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AA > SEC Filings for AA > Form 10-K on 13-Feb-2014All Recent SEC Filings

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Form 10-K for ALCOA INC


13-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

(dollars in millions, except per-share amounts and ingot prices; production and shipments in thousands of metric tons [kmt])

Overview

Our Business

Alcoa is a global leader in lightweight metals engineering and manufacturing. Alcoa's innovative, multi-material products, which include aluminum, titanium, and nickel, are used worldwide in aircraft, automobiles, commercial transportation, packaging, building and construction, oil and gas, defense, consumer electronics, and industrial applications.


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Alcoa is also the world leader in the production and management of primary aluminum, fabricated aluminum, and alumina combined, through its active participation in all major aspects of the industry: technology, mining, refining, smelting, fabricating, and recycling. Aluminum is a commodity that is traded on the London Metal Exchange (LME) and priced daily. Aluminum (primary and fabricated) and alumina represent approximately 80% of Alcoa's revenues, and the price of aluminum influences the operating results of Alcoa.

Alcoa is a global company operating in 30 countries. Based upon the country where the point of sale occurred, the U.S. and Europe generated 51% and 26%, respectively, of Alcoa's sales in 2013. In addition, Alcoa has investments and operating activities in, among others, Australia, Brazil, China, Guinea, Iceland, Russia, and Saudi Arabia, all of which present opportunities for substantial growth. Governmental policies, laws and regulations, and other economic factors, including inflation and fluctuations in foreign currency exchange rates and interest rates, affect the results of operations in these countries.

Management Review of 2013 and Outlook for the Future

In 2013, growth in global aluminum demand reached 7%, which was consistent with management's projection at the end of 2012; however, LME pricing levels declined on average 9% year-over-year. The continued weakness in the primary aluminum market led management to review existing high cost capacity for potential curtailment or shut down, resulting in 277 kmt of capacity taken offline in 2013 with another potential 183 kmt to be removed in 2014. Additionally, from a nonoperational perspective, the outlook for the smelting operations led to two significant, unusual noncash negative impacts to Alcoa's results related to the impairment of goodwill and the potential future realizability of certain deferred tax assets. The Company was able to more than offset cost headwinds with continued net productivity improvements across all operations. Additionally, the midstream and downstream operations continue to grow revenue through share gains and innovation while generating significant profits for the Company. Management continued its focus on liquidity and cash flows generating incremental improvements in procurement efficiencies, overhead rationalization, working capital, and disciplined capital spending. These actions enabled Alcoa to decrease debt while maintaining a stable level of cash on hand, resulting in a strengthened balance sheet.

The following financial information reflects some key measures of Alcoa's 2013 results:

• Sales of $23,032 and Loss from continuing operations of $2,285, or $2.14 per diluted share;

• Total segment after-tax operating income of $1,217, of which 80% was generated from the midstream and downstream operations;

• Cash from operations of $1,578, reduced by pension contributions of $462;

• Capital expenditures of $1,193, under $1,500 for the fourth consecutive year;

• Cash on hand at the end of the year of $1,437, in excess of $1,400 for the fifth consecutive year;

• Decrease in total debt of $510, and a decline of $2,259 since 2008; and

• Debt-to-capital ratio of 38.1%.

In 2014, management is projecting continued growth (increase of 7%) in the global consumption of primary aluminum, consistent with that of the last two years. All regions, except Europe, are expected to have three-to-eight percent increases in aluminum demand over 2013 with China (10%) expected to have the highest growth rate in 2014. After considering forecasted added production, along with few industry-wide capacity curtailments, management anticipates a balanced aluminum market. For alumina, growth in global consumption is estimated to be 9%, and supply is expected to slightly exceed overall demand due to new capacity in Australia, Saudi Arabia, and India, combined with added production in China.

Management also anticipates improved market conditions for value-add products in the aerospace, building and construction, packaging, and automotive global end markets, despite declines in certain regions. Aerospace is expected to be driven by large commercial aircraft, as well as strength in regional and business jets. As it relates to building and


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construction, awarded nonresidential contracts are up in North America while the decline in Europe is slowing down. The packaging market continues to see a conversion from steel cans to aluminum cans for existing products and the emergence of new products is increasing. For automotive, growth continues in both the U.S., as automakers strive to meet stricter emissions regulations, and China, due to a higher percentage of the population driving automobiles. Conversely, management expects a decline in the industrial gas turbine global end market due to pressure from low price coal in Europe and rising gas prices in the U.S. In the commercial transportation global end market, growth in the U.S., as orders and backlog have increased significantly, is expected to be offset by declines in Europe, due to regulatory change in emissions requirements.

