and fish in the river contain varying levels of polychlorinated biphenyls (PCBs). The project, which was selected by the U.S. Environmental Protection Agency (EPA) in a Record of Decision issued in April 2013, is aimed at capping PCB contaminated sediments with concentration in excess of one part per million in the main channel of the river and dredging PCB contaminated sediments in the near-shore areas where total PCBs exceed one part per million. At March 31, 2020 and December 31, 2019, the reserve balance associated with this matter was $170 and $171, respectively. Arconic Corporation completed the final design phase of the project, which was approved by the EPA in March 2019. Following the EPA’s approval, the actual remediation fieldwork commenced. The majority of the remaining expenditures related to the project are expected to occur between 2020 and 2022.
In June 2019, Arconic Corporation increased the reserve balance by $25 due to changes required in the EPA-approved remedial design and post-construction monitoring. These changes were necessary due to several items, the majority of which relate to navigation issues identified by a local seaway development company. Accordingly, the EPA requested an addendum to the final remedial design be submitted to address these issues. The proposed remedy is to dredge certain of the sediments originally identified for capping in the affected areas of the Grasse River, resulting in incremental project costs. As the project progresses, further changes to the reserve may be required due to factors such as, among others, additional changes in remedial requirements, increased site restoration costs, and incremental ongoing operation and maintenance costs.
Litigation.
All references to ParentCo in the matters described under this section Litigation refer to Arconic Inc. only and do not include its subsidiaries, except as otherwise stated.
Reynobond PE—On June 13, 2017, the Grenfell Tower in London, U.K. caught fire resulting in fatalities, injuries, and damage. A French subsidiary of ParentCo, Arconic Architectural Products SAS (AAP SAS), supplied a product, Reynobond PE, to its customer, a cladding system fabricator, which used the product as one component of the overall cladding system on Grenfell Tower. The fabricator supplied its portion of the cladding system to the facade installer, who then completed and installed the system under the direction of the general contractor. Neither ParentCo nor AAP SAS was involved in the design or
installation of the system used at the Grenfell Tower, nor did it have a role in any other aspect of the building’s refurbishment or original design. Regulatory investigations into the overall Grenfell Tower matter are being conducted, including a criminal investigation by the London Metropolitan Police Service (the “Police”), a Public Inquiry by the British government, and a consumer protection inquiry by a French public authority. The Public Inquiry was announced by the U.K. Prime Minister on June 15, 2017 and subsequently was authorized to examine the circumstances leading up to and surrounding the Grenfell Tower fire in order to make findings of fact and recommendations to the U.K. Government on matters such as the design, construction, and modification of the building, the role of relevant public authorities and contractors, the implications of the fire for the adequacy and enforcement of relevant regulations, arrangements in place for handling emergencies, and the handling of concerns from residents, among other things. Hearings for Phase 1 of the Public Inquiry began on May 21, 2018 and concluded on December 12, 2018. Phase 2 hearings of the Public Inquiry began in early 2020, following which a final report will be written and subsequently published. AAP SAS is participating as a Core Participant in the Public Inquiry and is also cooperating with the ongoing parallel investigation by the Police. ParentCo no longer sells the PE product for architectural use on buildings. Given the preliminary nature of these investigations and the uncertainty of potential future litigation, ParentCo cannot reasonably estimate at this time the likelihood of an unfavorable outcome or the possible loss or range of losses in the event of an unfavorable outcome.
