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KALU > SEC Filings for KALU > Form 10-Q on 24-Jul-2014All Recent SEC Filings

Show all filings for KAISER ALUMINUM CORP

Form 10-Q for KAISER ALUMINUM CORP


24-Jul-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Item should be read in conjunction with Part I, Item 1. "Financial Statements" of this Quarterly Report on Form 10-Q (this "Report").
This Report contains statements which constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear in a number of places in this Report and can be identified by the use of forward-looking terminology such as "believes," "expects," "may," "estimates," "will," "should," "plans," or "anticipates" or comparable terminology, or by discussions of strategy. Readers are cautioned that any such forward-looking statements are not guarantees of future performance and involve significant risks and uncertainties, and that actual results may vary materially from those in the forward-looking statements as a result of various factors. These factors include: the effectiveness of management's strategies and decisions; general economic and business conditions including cyclicality and other conditions in the aerospace, automobile and other end market segments we serve; developments in technology; new or modified statutory or regulatory requirements; and changing prices and market conditions. Part I, Item 1A. "Risk Factors" included in our Annual Report on Form 10-K for the year ended December 31, 2013 identifies other factors that could cause actual results to vary. No assurance can be given that these are all of the factors that could cause actual results to vary materially from the forward-looking statements.
Management's discussion and analysis of financial condition and results of operations ("MD&A") is designed to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. Our MD&A is presented in the following sections:
• Overview;

• Highlights of the Quarter Ended June 30, 2014;

• Results of Operations;

• Liquidity and Capital Resources;

• Contractual Obligations, Commercial Commitments, and Off-Balance-Sheet and Other Arrangements;

• Critical Accounting Estimates and Policies;

• New Accounting Pronouncements; and

• Available Information.

We believe our MD&A should be read in conjunction with the consolidated financial statement and related notes thereto included under Part I, Item 1. "Financial Statements" included in this Report and the consolidated financial statements and related notes included in Part II, Item 8. "Financial Statements and Supplementary Data" of our Annual Report on Form 10-K for the year ended December 31, 2013.
In the discussion of operating results below, certain items are referred to as non-run-rate items. For purposes of such discussion, non-run-rate items are items that, while they may recur from period-to-period, (i) are particularly material to results, (ii) affect costs primarily as a result of external market factors, and (iii) may not recur in future periods if the same level of underlying performance were to occur. Non-run-rate items are part of our business and operating environment but are worthy of being highlighted for the benefit of readers of our financial statements. Our intent is to allow readers of the financial statements to consider our results both in light of and separately from items such as unrealized, mark-to-market gains or losses on derivatives related to fluctuations in underlying metal prices, energy prices, our stock price and currency exchange rates. For a reconciliation of operating income excluding non-run-rate items to operating income, see "Results of Operations - Segment and Business Unit Information" below.
We also provide information regarding value added revenue which represents net sales less the hedged cost of alloyed metal. A fundamental part of our business model is to mitigate the impact of aluminum price volatility through pricing policies that allow us to pass metal cost fluctuations through to our customers and a hedging program that addresses metal price exposure in circumstances in which we are unable to pass metal cost fluctuations through to our customers due to firm-price customer sales agreements that specify the underlying metal price plus a conversion price. As a result of our pricing policies and hedging program, fluctuations in underlying metal price do not directly impact our profitability. Accordingly, value added revenue (including average realized value added revenue, third party value added revenue and value added revenue of the product categories of our Fabricated Products segment) is worthy of being highlighted for the benefit of users of our financial statements. Our intent is to allow readers of the financial statements to consider our net sales information both with and without the metal cost component thereof. For a reconciliation of valued added revenue to net sales, see "Results of Operations
- Segment and Business Unit Information" below.


