Kaiser Aluminum Corporation — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. Unaudited results; dollars in millions unless stated otherwise.
Business context and reporting period
Kaiser manufactures semi-fabricated specialty aluminum products, primarily for aerospace, general engineering, automotive and industrial markets. Its reportable segment is Fabricated Products. The company also holds a 49% non-controlling interest in Anglesey, whose aluminum smelting operations ceased in September 2009 and whose remelt operation began in late 2009.
Financial performance
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Net sales | $263.4 | $252.0 | $813.3 | $750.0 |
| Operating income | $13.2 | $42.6 | $32.0 | $84.8 |
| Net income | $5.5 | $23.0 | $14.4 | $46.4 |
| Diluted EPS | $0.29 | $1.14 | $0.74 | $2.31 |
| Operating margin | 5.0% | 16.9% | 3.9% | 11.3% |
| Net margin | 2.1% | 9.1% | 1.8% | 6.2% |
Q3 Fabricated Products shipments rose 22% to 129.3 million pounds; nine-month shipments increased 23% to 389.9 million pounds. The segment’s Q3 sales rose 22% to $263.4, while value-added revenue per pound declined to $1.06 from $1.12. For the nine months, value-added revenue per pound fell to $1.08 from $1.22.
Operating cash flow was $65.3 for the nine months, down from $119.2; capital expenditures were $34.9 versus $51.0. Cash increased to $143.7 at September 30 from $30.3 at year-end 2009. Current assets were $455.8 and current liabilities $138.7 (approximately 3.3 current ratio).
At September 30, reported debt carrying value was approximately $153.3, including $139.9 for the cash-convertible notes and $13.4 of other debt. The notes have $175.0 principal, a 4.5% stated coupon, approximately 11% effective interest rate and 2015 maturity. The $200.0 revolving facility had no borrowings; $157.2 remained available after letters of credit. The company reported compliance with its covenants.
Changes versus comparable periods
- Sales increased, driven mainly by higher Fabricated Products shipments. Management attributed volume gains to improving demand, reduced service-center destocking and stronger automotive production. Higher metal prices largely offset lower value-added revenue per pound.
- Despite sales growth, Q3 operating income fell to $13.2 from $42.6, and nine-month operating income fell to $32.0 from $84.8. Major factors included higher environmental expense, less favorable derivative and metal effects, and the prior-year comparison’s different mark-to-market impacts.
- Q3 included $13.1 of environmental expense in Fabricated Products. Management’s non-GAAP-style reconciliation showed segment operating income excluding identified non-run-rate items of $23.0, compared with $19.7 in Q3 2009; nine-month amounts were $84.6 versus $68.0. These adjustments are management-defined and should not be viewed as GAAP results.
- Interest expense increased following the March 2010 note issuance. Nine-month other expense included mark-to-market losses on the note conversion feature and related call options.
Outlook, risks and unusual items
- Management expected Q4 shipments and value-added revenue to be slightly below Q3 due to seasonality, with manufacturing efficiencies expected to improve. It anticipated aerospace and automotive demand and first-quarter 2011 shipments to improve; no numerical earnings or revenue guidance was provided.
- The Kalamazoo facility expansion was expected to be substantially complete in late 2010. Full-year 2010 capital expenditures were projected at $40–$50, including $25–$30 for Kalamazoo.
- On October 12, 2010, Kaiser agreed to acquire substantially all assets and assume substantially all liabilities of Alexco for approximately $90, expected to close in December subject to conditions and funded with existing cash. The filing also reports completion of the Nichols facility acquisition in August for approximately $15.7 consideration, plus assumed liabilities.
- Environmental remediation is a significant contingency. The company increased its reserve by $13.6 in Q3 to $20.6, primarily for long-term work at its Trentwood facility; a draft plan remains subject to review and regulatory approval, with a consent decree expected in 2012. Management estimated reasonably possible costs could exceed accruals by up to $23.8 over 30 years.
- Other notable items: the company declared a subsequent quarterly dividend of $0.24 per share; it repurchased approximately 1.2 million shares for $44.2 during Q1. A Q3 revision to asbestos-removal estimates produced a net $1.1 reduction in expense and approximately $0.06 per share benefit from downward cost revisions; upward revisions also increased related asset-retirement liabilities and assets.
- Key exposures include aluminum and natural-gas prices, foreign exchange, derivative valuation and counterparty risk, environmental remediation, customer and market demand, and execution of expansion and acquisitions. The filing states disclosure controls were effective and reports no material change in internal controls.
Investor verification priorities
- Reconcile the sharp GAAP earnings decline with management’s non-run-rate adjustments, particularly environmental costs and derivative/metal mark-to-market effects.
- Review environmental reserve assumptions, the pending Trentwood regulatory process and the potential additional exposure of up to $23.8.
- Assess the Alexco transaction’s final purchase terms, assumed liabilities, funding and effect on cash and borrowing availability.
- Track operating cash conversion, working-capital needs, Kalamazoo ramp-up, and the ability to meet investment and dividend commitments.
- Verify the cash-convertible notes’ effective financing cost, conversion-related derivative valuations, and the conditions and covenants governing the revolver.