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NOR > SEC Filings for NOR > Form 10-K on 3-Mar-2014All Recent SEC Filings

Show all filings for NORANDA ALUMINUM HOLDING CORP

Form 10-K for NORANDA ALUMINUM HOLDING CORP


3-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

You should read the following discussion of our results of operations and financial condition with the "Selected Historical Consolidated Financial Data," and the audited consolidated financial statements and related notes included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs, and that involve numerous risks and uncertainties, including, but not limited to, those described in the "Risk Factors" section of this report. Actual results may differ materially from those contained in any forward-looking statements. See "Cautionary Statement Concerning Forward-Looking Statements."

Introduction
The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is provided to supplement the consolidated financial statements and the related notes included elsewhere in this report to help provide an understanding of our financial condition, changes in financial condition and results of our operations. The MD&A is organized as follows:
Company Overview. This section provides a general description of our business as well as recent developments that we believe are necessary to understand our financial condition and results of operations and to anticipate future trends in our business.
Critical Accounting Policies and Estimates. This section discusses the accounting policies and estimates that we consider important to our financial condition and results of operations and that require significant judgment and estimates on the part of management in their application.
Selected Quarterly Consolidated Financial Data. This section provides the unaudited quarterly financial information for each of our years ended December 31, 2013 and 2012.
Results of Operations. This section provides a discussion of the results of operations on a historical basis for each of our years ended December 31, 2013, 2012 and 2011.
Liquidity and Capital Resources. This section provides an analysis of our cash flows for each of our years ended December 31, 2013, 2012 and 2011 and availability of funds at December 31, 2013.
Description of Certain Indebtedness. This section provides a general description of our senior secured credit facilities, our AcquisitionCo Notes and governing indenture.
Contractual Obligations and Contingencies. This section provides a discussion of our commitments as of December 31, 2013.

Company Overview
We are a leading North American integrated producer of value-added primary aluminum and high-quality rolled aluminum coils. We have two businesses: our upstream business and downstream business. Our upstream business is one of the largest U.S. producers of primary aluminum, and consists of three reportable segments: Primary Aluminum, Alumina and Bauxite. These three segments are closely integrated and consist of a smelter near New Madrid, Missouri, which we refer to as "New Madrid," and supporting operations at our bauxite mining operation ("St. Ann") and alumina refinery ("Gramercy"). In 2013, New Madrid produced approximately 586 million pounds (266,000 metric tonnes) of primary aluminum, representing approximately 14% of total 2013 U.S. primary aluminum production, based on statistics from CRU. Our downstream business comprises our Flat-Rolled Products segment, which is one of the largest aluminum foil producers in North America, and consists of four rolling mill facilities with a combined maximum annual production capacity of 410 to 495 million pounds, depending on production mix.
Key factors affecting our results of operations Prices and markets. Primary aluminum is a global commodity, and its price is set on the London Metal Exchange ("LME"). Our primary aluminum typically earns the Midwest transaction price ("MWTP") which consists of the LME aluminum price plus a Midwest premium. The average LME aluminum price for 2013 was $0.84 per pound. In 2012 and 2011, the average LME aluminum price was $0.92 per pound and $1.09 per pound, respectively. Declining LME aluminum prices have had a significant negative impact on our upstream business and our operating results. Profit margins in the Flat-Rolled Products segment are generally unaffected by short-term volatility in the underlying LME aluminum price, except in periods of rapid change, which could create significant differences between the cost of metal purchased and the price of metal sold to customers. The price of any given end-product is equal to the cost of the metal, the MWTP, and a negotiated fabrication premium. These fabrication premiums are determined in large part by industry capacity utilization, which in turn is driven by supply-demand fundamentals for our products.