On a company-wide basis, management has established and is committed to achieving the following specific goals in 2014:

• generating incremental savings over those realized in the previous five years from procurement, overhead, and working capital programs;

• generating positive cash flow from operations that will exceed capital spending; and

• achieving a debt-to-capital ratio between 30% and 35%.

Looking ahead over the next one to three years, management will focus on new strategic targets that build on the ones established three years ago. Previously, these targets included lowering Alcoa's refining and smelting operations on the cost curve to the 23rd (from 30th) and 41st (from 51st) percentiles, respectively, by 2015 and driving revenue growth, while improving margins that exceed historical levels, in the midstream (increase of $2,500) and downstream (increase of $1,600) operations by 2013. Management made significant progress on the 2010 targets as described below.

At December 31, 2013, Alcoa's refining operations were in the 27th percentile, a three-percentage point improvement, and smelting operations were in the 43rd percentile, an eight-percentage point improvement, on the respective cost curves. In 2013, actions taken to improve Alcoa's position on the cost curve for both refining and smelting operations included productivity improvements, which encompassed new initiatives as well as the full capitalization of initiatives implemented in 2012. Additionally, for the smelting operations, management initiated a permanent shutdown of 146 kmt of capacity in Canada and the U.S. combined and a temporary curtailment of 131 kmt of capacity in Brazil, virtually all of which was completed during the second half of 2013. These decisions were based on a 460 kmt smelting capacity review initiated by management in May 2013. The review of the remaining 183 kmt is expected to be completed in the first half of 2014 (see Primary Metals in Segment Information below).

The new targets for the refining and smelting operations are to further extend the 2015 target reductions on the cost curve by an additional two-percentage points and three-percentage points, respectively, by 2016, resulting in attaining the 21st percentile and 38th percentile, respectively. The full operation of the smelter and the refinery at the joint venture in Saudi Arabia is expected to provide a two-percentage point reduction on each of the respective cost curves. Additionally, initiatives to drive further productivity improvements will continue.

The new targets for the midstream and downstream operations are to increase revenue, while improving margins that meet or exceed historical levels, by $1,000 and $1,200, respectively, by 2016, of which 90% and 75%, respectively, is expected to be generated from innovation and share gains. A portion of the revenue increase for the midstream operations is expected to be generated from the expansion of the rolling facilities in both Davenport, IA (beginning in 2014) and in Tennessee (beginning in 2015) to meet rising U.S. automotive demand due to changing emission regulations and the construction of the rolling mill as part of a joint venture in Saudi Arabia (began in December 2013, additional automotive capacity by the end of 2014). For the downstream operations, the expansion of aluminum lithium capabilities in Lafayette, IN (beginning end of 2014) to meet the growing demand in the aerospace market is expected to contribute to the increase in revenue.


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Results of Operations

Earnings Summary

Loss from continuing operations attributable to Alcoa for 2013 was $2,285, or $2.14 per diluted share, compared with Income from continuing operations attributable to Alcoa of $191, or $0.18 per share, in 2012. The decrease of $2,476 in the results from continuing operations was mostly due to an impairment of goodwill, a discrete income tax charge for valuation allowances on certain deferred tax assets, and charges for the resolution of a legal matter. Other significant changes in the results from continuing operations included the following: lower realized prices for aluminum in the upstream and midstream businesses, higher input costs across three of the four segments, the absence of a gain on the sale of U.S. hydroelectric power assets, and restructuring and other charges related to the permanent shutdown of smelter capacity. These other changes were mostly offset by net productivity improvements, net favorable foreign currency movements, the absence of both a net charge for certain environmental remediation matters and a charge for the civil portion of a legal matter, and stronger volumes in three of the four segments.

Income from continuing operations attributable to Alcoa for 2012 was $191, or $0.18 per share, compared with $614, or $0.55 per share, in 2011. The decline of $423 in the results from continuing operations was primarily due to the following: lower realized prices for aluminum and alumina, higher input costs, and charges for the civil portion of a legal matter and certain environmental remediation matters. These items were partially offset by net productivity improvements, a gain on the sale of U.S. hydroelectric power assets, a decline in the results attributable to noncontrolling interests, lower restructuring charges, net favorable foreign currency movements, lower income taxes due to a decline in operating results, a favorable LIFO (last in, first out) impact, and higher volumes in the midstream and downstream segments.

