UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2007

 

Commission file number 0-52105

KAISER ALUMINUM CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(949) 614-1740

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o     Accelerated filer o     Non-accelerated filer þ

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.  Yes þ     No o

 

As of July 31, 2007, there were 20,583,279 shares of the Common Stock of the registrant outstanding.

 

 

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

PART I — FINANCIAL INFORMATION

 

 

CONSOLIDATED BALANCE SHEETS

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

STATEMENTS OF CONSOLIDATED INCOME

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

STATEMENTS OF CONSOLIDATED STOCKHOLDERS’ EQUITY AND

COMPREHENSIVE INCOME

 

(Unaudited)
(In millions of dollars, except share amounts)
For the Six Months Ended June 30, 2007

 

 

For the Six Months Ended June 30, 2006

(Predecessor)

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

STATEMENTS OF CONSOLIDATED CASH FLOWS

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(In millions of dollars, except share and per share amounts)
(Unaudited)

 

The accompanying financial statements include the financial statements of Kaiser Aluminum Corporation both before (the “Predecessor”) and after (the “Successor”) its emergence from chapter 11 bankruptcy in July 2006. Financial information related to Kaiser Aluminum Corporation after emergence is generally referred to throughout this Report as “Successor” information. Information of Kaiser Aluminum Corporation before emergence is generally referred to as “Predecessor” information. The financial information of the Successor is not comparable to that of the Predecessor given the impacts of the Plan (as defined below), implementation of fresh start reporting and other factors as more fully described below.

 

The Notes to Interim Consolidated Financial Statements are grouped into two categories: (1) those primarily affecting the Successor (Notes 1 through 14) and (2) those primarily affecting the Predecessor (Notes 15 through 18).

 

SUCCESSOR

 

 

This Report should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

 

Principles of Consolidation and Basis of Presentation.  The consolidated financial statements include the statements of Kaiser Aluminum Corporation (“Kaiser” or the “Company”) and its wholly owned subsidiaries. Investments in 50%-or-less-owned entities are accounted for primarily by the equity method. The only such affiliate at June 30, 2007 was Anglesey Aluminium Limited (“Anglesey”). Intercompany balances and transactions are eliminated.

 

The Company’s emergence from chapter 11 and adoption of fresh start accounting resulted in a new reporting entity for accounting purposes. Although the Company emerged from chapter 11 bankruptcy on July 6, 2006 (herein referred to as the “Effective Date”), the Company adopted “fresh start” accounting as required by the American Institute of Certified Professional Accountants Statement of Position 90-7 (“SOP 90-7”), Financial Reporting by Entities in Reorganization Under the Bankruptcy Code, effective as of the beginning of business on July 1, 2006. As such, it was assumed that the emergence was completed instantaneously at the beginning of business on July 1, 2006 such that all operating activities during the period from July 1, 2006 through December 31, 2006 are reported as applying to the Successor. The Company believes that this is a reasonable presentation as there were no material transactions between July 1, 2006 and July 6, 2006 that were not related to Kaiser’s Second Amended Plan of Reorganization (the “Plan”). Due to the implementation of the Plan, the application of fresh start accounting and changes in accounting policies and procedures, the financial statements of the Successor are not comparable to those of the Predecessor.

 

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the rules and regulations of the Securities and Exchange Commission. Accordingly, these financial statements do not include all of the disclosures required by GAAP for complete financial statements. In the opinion of management, the unaudited interim consolidated financial statements furnished herein include all adjustments, all of which are of normal recurring nature unless otherwise noted, necessary for a fair statement of the results for the interim periods presented.

 

The preparation of financial statements in accordance with GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities known to exist as of the date the financial statements are published, and the reported amounts of revenues and expenses during the reporting period. Uncertainties with respect to such estimates and assumptions are inherent in the preparation of the Company’s consolidated financial statements; accordingly, it is possible that the actual results

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

could differ from these estimates and assumptions, which could have a material effect on the reported amounts of the Company’s consolidated financial position and results of operation.

 

Operating results for the six months ended June 30, 2007, are not necessarily indicative of the results that may be expected for the year ended December 31, 2007.

 

Earnings per Share.  Basic earnings per share is computed by dividing earnings by the weighted average number of common shares outstanding during the applicable period. The shares owned by a voluntary employee beneficiary association (“VEBA”) for the benefit of certain union retirees, their surviving spouses and eligible dependents (the “Union VEBA”) that are subject to transfer restrictions, while treated in the balance sheet as being similar to treasury stock (i.e., as a reduction in Stockholders’ equity), are included in the computation of basic shares outstanding in the statement of income because such shares were irrevocably issued and have full dividend and voting rights.

 

Diluted earnings per share is computed by dividing earnings by the weighted average number of diluted common shares outstanding during the applicable period. The weighted average number of diluted shares includes the dilutive effect of the non-vested stock, restricted stock units and stock options granted during the periods from the dates of grant (see Note 12).

 

Restricted Cash.  Restricted cash totaled $25.2 at both June 30, 2007 and December 31, 2006, respectively. The restricted cash balances relate primarily to workers’ compensation and collateral for certain letters of credit.