Behrens et al. v. Arconic Inc. et al. On June 6, 2019, 247 plaintiffs comprised of survivors and estates of decedents of the Grenfell Tower fire filed a complaint against “Arconic Inc., Alcoa Inc., and Arconic Architectural Products, LLC” (collectively, for purposes of the description of such proceeding, the “ParentCo Defendants”), as well as Saint-Gobain Corporation, d/b/a Celotex and Whirlpool Corporation, in the Court of Common Pleas of Philadelphia County. The complaint alleges claims under Pennsylvania state law for products liability and wrongful death related to the fire. In particular, the plaintiffs allege that the ParentCo Defendants knowingly supplied a dangerous product (Reynobond PE) for installation on the Grenfell Tower despite knowing that Reynobond PE was unfit for use above a certain height. The ParentCo Defendants removed the case to the United States District Court for the Eastern District of Pennsylvania on June 19, 2019. On August 29, 2019, the ParentCo Defendants moved to dismiss the complaint on the bases, among other things, that: (i) the case should be heard in the United Kingdom, not the United States; (ii) there is no jurisdiction over necessary parties; and (iii) Pennsylvania product liability law does not apply to manufacture and sale of product overseas. On December 23, 2019, the Court issued an order denying the motion to dismiss the complaint on bases (ii) and (iii) suggesting a procedure for limited discovery followed by further briefing on those subjects. On January 23, 2020, the Court ordered that the parties complete discovery relating to forum non conveniens by March 16, 2020, but has since permitted discovery to extend past that deadline and cancelled the oral argument scheduled for May 7, 2020 to allow for ongoing discovery. Given the preliminary nature of this matter and the uncertainty of litigation, the ParentCo Defendants cannot reasonably estimate at this time the likelihood of an unfavorable outcome or the possible loss or range of losses in the event of an unfavorable outcome.
Howard v. Arconic Inc. et al. A purported class action complaint related to the Grenfell Tower fire was filed on August 11, 2017 in the United States District Court for the Western District of Pennsylvania against ParentCo and Klaus Kleinfeld. A related purported class action complaint was filed in the United States District Court for the Western District of Pennsylvania on September 15, 2017, under the caption Sullivan v. Arconic Inc. et al., against ParentCo, three former ParentCo executives, several current and former ParentCo directors, and banks that acted as underwriters for ParentCo’s September 18, 2014 preferred stock offering (the “Preferred Offering”). The plaintiff in Sullivan had previously filed a purported class action against the same defendants on July 18, 2017 in the Southern District of New York and, on August 25, 2017, voluntarily dismissed that action without prejudice. On February 7, 2018, on motion from certain putative class members, the court consolidated Howard and Sullivan, closed Sullivan, and appointed lead plaintiffs in the consolidated case. On April 9, 2018, the lead plaintiffs in the consolidated purported class action filed a consolidated amended complaint. The consolidated amended complaint alleged that the registration statement for the Preferred Offering contained false and misleading statements and omitted to state material information, including by allegedly failing to disclose material uncertainties and trends resulting from sales of Reynobond PE for unsafe uses and by allegedly expressing a belief that appropriate risk management and compliance programs had been adopted while concealing the risks posed by Reynobond PE sales. The consolidated amended complaint also alleged that between November 4, 2013 and June 23, 2017 ParentCo and Kleinfeld made false and misleading statements and failed to disclose material information about ParentCo’s commitment to safety, business and financial prospects, and the risks of the Reynobond PE product, including in ParentCo’s Form 10-Ks for the fiscal years ended December 31, 2013, 2014, 2015, and 2016, its Form 10-Qs and quarterly financial press releases from the fourth quarter of 2013 through the first quarter of 2017, its 2013, 2014, 2015, and 2016 Annual Reports, its 2016 Annual Highlights Report, and on its official website. The consolidated amended complaint sought, among other things, unspecified compensatory damages and an award of attorney and expert fees and expenses. On June 8, 2018, all defendants moved to dismiss the consolidated amended complaint for failure to state a claim. On June 21, 2019, the Court granted the defendants’ motion to dismiss in full, dismissing the consolidated amended complaint in its entirety without prejudice. On July 23, 2019, the lead plaintiffs filed a second amended complaint. The second amended complaint alleges generally the same claims as the consolidated amended complaint with certain additional
allegations, as well as claims that the risk factors set forth in the registration statement for the Preferred Offering were inadequate and that certain additional statements in the sources identified above were misleading. The second amended complaint seeks, among other things, unspecified compensatory damages and an award of attorney and expert fees and expenses. On September 11, 2019, all defendants moved to dismiss the second amended complaint. Plaintiffs' opposition to that motion was filed on November 1, 2019 and all defendants filed a reply brief on November 26, 2019. Given the preliminary nature of this matter and the uncertainty of litigation, ParentCo cannot reasonably estimate at this time the likelihood of an unfavorable outcome or the possible loss or range of losses in the event of an unfavorable outcome.
