KALU

Business Context and Reporting Period

Kaiser Aluminum Corporation filed its Form 10-Q for the quarterly period ended September 30, 2008. The company operates two primary segments: Fabricated Products (value-added aluminum products for aerospace, defense, and automotive industries) and Primary Aluminum (commodity grade products via a 49% interest in Anglesey Aluminium Limited). The reporting period was significantly impacted by a fire at the Anglesey smelter in June 2008 and sharp declines in metal and energy prices.

Key Financial Metrics

Note: Q3 2008 results include $43.8 million in non-cash mark-to-market losses on derivatives and an estimated $20 million adverse impact from the Anglesey outage.

Material Changes vs. Prior Period

• Profitability Decline: The company swung from a net income of $24.8 million in Q3 2007 to a net loss of $22.1 million in Q3 2008. Operating income dropped 183% year-over-year.
• Derivative Losses: A significant driver of the loss was $43.8 million in unrealized, non-cash mark-to-market losses on derivative positions due to declines in metal, natural gas, and foreign currency prices.
• Anglesey Outage: A fire at the Anglesey smelter on June 12, 2008, reduced production capacity to one-third during the latter half of June. This resulted in an estimated $20 million pre-tax adverse operating impact in Q3 2008 and $26.8 million for the nine-month period.
• Liquidity Drain: Cash and cash equivalents plummeted from $68.7 million at year-end 2007 to $1.1 million at September 30, 2008. This was driven by increased inventory, capital expenditures ($61.0 million for the nine months), stock repurchases ($28.1 million), and dividends ($12.4 million).
• Segment Performance:
  • Fabricated Products: Operating income fell to $19.5 million (from $39.8 million) due to LIFO charges ($0.7 million) and metal losses, despite a 6% increase in sales price.
  • Primary Aluminum: Recorded an operating loss of $44.9 million (vs. $13.4 million income) primarily due to the Anglesey outage and derivative mark-to-market losses.

Guidance, Outlook, and Risks

• Anglesey Recovery: Production restart activities were completed at the end of October 2008 with ~90% of pots operating. Full production is expected by mid-December 2008. The company expects an additional adverse impact of $4 million to $6 million in Q4 2008.
• Power Contract Uncertainty: Anglesey's power contract expires in September 2009. The nuclear plant supplying power is slated for decommissioning in late 2010. Management notes increasing difficulty in securing viable power prices, creating uncertainty about the long-term viability of the smelter.
• Dividend Suspension: Anglesey suspended dividends in July 2008 to assess the impact of the fire and insurance recovery. No assurance is given that dividends will be declared in the foreseeable future.
• Market Risks: The company faces significant exposure to fluctuations in primary aluminum prices, natural gas costs, and foreign exchange rates (specifically the Pound Sterling). While hedging is used, mark-to-market accounting creates volatility in reported earnings.
• Capital Expenditures: Total capital expenditures for 2008 are expected to be in the $90 million to $100 million range. The $139 million heat treat plate expansion project at the Trentwood facility is complete.

Investor Verification Checklist

• Insurance Recovery: Verify the status and expected timing of insurance claims related to the Anglesey fire, as this could materially impact future earnings.
• Anglesey Power Contract: Monitor negotiations for a new power contract for Anglesey, as failure to secure viable pricing could lead to a permanent shutdown of the smelter.
• Liquidity Position: Assess the company's ability to fund operations and capital projects with only $1.1 million in cash, relying heavily on the $220.3 million remaining availability under its revolving credit facility.
• Derivative Valuation: Review the sensitivity of earnings to further declines in metal and energy prices, given the significant unrealized losses already booked.
• Inventory Valuation: Note the subsequent event disclosure indicating a potential $8.6 million lower-of-cost-or-market write-down if LME prices remain at October 31, 2008 levels ($0.89/lb).