 

New Accounting Pronouncements.  Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS No. 157”) was issued in September 2006 to increase consistency and comparability in fair value measurements and to expand their disclosures. The new standard includes a definition of fair value as well as a framework for measuring fair value. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements. The standard is effective for fiscal periods beginning after November 15, 2007 and should be applied prospectively, except for certain financial instruments where it must be applied retrospectively as a cumulative-effect adjustment to the balance of opening retained earnings in the year of adoption. The Company is still evaluating SFAS No. 157 but does not currently anticipate that the adoption of this standard will have a material impact on its financial statements.

 

Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (“SFAS No. 159”) was issued in February 2007 and will become effective for the Company on January 1, 2008. SFAS No. 159 permits entities the option to measure many financial instruments and certain other items at fair value. Unrealized gains and losses in respect of assets and liabilities for which the fair value option has been elected will be reported in earnings. Selection of the fair value option is irrevocable and can be applied on a partial basis, i.e., to some but not all similar financial assets or liabilities. The Company is currently evaluating what impact, if any, this pronouncement will have on its consolidated financial statements.

 

Significant accounting policies of the Predecessor are discussed in Note 15.

 

 

Substantially all product inventories are stated on a last-in, first-out (“LIFO”) basis, not in excess of market value. Replacement cost is not in excess of LIFO cost. Other inventories, principally operating supplies and repair and maintenance parts, are stated at the lower of average cost or market value. Inventory costs consist of material, labor and manufacturing overhead, including depreciation. Abnormal costs, such as idle facility expenses, freight, handling costs and spoilage, are accounted for as current period charges.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Inventories consist of the following:

 

 

As stated above, the Company determines cost for substantially all of its product inventories on a LIFO basis. All Predecessor LIFO layers were eliminated in connection with the application of fresh start accounting. The Successor applies LIFO differently than the Predecessor in that the Successor views each quarter on a standalone year to date basis for computing LIFO, whereas the Predecessor recorded LIFO amounts with a view to the entire fiscal year which, with certain exceptions, tended to result in LIFO charges being recorded in the fourth quarter or the second half of the year. The Company recorded a net non-cash LIFO benefit (charge) of approximately $6.0 and $(2.0) during the quarter and six month periods ended June 30, 2007, respectively. The Company recorded a non-cash LIFO charge of approximately $21.7 during the quarter and six month periods ended June 30, 2006. These amounts are primarily a result of changes in metal prices and, in 2007, changes in inventory volumes.

 

Pursuant to fresh start accounting, as more fully discussed in Note 2 of Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, all inventory amounts at the Effective Date were stated at fair market value. Raw materials and Operating supplies and repairs and maintenance parts were recorded at published market prices including any location premiums. Finished products and Work in process (“WIP”) were recorded at selling price less cost to sell, cost to complete and a reasonable apportionment of the profit margin associated with the selling and conversion efforts. As a result, as reported in Note 2 of Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, inventories were increased by approximately $48.9 at the Effective Date.

 

Given the recent strength in demand for many types of fabricated aluminum products and primary aluminum, the Company has a larger volume of raw materials, WIP and finished goods than is its historical average, and the price for such goods that was reflected in the opening inventory balance at the Effective Date, given the application of fresh start accounting, is higher than long term historical averages. As such, with the inevitable ebb and flow of business cycles, non-cash LIFO charges will result when inventory levels drop and/or margins compress. Such adjustments could be material to results in future periods.

 

 

See Note 3 of Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, for summary financial information for Anglesey, a 49.0% owned unconsolidated aluminum company, which owns an aluminum smelter at Holyhead, Wales. The Company’s equity in income before income taxes of Anglesey is treated as a reduction (increase) in Cost of products sold. The income tax effects of the Company’s equity in income are included in the Company’s income tax provision.

 

The nuclear plant that supplies power to Anglesey is currently slated for decommissioning in late 2010. For Anglesey to be able to operate past September 2009, when its current power contract expires, Anglesey will have to secure a new or alternative power contract at prices that make its operation viable. No assurances can be provided

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

that Anglesey will be successful in this regard. In addition, given the potential for future shutdown and related costs, Anglesey temporarily suspended dividends during the last half of 2006 and the first half of 2007 while it studied future cash requirements. Based on a review of cash available for future cash requirements, Anglesey removed the temporary suspension of dividends and declared a dividend in August 2007. The dividend is expected to be paid in the latter half of August 2007, of which approximately 2.3 million Pounds Sterling (or approximately $4.5) will be paid to the Company in respect of its ownership interests. Dividends over the past five years have fluctuated substantially depending on various operational and market factors. During the last five years, cash dividends received were as follows: 2006 — $11.8, 2005 — $9.0, 2004 — $4.5, 2003 — $4.3 and 2002 — $6.0.

 

At June 30, 2007 and December 31, 2006, the receivables from Anglesey were none and $1.3, respectively.

 

As a result of fresh start accounting, the Company decreased its investment in Anglesey at the Effective Date by $11.6 (see Note 2 of Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006). The $11.6 difference between the Company’s share of Anglesey’s equity and the investment amount reflected in the Company’s balance sheet is being amortized (included in Cost of products sold) over the period from July 2006 to September 2009, the end of the current power contract. The non-cash amortization was approximately $.9 and $1.8 for the quarter and six month periods ended June 30, 2007, respectively.