Net loss attributable to Alcoa for 2013 was $2,285, or $2.14 per share, compared with Net income attributable to Alcoa of $191, or $0.18 per share, in 2012, and Net income attributable to Alcoa of $611, or $0.55 per share, in 2011. In 2011, net income of $611 included a loss from discontinued operations of $3 (see Loss From Discontinued Operations below).

Sales-Sales for 2013 were $23,032 compared with sales of $23,700 in 2012, a decline of $668, or 3%. The decrease was primarily due to lower primary aluminum volumes, including those related to curtailed and shutdown smelter capacity; a decline in realized prices for aluminum, driven by lower London Metal Exchange (LME) prices; and unfavorable pricing in the midstream segment due to a decrease in metal prices; somewhat offset by higher volumes in the Alumina, midstream, and downstream segments.

Sales for 2012 were $23,700 compared with sales of $24,951 in 2011, a decrease of $1,251, or 5%. The decline was mainly the result of a drop in realized prices for aluminum and alumina, driven by lower LME prices, unfavorable pricing in the midstream segment due to a decrease in metal prices, and unfavorable foreign currency movements, mostly due to a weaker euro, somewhat offset by higher volumes in the midstream and downstream segments and favorable product mix in the midstream segment.

Cost of Goods Sold-COGS as a percentage of Sales was 83.7% in 2013 compared with 86.1% in 2012. The percentage was positively impacted by net productivity improvements across all segments, the absence of a net charge for five environmental remediation matters ($194), net favorable foreign currency movements due to a stronger U.S. dollar, and a positive impact related to the March 2012 fire at the cast house in Massena, NY (insurance recovery in 2013 plus the absence of business interruption and repair costs that occurred in 2012). These items were partially offset by the previously mentioned realized price impacts and higher input costs, including those related to bauxite mining and planned maintenance outages at various power plants.

COGS as a percentage of Sales was 86.1% in 2012 compared with 82.1% in 2011. The percentage was negatively impacted by the previously mentioned lower realized prices in the upstream and midstream segments, higher input costs, and a net charge for five environmental remediation matters ($194). These items were somewhat offset by net


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productivity improvements, net favorable foreign currency movements due to a stronger U.S. dollar, and a change in LIFO adjustments from unfavorable to favorable, primarily due to lower prices for alumina and metal and lower costs for calcined coke.

Selling, General Administrative, and Other Expenses-SG&A expenses were $1,008, or 4.4% of Sales, in 2013 compared with $997, or 4.2% of Sales, in 2012. The increase of $11 was principally the result of higher labor costs, partially offset by a decrease in professional expenses and contract services and lower bad debt expense.

SG&A expenses were $997, or 4.2% of Sales, in 2012 compared with $1,027, or 4.1% of Sales, in 2011. The decline of $30 was mostly due to lower stock-based compensation expense; a decrease in bad debt expense due to the absence of charges for anticipated customer credit losses, primarily related to those in Europe; a decline in travel expense; and less spending across various other expenses. These items were partially offset by higher pension costs, due to the recognition of higher net actuarial losses, and increased professional expenses, due to consulting fees associated with productivity initiatives and higher legal expenses.

Research and Development Expenses-R&D expenses were $192 in 2013 compared with $197 in 2012 and $184 in 2011. The decrease in 2013 as compared to 2012 was mainly driven by lower spending related to inert anode and carbothermic technology for the Primary Metals segment and other various projects, mostly offset by new spending related to an upgrade of a Micromill™ in San Antonio, TX for the Global Rolled Products segment. This upgrade is expected to be completed by the end of 2015 and, as a result, the Micromill™ will develop and qualify aluminum products for the automotive and packaging end markets. The increase in 2012 as compared to 2011 was primarily caused by additional spending related to inert anode technology for the Primary Metals segment.

Provision for Depreciation, Depletion, and Amortization-The provision for DD&A was $1,421 in 2013 compared with $1,460 in 2012. The decrease of $39, or 3%, was mostly due to net favorable foreign currency movements due to a stronger U.S. dollar, particularly against the Australian dollar and Brazilian real; a reduction in expense related to the permanent shutdown of smelter capacity in Canada, the U.S., and Italy that occurred mid 2013; and the absence of expense due to the divestiture of U.S. hydroelectric power assets in late 2012. These declines were slightly offset by new depreciation associated with a hydroelectric power project in Brazil (Machadinho). In early 2013, there was a change in the legal structure of the entity that owned the project resulting in Alcoa recording its 30.99% share of the project's assets directly, whereas in 2012, Alcoa's share was recorded as an equity method investment.