Because primary aluminum is a global commodity, we have experienced and expect to continue to be subject to volatile primary aluminum prices. This price volatility is influenced primarily by the global supply-demand balance for those commodities and related processing services, and other related factors such as speculative activities by market participants, production activities by competitors and political and economic conditions, as well as production costs in major production regions. Increases or decreases in primary aluminum prices result in increases and decreases in our revenues (assuming all other factors are unchanged). At times, we have partially hedged this volatility through the use of derivative financial instruments. See Item 7A, "Quantitative and Qualitative Disclosures about Market Risk," for further discussion of derivative instruments. See "Critical Accounting Policies and Estimates" for further discussion of our accounting for these derivative instruments.
Demand. We are a North American producer with a majority of our primary aluminum sales in the form of value-added products delivered within a one-day delivery radius of New Madrid. Therefore, while global market trends determine the LME aluminum price and impact our margins, domestic supply and demand for our value-added products also directly impact our margins.
Our integrated operations provide us the flexibility to shift a portion of our upstream production to our downstream business, reducing our overall external purchase requirements, and allow us to retain the economic differential between LME aluminum pricing and our production costs.
Production. Our rolling mills have a combined maximum annual production capacity of 410 to 495 million pounds, depending on our product mix. In 2013, 2012 and 2011 our Primary Aluminum segment produced approximately 586 million pounds, 575 million pounds and 583 million pounds, respectively, of primary aluminum. Production costs. The key cost components at our smelter are power and alumina; however, other integrated input costs, such as wages, carbon products and caustic soda may affect our results as well.
We have a long-term contract with Ameren for our electricity supply at New Madrid. This contract provides a secure supply at a rate established by MoPSC, and cannot be altered without the MoPSC's approval. The contract provides that the rate for power will be established by the MoPSC based on two components: a base rate and a fuel adjustment charge. The MoPSC determines whether to make changes to the base rate and fuel adjustment charge.
On February 13, 2014, we filed a petition with the MoPSC to change the rate design for Ameren customers in Missouri. Under the proposed ten-year rate structure, New Madrid's base power rate would be reduced to an initial rate of $30 per megawatt hour. Further, New Madrid would not be subject to fuel adjustment charges, but would share in future base power rate increases granted to Ameren Missouri by the MoPSC, subject to a two percent cap for each general rate case. Compared to New Madrid's 2013 electricity rates, the rate change would have reduced our Net Cash Cost by over 8 cents per pound. The MoPSC has complete discretion to decide the schedule for consideration of the filing or not to consider it at all. With the support of various consumer groups, we have requested that the MoPSC approve the reduced rate on an expedited basis with an effective date of August 1, 2014.
Our vertical integration with Gramercy provides us with a secure supply of alumina at a cost effectively equal to Gramercy and St. Ann's combined cost of production, net of bauxite and alumina sales to third parties. St. Ann sells bauxite to third parties and Gramercy sells chemical and smelter grade alumina to third parties on market terms. Margins from these third-party sales effectively reduce the cost for producing smelter grade alumina for our smelter in New Madrid, thus lowering our Net Cash Cost.
Historically, natural gas prices have shown a high level of volatility. Henry Hub Index natural gas prices averaged $3.73 per million BTU in 2013, $2.75 in 2012 and $4.00 in 2011. We have, from time to time, entered into forward swaps to mitigate the effect of fluctuations in natural gas prices. Since January 1, 2013, we have not been a party to any forward swaps for natural gas. During 2013, in our downstream business, aluminum metal units, which represent a pass-through cost to our customers, accounted for 72% of production costs with value-added conversion costs accounting for the remaining 28%. Conversion costs include labor, energy and operating supplies, including maintenance materials. Energy includes natural gas and electricity, which made up approximately 13% of conversion costs during 2013.
Productivity Program
CORE stands for "Cost-Out, Reliability, and Effectiveness," and represents our productivity program. We believe CORE is an effective part of our efforts to manage our productivity, where we identify opportunities throughout the organization to either remove existing costs, or to affect processes or business arrangements. We then utilize project teams to address the opportunity. Although results will vary from year to year, our overarching aim is to use CORE projects to offset the effects of inflation and to mitigate the impact of unexpected cost increases.
During the three year period 2011-2013, we achieved $195.7 million in savings through our Cost-Out, Reliability and Effectiveness ("CORE") productivity program, surpassing our three-year goal of $140 million.
October 30, 2013, we announced productivity targets totaling $225 million for the three year period from 2014 to 2016. These targets include $150 million of productivity gains to offset the normal effects of inflation and unplanned events, plus an additional $75 million of gains from functional streamlining, improving production processes, and changes in strategic sourcing of input costs.