 

In the six months ended June 30, 2007, the Company recorded a $.2 charge for share-based equity compensation for employees of Anglesey who participate in the employee share savings plan of its parent (“Rio Tinto”). The $.2 has been recognized as a reduction in the equity in earnings of Anglesey for the six months ended June 30, 2007. In accordance with Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, this transaction has been accounted for as a capital transaction of Anglesey. As a result, the Company increased its Additional capital for the six months ended June 30, 2007 by $.2 rather than adjust its Investment in and advances to unconsolidated affiliate.

 

 

The Company has conditional asset retirement obligations (“CAROs”) at several of its fabricated products facilities. The vast majority of such CAROs consist of incremental costs that would be associated with the removal and disposal of asbestos (all of which is believed to be fully contained and encapsulated within walls, floors, ceilings or piping) at certain of the older plants if such plants were to undergo major renovation or be demolished. No plans currently exist for any such renovation or demolition of such facilities and the Company’s current assessment is that the most probable scenarios are that no such CARO would be triggered for 20 or more years, if at all. Nonetheless, the retroactive application of FASB Interpretation No. 47 (“FIN 47”), Accounting for Conditional Assets Retirement Obligations, an interpretation of FASB Statement No. 143 (“SFAS No. 143”) resulted in the Company recognizing, a Long term liability of approximately $2.5 at December 31, 2005.

 

The Company’s estimates and judgments that affect the probability weighted estimated future contingent cost amounts did not change during the six months ended June 30, 2007. The Company’s results for each of the six month periods ended June 30, 2007 and 2006 included an incremental accretion of the estimated liability of $.1 (recorded in Cost of products sold). The estimated fair value of the CARO at June 30, 2007 was $3.0.

 

Anglesey (see Note 3) also recorded a CARO liability of approximately $15.0 in its financial statements as of December 31, 2005. The treatment applied by Anglesey was not consistent with the principles of SFAS No. 143 or FIN 47. Accordingly, the Company adjusted Anglesey’s recording of the CARO to comply with US GAAP treatment. The Company adjusted its equity in earnings for Anglesey for the quarters ended June 30, 2007 and 2006 by $.2 and $.1, respectively, and for the six month periods ended June 30, 2007 and 2006 by $.3 and $.3, respectively, to reflect the impact of applying US GAAP with respect to the Anglesey CARO liability. During the first quarter of 2007, based on a new surveyor’s report received in late March 2007 and new environment-related regulations enacted in Wales, Anglesey increased its CARO liability by approximately $9.0. The Company adjusted

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Anglesey’s recording of the incremental CARO to comply with US GAAP resulting in an additional Anglesey CARO liability of $2.8 being recognized by the Company. The net impact to the income statement for the six months ended June 30, 2007 was $.3 representing additional accretion and asset depreciation related to the incremental CARO.

 

For purposes of the Company’s fair value estimates, a credit adjusted risk free rate of 7.5% was used.

 

5.  Property, Plant and Equipment

 

The major classes of property, plant, and equipment are as follows:

 

 

Approximately $69.4 of the Construction in progress at June 30, 2007, relates to the Company’s Spokane, Washington facility (see Note 9).

 

 

Long-term debt consisted of the following:

 

 

On the Effective Date, the Company and certain subsidiaries of the Company entered into a new Senior Secured Revolving Credit Agreement with a group of lenders providing for a $200.0 revolving credit facility (the “Revolving Credit Facility”), of which up to a maximum of $60.0 may be utilized for letters of credit. Under the Revolving Credit Facility, the Company is able to borrow (or obtain letters of credit) from time to time in an aggregate amount equal to the lesser of $200.0 and a borrowing base comprised of eligible accounts receivable, eligible inventory and certain eligible machinery, equipment and real estate, reduced by certain reserves, all as specified in the Revolving Credit Facility. The Revolving Credit Facility has a five-year term and matures in July 2011, at which time all principal amounts outstanding thereunder will be due and payable. Borrowings under the Revolving Credit Facility bear interest at a rate equal to either a base prime rate or LIBOR, at the Company’s option, plus a specified variable percentage determined by reference to the then remaining borrowing availability under the Revolving Credit Facility. The Revolving Credit Facility may, subject to certain conditions and the agreement of lenders thereunder, be increased up to $275.0 at the request of the Company.

 

Concurrent with the execution of the Revolving Credit Facility, the Company also entered into a Term Loan and Guaranty Agreement with a group of lenders (the “Term Loan Facility”). The Term Loan Facility provides for a $50.0 term loan and is guaranteed by the Company and certain of its domestic operating subsidiaries. The Term Loan Facility was fully drawn on August 4, 2006. The Term Loan Facility has a five-year term and matures in July

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2011, at which time all principal amounts outstanding thereunder will be due and payable. Borrowings under the Term Loan Facility bear interest at a rate equal to either a premium over a base prime rate or LIBOR, at the Company’s option. At June 30, 2007, the average interest rate applicable to borrowings under the Term Loan Facility was 9.6%.