Raul v. Albaugh, et al. On June 22, 2018, a derivative complaint was filed nominally on behalf of ParentCo by a purported ParentCo stockholder against the then members of ParentCo’s Board of Directors and Klaus Kleinfeld and Ken Giacobbe, naming ParentCo as a nominal defendant, in the United States District Court for the District of Delaware. The complaint raises similar allegations as the consolidated amended complaint and second amended complaint in Howard, as well as allegations that the defendants improperly authorized the sale of Reynobond PE for unsafe uses, and asserts claims under Section 14(a) of the Securities Exchange Act of 1934, as amended, and Delaware state law. On July 13, 2018, the parties filed a stipulation agreeing to stay this case until the final resolution of the Howard case, the Grenfell Tower Public Inquiry in London, and the investigation by the Police and on July 23, 2018, the Court approved the stay. Given the preliminary nature of this matter and the uncertainty of litigation, ParentCo cannot reasonably estimate at this time the likelihood of an unfavorable outcome or the possible loss or range of losses in the event of an unfavorable outcome.
While ParentCo believes that these cases are without merit and intends to challenge them vigorously, there can be no assurances regarding the ultimate resolution of these matters.
Stockholder Demands. The ParentCo Board of Directors also received letters, purportedly sent on behalf of stockholders, reciting allegations similar to those made in the federal court lawsuits and demanding that the ParentCo Board authorize ParentCo to initiate litigation against members of management, the ParentCo Board, and others. The ParentCo Board of Directors appointed a Special Litigation Committee of the ParentCo Board to review, investigate, and make recommendations to the ParentCo Board regarding the appropriate course of action with respect to these stockholder demand letters. On May 22, 2019, the Special Litigation Committee, following completion of its investigation into the claims demanded in the demand letters, recommended to the ParentCo Board that it reject the demands to authorize commencement of litigation. On May 28, 2019, the ParentCo Board adopted the Special Litigation Committee’s findings and recommendations and rejected the demands that it authorize commencement of actions to assert the claims set forth in the demand letters.
General. In addition to the matters described above, various other lawsuits, claims, and proceedings have been or may be instituted or asserted against ParentCo or Arconic Corporation, including those pertaining to environmental, product liability, safety and health, employment, tax, and antitrust matters. While the amounts claimed in these other matters may be substantial, the ultimate liability is not readily determinable because of the considerable uncertainties that exist. Accordingly, it is possible that Arconic Corporation’s liquidity or results of operations in a reporting period could be materially affected by one or more of these other matters. However, based on facts currently available, management believes that the disposition of these other matters that are pending or asserted will not have a material adverse effect, individually or in the aggregate, on the results of operations, financial position or cash flows of Arconic Corporation.
Management evaluated all activity of Arconic Corporation and concluded that no subsequent events have occurred that would require recognition in the Combined Financial Statements or disclosure in the Notes to the Combined Financial Statements, except as described below.
On April 1, 2020, ParentCo completed its separation into two standalone, publicly-traded companies (see Note A).
On April 2, 2020, Arconic Corporation borrowed $500 under its revolving credit facility (see Note L).
On April 8, 2020, Arconic Corporation initiated a series of actions to mitigate the impacts of the COVID-19 pandemic on the Company (see Note A).
On May 13, 2020, Arconic Corporation executed a refinancing of certain of its existing financing arrangements (see Note L).