Since announcing our three year CORE productivity targets, excluding any effects of the rate design petition, we have initiated activities expected to generate over $30 million of recurring run-rate savings over the course of 2014. These actions included fourth quarter 2013 workforce reductions expected to generate approximately $18 to $20 million of annual savings. Seasonality and the effects of inflation We are subject to seasonality associated with the demand cycles of many of our end-use customers, which results in lower shipment levels from November to February each year. To match this demand seasonality, working capital is typically a use of cash in the first quarter of each year, and provides cash in the third and fourth quarter of each year. Our power contracts have seasonally adjusted pricing which results in fluctuations in our cost of production; the rates from June to September are approximately 45% higher than the rates from October to May.
We experience inflationary pressures for input costs, such as wages, carbon products such as coke, chemical products such as caustic soda, and other key inputs. We may not be able to offset fully the inflationary impact from these input costs or energy costs through price increases, productivity improvements or cost reduction programs.
Off balance sheet arrangements
We do not have any significant off balance sheet arrangements. Government regulations and environmental matters Our operations are subject to a wide variety of U.S. federal, state, local and foreign environmental laws and regulations, including those governing emissions to air, discharges to waters, generation, use, storage, transportation, treatment and disposal of hazardous materials and wastes, land reclamation and employee health and safety. Compliance with environmental laws and regulations can be costly, and we have incurred and will continue to incur costs, including capital expenditures, to comply with these requirements. Additionally, certain of our raw material suppliers may be subject to significant environmental compliance costs, which they may pass through to us. As these direct or indirect regulatory costs increase and are passed through to our customers, our products may become less competitive than other materials, which could reduce our sales. If we are unable to comply with environmental laws and regulations, we could incur substantial costs, including fines and civil or criminal sanctions, or costs associated with upgrades to our facilities or changes in our manufacturing processes in order to achieve and maintain compliance. In addition, environmental requirements change frequently and have tended to become more stringent over time. We cannot predict what environmental laws or regulations will be enacted or amended in the future, how existing or future laws or regulations will be interpreted or enforced, or the amount of future expenditures that may be required to comply with such laws or regulations. Our costs of compliance with current and future environmental requirements could materially and adversely affect our business, financial condition, results of operations and cash flows.
The Environmental Protection Agency ("EPA") has developed National Ambient Air Quality Standards ("NAAQS") for six compounds currently identified as criteria pollutants. The NAAQS establishes acceptable ambient air levels of each pollutant based on a review of their effects on human health and the environment. Sulfur dioxide ("SO2"), an emission from our New Madrid smelter facility, is one such criteria pollutant. To determine our smelter's compliance with NAAQS, we measure emissions using currently acceptable methods. In 2010, the EPA issued regulations that increased the stringency of the SO2 NAAQS. Federal and state regulators are in the process of developing measurement methods and time-lines that will govern the implementation of those regulations. Once finalized, these implementation requirements may present material implications for our smelter's compliance with NAAQS. Failure to meet NAAQS may require us to incur material capital and operational costs to bring our smelter into compliance and could have negative implications for permits necessary to support increases in production volumes at our smelter.
We accrue for costs associated with environmental investigations and remedial efforts when it becomes probable that we are liable and the associated costs can be reasonably estimated. Our environmental-related liabilities of $20.8 million and $21.5 million at December 31, 2013 and 2012, respectively, comprised the following:
Reclamation obligation at St. Ann to rehabilitate the land disturbed by the Bauxite mining operations;

Asset retirement obligations at New Madrid related to spent pot liners;

Asset retirement obligations at Gramercy related to red mud lakes; and

Environmental remediation obligations at Gramercy for clean-up costs.