The provision for DD&A was $1,460 in 2012 compared with $1,479 in 2011. The decrease of $19, or 1%, was principally the result of the cessation of DD&A due to the decision at the end of 2011 to permanently shut down and demolish the smelter in Tennessee (see Restructuring and Other Charges below) and the absence of DD&A on various in-use assets that reached the end of their estimated useful life in 2011. These declines were partially offset by an increase related to assets placed into service associated with a new hydroelectric power project in Brazil (Estreito) and higher DD&A due to the capitalization of new haul roads and the write-off of old haul roads no longer in use for mining sites in Australia.

Impairment of Goodwill-In 2013, Alcoa recognized an impairment of goodwill in the amount of $1,731 ($1,719 after noncontrolling interest) related to the annual impairment review of the Primary Metals segment (see Goodwill in Critical Accounting Policies and Estimates below).


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Restructuring and Other Charges-Restructuring and other charges for each year in the three-year period ended December 31, 2013 were comprised of the following:

                                                                2013        2012        2011
Resolution of a legal matter                                    $ 391       $  85       $   -
Layoff costs                                                      201          47          93
Asset impairments                                                 116          40         150
Other                                                              82          21          61
Reversals of previously recorded layoff and other exit costs       (8 )       (21 )       (23 )
Restructuring and other charges                                 $ 782       $ 172       $ 281

Layoff costs were recorded based on approved detailed action plans submitted by the operating locations that specified positions to be eliminated, benefits to be paid under existing severance plans, union contracts or statutory requirements, and the expected timetable for completion of the plans.

2013 Actions. In 2013, Alcoa recorded Restructuring and other charges of $782 ($585 after-tax and noncontrolling interests), which were comprised of the following components: $391 ($305 after-tax and noncontrolling interest) related to a legal matter; $245 ($183 after-tax) for exit costs related to the permanent shutdown and demolition of certain structures at three smelter locations (see below); $87 ($61 after-tax and noncontrolling interests) for layoff costs, including the separation of approximately 1,110 employees (340 in the Primary Metals segment, 260 in the Engineered Products and Solutions segment, 250 in the Global Rolled Products segment, 85 in the Alumina segment, and 175 in Corporate), of which 590 relates to a global overhead reduction program, and $9 in pension plan settlement charges related to previously separated employees; $25 ($17 after-tax) in net charges, including $12 ($8 after-tax) for asset impairments, related to retirements and/or the sale of previously idled structures; $25 ($13 after-tax and noncontrolling interests) for asset impairments related to the write-off of capitalized costs for projects no longer being pursued due to the market environment; a net charge of $17 ($12 after-tax and noncontrolling interests) for other miscellaneous items, including $3 ($2 after-tax) for asset impairments; and $8 ($6 after-tax and noncontrolling interests) for the reversal of a number of small layoff reserves related to prior periods.

In May 2013, management approved the permanent shutdown and demolition of
(i) two potlines (capacity of 105 kmt-per-year) that utilize Soderberg technology at the smelter located in Baie Comeau, Québec, Canada (remaining capacity of 280 kmt-per-year composed of two prebake potlines) and (ii) the smelter located in Fusina, Italy (capacity of 44 kmt-per-year). Additionally, in August 2013, management approved the permanent shutdown and demolition of one potline (capacity of 41 kmt-per-year) that utilizes Soderberg technology at the Massena East, N.Y. smelter (remaining capacity of 84 kmt-per-year composed of two Soderberg potlines - see Primary Metals in Segment Information below). The aforementioned Soderberg lines at Baie Comeau and Massena East were fully shut down by the end of September 2013 while the Fusina smelter was previously temporarily idled in 2010. Demolition and remediation activities related to all three facilities began in late 2013 and are expected to be completed by the end of 2014 (Massena East), 2015 (Baie Comeau), and 2017 (Fusina).

The decisions on the Soderberg lines for Baie Comeau and Massena East are part of a 15-month review of 460 kmt of smelting capacity initiated by management in May 2013 for possible curtailment, while the decision on the Fusina smelter is in addition to the capacity being reviewed. Factors leading to all three decisions were in general focused on achieving sustained competitiveness and included, among others: lack of an economically viable, long-term power solution
(Italy); changed market fundamentals; other existing idle capacity; and restart costs. The remaining 183 kmt of smelting capacity subject to this review is expected to be completed during the first half of 2014 (see Primary Metals in Segment Information below). As such, future restructuring charges may be recognized if the decision to shut down more capacity is made in 2014.