 

Amounts owed under each of the Revolving Credit Facility and the Term Loan Facility may be accelerated upon the occurrence of various events of default set forth in each such agreement, including, without limitation, the failure to make principal or interest payments when due and breaches of covenants, representations and warranties.

 

The Revolving Credit Facility is secured by a first priority lien on substantially all of the assets of the Company and certain of its US operating subsidiaries that are also borrowers thereunder. The Term Loan Facility is secured by a second lien on substantially all of the assets of the Company and the Company’s US operating subsidiaries that are the borrowers or guarantors thereof.

 

Both credit facilities place restrictions on the ability of the Company and certain of its subsidiaries to, among other things, incur debt, create liens, make investments, pay dividends, sell assets, undertake transactions with affiliates and enter into unrelated lines of business.

 

At June 30, 2007, there were no borrowings outstanding under the Revolving Credit Facility, there were approximately $12.9 of outstanding letters of credit and there was $50.0 outstanding under the Term Loan Facility.

 

 

Tax Provision.  The (provision) benefit for income taxes for the quarter and six month periods ended June 30, 2007 and 2006 consisted of:

 

 

The income tax provision for the six month period ended June 30, 2007 was $44.3, with an effective tax rate of 46.1%. The effective tax rate of 46.1% was a result of several factors including:

 

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Although the Company had between approximately $975 and $1,050 of tax attributes available at December 31, 2006 to offset the impact of future income taxes, the Company does not meet the “more likely than not” criteria for recognition of such attributes primarily because the Company does not have sufficient history of paying taxes. As such, the Company recorded a full valuation allowance against the amount of tax attributes available and no deferred tax asset was recognized. The benefit associated with any reduction of the valuation allowance is first utilized to reduce intangible assets with any excess being recorded as an adjustment to Stockholders’ equity rather than as a reduction of income tax expense. Therefore, despite the existence of such tax attributes, the Company expects to record a full statutory tax provision in future periods and, accordingly, the benefit of any tax attributes realized will only affect future balance sheets and statements of cash flows. If the Company ultimately determines that it meets the “more likely than not” recognition criteria, the amount of net operating loss carryforwards (“NOLs”) and other deferred tax assets would be recorded on the balance sheet and would be recorded as an adjustment to Stockholders’ equity.

 

Foreign taxes primarily represent Canadian income taxes and United Kingdom income taxes in respect of the Company’s ownership in Anglesey. The provision for income tax is based on an assumed effective rate for each applicable period.

 

Results of operations for discontinued operations are net of an income tax benefit of $.2 for the quarter ended June 30, 2006.

 

Other.  The Company and its subsidiaries file income tax returns in the US federal jurisdiction and various states and foreign jurisdictions. The Company’s federal income tax return for the 2004 tax year is currently under examination by the Internal Revenue Service. The Company does not expect that the results of this examination will have a material effect on its financial condition or results of operations. The Canada Revenue Agency audited and issued an assessment notice for 1999. A Notice of Objection has been filed. The 2000 and 2001 tax years are currently under audit by the Canada Revenue Agency. The Company does not expect that the results of these examinations will have a material effect on its financial condition or results of operations. Certain past years are still subject to examination by taxing authorities and the use of NOLs in future periods could trigger a review of attributes and other tax matters in years that are not otherwise subject to examination.

 

No US federal or state liability has been recorded for the undistributed earnings of the Company’s Canadian subsidiaries at June 30, 2007. These undistributed earnings are considered to be indefinitely reinvested. Accordingly, no provision for US federal and state income taxes or foreign withholding taxes has been provided on such undistributed earnings. Determination of the potential amount of unrecognized deferred US income tax liability and foreign withholding taxes is not practicable because of the complexities associated with its hypothetical calculation.

 

The Company has unrecognized tax benefits of $16.0 and $14.6 at June 30, 2007 and December 31, 2006, respectively. The change was primarily due to currency fluctuations. The Company recognizes interest and penalties related to these unrecognized tax benefits in the income tax provision. During the quarter and six month periods ended June 30, 2007, the Company recognized approximately $2.7 and $3.2, respectively, in currency fluctuations, interest and penalties. The foreign currency impact on unrecognized tax benefits, interest and penalties resulted in a $1.9 currency translation adjustment that was recorded in Accumulated other comprehensive income. Additionally, the Company had approximately $7.9 and $4.7 accrued at June 30, 2007 and December 31, 2006, respectively, for interest and penalties. The Company anticipates it will not have a change in unrecognized tax benefits for the next twelve months that would have a material impact on the Company’s earnings.