All accrued amounts have been recorded without giving effect to any possible future recoveries. With respect to ongoing environmental compliance costs, including maintenance and monitoring, we expense the costs when incurred. Additionally, at December 31, 2013 and 2012, we had $9.2 million of restricted cash in an escrow account as security for the payment of red mud lake closure obligations that would arise under state environmental laws upon the termination of operations at the Gramercy facility.
For the year ended December 31, 2013, we incurred $8.9 million of capital expenditures related to compliance with environmental regulations. We anticipate environmental capital expenditures to range from $7.0 million to $9.0 million in 2014 and from $13.0 million


to $18.0 million in each of the years 2015 and 2016. We have incurred, and in the future will continue to incur, operating expenses related to environmental compliance. As part of our general capital expenditure plan, we also expect to incur capital expenditures for other capital projects that may, in addition to improving operations, reduce certain environmental impacts. Critical Accounting Policies and Estimates Our principal accounting policies are described in Note 1, "Accounting Policies" of the audited consolidated financial statements included elsewhere in this report. The preparation of the consolidated financial statements in accordance with U.S. GAAP requires management to make significant judgments and estimates. Some accounting policies have a significant impact on amounts reported in our consolidated financial statements. Our financial position and results of operations may be materially different when reported under different conditions or when using different assumptions in the application of such policies. In the event estimates or assumptions prove to be different from actual amounts, adjustments are made in subsequent periods to reflect more current information. Significant accounting policies, including areas of critical management judgments and estimates, include the following financial statement areas:

 Revenue recognition                          Asset retirement obligations
 Impairment of long-lived assets              Land obligation
                                                Derivative instruments and
 Goodwill and other intangible assets         hedging activities
 Inventory valuation

Revenue recognition
Revenue is recognized when title and risk of loss pass to customers in accordance with contract terms.
Impairment of long-lived assets
Our long-lived assets, primarily property, plant and equipment, comprise a significant amount of our total assets. We evaluate our long-lived assets and make judgments and estimates concerning the carrying value of these assets, including amounts to be capitalized, depreciation and useful lives. We evaluate the recoverability of our long-lived assets for possible impairment when events or circumstances indicate that the carrying amounts may not be recoverable. Long-lived assets are grouped and evaluated for impairment at the lowest levels for which there are identifiable cash flows that are independent of the cash flows of other groups of assets. If it is determined that the carrying amounts of such long-lived assets are not recoverable, the assets are written down to their estimated fair value.
This evaluation requires us to make long-term forecasts of future revenues and costs related to the assets subject to review. These forecasts require assumptions about demand for our products and future market conditions. Significant and unanticipated changes to these assumptions could require a provision for impairment in a future period. Although we believe the assumptions and estimates we have made in the past have been reasonable and appropriate, different assumptions and estimates could materially impact our reported financial results.
Goodwill and other indefinite-lived intangible assets Goodwill represents the excess of acquisition consideration paid over the fair value of identifiable net tangible and identifiable intangible assets acquired. Goodwill and other indefinite-lived intangible assets are not amortized, but are reviewed for impairment at least annually, in the fourth quarter, or upon the occurrence of certain triggering events. Effective January 1, 2012, we adopted new accounting standards that allow a qualitative assessment to determine whether further impairment testing is necessary. We elected to continue to evaluate goodwill and other indefinite-lived intangible assets for impairment using a two-step process, which is based on a quantitative assessment. The first step is to compare the fair value of each of our reporting units to their respective book values, including goodwill. If the fair value of a reporting unit exceeds its book value, reporting unit goodwill is not considered impaired and the second step of the impairment test is not required. If the book value of a reporting unit exceeds its fair value, the second step of the impairment test is performed to measure the amount of impairment loss, if any. The second step of the impairment test compares the implied fair value of the reporting unit's goodwill with the book value of that goodwill. If the book value of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination.
Our analysis includes assumptions about future profitability and cash flows of our segments, which reflect our best estimates based on information that was known or knowable at the date of the valuations. It is at least reasonably possible that the assumptions we employ will be materially different from the actual amounts or results, and that future impairment charges may be necessary. The carrying value of our Primary Aluminum segment's goodwill was $137.6 million at December 31, 2013. As of October 1, 2013, the date of our last annual goodwill impairment test, the fair value of the Primary Aluminum segment exceeded its carrying value by approximately 22%. Our 2013 fair value analysis included assumptions about key factors affecting the Primary Aluminum segment's future profitability and cash flows, including the long-term price for primary aluminum. Because LME aluminum prices declined throughout 2013, we determined it necessary to perform interim impairment testing during 2013. We will continue to monitor our Primary Aluminum segment's expected future cash flows for risk of impairment in the future. Factors that could cause a decline in expected future


cash flows include a further decline in expected aluminum prices without corresponding decreases in expected prices for production inputs, significant increases in cost of production inputs such as electricity, potential negative effects of proposed legislation related to sulfur dioxide ("SO2"), emissions, or a significant increase in cash flow discount rates. Additionally, a sustained decline in our stock price or a downgrading of our credit ratings, when combined with the factors noted above, may cause us to further evaluate our impairment risk.
Inventory valuation
Inventories are stated at the lower of cost or market ("LCM"). We use the last-in-first-out ("LIFO") method of valuing raw materials, work-in-process and finished goods inventories at our New Madrid smelter and our rolling mills. Inventories at Gramercy and St. Ann and supplies at New Madrid are valued at weighted-average cost. The remaining inventories (principally supplies) are stated at cost using the first-in first-out ("FIFO") method. Inventories in our Flat-Rolled Products segment, our Bauxite segment and our Alumina segment are valued using a standard costing system, which gives rise to cost variances. Variances are capitalized to inventory in proportion to the quantity of inventory remaining at period end to quantities produced during the period. Variances are recorded such that ending inventory reflects actual costs on a year-to-date basis.
As of the date of the Apollo Acquisition, a new base layer of LIFO inventories was established at fair value, such that FIFO basis and LIFO basis were equal. For layers added between the acquisition date and period end, we use a dollar-value LIFO approach where a single pool for each segment represents a composite of similar inventory items. Increases and decreases in inventory are measured on a pool basis rather than item by item. In periods following the Apollo Acquisition, LIFO cost of sales generally reflect sales at current production costs, which are substantially lower than the fair value cost recorded at the date of acquisition, to the extent that quantities produced exceed quantities sold. In periods when quantities sold exceed quantities produced, cost of goods sold generally reflect the higher fair value cost per unit.
As LME aluminum prices fluctuate, our inventory will be subject to market valuation reserves. In periods when the LME aluminum price at a given balance sheet date is higher than the LME aluminum price at the time of the Apollo Acquisition (the date used to determine the fair value of the majority of our inventory), no reserves will be necessary.
The following table illustrates the sensitivity of our LIFO adjustment by showing the amount by which pre-tax income would have changed for the year ended December 31, 2013, given certain specified changes in inventory costs:

                                                                       Increase (decrease)
                                                                        in pre-tax income
       Inventory item                       Sensitivity                  ($ in millions)
Primary Aluminum segment:
Coke                          10% increase in price                                (1.3 )
Alumina                       $0.10 increase in LME aluminum per pound             (1.8 )
Flat-Rolled Products segment:
Metal                         $0.10 increase in LME aluminum per pound             (4.7 )

Asset retirement obligations
We record our costs for legal obligations associated with the retirement of a tangible long-lived asset that results from its acquisition, construction, development or normal operation as asset retirement obligations. We recognize liabilities at fair value for our existing legal asset retirement obligations and adjust these liabilities for accretion costs and revision in estimated cash flows. The related asset retirement costs are capitalized as increases to the carrying amount of the associated long-lived assets and depreciation on these capitalized costs is recognized.
Land obligation
In cases where land to be mined is privately owned, St. Ann agrees to purchase the residents' property, including land, crops, homes, and other improvements in exchange for consideration paid in the form of cash, a commitment to relocate the residents to another area, or a combination of these two options (the "St. Ann Land Obligation"). We account for the costs associated with fulfilling the St. Ann Land Obligation by recording an asset (included in other assets in our consolidated balance sheets) for the estimated cost of the consideration, with a corresponding liability (included in accrued liabilities and other long-term liabilities in our consolidated balance sheets). We amortize those costs over a three-year period, representing the approximate time the land is used for mining purposes (the "Mining Period").
We record the costs to acquire and develop the assets to be used to satisfy the obligations, such as land, land improvements, and housing, as property, plant and equipment in our consolidated balance sheets. As cash is paid or title to land, land improvements and houses is transferred, we remove those assets from our consolidated financial statements and reduce the land obligation. Relocating residents occurs often over several years, requiring management to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the consolidated financial statements. Actual results could differ from these estimates. As such, estimates of the cost to fulfill the . . .

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