Kaiser Aluminum Corporation — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Financial statements are unaudited; amounts are in millions of dollars unless stated otherwise. Kaiser manufactures semi-fabricated specialty aluminum products and reports one segment, Fabricated Products.
Key financial results
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $338.8 | $282.4 | $661.4 | $549.9 |
| Operating income | $15.4 | $4.0 | $35.9 | $18.8 |
| Net income | $4.5 | $0.1 | $15.8 | $8.9 |
| Diluted EPS | $0.24 | $0.01 | $0.83 | $0.45 |
| Operating cash flow | Not stated quarterly | Not stated quarterly | $32.9 | $38.6 |
- Q2 sales rose 20%; shipments increased 9% to 145.2 million pounds. For the first half, sales rose 20% and shipments rose 11% to 289.3 million pounds. Management attributed growth to higher metal prices passed through to customers, improved demand, and acquired operations.
- Q2 operating margin was approximately 4.5% versus 1.4% a year earlier; net margin was approximately 1.3% versus near zero. First-half operating margin was approximately 5.4% versus 3.4%; net margin was approximately 2.4% versus 1.6%.
- Fabricated Products operating income was $32.9 in Q2 and $56.6 for the first half, compared with $32.2 and $54.3 in the prior-year periods. Excluding management-identified non-run-rate items, segment income was $32.0 for Q2 and $57.2 for the first half, below prior-year adjusted results of $33.7 and $59.8.
- First-half cash from operations of $32.9 was below $38.6 in 2010. Investing used $97.6, including $83.2 net cash paid for the Alexco acquisition; financing used $11.1. Cash fell $75.8 to $59.8.
- At June 30, cash was $59.8, current assets $439.7, and current liabilities $164.9. The $200.0 revolving facility had no borrowings, $8.5 of letters of credit, and $191.5 net availability. Cash plus net availability was about $251.3.
- Debt included $175.0 principal of cash-convertible notes (carrying value $144.6 after discount) and $12.4 of secured notes payable; no revolver borrowings. The notes carry a 4.5% coupon, mature in 2015, and have an approximately 11% effective interest rate. The company reported compliance with credit-facility covenants.
- Capital expenditures were $14.1 in the first half. The regular dividend was $0.24 per share per quarter; $9.4 was paid in the first half. A further $0.24 dividend was declared for payment in August.
Material changes and unusual items
- Effective January 1, 2011, Kaiser acquired Alexco’s Chandler, Arizona aerospace extrusion assets for $83.2 net cash consideration. The operation contributed $11.2 of Q2 sales and $3.2 of pretax income; first-half contributions were $21.1 and $5.4. Goodwill rose to $37.2 and net intangible assets to $38.3.
- Sales increases largely reflected higher aluminum prices, not equivalent growth in value-added economics. The average realized value-added revenue per pound was $1.10 in Q2 2011 versus $1.11 in Q2 2010, and $1.09 in both first-half periods.
- Q2 included $13.1 of net non-cash mark-to-market losses on derivatives; first-half derivative mark-to-market losses were $7.1. Changes in aluminum and the stock price affected hedge and convertible-note derivative valuations. First-half LIFO charges were $19.9, versus $8.2 in 2010.
- First-half interest expense rose to $8.9 from $3.5, partly reflecting the notes and less interest capitalization. Other expense was $3.4 in Q2, principally reflecting derivative valuation movements.
- Environmental expense was $2.5 in Q2, mainly related to historical matters at non-operating sites. The recorded environmental accrual was $21.8; management said reasonably possible additional costs could reach $21.6 over as much as 30 years. The Trentwood remediation plan remained subject to regulatory review, with a consent decree expected in 2012.
Outlook, risks, and contingencies
- Management expected second-half 2011 value-added revenue to be similar to the first half: a strong aerospace order book was expected to offset seasonal weakness in general engineering and automotive. It anticipated improving efficiencies and metal-cost recovery to support profitability, partly offset by higher planned maintenance.
- Management cited continued aerospace demand and expected aircraft production ramp-ups in 2012 and beyond, gradual improvement in general engineering, and growth in automotive extrusion programs. It expected 2011 capital spending of $35–$45 million and said it would consider complementary acquisitions. These are forward-looking expectations, not guarantees.
- Key exposures include cyclical aerospace, automotive and industrial demand; aluminum, energy and foreign-exchange prices; and derivative mark-to-market volatility. Natural-gas price exposure was substantially hedged for approximately 93% of expected remainder-2011 purchases, 74% for 2012, and 32% for 2013.
- The company reported $15.6 of gross unrecognized tax benefits and $7.1 accrued for related interest and penalties. It also disclosed Canadian tax assessments and continuing environmental and other legal contingencies. Management said pending legal matters were sufficiently reserved and were not expected to materially affect financial position, results, or liquidity.
- Management believed available cash, operating cash generation, and revolver availability would fund requirements for at least 12 months, while acknowledging dependence on future operating performance and continued borrowing access.
Important facts for investors to verify
- How much reported sales growth reflects shipment and mix gains versus aluminum-price pass-through, and whether value-added revenue and adjusted segment profitability improve.
- Whether operating cash flow converts earnings into cash as working-capital requirements and capital spending continue, particularly after the acquisition-related cash outlay.
- The expected timing, terms, and ultimate cost of Trentwood and other environmental remediation; current accruals represent management’s estimate and additional costs are reasonably possible.
- The drivers and potential cash consequences of derivative and convertible-note valuations, including the hedge effectiveness and 2015 note maturity obligations.
- Whether aerospace orders, automotive programs, and planned efficiency improvements deliver the outlook, while accounting for seasonal weakness, maintenance spending, and acquisition integration.