 

In connection with the sale of the Company’s interests in and related to Queensland Alumina Limited (“QAL”), the Company made payments totaling approximately $8.5 for alternative minimum tax (“AMT”) in the United States (approximately $8.0 of Federal AMT and approximately $.5 of state AMT). Such payments were made in the fourth quarter of 2005. Upon completion of the Company’s 2005 federal income tax return, the Company determined that approximately $1.0 of AMT was overpaid and was refundable. The Company applied for the refund in the 2005 federal income tax return filed in September 2006 and received the refund in October 2006.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The Company believed that the remainder of the United States AMT amounts paid in respect of the sale of interests should, in accordance with the Intercompany Settlement Agreement entered into in connection with the Company’s chapter 11 bankruptcy, be reimbursed to the Company from the funds held by the liquidating trustee for the plan of liquidation of two former subsidiaries of the Company (Kaiser Alumina Australia Corporation and Kaiser Finance Corporation). A claim for reimbursement of $7.2 was made in January 2007. In May 2007, the liquidating trust approved the claim and the Company received the $7.2 reimbursement, which amount was recorded as a benefit in Other operating benefits (charges), net in the second quarter of 2007 (see Note 11).

 

 

 

General.  Upon the Company’s emergence from chapter 11 bankruptcy, the 2006 Equity and Performance Incentive Plan (the “Equity Incentive Plan”) became effective. Officers and other key employees of the Company or one or more of its subsidiaries, as well as directors of the Company, are eligible to participate in the Equity Incentive Plan. The Equity Incentive Plan permits the granting of awards in the form of options to purchase common shares, stock appreciation rights, shares of non-vested and vested stock, restricted stock units, performance shares, performance units and other awards. The Equity Incentive Plan will expire on July 6, 2016. No grants will be made after that date, but all grants made on or prior to such date will continue in effect thereafter subject to the terms thereof and of the Equity Incentive Plan. The Company’s Board of Directors may, in its discretion, terminate the Equity Incentive Plan at any time. The termination of the Equity Incentive Plan will not affect the rights of participants or their successors under any awards outstanding and not exercised in full on the date of termination.

 

Subject to certain adjustments that may be required from time to time to prevent dilution or enlargement of the rights of participants under the Equity Incentive Plan, 2,222,222 common shares were reserved for issuance under the Equity Incentive Plan.

 

Compensation charges related to the Equity Incentive Plan for the quarter ended June 30, 2007, were $2.5, of which $2.4 related to vested and non-vested common shares and restricted stock units and $.1 related to stock options. During the six month period ended June 30, 2007, compensation charges related to the Equity Incentive Plan were $4.5, of which $4.4 related to vested and non-vested common shares and restricted stock units and $.1 related to stock options. The total charges for both periods were included in Selling, administrative, research and development and general expense.

 

At June 30, 2007, 1,601,683 common shares were available for additional awards under the Equity Incentive Plan.

 

Non-vested Common Shares and Restricted Stock Units.  In April 2007, the Company issued 54,381 non-vested common shares and granted 1,260 restricted stock units to executive officers and other key employees. The shares and the restricted stock units are subject to a three year vesting requirement that lapses on April 3, 2010. The fair value of the shares issued, after assuming a 5% forfeiture rate, of $4.1 is being amortized to expense over a three year period on a ratable basis. The restricted stock units have the same rights as non-vested common shares and the employee will receive one common share for each restricted stock unit upon the vesting of the restricted stock unit. The restricted stock units vest one third on the first anniversary of the grant date and one third on each of the second and third anniversaries of the date of issuance. The fair value of the restricted stock units issued, after assuming a 5% forfeiture rate, of $.1 is being amortized to expense over the vesting period on a ratable basis.

 

In June 2007, the Company granted 7,281 non-vested common shares to its non-employee directors. The shares are subject to a one year vesting requirement that lapses on June 6, 2008. The fair value of the shares granted of $.5 is being amortized to expense over a one year period on a ratable basis. An additional 3,877 common shares were issued to non-employee directors electing to receive common shares in lieu of all or a portion of their annual retainer fee. The fair value of the shares ($.3), based on the fair value of the shares at date of issuance, was recognized in earnings in the quarter ended June 30, 2007 as a period expense.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The fair value of the non-vested common shares and restricted stock units is determined based on the closing trading price of the common shares on the grant date. Summaries of the non-vested common shares and restricted stock units for the quarter and six month periods ended June 30, 2007 was as follows:

 

 

Under the Equity Incentive Plan, the Company allows participants to elect to have the Company withhold common shares to satisfy minimum statutory tax withholding obligations arising on the vesting of non-vested shares, restricted stock units and stock options. When the Company withholds the shares, it is required to remit to the appropriate taxing authorities the fair value of the shares withheld. During the quarter ended June 30, 2007, 3,862 shares (which are included in vested shares in the above tables) were withheld upon the vesting of common shares. The fair value of the common shares withheld ($.3) has been charged to Treasury stock in the quarter ended June 30, 2007 as such shares were purchased by the Company and not cancelled at June 30, 2007.

 

As of June 30, 2007, there was $18.0 of unrecognized compensation cost related to non-vested common shares and restricted stock units. That cost is expected to be recognized over a weighted-average period of 2.1 years.

 

Stock Options.  On April 3, 2007, the Company granted options to purchase 25,137 of its common shares to executive officers and other key employees with a contractual life of ten years.