In 2013, exit costs related to these actions included $114 for the layoff of approximately 550 employees (Primary Metals segment), including $83 in pension costs; accelerated depreciation of $58 (Baie Comeau) and asset impairments


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of $18 (Fusina and Massena East) representing the write-off of the remaining book value of all related properties, plants, and equipment; and $55 in other exit costs. Additionally in 2013, remaining inventories, mostly operating supplies and raw materials, were written down to their net realizable value resulting in a charge of $9 ($6 after-tax), which was recorded in Cost of goods sold on the Statement of Consolidated Operations. The other exit costs of $55 represent $48 in asset retirement obligations and $5 in environmental remediation, both triggered by the decisions to permanently shut down and demolish these structures, and $2 in other related costs.

As of December 31, 2013, approximately 1,020 of the 1,660 employees were separated. The remaining separations for the 2013 restructuring programs are expected to be completed by the end of 2014. In 2013, cash payments of $33 were made against layoff reserves related to the 2013 restructuring programs.

2012 Actions. In 2012, Alcoa recorded Restructuring and other charges of $172 ($106 after-tax and noncontrolling interests), which were comprised of the following components: $85 ($33 after-tax and noncontrolling interest) related to the civil portion of a legal matter; $47 ($29 after-tax and noncontrolling interests) for the layoff of approximately 800 employees (390 in the Engineered Products and Solutions segment, 250 in the Primary Metals segment, 85 in the Alumina segment, and 75 in Corporate), including $10 ($7 after-tax) for the layoff of an additional 170 employees related to the previously reported smelter curtailments in Spain (see 2011 Actions below); $30 ($30 after-tax) in asset impairments and $6 ($6 after-tax) for lease and contract termination costs due to a decision to exit the lithographic sheet business in Bohai, China; $11 ($11 after-tax) in costs to idle the Portovesme smelter (see 2011 Actions below); $10 ($8 after-tax) in other asset impairments; a net charge of $4 ($4 after-tax and noncontrolling interests) for other miscellaneous items; and $21 ($15 after-tax and noncontrolling interests) for the reversal of a number of layoff reserves related to prior periods, including $10 ($7 after-tax) related to the smelters in Spain. The reversal related to the smelters in Spain is due to lower than expected costs based on agreements with employee representatives and the government, as well as a reduction of 55 in the number of layoffs due to the anticipation of the restart of a portion of the previously curtailed capacity based on an agreement with the Spanish government that will provide interruptibility rights (i.e. compensation for power interruptions when grids are overloaded) to the smelters during 2013. A portion of this reversal relates to layoff costs recorded at the end of 2011 (see 2011 Actions below) and a portion of this reversal relates to layoff costs recorded during 2012 (see above).

As of December 31, 2013, the separations associated with 2012 restructuring programs were essentially complete. In 2013 and 2012, cash payments of $17 and $16, respectively, were made against layoff reserves related to the 2012 restructuring programs.

2011 Actions. In 2011, Alcoa recorded Restructuring and other charges of $281 ($181 after-tax and noncontrolling interests), which were comprised of the following components: $127 ($82 after-tax) in asset impairments and $36 ($23 after-tax) in other exit costs related to the permanent shutdown and planned demolition of certain idled structures at two U.S. locations (see below); $93 ($68 after-tax and noncontrolling interests) for the layoff of approximately 1,600 employees (820 in the Primary Metals segment, 470 in the Global Rolled Products segment, 160 in the Alumina segment, 20 in the Engineered Products and Solutions segment, and 130 in Corporate), including the effects of planned smelter curtailments (see below); $23 ($12 after-tax and noncontrolling interests) for other asset impairments, including the write-off of the carrying value of an idled structure in Australia that processed spent pot lining and adjustments to the fair value of the one remaining foil location while it was classified as held for sale due to foreign currency movements; $20 ($8 after-tax and noncontrolling interests) for a litigation matter related to the former St. Croix location; a net charge of $5 ($4 after-tax) for other miscellaneous items; and $23 ($16 after-tax) for the reversal of previously recorded layoff reserves due to normal attrition and changes in facts and circumstances, including a change in plans for Alcoa's aluminum powder facility in Rockdale, TX.

In late 2011, management approved the permanent shutdown and demolition of certain facilities at two U.S. locations, each of which was previously temporarily idled for various reasons. The identified facilities are the smelter located in Alcoa, TN (capacity of 215 kmt-per-year) and two potlines (capacity of 76 kmt-per-year) at the smelter located in Rockdale, TX (remaining capacity of 191 kmt-per-year composed of four potlines). Demolition and remediation activities related to these actions began in 2012 and are expected to be completed in 2015 for the Tennessee smelter


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