Overview
We are a leading North American manufacturer of semi-fabricated specialty aluminum products for the following end market applications: aerospace and high strength products (which we refer to as Aero/HS products); general engineering products (which we refer to as GE products); extrusions for automotive applications (which we refer to as Automotive Extrusions); and other industrial products (which we refer to as Other products).
At June 30, 2014, we operated 11 focused production facilities in the United States and one facility in Canada that produce rolled, extruded, and drawn aluminum products used principally for aerospace and defense, automotive, consumer durables, electronics, electrical, and machinery and equipment end market applications. Through these facilities, we recorded net sales of approximately $679.2 million on shipments of approximately 303.5 million pounds of semi-fabricated aluminum products during the six months ended June 30, 2014. We have long-standing relationships with our customers, which consist primarily of blue-chip companies including leading aerospace companies, automotive suppliers and metal distributors. In our served markets, we seek to be the supplier of choice by providing "Best in Class" customer satisfaction and offering a broad product portfolio. We have a culture of continuous improvement that is facilitated by the Kaiser Production System ("KPS"), an integrated application of tools such as Lean Manufacturing, Six Sigma and Total Productive Manufacturing. We believe KPS enables us to continuously reduce our own manufacturing costs, eliminate waste throughout the value chain, and deliver "Best in Class" customer service through consistent, on-time delivery of quality products on short lead times. We strive to tightly integrate the management of the operations within our Fabricated Products segment across multiple production facilities, product lines and target markets in order to maximize the efficiency of product flow to our customers.
A fundamental part of our business model is to mitigate the impact of aluminum price volatility on our cash flow. We purchase primary and scrap aluminum from third party suppliers to manufacture our products, and the price for the aluminum we purchase is typically based on the Average Midwest Transaction Price ("Midwest Price"). The Midwest Price represents the London Metal Exchange price ("LME") plus a Midwest premium which fluctuates in response to the aluminum supply/demand dynamics in North America. We manage the risk of fluctuations in the price of aluminum through either (i) pricing policies that allow us to pass the underlying cost of metal onto customers or (ii) hedging by purchasing financial derivatives to shield us from exposure related to firm-price sales contracts that specify the underlying metal price plus a conversion price. While we can generally pass metal price movement through to customers, for some of our higher value added products sold on a spot basis, the pass through of metal price movements can sometimes lag by as much a several months, with a favorable impact to us when metal prices decline and an adverse impact to us when metal prices increase. The average London Metal Exchange ("LME") plus Midwest premium transaction price per pound of primary aluminum for the quarters ended June 30, 2014 and June 30, 2013 was $0.81 + $0.19 and $0.83 + $0.12, respectively. The LME plus Midwest premium transaction price per pound of primary aluminum for the six months ended June 30, 2014 and June 30, 2013 was $0.79 + $0.19 and $0.87 + $0.11, respectively. At July 21, 2014, the LME plus Midwest premium transaction price per pound was $0.90 + $0.20.
Our highly engineered products are manufactured to meet demanding requirements of aerospace/high strength, general engineering, automotive and other industrial end market applications. We have focused our business on select end market applications where we believe we have sustainable competitive advantages and opportunities for long-term profitable growth. We believe that we differentiate ourselves with "Best in Class" customer satisfaction and a broad product offering, including our KaiserSelect® product line. Our KaiserSelect® products are manufactured to deliver enhanced product characteristics with improved consistency which results in such benefits as better performance, lower waste, and, in many cases, lower cost for our customers.
In the commercial aerospace sector, we believe that global economic growth and development will continue to drive growth in airline passenger miles. In addition, trends such as longer routes, larger payloads and focus on fuel efficiency have increased the demand for new and larger aircraft. We believe that the long-term demand drivers, including growing build rates, larger airframes and increased use of monolithic design (where aluminum plate is heavily machined to form the desired part from a single piece of metal as opposed to using aluminum sheet, extrusions or forgings that are affixed to one another using rivets, bolts or welds) throughout the industry will continue to increase demand for our high strength aerospace plate. We believe the strength of overall plate demand is demonstrated by the existing greater than eight-year backlog for the two primary manufacturers of commercial aircraft. Our Aero/HS and GE products are also sold for use in defense end market applications. Requirements of military engagements and sequestration of spending by the United States government will determine near-term demand for our Aero/HS and GE products for use in such applications. In the long-term, we expect the production of the F-35, or Joint Strike Fighter, to be a demand driver for our Aero/HS products.