 

The fair value of each of the Company’s stock option awards is estimated on the date of grant using a Black-Scholes option-pricing model that uses the assumptions noted in the table below. The fair value of the Company’s stock option awards, which are subject to graded vesting, is expensed on a straight line basis over the vesting period of the stock options. Due to the Company’s short trading history for its common shares since emergence from bankruptcy on July 6, 2007, expected volatility could not be reliably calculated based on the historical volatility of the common shares. As such, the Company has determined volatility for use in the Black-Sholes option-pricing model using the volatility of the stock of a number of similar public companies over a period equal to the expected option life of six years. The risk-free rate for periods within the contractual life of the stock option award is based on the yield curve of a zero-coupon US Treasury bond on the date the stock option is awarded. The Company uses historical data to estimate employee terminations and the simplified method to estimate the expected option life within the valuation model.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The significant weighted average assumptions used in determining the grant date fair value of the option awards granted in the quarter ended June 30, 2007 were as follows:

 

 

Prior to April 3, 2007, the Company had no outstanding options to purchase common shares. A summary of the Company’s stock option activity for the quarter ended June 30, 2007 is as follows:

 

 

The weighted average fair value of the options granted during the quarter ended June 30, 2007 was $39.90. At June 30, 2007, there was $.9 of unrecognized compensation expense related to stock options. The expense is expected to be recognized over a weighted-average period of 2.75 years.

 

 

Under the Plan, the Union VEBA had rights to receive 11,439,900 common shares upon the Company’s emergence from chapter 11 bankruptcy. However, prior to the Company’s emergence, the Union VEBA sold its rights to approximately 2,630,000 shares and received net proceeds of approximately $81.

 

During the first quarter of 2007, 6,281,180 common shares were sold to the public by existing stockholders pursuant to a registered offering. The Company did not sell any shares in, and did not receive any proceeds from, the offering. The Union VEBA was one of the selling stockholders and, after the offering, now owns approximately 26.7% of the outstanding common shares. Of the 3,337,235 shares sold by the Union VEBA in the offering, 819,280 common shares were unable to be sold without the Company’s approval under an agreement restricting the Union VEBA’s ability to sell or otherwise transfer its common shares. However, during the first quarter of 2007, the Union VEBA received approval from the Company to include such shares in the offering.

 

The 819,280 previously restricted shares were treated as a reduction of Stockholders’ equity (at the $24.02 per share reorganization value) in the December 31, 2006 balance sheet. As a result of the relief of the restrictions, during the first quarter of 2007: (i) the value of the 819,280 shares previously restricted was added to VEBA assets at the approximate $58.19 per share price realized by the Union VEBA in the offering (totaling $47.7); (ii) approximately $19.7 of the December 31, 2006 reduction in Stockholders’ equity associated with the restricted shares (common shares owned by Union VEBA subject to restrictions) was reversed and (iii) the difference between the two amounts (approximately $23, net of income taxes of $5) was credited to Additional capital.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The Company’s VEBA obligation is an annual variable cash contribution. The annual contribution to the Union VEBA and another VEBA for the benefit of salaried retirees (collectively, the VEBAs) will be 10% of the first $20.0 of annual cash flow (as defined; in general terms, the principal elements of cash flow are earnings before interest expense, provision for income taxes and depreciation and amortization less cash payments for, among other things, interest, income taxes and capital expenditures), plus 20% of annual cash flow, as defined, in excess of $20.0. Such annual payments may not exceed $20.0 and are limited (with no carryover to future years) to the extent that the payments would cause the Company’s liquidity to be less than $50.0. Such amounts are determined on an annual basis and payable no later than 15 days following the date of filing of the Company’s Annual Report on Form 10-K. During the reorganization process, $49.7 of contributions were made to the VEBAs, of which $12.7 was available at December 31, 2006 to reduce post emergence payments that become due pursuant to the annual variable cash contribution obligation. The $12.7 carryforward amount was reduced by $1.9, the amount of contribution obligation for the period from July 1, 2006 to December 31, 2006, leaving $10.8 available at June 30, 2007 to reduce future annual variable cash payments.

 

Future payments of annual variable contributions will first be applied to reduce any individual VEBA obligations recorded in the Company’s balance sheet at that time. Any remaining amount of annual variable contributions in excess of recorded obligations will be recorded as a VEBA asset in the balance sheet. No accounting recognition has been accorded at this time to the $10.8 of excess pre-emergence VEBA contributions available at June 30, 2007 to reduce future annual variable cash payments.

 

 

The following tables present the components of net periodic pension benefits cost for the quarter and six month periods ended June 30, 2007 and 2006:

 

 

The following tables present the allocation of these charges:

 

 

For all periods presented, substantially all of the Fabricated products segment’s related charges are in Cost of products sold with the balance being in Selling, administrative, research and development and general expense.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

See Note 7 of Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 for key assumptions with respect to the Company’s pension plans and key assumptions made in computing the net obligations of each VEBA.

 

 

Commitments.  The Company and its subsidiaries have a variety of financial commitments, including purchase agreements, forward foreign exchange and forward sales contracts (see Note 10), letters of credit and guarantees. They also have agreements to supply alumina to and to purchase aluminum from Anglesey (see Note 3). During the third quarter of 2005 and in August 2006, orders were placed for certain equipment and/or services intended to augment the heat treat and aerospace capabilities at the Company’s Trentwood facility in Spokane, Washington. The Company expects the total costs for such equipment and services to be approximately $105. Approximately $88 of such costs were incurred from inception of the Trentwood project through the second quarter of 2007. The balance is expected to be incurred primarily in the last two quarters of 2007. In June 2007, orders were placed for additional equipment to augment the facility’s heat treat and aerospace capabilities. The Company expects the additional cost obligations to be in the range of $34 and will be incurred primarily during the remainder of 2007 and in 2008.

 

Minimum rental commitments under operating leases at December 31, 2006, are as follows: years ending December 31, 2007 — $3.0; 2008 — $2.4; 2009 — $2.1; 2010 — $1.0; 2011 — $.7; thereafter — $.1.

 

Environmental Contingencies.  The Company and its subsidiaries are subject to a number of environmental laws and regulations, to fines or penalties assessed for alleged breaches of the environmental laws, and to claims and litigation based upon such laws and regulations.

 

A substantial portion of the Company’s pre-emergence obligations, primarily in respect of non-owned locations, was resolved by the chapter 11 proceedings. Based on the Company’s evaluation of the remaining environmental matters, the Company has environmental accruals totaling $8.6 at June 30, 2007. Such amounts are primarily related to potential solid waste disposal and soil and groundwater remediation matters. These environmental accruals represent the Company’s estimate of costs reasonably expected to be incurred based on presently enacted laws and regulations, currently available facts, existing technology, and the Company’s assessment of the likely remediation action to be taken. The Company expects that these remediation actions will be taken over the next several years and estimates that expenditures to be charged to these environmental accruals will be approximately $1.8 in the last two quarters of 2007, $2.0 in 2008, $1.1 in 2009, $2.6 in 2010 and $1.1 in 2011 and thereafter.

 

As additional facts are developed and definitive remediation plans and necessary regulatory approvals for implementation of remediation are established or alternative technologies are developed, changes in these and other factors may result in actual costs exceeding the current environmental accruals. The Company believes that it is reasonably possible that costs associated with these environmental matters may exceed current accruals by amounts that could be, in the aggregate, up to an estimated $15.1. As the resolution of these matters is subject to further regulatory review and approval, no specific assurance can be given as to when the factors upon which a substantial portion of this estimate is based can be expected to be resolved. However, the Company is currently working to resolve certain of these matters.

 

Other Contingencies.  The Company and its subsidiaries are involved in various other claims, lawsuits, and proceedings relating to a wide variety of matters related to past or present operations. While uncertainties are inherent in the final outcome of such matters and it is presently impossible to determine the actual costs that ultimately may be incurred, management currently believes that the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company’s consolidated financial position, results of operations, or liquidity.

 

Commitment and contingencies of the Predecessor are discussed in Note 18.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

General.  In conducting its business, the Company uses various instruments, including forward contracts and options, to manage the risks arising from fluctuations in aluminum prices, energy prices and exchange rates. The Company has historically entered into derivative transactions from time to time to limit its exposure resulting from (1) its anticipated sales of primary aluminum and fabricated aluminum products, net of expected purchase costs for items that fluctuate with aluminum prices, (2) the energy price risk from fluctuating prices for natural gas used in its production process, and (3) foreign currency requirements with respect to its cash commitments with foreign subsidiaries and affiliate. As the Company’s hedging activities are generally designed to lock-in a specified price or range of prices, realized gains or losses on the derivative contracts utilized in the hedging activities (excluding the impact of mark-to-market fluctuations on those contracts discussed below) generally offset at least a portion of any losses or gains, respectively, on the transactions being hedged.

 

The Company’s share of primary aluminum production from Anglesey is approximately 150,000,000 pounds annually. Because the Company purchases alumina for Anglesey at prices linked to primary aluminum prices, only a portion of the Company’s net revenues associated with Anglesey are exposed to price risk. The Company estimates the net portion of its share of Anglesey production exposed to primary aluminum price risk to be approximately 100,000,000 pounds annually (before considering income tax effects).

 

The Company’s pricing of fabricated aluminum products is generally intended to lock-in a conversion margin (representing the value added from the fabrication process(es)) and to pass metal price risk on to its customers. However, in certain instances the Company does enter into firm price arrangements. In such instances, the Company does have price risk on its anticipated primary aluminum purchase in respect of the customer’s order. Total fabricated products shipments during the six months ended June 30, 2007 and 2006 that contained fixed price terms were (in millions of pounds) 98.7 and 103.9, respectively.

 

During the last three years, the volume of fabricated products shipments with underlying primary aluminum price risk were at least as much as the Company’s net exposure to primary aluminum price risk at Anglesey. As such, the Company considers its access to Anglesey production overall to be a “natural” hedge against Fabricated products firm metal-price risks. However, since the volume of fabricated products shipped under firm prices may not match up on a month-to-month basis with expected Anglesey-related primary aluminum shipments, the Company may use third party hedging instruments to eliminate any net remaining primary aluminum price exposure existing at any time.