Commercial aerospace and defense end market applications have demanding customer requirements for quality and consistency. As a result, there are a limited number of suppliers worldwide who are qualified to serve these market segments. We believe barriers to entry include significant capital requirements, technological expertise and a rigorous qualification process for safety-critical applications.
We expect the 2014 North American automotive sector build rates to increase approximately 5.2% over 2013 based on data from IHS, a provider of technical information. Our Automotive Extrusions typically have specific performance attributes in terms of machinability and/or mechanical properties for specific applications across a broad mix of North American original equipment manufacturers ("OEMs") and automotive platforms. We believe that these attributes are not easily replicated by our competitors and are important to our customers, who are typically first tier automotive suppliers. Additionally, we believe that in North America, from 2001 to 2013, the aluminum extrusion content per vehicle grew at a compound annual growth rate of 2.7% based on data provided by the Aluminum Association and IHS, as automotive OEMs and their suppliers found opportunities to decrease weight without sacrificing structural integrity and safety performance. We also believe the United States' Corporate Average Fuel Economy ("CAFE") regulations, which increase fuel efficiency standards on an annual basis, will continue to drive growth in demand for aluminum extruded components in passenger vehicles as a replacement for the heavier weight of steel components.
Our GE products serve the North American industrial market segments, and demand for these products generally tracks the broader economic environment. Highlights of the quarter ended June 30, 2014 include:
• Fabricated Products segment shipments of 151.7 million pounds, a 4% increase from the second quarter of 2013, reflecting record heat treat plate and automotive extrusion shipments

• Consolidated net income of $24.5 million and earnings per diluted share of $1.33;

• Combined cash and cash equivalents, short-term investments, and net borrowing availability under our revolving credit facility of approximately $552.3 million, with no borrowings under the revolving credit facility, as of June 30, 2014;

• Declaration and payment of a regular dividend of $0.35 per common share, or $6.4 million; and

• Repurchase of 162,381 shares of our common stock at the weighted average price per share of $69.46.

Results of Operations
Consolidated Results of Operations
Net Sales. Net sales for the quarter ended June 30, 2014 totaled $344.1 million and $328.9 million for the quarter ended June 30, 2013. This increase in Net sales was due to a 5% increase in Fabricated Products segment shipment volume. Aero/HS shipment volume increased 10% and Automotive Extrusions shipment volume increased 28%, which together accounted for 7% of the increase in Fabricated Products segment shipment volume. The 7% increase was partially offset by a decrease in shipment volume from Other Products and GE Products. The average realized sales price per pound was relatively the same at $2.27 for the quarter ended June 30, 2014 compared to $2.26 for the quarter ended June 30, 2013. Net sales for the six months ended June 30, 2014 totaled $679.2 million, reflecting a slight increase compared to $666.3 million for the six months ended June 30, 2013, as a 6% increase in Fabricated Products segment shipment volume was partially offset by a 4% decrease in average realized sales price per pound. The increase in Fabricated Products segment shipment volume was due primarily to a 27% increase in Automotive Extrusions shipment volume and a 5% increase in both aero/HS and GE Products shipment volume. The decline in the average realized sales price per pound in the six months ended June 30, 2014 reflected both lower hedged cost of alloyed metal which we pass onto customers and lower average realized value added revenue per pound. Fluctuation in underlying primary aluminum market prices does not necessarily directly impact profitability because (i) a substantial portion of the business conducted by the Fabricated Products segment passes primary aluminum price changes directly onto customers and (ii) our hedging activities in support of the Fabricated Products segment's firm price sales agreements limit our losses, as well as gains, from primary metal price changes. The reduction in average realized value added revenue per pound reflected (i) revenue recognized in the six months ended June 30, 2013 due to a $4.5 million payment from a customer in lieu of fulfilling minimum volume obligations under a multi-year contract as well as
(ii) a 10% decrease in value added revenue per pound for Aero/HS Products due to lower pricing, offset by (iii) higher value added revenue per pound for Automotive Extrusions due to a richer mix of higher valued products.


Cost of Products Sold Excluding Depreciation and Amortization and Other Items. Cost of products sold, excluding depreciation and amortization and other items in the quarter ended June 30, 2014 totaled $275.5 million, or 80% of Net sales, compared to $261.5 million, or 80% of Net sales, in the quarter ended June 30, 2013. The $14.0 million increase in Cost of products sold excluding depreciation and amortization and other items for the quarter ended June 30, 2014 as compared to June 30, 2013 was due primarily to higher shipment volume. See "Segment and Business Unit Information" below for a further discussion of the comparative results of operations for the quarters ended June 30, 2014 and June 30, 2013.)
Cost of products sold, excluding depreciation and amortization and other items in the six months ended June 30, 2014 totaled $558.4 million, or 82% of Net sales, compared to $525.1 million, or 79% of Net sales, in the six months ended June 30, 2013. Approximately $28.2 million of the increase in Cost of products sold excluding depreciation and amortization and other items for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013 was due to higher shipment volume at a higher LIFO cost of inventory. The increase was also due to higher major maintenance of $3.1 million related to the ramp up of major 2013 capital improvement projects, and higher energy cost of $1.9 million related to the severe 2014 winter season.
Selling, Administrative, Research and Development, and General. Selling, administrative, research and development, and general expense totaled $22.0 million in the quarter ended June 30, 2014 compared to $21.8 million in the quarter ended June 30, 2013. The slight increase was primarily due to increases in employee incentive compensation relating to the Company's long-term incentive programs.
Selling, administrative, research and development, and general expense for the six months ended June 30, 2014 totaled $42.3 million compared to $43.5 million in the six months ended June 30, 2013. The decrease was due primarily to a $2.2 million decrease in employee incentive compensation primarily as a result of changes to the Company's short-term incentive plan and vesting provision upon retirement with respect to certain non-vested common shares and market-based shares in the first quarter of 2014, partially offset by a $0.7 million increase in research and development costs.
Net Periodic Pension Benefit Income Relating to VEBAs. Net periodic pension benefit income relating to two voluntary employee's beneficiary associations that provide benefits for certain eligible retirees, their surviving spouses and eligible dependents ("VEBAs") totaled $6.1 million and $5.7 million for the quarters ended June 30, 2014 and June 30, 2013, respectively. Net periodic pension benefit income relating to VEBAs totaled $11.7 million and $11.3 million for the six months ended June 30, 2014 and June 30, 2013, respectively. The increase was primarily due to an increase in expected return on plan assets.
Interest Expense. Interest expense of $9.2 million and $18.0 million in the quarter and six months ended June 30, 2014, respectively, was primarily related to interest expense incurred on our 4.5% Cash Convertible Senior Notes due April 1, 2015 (the "Convertible Notes") and our 8.250% Senior Notes due June 1, 2020 (the "Senior Notes") issued on May 23, 2012, net of $0.8 million and $1.9 million of interest expense capitalized as part of Construction in progress, respectively, for the two periods. Non-cash amortization of the discount on the Convertible Notes accounted for $2.3 million and $4.4 million of the total interest expense in the quarter and six months ended June 30, 2014, respectively.
Interest expense of $9.0 million and $18.3 million in the quarter and six months ended June 30, 2013, respectively, was primarily related to interest expense incurred on the Convertible Notes and Senior Notes, net of $0.7 million and $1.1 million of interest expense capitalized as part of Construction in progress, respectively, for the two periods. Non-cash amortization of the discount on the Convertible Notes accounted for $2.1 million and $4.0 million of the total interest expense in the quarter and six months ended June 30, 2013, respectively.
Income Tax Provision. See Note 4 of Notes to Interim Consolidated Financial Statements included in Part I, Item 1. "Financial Statements" of this Report for disclosure regarding our income tax provision. Derivatives
See Note 8 of Notes to Interim Consolidated Financial Statements included in Part I, Item 1. "Financial Statements" of this Report for disclosure regarding our derivatives.
Fair Value Measurements
See Note 9 of Notes to Interim Consolidated Financial Statements included in Part I, Item 1. "Financial Statements" of this Report for disclosure regarding our fair value measurements.


Deferred Tax Assets
The Company's non-current net deferred tax assets were $45.8 million and $69.1 million at June 30, 2014 and December 31, 2013, respectively, of which, $158.4 million and $152.4 million were related to a deferred tax liability for the Company's VEBA postretirement medical obligations at June 30, 2014 and December 31, 2013, respectively.
See Note 6 of Notes to Consolidated Financial Statements included in Part II, Item 8. "Financial Statements and Supplementary Data" in the Company's Annual Report Form 10-K for the year ended December 31, 2013 for additional information regarding our deferred tax assets.
Segment and Business Unit Information
Consistent with the manner in which our chief operating decision maker reviews and evaluates our business, we have one operating segment, which we refer to as Fabricated Products, that produces semi-fabricated specialty aluminum products, such as aluminum sheet and plate and extruded and drawn products, primarily used in aerospace/high strength, general engineering, automotive and other industrial end market applications. We categorize our products by these end market applications as follows: Aero/HS products, GE products, Automotive Extrusions, and Other products. We also have a business unit, All Other, which provides general and administrative support for our operations. For purposes of segment reporting under GAAP, we treat the Fabricated Products segment as a reportable segment. All Other is not considered a reportable segment.
The accounting policies of the segment and business unit are the same as those described in Note 1 of Notes to Interim Consolidated Financial Statements in Part I, Item 1. "Financial Statements" of this Report. Segment results are evaluated internally before interest expense, other (expense) income and income taxes.
The following data should be read in conjunction with our consolidated financial statements and the notes thereto included in Part I, Item 1. "Financial Statements" of this Report. See Note 11 of Notes to Interim Consolidated Financial Statements included in Part I, Item 1. "Financial Statements" of this Report for further information regarding segments. Interim results are not necessarily indicative of those for a full year. Fabricated Products
The table below provides selected operational and financial information (in millions of dollars except shipments and average realized sales price) for our Fabricated Products segment, for each period presented.


                                                    Quarter Ended           Six Months Ended
                                                       June 30,                 June 30,
                                                  2014         2013         2014         2013
Shipments (mm lbs)                                151.7        145.4         303.5       285.4
Composition of average realized third-party
sales price (per pound):
Average realized third-party sales price1       $  2.27     $   2.26     $    2.24     $  2.33
Less: hedged cost of alloyed metal price          (1.02 )      (1.00 )       (1.00 )     (1.03 )
Average realized third-party value added
revenue                                         $  1.25     $   1.26     $    1.24     $  1.30

Composition of net sales:
Net sales                                       $ 344.1     $  328.9     $   679.2     $ 666.3
Less: hedged cost of alloyed metal               (154.5 )     (145.4 )      (304.0 )    (295.4 )
Third-party value added revenue                 $ 189.6     $  183.5     $   375.2     $ 370.9

Segment operating income                        $  50.2     $   45.0     $    85.6     $ 100.2
Impact to operating income of non-run-rate
items:
Adjustments to plant-level LIFO2                    0.5          0.7          (4.1 )       5.4
Mark-to-market gains (losses) on derivative
instruments                                         1.5         (4.2 )         3.5        (4.9 )
Workers' compensation benefit due to
discounting                                         0.1          0.8           0.3         0.8
Impairment loss                                    (0.2 )          -          (0.2 )         -
Environmental expenses                             (0.1 )          -          (0.3 )      (0.3 )
Total non-run-rate items                            1.8         (2.7 )        (0.8 )       1.0
Segment operating income excluding non-run-rate
items                                           $  48.4     $   47.7     $    86.4     $  99.2


_____________________


1 Average realized prices for our Fabricated Products segment are subject to fluctuations due to changes in product mix and underlying primary aluminum prices, and are not necessarily indicative of changes in underlying profitability.

2 We manage our Fabricated Products segment business on a monthly LIFO basis at each plant, but report inventory externally on an annual LIFO basis in accordance with GAAP on a consolidated basis. This amount represents the conversion from GAAP LIFO applied on a consolidated basis for the Fabricated Products segment to monthly LIFO applied on a plant-by-plant basis.

As noted above, operating income excluding identified non-run-rate items for the quarter ended June 30, 2014 was $0.7 million higher than operating income excluding such items for the quarter ended June 30, 2013. Higher operating income in the quarter ended June 30, 2014 reflected the $1.6 million impact from higher shipment volume and improved manufacturing cost efficiencies of $1.1 million partially offset by higher depreciation of $0.8 million and higher energy costs of $0.6 million.
Segment operating income excluding identified non-run-rate items for the six months ended June 30, 2014 was $12.8 million lower than operating income excluding such items for the six months ended June 30, 2013. Lower segment operating income in the six months ended June 30, 2014 primarily reflected the impact of (i) the $4.5 million customer payment received in the quarter ended March, 31, 2013, (ii) $3.1 million of higher planned major maintenance expense,
(iii) $1.9 million of higher energy costs and (iv) $1.1 million of higher depreciation expense. The table below provides shipment and value added revenue information (in millions of dollars except shipments and value added revenue per pound) for each of the product categories (which are based on end market applications) of our Fabricated Products segment, for each period presented:


                                   Quarter Ended                                 Six Months Ended
                                     June 30,                                        June 30,
                           2014                    2013                    2014                    2013
Aero/HS Products:
. . .
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