 

At June 30, 2007, the fabricated products business held contracts for the delivery of fabricated aluminum products that have the effect of creating price risk on anticipated purchases of primary aluminum during the last two quarters of 2007 and for the period 2008 through 2011 totaling approximately (in millions of pounds): 2007 — 109, 2008 — 101, 2009 — 86, 2010 — 86 and 2011 — 77.

 

The following table summarizes the Company’s material derivative positions at June 30, 2007:

 

 

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

 

The Company currently reflects changes in the market value of its derivative instruments in Net income (rather than deferring such gains/losses to the date of the underlying transactions to which the related hedges occur). Included in Net income for the quarter and six month periods ended June 30, 2007 were realized gains of $1.2 and $1.7, respectively, and unrealized gains of $1.9 and $.5, respectively. Included in Net income for the quarter and six month periods ended June 30, 2006 were realized gains of $1.8 and $3.0, respectively, and unrealized gains of $1.9 and $6.1, respectively.

 

Income Statement Treatment.  In connection with the Company’s preparation of its December 31, 2005 financial statements, the Company concluded that its derivative financial instruments did not meet certain specific documentation criteria in Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”). Accordingly, the Company restated its prior results for the quarters ended March 31, June 30 and September 30, 2005 and marked all of its derivatives to market in 2005. The change in accounting for derivative contracts was related to the form of the Company’s documentation. The Company determined that its hedging documentation did not meet the strict documentation standards established by SFAS No. 133. More specifically, the Company’s documentation did not comply with SFAS No. 133 in respect of the Company’s methods for testing and supporting that changes in the market value of the hedging transactions would correlate with fluctuations in the value of the forecasted transactions to which they relate. The Company had documented that the derivatives it was using would qualify for the “short cut” method whereby regular assessments of correlation would not be required. However, it ultimately concluded that, while the terms of the derivatives were essentially the same as the forecasted transaction, they were not identical and, therefore, the Company should have done certain mathematical computations to prove the ongoing correlation of changes in value of the hedge and the forecasted transaction. As a result, under SFAS No. 133, the Company “de-designated” its open derivative transactions and reflected fluctuations in the market value of such derivative transactions in its results each period rather than deferring the effects until the forecasted transactions (to which the hedges relate) occur.

 

The rules provide that, once de-designation has occurred, the Company can modify its documentation and re-designate the derivative transactions as “hedges” and, if appropriately documented, re-qualify the transactions for prospectively deferring changes in market fluctuations after such corrections are made. However, due to the significant administrative and other costs involved in hedge accounting, the Company has decided, at this time, that

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

it will continue to account for derivative instruments in its financial statements using the mark-to-market accounting treatment.

 

11.  Other Operating Benefits (Charges), Net

 

Other operating benefits (charges), net, for the quarter and six month periods ended June 30, 2007 and 2006, was as follows:

 

 

The PBGC proceeds consist of a payment related to a settlement agreement entered into with the PBGC in connection with the Company’s chapter 11 reorganization (see Note 8 of Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006 for additional information regarding the PBGC agreement).

 

Post-emergence chapter 11-related items include primarily professional fees and expenses incurred after emergence which related directly to the Company’s reorganization.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Basic and diluted earnings per share for the quarter and six month periods ended June 30, 2007 were calculated as follows:

 

 

Options to purchase 25,137 common shares at an average exercise price of $80.01 were outstanding at June 30, 2007. At June 30, 2007, 574,800 non-vested common shares and restricted stock units were outstanding. Diluted income per share reflects the potential dilutive effect of options to purchase common shares and non-vested common shares and restricted stock units using the treasury stock method. Options to purchase 25,137 common shares for the quarter and six month periods ended June 30, 2007 were excluded from the average diluted shares computation because their inclusion would have been anti-dilutive. Additionally, 351,298 and 372,782 non-vested common shares and restricted stock units for the quarter and six month periods ended June 30, 2007, respectively, were excluded from the average share computation because their inclusion would be anti-dilutive.

 

 

On June 27, 2007, the Company’s Board of Directors declared an initial quarterly cash dividend of $.18 per share. The dividend (approximately $3.7) will be payable on August 17, 2007 to stockholders of record at the close of business on July 27, 2007.

 

 

The Company’s primary line of business is the production of fabricated aluminum products. In addition, the Company owns a 49% interest in Anglesey (see Note 3).

 

The Company’s continuing operations are organized and managed by product type and include two operating segments of the aluminum industry and the corporate segment. The aluminum industry segments include: Fabricated products and Primary aluminum. The Fabricated products segment sells value-added products such as heat treat aluminum sheet and plate, extrusions and forgings which are used in a wide range of industrial applications, including for automotive, aerospace and general engineering end-use applications. The Primary aluminum segment produces, through its investment in Anglesey, commodity grade products as well as value-added products such as ingot and billet, for which the Company receives a premium over normal commodity market prices and conducts hedging activities in respect of the Company’s exposure to primary aluminum price risk. The accounting policies of the segments are the same as those described in Note 1 of Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES

 

NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Business unit results are evaluated internally by management before any allocation of corporate overhead and without any charge for income taxes, interest expense or Other operating benefits (charges), net.

 

Financial information by operating segment, excluding discontinued operations, for the quarter and six month periods ended June 30, 2007 and 2006 is as follows: