Item 1A.Risk Factors
In addition to the factors discussed elsewhere in this Report, the risks described below are those that we believe are material to our company. The occurrence of any of the events discussed below could significantly and adversely affect our business, prospects, financial position, results of operations and cash flows as well as the trading price of our securities.
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WE ARE SUBJECT TO CHANGES IN DEMAND FOR OUR PRODUCTS.
The COVID-19 pandemic has impacted and could in the future materially and adversely affect our business.
The novel strain of the coronavirus identified in China in late 2019, and now affecting the global community, has impacted and is expected to continue to impact our operations. The full nature and extent of the impact is highly uncertain. Among other things, uncertainties relating to the COVID-19 pandemic include the duration of the pandemic and the actions, or perception of actions that may be taken, to contain or treat its impact by governments and others, including declarations of states of emergency, business closures, manufacturing restrictions and prolonged periods of travel, commercial and/or other similar restrictions and limitations.
Furthermore, as a result of the COVID-19 pandemic and the measures implemented to contain its spread, our customers have been, and could continue to be, negatively impacted as a result of disruption in demand, which has and could in the future negatively impact our sales and have a material adverse effect on our business, results of operations and financial condition. Similarly, as a result of the COVID‐19 pandemic and measures implemented to contain its spread, our suppliers may not have the materials, capacity or capability to enable the manufacture of our products according to our schedule and specifications. Because of impacts to suppliers’ operations, we may need to seek alternate suppliers, which may be more expensive, may not be available or may result in delays in shipments to us and subsequently to our customers, each of which would affect our results of operations.
The COVID-19 pandemic has also disrupted our internal operations by heightening the risk that a significant portion of our workforce will suffer illness or otherwise not be permitted or be unable to work and exposing us to cyber and other risks associated with a large number of our employees working remotely. Certain of our facilities have experienced temporary work disruptions as a result of the COVID-19 pandemic, and we cannot predict whether our facilities will experience more significant or frequent disruptions in the future. We may need to further reduce our workforce as a result of declines in our business caused by the COVID-19 pandemic, and any such reduction would cause us to incur costs. Moreover, there can be no assurance that we would be able to rehire our workforce in the event our business experiences a subsequent recovery.
The impact of the COVID-19 pandemic continues to evolve, and its duration and ultimate disruption to our customers and to our supply chain, and related financial impact to us, cannot be estimated at this time. Should such disruption continue for an extended period of time, the impact could have a more severe adverse effect on our business, results of operations and financial condition. Additionally, weaker economic conditions generally could result in impairment in value of our tangible or intangible assets, or our ability to raise additional capital, if needed.
On March 27, 2020, President Trump signed into law the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”) and on December 27, 2020 he signed a second COVID-19 pandemic relief bill (“Second CARES Act”) into law. The CARES Act and the Second CARES Act, among other things, include provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. We continue to monitor the impact of these relief packages and, where there are opportunities to minimize the impact of the COVID-19 pandemic on our business and employees, we have taken action to apply or invoke these regulations.
The COVID-19 pandemic caused downturns in the commercial aerospace industry, which has adversely affected our business, and could cause additional downturns in the automotive and ground transportation industries, which would further adversely affect our business.
We derive a significant portion of our revenue from products sold to the aerospace and automotive and ground transportation industries. Concerns regarding and measures implemented in response to pandemics of infectious disease have and could further cause changes in global travel patterns, negatively influencing demand for new commercial aircraft and other vehicles, resulting in cancellations or deferrals of orders and/or decreases in new deliveries. Moreover, because new automotive vehicle demand is tied closely to overall economic strength, economic uncertainty and/or increased unemployment that results from the COVID-19 pandemic or measures undertaken in response could lead to weak demand for, or lower production of, new cars, light trucks, SUVs and heavy duty vehicles and trailers, which, in turn, could adversely affect demand for our products. For example, several of our automotive customers have temporarily suspended operations in the past and could do so again in response to the COVID-19 pandemic and/or in accordance with governmental requirements. Despite existing backlogs, adverse developments resulting from the pandemic may lead to reduced demand for our products, which could adversely affect our financial position, results of operations and cash flows.
We operate in a highly competitive industry.
We compete with others in the fabricated products segment of the aluminum industry based upon quality, availability, price, customer service and delivery performance. Some of our competitors are substantially larger than we are, have greater financial resources than we do, operate more facilities than we do, are geographically closer to our customers than we are, employ more efficient or advanced technologies than we do or have other strategic advantages. Additionally, new parties may become capable of
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manufacturing similar products and qualifying them with our customers, which could lead to further competitive pressure. Competitors’facilities located in certain other countries may have a manufacturing cost advantage compared to our facilities, which are located in the United States and Canada. Such foreign competitors may sell products similar to our products at lower prices as a result of having lower manufacturing costs or due to currency exchange rates that periodically favor foreign competition. Some foreign competitors may also dump their products in the United States and Canada in violation of existing trade laws. We may not be able to compete by differentiating ourselves based on the quality, availability and delivery of our products or our customer service. Additionally, we may not be able to reduce our cost structure and our selling prices to be competitive with others, and tariffs introduced to protect manufacturers in the United States and Canada from foreign price competition may not be fully effective. Increased competition could cause a reduction in demand for our products and our shipment volumes, our product pricing or both shipment volumes and product pricing, which could have an adverse effect on our financial position, results of operations and cash flows.
Reductions in demand for our products may be more severe than, and may occur prior to, reductions in demand for our customers’ products.
Most of our products undergo further fabrication by other parties before being deployed in their end uses. In particular, our Aero/HS products undergo numerous stages of further fabrication or assembly by a number of parties in the supply chain, often over the course of many months. The lead time from when we sell our Aero/HS product to when the finished product is installed on an aircraft often exceeds a year. Due to this long lead time, demand for our products may increase prior to demand for our customers’ products or may decrease when our customers experience or anticipate softening demand for their products. Our customers typically respond to reduced demand for their products by depleting their inventory until their inventory falls to a new desired level. This causes a greater reduction in demand for our products than our customers experience for their products. Further, the reduction in demand for our products can be exacerbated if our customers’ inventory levels had been higher than normal, if production is delayed for specific commercial airframe models, if our customers previously had purchased products from us at committed sales contract volumes that exceeded their actual need or for other reasons. The amplified reduction in demand for our products while our customers consume their inventory to meet their business needs (destocking) may adversely affect our financial position, results of operations and cash flows.
Our customers may reduce their demand for aluminum products in favor of alternative materials.
Our products compete with other materials for use in various customer applications. For instance, the commercial aerospace industry has used and continues to evaluate the further use of titanium, composites and carbon fiber materials as alternatives to aluminum to reduce aircraft weight and increase fuel efficiency. Additionally, while the automotive industry has continued to increase use of aluminum in vehicle production to reduce vehicle weight and increase fuel efficiency, manufacturers may revert to steel or other materials for certain applications and rely on improved drivetrain technology, more efficient engines, aerodynamics or other measures to achieve fuel efficiency goals. The willingness of customers to use materials other than aluminum could adversely affect the demand for our products, particularly our Aero/HS products and Automotive Extrusions, and thus could adversely affect our financial position, results of operations and cash flows.
Our customers may reduce their demand for our products if the government relaxes fuel efficiency standards or if oil prices remain low for a protracted period of time.
Efficient use of fossil fuels partially drives demand for aluminum in transportation applications. The USEPA, other federal regulatory agencies and regulatory agencies of certain states have generally sought to limit growth of fossil fuel usage by establishing stricter fuel efficiency standards. In addition, newly elected and/or changing administrations could accelerate efforts to not only limit, but reduce, fossil fuel usage and carbon emissions beyond what may be technologically possible for certain products and manufacturing processes and revisit or reverse the environmental agendas of previous administrations with respect to previously established fuel efficiency standards. Additionally, in periods of lower oil prices, the economic benefits of replacing older aircraft and automobiles with more fuel-efficient models are less compelling. A relaxation of fuel efficiency standards by the regulatory agencies or an extended period of moderate oil prices could reduce demand for new more efficient aircraft and automobiles, which could adversely affect the demand for our products and have an adverse effect on our financial position, results of operations and cash flows.
The commercial aerospace industry is cyclical and downturns in the commercial aerospace industry could adversely affect our business.
We derive a significant portion of our revenue from products sold to the aerospace industry. Notwithstanding a secular growth trend spanning nearly two decades, the aerospace industry is highly cyclical. Numerous factors that influence demand for new commercial aircraft could result in cancellations or deferrals of aircraft orders and a global decrease in new commercial aircraft deliveries. These factors have recently included the impacts of the COVID-19 pandemic on global travel, but also include but are not limited to: (i) declines or reduced growth trends in global travel and airline passenger traffic; (ii) the rate of replacement of older
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aircraft with more fuel efficient aircraft; (iii) changing airline strategies affecting preferences for single-aisle aircraft models as opposed to twin-aisle or jumbo aircraft models; (iv) airline industry profitability; (v) the state of regional and global economies; (vi)concerns regarding terrorism or the threat of terrorism; (vii) concerns regarding new pandemics of infectious disease; and (viii)safety concerns with newly introduced and existing aircraft. Despite existing backlogs, adverse developments in any one or more of these influencing factors may lead to reduced demand for new aircraft that utilize our products, which could adversely affect our financial position, results of operations and cash flows.
Reductions in defense spending for aerospace and non-aerospace military applications could adversely affect demand for our products.
Our products are used in a wide variety of military applications, including military aircraft, armored vehicles and ordnance. Certain military programs are used by the U.S. armed forces, as well as by the defense forces of our allied foreign powers. Military programs that currently use or in the future could use our products may be subject to changes in military strategy and government priorities. Further, while many of the U.S. government programs span several years, they are often funded annually, and funding is generally subject to congressional appropriations. When U.S. and foreign allied governments are faced with competing national priorities, such as addressing financial or spending crises or public health emergencies, there can be significant pressure to reduce defense spending, which could reduce the demand for our products and adversely affect our financial position, results of operations and cash flows.
Downturns in the automotive and ground transportation industries could adversely affect our business.
The demand for our Automotive Extrusions and many of our general engineering and other industrial products is dependent on the production of cars, light trucks, SUVs and heavy duty vehicles and trailers in North America. The automotive industry is highly cyclical, as new vehicle demand is dependent on consumer spending and is tied closely to the overall strength of the North American economy. Even with the automotive industry’s growing use of aluminum to reduce vehicle weight, weak demand for, or lower production of, new cars, light trucks, SUVs and heavy duty vehicles and trailers could adversely affect the demand for our products and have an adverse effect on our financial position, results of operations and cash flows.
Changes in consumer demand for particular motor vehicles could adversely affect our business.
Sensitivity to fuel prices, an increased preference for environmentally friendly alternatives and other consumer preferences can influence consumer demand for motor vehicles that have a higher content of the aluminum Automotive Extrusions that we supply. The loss of business with respect to, or a lack of commercial success of, one or more particular vehicle models for which we are a significant supplier could have an adverse impact on our financial position, results of operations and cash flows.
WE ARE SUBJECT TO SALES-RELATED RISKS.
We depend on a core group of significant customers.
In 2020, Reliance and Boeing were our two largest customers, representing approximately 26% and 11%, respectively, of our net sales. Our five largest customers in total accounted for approximately 54% of our 2020 net sales. Most of these customers have one or more sizable sales agreements with us. If one or more of these customers experienced a prolonged period of adverse demand, depressed business activity or financial distress, if any of these customers breached or sought relief from its contractual obligations under its sales agreements with us or if any of these customer relationships otherwise ended or materially deteriorated and such lost business was not successfully replaced, our financial position, results of operations and cash flows could be adversely affected.
We experience fluctuation in certain costs that we cannot pass through to our customers and face pressure from our customers on pricing.
We are unable to pass fluctuations of certain costs through to our customers, including the cost of energy, certain raw materials and freight. Further, cost cutting initiatives that many of our customers have adopted generally result in downward pressure on pricing. If we are unable to generate sufficient productivity improvements and cost savings in the future to offset reductions in our selling prices and increases in our costs that we cannot pass through to our customers, our financial position, results of operations and cash flows could be adversely affected.
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WE OPERATE GLOBALLY AND ARE SUBJECT TO GEO-POLITICAL RISKS.
Our industry is very sensitive to foreign economic, regulatory and political factors that may adversely affect our business.
We import primary aluminum from, and manufacture fabricated products used in, foreign countries. Our financial position, results of operations and cash flows could be adversely affected by numerous factors in the politically and economically diverse jurisdictions: (i) from which our input materials are sourced; (ii) in which we operate; (iii) in which our customers operate; or (iv) in which our products are consumed or further fabricated. Such factors include but are not limited to:
• the adoption of tariffs, duties and other forms of taxation;
• trade disputes;
• the imposition of currency restrictions;
• civil unrest and labor problems;
• the nationalization or appropriation of rights or other assets; and
• acts or threats of war or terrorism.
WE ARE VULNERABLE TO PRODUCT AND MANUFACTURING-RELATED RISKS.
We may experience difficulties in the launch or production ramp-up of new products which could adversely affect our business.
As we ramp up manufacturing processes for newly introduced products, we may experience difficulties, including manufacturing disruptions, delays or other complications, which could adversely impact our ability to serve our customers, our reputation, our costs of production and, ultimately, our financial position, results of operations and cash flows.
Unplanned events may interrupt our production operations, which may adversely affect our business.
The production of fabricated aluminum products is subject to unplanned events such as explosions, fires, inclement weather, natural disasters, accidents, equipment failures, labor disruptions, transportation interruptions, public utilities interruptions and supply interruptions. Operational interruptions could significantly curtail the production capacity of a facility for a period of time. We have redundant capacity and capability to produce many of our extruded products within our manufacturing platform to mitigate our business risk from such interruptions, but interruptions at our Trentwood facility where our production of plate and sheet is concentrated, could significantly compromise our ability to meet our customers’ needs. Delayed delivery of our products to customers who require on-time delivery from us may cause customers to purchase alternative products at a higher cost, reschedule their own production or incur other incremental costs. Customers may be able to pursue financial claims against us for their incremental costs, and we may incur costs to correct such problems in addition to any liability resulting from such claims. Interruptions may also harm our reputation among actual and potential customers, potentially resulting in a loss of business. To the extent these losses are not covered by insurance, our financial position, results of operations and cash flows could be adversely affected by such events.
WE ARE SUBJECT TO RISKS ASSOCIATED WITH OUR STRATEGIC TRANSACTIONS AND INITIATIVES.
We may not be able to successfully implement our productivity enhancement and cost reduction initiatives that are necessary to offset competitive price pressure.
Over time, we have experienced pricing pressure on many of our products and anticipate continued pricing pressure in the future. Ongoing and heightened competitive price pressure makes it increasingly important for us to be a low cost producer. Although we have undertaken and expect to continue to undertake productivity enhancement and cost reduction initiatives, including significant investments in our facilities to improve our manufacturing efficiency, cost and product quality, we cannot make assurances that we will complete all of these initiatives, that we will fully realize the estimated cost savings from such activities, that short-to-medium term improvements from new efficiencies and lower cost structure achieved will become permanent or that we will be able to continue to reduce cost and increase productivity over the long term.
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Our investment and other expansion projects may not be completed, start up as scheduled or deliver the expected capacity and other benefits.
Our ability to complete our investment and expansion projects and the timing and costs of doing so are subject to various risks associated with all major construction projects, many of which are beyond our control, including technical or mechanical problems and economic conditions. Additionally, the start-up of operations after such projects have been completed can be complicated and costly. If we are unable to fully complete these projects, if the actual costs for these projects exceed our expectations, if the start-up phase after completion is more complicated than anticipated or if the capacity and other benefits of these projects are less than anticipated, our financial position, results of operations and cash flows could be adversely affected.
We may not realize the benefits of the Warrick Rolling Mill acquisition.
Our recently announced Warrick Rolling Mill acquisition is subject to a number of closing conditions and there can be no assurance that such conditions will be satisfied or that we will be able to complete the Warrick Rolling Mill acquisition within the planned timeframe or at all. Furthermore, completing the Warrick Rolling Mill acquisition could disrupt our business and/or dilute or adversely affect the price of our common stock. Additional risks associated with the Warrick Rolling Mill acquisition may include:
• diversion of management’s time and attention from our existing business;
• difficulties achieving anticipated operational improvements; and
If we fail to successfully integrate the Warrick Rolling Mill, we may not realize the benefits expected from the transaction and/or it may have adverse effects on our financial position, results of operations and cash flows.
WE ARE SUBJECT TO COMMODITY-RELATED PRICE FLUCTUATIONS.
Our business could be adversely affected by increases in the cost of aluminum.
Our largest inputs to produce fabricated aluminum products are primary aluminum and recycled scrap aluminum. Primary aluminum pricing fluctuates in response to global supply and demand and also reflects the impact of duties and tariffs imposed by the United States and certain other countries. Recycled scrap aluminum is generally priced at a discount to primary aluminum that loosens and tightens in response to regional aluminum scrap supply and demand. The timing and magnitude of changes in market pricing for primary and scrap aluminum are largely unpredictable. Our pricing structures for fabricated aluminum products generally allow us to pass fluctuations in the price of primary aluminum through to our customers so that we can minimize our exposure to metal price risk. However, competitive dynamics for certain of our high value added products may limit the amount or delay the timing of selling price increases on our products to recover our increased aluminum costs, resulting in a time lag during which we may be partially exposed to metal price risk. If these events were to occur, they could have an adverse effect on our financial position, results of operations and cash flows. In addition, if the market price for primary aluminum were to remain high for an extended period of time, the corresponding increase in our selling price for our fabricated products may cause some of our customers to switch to other materials in lieu of our products, causing sales of our fabricated aluminum products to decrease, which could adversely affect our financial position, results of operations and cash flows.
Our business could be adversely affected by the pricing and availability of recycled scrap aluminum.
We can efficiently use certain forms of recycled scrap aluminum in lieu of primary aluminum and alloying metals in our operations because recycled scrap aluminum trades at a discount to primary aluminum. The size of the discount to primary aluminum depends on regional scrap aluminum supply and demand dynamics. Larger discounts, generally available in periods of ample regional scrap aluminum supply relative to demand, enhance the economic advantage to us of using recycled scrap aluminum in lieu of primary aluminum and alloying metals. The timing and magnitude of changes in scrap discounts relative to primary aluminum are largely unpredictable. If the availability of recycled scrap aluminum in our regional markets were to tighten, scrap discounts relative to primary aluminum could decline and the amount of recycled scrap aluminum we could procure for use in our operations could decline, either of which could have an adverse effect on our financial position, results of operations and cash flows.
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Reduced pricing for aluminum can reduce our borrowing availability and cause our liquidity to decline.
Lower aluminum prices reduce the market value of our inventory and generally cause a reduction in our accounts receivable as we pass through a lower underlying metal price to our customers. Because the amount we can borrow under our revolving credit facility with Wells Fargo Bank, National Association, as administrative agent, and the other financial institutions party thereto (“Revolving Credit Facility”) is determined by the value of our receivables and inventory, which serve as collateral for the facility, a reduction in aluminum prices can reduce our borrowing availability and our liquidity, which could have an adverse effect on our financial position, results of operations and cash flows.
Our hedging programs have been and could continue to be adversely impacted by fluctuations as a result of the impacts of the COVID-19 pandemic.
We use forward contracts to protect against fluctuations in commodity price and currency exchange rate risks. The effectiveness of these hedges depends, in part, on our ability to accurately forecast future product demand and related cash flow. Due to the economic impacts of the COVID-19 pandemic and related governmental responses, our customers’ businesses are subject to many uncertainties and, as a result, we have experienced, and may continue to experience, unanticipated volatility in product demand and related cash flows. When we experience such volatility or are otherwise unable to make accurate predictions with respect to our forward swaps designated as cash flow or fair value hedges, such hedging activities may become ineffective. The early settlement, reclassification of cumulative losses and/or the periodic adjustment to fair value through Net income associated with ineffective hedging activities could have a material negative impact on our financial position, results of operations and cash flows.
Our hedging programs may limit the income and cash flows we would otherwise expect to receive if our hedging program were not in place and may otherwise affect our business.
In the ordinary course of business, we enter into hedging transactions to limit our exposure to risks relating to changes in the market prices of primary aluminum, certain alloying metals, natural gas and electricity, as well as fluctuations in foreign currency exchange rates. To the extent that market prices or exchange rates at the expiration of these hedging transactions would have been more favorable to us than the fixed prices or rates established by these hedging transactions, our income and cash flows will be lower than they otherwise would have been. Our liquidity could also be adversely affected to the extent we incur margin calls from our hedging counterparties due to the market price of the underlying commodity or the foreign currency exchange rates deviating adversely from fixed, floor or ceiling prices or rates established by our outstanding hedging transactions. Our failure to satisfy certain covenants in the underlying hedging documents or the occurrence of an event of default thereunder could also trigger margin calls that could adversely impact our liquidity, financial position, results of operations and cash flows. Our hedging programs also expose us to the creditworthiness of our hedging counterparties, which is inherently difficult to assess and can change quickly and dramatically. Non-performance by a hedging counterparty could have an adverse effect on our financial position, results of operations and cash flows.
WE ARE SUBJECT TO RISKS RELATED TO OUR INDEBTEDNESS.
Covenants and events of default in our debt instruments could limit our ability to undertake certain types of transactions and adversely affect our liquidity.
Our Revolving Credit Facility and the indentures governing our 4.625% Senior Notes due 2028 (“4.625% Senior Notes”) and 6.50% Senior Notes due 2025 (“6.50% Senior Notes”) contain a number of restrictive covenants that impose operating and financial restrictions on us and may limit our ability to engage in acts that may be in our long-term best interest, including restrictions on our ability to:
• incur additional indebtedness and guarantee indebtedness;
• prepay, redeem or repurchase certain debt;
• issue certain preferred stock or similar equity securities;
• make loans and investments;
• sell assets;
• incur liens;
• enter into transactions with affiliates;
• alter the businesses we conduct;
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• consolidate, merge or sell all or substantially all of our assets.
In addition, restrictive covenants in our Revolving Credit Facility require us in certain circumstances to maintain specified financial ratios and satisfy other financial condition tests. Our ability to meet those financial ratios and tests can be affected by events beyond our control and we may be unable to meet them.
A breach of the covenants or restrictions under our Revolving Credit Facility or under the indentures governing the 4.625% Senior Notes and 6.50% Senior Notes could result in an event of default under the applicable indebtedness. Such a default may allow the creditors to accelerate the related debt. A payment default or an acceleration following an event of default under our Revolving Credit Facility or our indentures for our 4.625% Senior Notes and 6.50% Senior Notes could trigger an event of default under the other indebtedness obligation, as well as any other debt to which a cross-acceleration or cross-default provision applies, which could result in the principal of and the accrued and unpaid interest on all such debt becoming due and payable. In addition, an event of default under our Revolving Credit Facility could permit the lenders under our Revolving Credit Facility to terminate all commitments to extend further credit under that facility. Furthermore, if we were unable to repay any amounts due and payable under our Revolving Credit Facility, those lenders could proceed against the collateral granted to them to secure that indebtedness. In the event our lenders or noteholders accelerate the repayment of our borrowings, we and our subsidiaries may not have sufficient assets to repay that indebtedness.
As a result of these restrictions, we may be:
In addition, our financial results, our level of indebtedness and our credit ratings could adversely affect the availability and terms of any additional or replacement financing.
More detailed descriptions of our Revolving Credit Facility and the indentures governing our 4.625% Senior Notes and 6.50% Senior Notes are included in filings made by us with the SEC, along with the documents themselves, which provide the full text of these covenants.
Restrictive covenants in our debt instruments contain significant qualifications and exceptions.
While our Revolving Credit Facility and the indentures governing the 4.625% Senior Notes and 6.50% Senior Notes place limitations on our ability to pay dividends or make other distributions, repurchase or redeem capital stock, make loans and investments and incur additional indebtedness, investors should be aware that these limitations are subject to significant qualifications and exceptions. The aggregate amount of payments made or incremental debt incurred in compliance with these limitations could be substantial.
As indicated above, more detailed descriptions of our Revolving Credit Facility and the indentures governing our 4.625% Senior Notes and 6.50% Senior Notes are included in filings made by us with the SEC, along with the documents themselves, which provide the full text of these covenants.
Servicing our debt requires a significant amount of cash and we may not have sufficient cash flow from our business to pay our debt.
Our ability to make scheduled interest and principal payments on our debt obligations or to refinance such obligations depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business, legislative, regulatory and other factors beyond our control. We may be unable to maintain a level of cash flows from operating activities sufficient to permit us to pay the interest, principal and premium, if any, on our indebtedness.
If our cash flows and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and could be forced to reduce or delay investments and capital expenditures, dispose of material assets or operations, restructure or refinance our indebtedness or seek additional debt or equity capital. We may not be able to effect any such alternative measures, if necessary, on commercially reasonable terms or at all and, even if successful, those alternative actions may not allow us to meet our scheduled debt service obligations. Our Revolving Credit Facility and the indentures governing the 4.625% Senior Notes and 6.50% Senior Notes restrict our ability to dispose of assets and use the proceeds from those dispositions and may also restrict our
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ability to raise debt or certain forms of equity capital to be used to repay other indebtedness when it becomes due. We may not be able to consummate asset dispositions or to obtain proceeds in an amount sufficient to meet any debt service obligations then due.
If we cannot make scheduled payments on our debt, we will be in default and holders of the 4.625% Senior Notes and 6.50% Senior Notes could declare all outstanding principal and interest to be due and payable, the lenders under our Revolving Credit Facility could terminate their commitments to loan money, the lenders could foreclose against the assets securing their borrowings and we could be forced into bankruptcy or liquidation.
We are a holding company and depend on our subsidiaries for cash to meet our obligations and pay any dividends.
We are a holding company and conduct all of our operations through our subsidiaries, certain of which are not guarantors of our 4.625% Senior Notes, 6.50% Senior Notes or our Revolving Credit Facility. Accordingly, repayments of our 4.625% Senior Notes, 6.50% Senior Notes and amounts due under our Revolving Credit Facility are dependent on the generation of cash flow by our subsidiaries and their ability to make such cash available to us by dividend, loan, debt repayment or otherwise. Our subsidiaries that are not guarantors of our 4.625% Senior Notes, 6.50% Senior Notes or the Revolving Credit Facility have no obligation to pay amounts due on the 4.625% Senior Notes, 6.50% Senior Notes or the Revolving Credit Facility or to make funds available for that purpose. Our subsidiaries may not be able to, or may not be permitted to, make distributions to enable us to make payments in respect of our indebtedness. Each of our subsidiaries is a distinct legal entity and, under certain circumstances, legal and contractual restrictions may limit our ability to obtain cash from our subsidiaries. In the event that we do not receive distributions from our subsidiaries, we may be unable to make required interest and principal payments on the 4.625% Senior Notes, the 6.50% Senior Notes or our Revolving Credit Facility, or other indebtedness.
Our inability to receive distributions from our subsidiaries, otherwise generate sufficient cash flows to satisfy our debt obligations or refinance our indebtedness on commercially reasonable terms, or at all, would adversely affect our financial position and results of operations.
WE ARE SUBJECT TO RISKS RELATED TO OUR COLLECTIVE BARGAINING AGREEMENTS.
Our failure to maintain satisfactory labor relations could adversely affect our business.
At December 31, 2020, approximately 63% of our employees were represented by labor unions under labor contracts with varying durations and expiration dates. Employees at our Trentwood and Newark, Ohio facilities are represented by the USW under a single contract that extends through September 2025. The USW also represents employees at five other facilities, four of which have contracts expiring in 2021. As part of any labor negotiation, the future wages, healthcare benefits and excise taxes that may result therefrom, and other benefits that we agree to, could adversely affect our future financial position, results of operations and cash flows. In addition, negotiations could divert management attention, result in unsatisfactory terms and conditions, fail in coming to any agreement at all or result in strikes, work stoppages or other union-initiated work actions, any of which could have an adverse effect on our financial position, results of operations and cash flows. Moreover, the existence of labor agreements may not prevent such union-initiated work actions.
Our participation in multi-employer union pension plans may have an adverse effect on our financial performance.
We participate in several multi-employer pension plans pursuant to our collective bargaining agreements. Our contribution amounts to these plans were established by collective bargaining and, along with benefit levels and related items, will be issues in our future collective bargaining negotiations. Based on the most recent information available to us, we believe some of these plans are underfunded and may require increased contributions from participating employers to fill the funding shortfall in the future. An employer that withdraws or partially withdraws from a multi-employer pension plan may incur a withdrawal liability for the portion of the plan’s underfunding that is allocable to the withdrawing employer under very complex actuarial and allocation rules. The failure of a withdrawing employer to fund these obligations can increase the burden of the remaining participating employers to make up the funding shortfall, which could have an adverse effect on our financial position, results of operations and cash flows. The increase or decrease in our contributions to these multi-employer pension plans will depend on our future collective bargaining, actions taken by trustees who manage the plans, actions of other participating employers, government regulations and the actual return on assets held in the plans, among other factors.
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The USW has director nomination rights through which it may influence us, and interests of the USW may not align with our interests or the interests of our stockholders, debt holders and other stakeholders.
Pursuant to agreements we have with the USW, the USW has the right, subject to certain limitations, to nominate candidates which, if elected, would constitute 40% of our Board of Directors through December 31, 2025. As a result, the directors nominated by the USW have a significant voice in the decisions of our Board of Directors. It is possible that the USW may seek to extend the term of the agreement and its right to nominate board members beyond 2025.
WE ARE SUBJECT TO ENVIRONMENTAL-RELATED RISKS.
Environmental compliance, cleanup and damage claims may decrease our cash flow and adversely affect our business.
We are subject to numerous environmental laws and regulations with respect to, among other things: (i) air and water emissions and discharges; (ii) the generation, storage, treatment, transportation and disposal of solid and hazardous waste; and (iii) the release of hazardous or toxic substances, pollutants and contaminants into the environment. In addition to environmental laws and regulations, environmental activists, lobbyists and consumers have targeted manufacturers for the purported impact of their operations on the environment. Compliance with existing and new environmental laws and standards or the implications of any actions by third parties are and may continue to be costly.
We have accrued and will accrue for costs that are reasonably expected to be incurred based on available information with respect to fines, penalties and expenses for alleged breaches of environmental laws in connection with our existing operations and investigations and environmental cleanup activities with respect to certain of our former operations. However, actual costs could exceed accrued amounts, perhaps significantly, and such expenditures could occur sooner than anticipated, which could adversely affect our financial position, results of operations and cash flows.
Additionally, we may be subject to new claims from governmental authorities or third parties related to alleged injuries to the environment, human health or natural resources, including claims with respect to waste disposal sites, the cleanup of sites currently or formerly used by us or exposure of individuals to hazardous materials. New laws or regulations or changes to existing laws and regulations may also be enacted, including government mandated green initiatives and limitations on carbon emissions that increase the cost or complexity of compliance. Costs related to any new investigation, cleanup or other remediation, fines or penalties, resolution of third-party claims or compliance with new or amended laws and regulations may be significant and could have an adverse effect on our financial position, results of operations and cash flows.
Governmental regulation relating to greenhouse gas emissions may subject us to significant new costs and restrictions on our operations.
Laws enacted by the U.S. Congress or policies of the USEPA could regulate greenhouse gas emissions through cap-and-trade systems, carbon taxes or other programs under which emitters would be required to buy allowances to offset emissions of greenhouse gas, pay carbon based taxes, make significant capital investments, alter manufacturing practices or curtail production. In addition, several states, including the state of Washington, in which we have manufacturing operations, have considered and continue to consider various greenhouse gas regulation and reduction programs through legislative proposals, executive orders and ballot initiatives. Certain of our manufacturing plants use significant amounts of electricity and natural gas and certain of our plants emit amounts of greenhouse gas above certain minimum thresholds that have or may be imposed. While certain of our operations, including the melting of aluminum scrap, require the use of natural gas to achieve the required temperatures, greenhouse gas regulations could restrict our access to natural gas and limit our ability to use natural gas and increase the price we pay for natural gas and electricity, any one of which could significantly increase our costs, reduce our competitiveness in the global economy or otherwise adversely affect our business, operations or financial results.
WE ARE SUBJECT TO CYBERSECURITY AND PRIVACY RISKS.
We are subject to risks relating to our information technology systems.
We rely on information technology networks and systems to process, transmit and store electronic information, operate our business and communicate among our locations and with our customers, suppliers and other interested parties. Such information technology systems are subject to: (i) interruption or damage from power outages; (ii) cyber security breaches and other types of unauthorized access and/or use; and (iii) cyberattacks in the form of computer viruses, worms, malicious computer programs, denial‐of‐service attacks and other illegal or illicit means. Cyberattack and security breach strategies and methods continue to evolve and become more sophisticated. Accordingly, preventing intrusions and detecting successful intrusions and defending against them continues to be more difficult and requires ever-increasing vigilance.
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A breach in cyber security could result in manipulation and destruction of sensitive data, cause critical systems to malfunction, be damaged or shut down and lead to disruption of our operations and production downtimes, potentially for lengthy periods of time. Theft of personal or other confidential data and sensitive proprietary information could also occur as a result of a breach in cyber security, exposing us to costs and liabilities associated with privacy and data security laws in the jurisdictions in which we operate. Additionally, a breach could expose us, our customers, our suppliers and our employees to risks of misuse of such information. Such negative consequences of cyberattacks or security breaches could adversely affect our reputation, competitive position, business or results of operations. The lost profits and increased costs related to cyber or other security threats or disruptions may not be fully insured against or indemnified by other means.
In addition, from time to time we may implement new technology systems or replace and/or upgrade our current information technology systems. These upgrades or replacements may not improve our productivity to the levels anticipated and may subject us to inherent costs and risks associated with implementing, replacing and updating these systems, including potential disruption of our internal control structure, substantial capital expenditures, demands on management time and other risks of delays or difficulties in transitioning to new systems or of integrating new systems into other existing systems. Our inability to prevent information technology system disruptions or to mitigate the impact of such disruptions could have an adverse effect on us.
WE ARE SUBJECT TO RISKS RELATED TO TAX REGULATIONS.
We may not be able to utilize all of our net operating loss carryforwards.
Our ability to utilize our net operating loss carryforwards and other tax attributes could be limited to the extent they expire before we fully utilize them or if changes in federal or certain state tax laws reduce or eliminate our ability to use them to offset income taxes. Additionally, a change in our ownership, specifically a change in ownership of more than 50% during any period of 36 consecutive months (“ownership change”), as determined under the Internal Revenue Code of 1986 (“Code”), could reduce our ability to fully use our net operating loss carryforwards and other significant tax attributes.
Furthermore, our tax returns for certain past years are still subject to examination by taxing authorities, and the use of net operating loss carryforwards in future periods could trigger a review of attributes and other tax matters in years that are not otherwise subject to examination. After our net operating loss carryforwards and other significant tax attributes are fully utilized or if they become unavailable to us before we fully utilize them, our future income will not be shielded from federal and state income taxation and the funds otherwise available for general corporate purposes would be reduced.
We could engage in or approve transactions involving our common shares that impair the use of our federal income tax attributes.
Section 382 of the Code affects our ability to use our federal income tax attributes, including our net operating loss carryforwards, following a more than 50% change in ownership during any period of 36 consecutive months, an ownership change, as determined under the Code. Certain transactions may be included in the calculation of an ownership change, including transactions involving our repurchase or issuance of our common shares. When we engage in or approve any transaction involving our common shares that may be included in the calculation of an ownership change, our practice is to first perform the calculations necessary to confirm that our ability to use our federal income tax attributes will not be affected. These calculations are complex and reflect certain necessary assumptions. Accordingly, it is possible that we could approve or engage in a transaction involving our common shares that causes an ownership change and inadvertently impairs the use of our federal income tax attributes. Furthermore, we may intentionally pursue a transaction that impairs the use of our federal income tax attributes if our strategy changes.
WE MAY ENGAGE IN ACTIVITIES THAT AFFECT OUR COMMON STOCK.
Payment of dividends may not continue in the future and our payment of dividends and stock repurchases are subject to restrictions.
Our Board of Directors has declared a cash dividend for each quarter since the summer of 2007. In addition, our Board of Directors has authorized a stock repurchase program. The future declaration and payment of dividends and the purchase of our shares under the repurchase program, if any, are at the discretion of the Board of Directors and will depend on a number of factors, including our financial and operating results, liquidity position, anticipated cash requirements and regulatory rules. Additionally, our Revolving Credit Facility and the indentures for our 4.625% Senior Notes and 6.50% Senior Notes impose limitations on our ability to pay dividends and repurchase our common shares. We can give no assurance that dividends will be declared and paid, that dividends will not be reduced or that purchases of our shares pursuant to our repurchase program will occur in the future.
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Delaware law and our governing documents may impede or discourage a takeover, which could adversely affect the value of our common stock.
Provisions of Delaware law and our certificate of incorporation and bylaws may discourage a change of control of our company or deter tender offers for our common stock. We are currently subject to anti-takeover provisions under Delaware law. These anti‐takeover provisions impose various impediments to the ability of a third party to acquire control of us. Additionally, provisions of our certificate of incorporation and bylaws impose various procedural and other requirements, which could make it more difficult for stockholders to effect certain corporate actions. For example, our certificate of incorporation authorizes our Board of Directors to determine the rights, preferences and privileges and restrictions of unissued shares of preferred stock without any vote or action by our stockholders. As a result, our Board of Directors can authorize and issue shares of preferred stock with voting or conversion rights that could adversely affect the voting or other rights of holders of common stock. Our certificate of incorporation also divides our Board of Directors into three classes of directors who serve for staggered terms. A significant effect of a classified Board of Directors may be to deter hostile takeover attempts because an acquirer could experience delays in replacing a majority of directors. Moreover, stockholders are not permitted to call a special meeting.
WE ARE SUBJECT TO A VARIETY OF OTHER RISKS AS A PUBLICLY TRADED U.S. MANUFACTURING COMPANY.
As a publicly traded U.S. manufacturing company, we are subject to a variety of other risks, each of which could adversely affect our financial position, results of operations or cash flows or the price of our common stock. These risks include but are not limited to:
• new or modified legislation related to health care;
• changes in tax laws and regulations; and
Item 1B.Unresolved Staff Comments
None.
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Item 2.Properties
The following table provides information regarding the location, size and ownership of our principal production facilities as of December 31, 2020:
Location Square footage Owned or Leased
Chandler, Arizona (Extrusion) 115,000 Leased1
Chandler, Arizona (Tube) 101,700 Leased1
Columbia, New Jersey 32,900 Owned
Florence, Alabama 249,300 Owned
Jackson, Tennessee 310,000 Owned
London, Ontario (Canada) 306,000 Owned
Los Angeles, California 183,000 Owned
Richland, Washington 45,000 Leased3
Richmond, Virginia (Bellwood) 474,000 Owned
Spokane, Washington (Trentwood) 2,886,000 Owned/Leased4
Production facilities and equipment are generally in good condition and suitable for their intended uses. For additional information regarding our production facilities, see the table under Item 1. Business “Business Operations - Manufacturing Processes” of this Report.
Item 3.Legal Proceedings
None.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our outstanding common stock is traded under the ticker symbol “KALU” on the Nasdaq Global Select Market.
Holders
As of February 22, 2021, there were approximately 484 holders of record of our common stock.
Stock Performance Graph
The following graph compares the cumulative total shareholder return on our common stock with: (i) the S&P SmallCap 600 Index; (ii) the Russell 2000 Index; and (iii) the S&P SmallCap 600 Materials Index. We are a component of each of these indices. The graph assumes: (i) an initial investment of $100 as of December 31, 2015 and (ii) reinvestment of all dividends. The performance graph is not necessarily indicative of the future performance of our stock price.
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Among Kaiser Aluminum Corporation, the S&P SmallCap 600 Index,
the Russell 2000 Index and the S&P SmallCap 600 Materials Index
Issuer Repurchases of Equity Securities
We made no stock repurchases during the quarter ended December 31, 2020. In September 2018, our Board of Directors authorized an additional $100.0 million for us to repurchase shares of our common stock. At December 31, 2020, $93.1 million remained available to repurchase our common shares pursuant to the stock repurchase program. The September 2018 authorization does not have an expiration date. On March 18, 2020, we suspended our share repurchase program in response to ongoing economic uncertainty arising from the Coronavirus Disease 2019 (“COVID-19”) pandemic.
Item 6.Selected Financial Data
Reserved.
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Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations
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:
• Management Review of 2020 and Outlook for the Future;
• Results of Operations;
• Liquidity and Capital Resources;
• Critical Accounting Estimates and Policies; and
• New Accounting Pronouncements.
Our MD&A should be read in conjunction with our consolidated financial statements and related notes included in Item 8. ”Financial Statements and Supplementary Data” of this Report. For a detailed discussion of items impacting the year ended December 31, 2018, as well as a year-to-year comparison of our financial position and results of operations for the years ended December 31, 2019 and December 31, 2018, refer to Part II, Item 7. “Management’s Discussion and Analysis” of our Annual Report on Form 10-K for the years ended December 31, 2018 and 2019, respectively, and filed with the Securities and Exchange Commission (“SEC”) on February 22, 2019 and February 25, 2020, respectively.
This information contains certain non-GAAP financial measures. A non-GAAP financial measure is defined as a numerical measure of a company’s financial performance that excludes or includes amounts so as to be different than the most directly comparable measure calculated and presented in accordance with generally accepted accounting principles (“GAAP”) in the statements of income, balance sheets or statements of cash flows of the company. We have provided a reconciliation of non-GAAP financial measures to the most directly comparable financial measure in the accompanying tables. We have also provided discussion of the reasons we believe that presentation of the non-GAAP financial measures provide useful information to investors, as well as any additional ways in which we use the non-GAAP financial measures. The non-GAAP financial measures used in the following discussions are value added revenue (“VAR”), earnings before interest, taxes, depreciation and amortization adjusted for non-run-rate items (“Adjusted EBITDA”) and ratios related thereto. These measures are presented because management uses this information to monitor and evaluate financial results and trends and believes this information to also be useful for investors.
In the discussion of operating results below, we refer to certain items 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 users of the financial statements to consider our results both in light of and separately from such items. For a reconciliation of Adjusted EBITDA to Net income, see “Results of Operations - Selected Operational and Financial Information” below. Reconciliations of certain forward-looking non-GAAP financial measures to comparable GAAP measures are not provided because certain items required for such reconciliations are outside of our control and/or cannot be reasonably predicted or provided without unreasonable effort.
Our pricing policies and hedging program are intended to significantly reduce or eliminate the impact on our profitability of fluctuations in underlying metal price so that our earnings are predominantly associated with the conversion of aluminum to semi‐fabricated mill products. To allow users of our financial statements to consider the impact of metal cost on our Net sales, we disclose Net sales as well as VAR, which is Net sales less the Hedged Cost of Alloyed Metal. As used in this discussion, “Hedged Cost of Alloyed Metal” is the cost of our metal inputs at the average Midwest Transaction Price (“Midwest Price”) of aluminum plus the cost of alloying elements and any realized gains and/or losses on settled hedges related to the metal sold in the referenced period. The average Midwest Price of aluminum reflects the primary aluminum supply/demand dynamics in North America. For a reconciliation of VAR to Net sales, see “Results of Operations - Selected Operational and Financial Information” below.
Management Review of 2020 and Outlook for the Future
Review
During 2020, we demonstrated solid execution under very challenging business conditions, as we navigated the significant decline in commercial aerospace demand during the second half of the year while managing strong demand for our general engineering (“GE products”) and automotive (“Automotive Extrusions”) end market applications and defense related applications.
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For the full year 2020 compared to our 2019 results, Net sales of $1,172.7 milliondecreased approximately 23% and VAR of $697.1million declinedapproximately 19%, reflecting a strong quarter ended March 31, 2020, followed by significant COVID-19 pandemic related disruptions to our operations and end markets during the remainder of the year. Despite the decline in Net sales and VAR, we reported full year Net income of $28.8 million, Adjusted EBITDA of $153.8 million and an EBITDA margin (Adjusted EBITDA as a percentage of VAR) at 22%. Our results reflected our ability to quickly flex costs and operating levels in response to rapidly changing business conditions.
Demand for our aerospace and high strength end market applications (“Aero/HS products”) declined sharply from 2019 levels, reflecting the COVID-19 pandemic impact on commercial airline travel, delays in recertification of the Boeing 737 MAX and destocking within the supply chain. While commercial aerospace demand fell sharply in the second half of 2020, we experienced strong demand throughout the year for our defense related applications, specifically from the F-35 Joint Strike Fighter program and other legacy military aircraft programs. Automotive Extrusions demand regained strength following significant but temporary COVID-19 pandemic related supply chain shutdowns in the quarter ended June 30, 2020. Planned program launches for multiple new platforms ramped up during the second half of 2020 and new programs were awarded during the year reflecting the continued trend for aluminum content growth. Demand for our GE products reflected steady underlying demand driven in part by strength in semi‐conductor and automotive applications, restocking in the supply chain and strong customer preference for KaiserSelect® plate.
Outlook
For the full year 2021, we anticipate total VAR to be up 5% to 10% year-over-year and an EBITDA margin comparable to 2020 driven by strong growth in Automotive Extrusions, defense applications and GE products.
We anticipate VAR for our Aero/HS products to be down 5% to 8% year-over-year on slightly lower shipments compared to 2020, which reflected strong demand for our commercial aerospace applications during the first half of 2020. Commercial aerospace demand continues to reflect weak airline travel impacted by the COVID-19 pandemic and destocking in the supply chain. We continue to anticipate full recovery of commercial aerospace demand in 2023 to 2024.
Lower commercial aerospace demand in 2021 is expected to be mitigated in part by continued strength in demand for defense related applications as build rates for the F-35 Joint Strike Fighter are expected to increase 20% to 30% compared to 2020, while business and regional jet demand continues to improve.
VAR and shipments for our Automotive Extrusions are anticipated to increase 35% to 45% year-over-year as North American build rates are expected to increase more than 25% to approximately 16.0 million units in 2021 from 13.0 million units in 2020, and numerous new product launches in 2020 and 2021 increase our aluminum content on vehicles.
VAR and shipments for our GE products are anticipated to increase 10% to 15% year-over-year, reflecting solid service center and end market demand driven by continued growth in semi-conductor and automotive demand. In addition, reshoring continues as many North American original equipment manufacturers secure domestic supply for their raw material needs to minimize risk of supply chain disruption.
Our planned acquisition of Alcoa Warrick LLC and certain assets comprising the aluminum casting and rolling mill facility located in Warrick County, Indiana (collectively, the “Warrick Rolling Mill”) provides an opportunity for further value creation with strong secular growth in the non-cyclical packaging business. The transaction is anticipated to close on March 31, 2021 and is expected to be immediately accretive to earnings and cash flow. The outlook for the beverage and food packaging markets is strong with favorable demand and industry dynamics driving growth. North American can demand was up 5% year-over-year in 2020 and is projected to increase an additional 3% to 5% in 2021. The Warrick Rolling Mill is one of only four dedicated can sheet mills in North America and we expect to become a significant participant in the supply chain solution in meeting the growing North American demand.
Results of Operations
Fiscal 2020 Summary
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Consolidated Selected Operational and Financial Information
The following data should be read in conjunction with our consolidated financial statements and the notes thereto included in Item 8. “Financial Statements and Supplementary Data” of this Report.
Net Sales. We reported Net sales for 2020 of $1,172.7 million, compared to $1,514.1 million for 2019. The decrease in Net sales during 2020 compared to 2019 reflected a 122.6 million pound (20%) decrease in shipment volume and a $0.09/lb (4%) decrease in average realized sales price per pound. The shipment volume decrease reflected: (i) a 100.3 million pound (37%) decrease in Aero/HS products reflecting the impact of the pandemic on demand for our aerospace applications; (ii) an 11.4 million pound (55%) decrease in our other industrial end market application (“Other products”) reflecting our planned exit from non‐strategic applications; (iii) a 10.2 million pound (11%) decrease in Automotive Extrusions reflecting the impact of the temporary shutdown of the North American automotive supply chain during the quarter ended June 30, 2020 due to the pandemic; and (iv) a 0.7 million pound (0.3%) decrease in GE products. The decrease in average realized sales price per pound reflected an $0.11/lb (10%) decrease in average Hedged Cost of Alloyed Metal prices per pound, partially offset by a $0.02 (1%) increase in VAR per pound due primarily to approximately $14.8 million of additional net sales associated with provisions under multi-year contracts with our customers. See the table in “Selected Operational and Financial Information” below for further details.
Cost of Products Sold, Excluding Depreciation and Amortization and Other Items. Cost of products sold, excluding depreciation and amortization and other items for 2020 totaled $941.3 million, or 80% of Net sales, compared to $1,215.2 million, or 80% of Net sales, in 2019. The decrease during 2020 compared to 2019 of $273.9 million reflected a $183.0 million decrease in Hedged Cost of Alloyed Metal and a $90.9 million decrease in net manufacturing conversion and other costs. Of the $183.0 million decrease in Hedged Cost of Alloyed Metal, $129.1 million was due to lower shipment volume, as discussed above in “Net Sales,” and $53.9 million was due to lower hedged metal prices. The $90.9 million decrease in net manufacturing conversion and other costs reflected: (i) a $90.7 million decrease related to lower sales volume; (ii) $17.4 million of lower benefits and overhead costs; and (iii) a $7.6 million reduction in major maintenance, partially offset by: (i) an increase of $23.0 million in manufacturing costs due to manufacturing inefficiencies and (ii) an increase of $2.3 million in environmental costs associated with on-going historical environmental cleanup.See “Selected Operational and Financial Information” below for a further discussion of the comparative results of operations for 2020 and 2019.
Depreciation and Amortization. Depreciation and amortization for 2020 was $52.2 million compared to $49.1 million for 2019. The increase of $3.1 million was due to various construction-in-progress projects being placed in service during 2020 related primarily to critical sustaining and enhancement projects, as well as for upgrades to equipment supporting Automotive Extrusions.
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Selling, General, Administrative, Research and Development (“SG&A and R&D”). SG&A and R&D expense totaled $91.2million in 2020 compared to $98.0 million in 2019. The decrease during 2020 was due primarily to: (i) a $3.9 million reduction in salaries and benefits; (ii) a $3.2 million reduction in travel costs;(iii) a $3.0 million reduction in employee incentive programs; and (iv) a $1.2 million reduction in miscellaneous expenses, partially offset by a $5.5 million increase in legal fees and consulting charges, primarily related to the pending Warrick Rolling Mill acquisition.
Goodwill Impairment. See Note 4 of Notes to Consolidated Financial Statements included in this Report for further details.
Restructuring Costs. See Note 12 of Notes to Consolidated Financial Statements included in this Report for further information regarding the restructuring plan.
Other Operating (Income) Charges, Net. Other operating (income) charges, net, was $0.6 million of income and $0.9 million of charges for the years ended December 31, 2020 and December 31, 2019, respectively. During the year ended December 31, 2020, we recognized $1.3 million of payroll subsidies received by our subsidiary Kaiser Aluminum Canada Limited under the Canada Emergency Wage Subsidy (“CEWS”) Program, which was partially offset by $0.5 million of impairment charges related to property, plant and equipment. The 2019 amount reflected an impairment charge related to property, plant and equipment.
Interest Expense. Interest expense represents cash and non-cash interest expense incurred on our 6.50% Senior Notes, 4.625% unsecured senior notes due March 1, 2028 (“4.625% Senior Notes”) and our Revolving Credit Facility, net of capitalized interest. Interest expense was $40.9 million and $24.6 million for 2020 and 2019, respectively. See Note 9 of Notes to Consolidated Financial Statements included in this Report for a discussion of our debt and credit facilities that were in effect during each of the years 2020 and 2019 and Note 1 of Notes to Consolidated Financial Statements included in this Report for a discussion of our interest expense capitalized as part of construction in progress.
Other Expense, Net. See Note 13 of Notes to Consolidated Financial Statements included in this Report for details.
Income Tax Provision. The income tax provision for 2020 was $10.0 million, resulting in an effective tax rate of 25.9%.There was no material difference between the effective tax rate and the projected blended statutory tax rate for 2020.
The income tax provision for 2019 was $18.4 million, resulting in an effective tax rate of 22.9%. The difference between the effective tax rate and the projected blended statutory tax rate for 2019 was primarily due to a decrease of $7.7 million (10% of taxable income) for cumulative research and development credits recognized for the tax years 2010 through 2019, partially offset by: (i) an increase in unrecognized tax benefits, including interest and penalties, of $2.7 million (3% of taxable income); (ii) an increase of $1.7 million (2% of taxable income) for certain executive compensation; and (iii) an increase of $1.5 million (2% of taxable income) in the valuation allowance for federal and certain state net operating losses.
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Selected Operational and Financial Information
The following data should be read in conjunction with our consolidated financial statements and the notes thereto included in Part II, Item 8. “Financial Statements and Supplementary Data” of this Report.
The following table provides selected operational and financial information (in millions of dollars):
Year Ended December 31,
Other expense, net 1.4 20.7
Depreciation and amortization 52.2 49.1
Non-run-rate items:
Restructuring charges 7.5 —
Adjustments to plant-level LIFO1 2.4 3.4
Mark-to-market (gain) loss on derivative instruments2 (2.6 ) 5.8
Workers' compensation cost due to discounting 1.8 0.8
Goodwill impairment3 — 25.2
Non-cash asset impairment charges 0.5 0.9
Net periodic post retirement service cost relating to Salaried VEBA 0.1 0.1
Environmental expenses4 5.3 1.7
Acquisition costs5 5.5 —
Total non-run-rate items 20.5 37.9
Adjusted EBITDA for 2020 was $153.8 million as compared to $212.7 million for 2019. The decline primarily reflected: (i) a $74.2 million sales impact and (ii) $14.2 million in manufacturing inefficiencies, partially offset by: (i) a $17.1 million reduction in plant and corporate overhead; (ii) a $7.6 million reduction in major maintenance; and (iii) a $4.7 million reduction in incentive compensation expense.
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The following table provides our shipment and VAR information (in millions of dollars, except shipments and VAR per pound) by end market applications:
Year Ended December 31,
Aero/HS Products:
$ $ / lb $ $ / lb
Automotive Extrusions:
$ $ / lb $ $ / lb
Less: Hedged Cost of Alloyed Metal (78.4 ) (0.93 ) (97.2 ) (1.03 )
GE Products:
$ $ / lb $ $ / lb
Other Products:
Shipments (mmlbs) 9.4 20.8
$ $ / lb $ $ / lb
Less: Hedged Cost of Alloyed Metal (8.4 ) (0.89 ) (21.3 ) (1.03 )
Total:
$ $ / lb $ $ / lb
Liquidity and Capital Resources
Summary
The following table summarizes our liquidity (in millions of dollars):
As of December 31,
Available cash and cash equivalents $ 780.3 $ 264.3
Short-term investments — 78.7
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We place our cash in bank deposits and money market funds with high credit quality financial institutions. Cash equivalents consist primarily of investment-grade commercial paper, money market accounts and investments which, when purchased, have a maturity of 90 days or less. Short-term investments represent holdings in investment-grade commercial paper with a maturity at the time of purchase of greater than 90 days.
See Note 16 of Notes to Consolidated Financial Statements included in this Report for information regarding restricted cash at December 31, 2020.
We and certain of our subsidiaries have a Revolving Credit Facility with Wells Fargo Bank, National Association, as administrative agent, and the other financial institutions party thereto (see Note 9 of Notes to Consolidated Financial Statements included in this Report). There were no borrowings under our Revolving Credit Facility during the years ending or as of December 31, 2020 or December 31, 2019, respectively.
Cash Flows
The following table summarizes our cash flows from operating, investing and financing activities (in millions of dollars):
Year Ended December 31,
Total cash provided by (used in):
Investing activities $ 26.9 $ (101.8 )
Financing activities $ 281.9 $ 8.5
Cash provided by operating activities for the year ended December 31, 2020 included: (i) a decrease in Trade and other receivables of $60.8 million driven primarily by lower Net sales; (ii) a decrease in Inventories of $25.6 million to better align with operations; and (iii) a reduction in Contract assets of $18.5 million driven primarily by timing and volume of shipments related to revenue on products recognized over-time.
Cash provided by operating activities for the year ended December 31, 2019 included: (i) a decrease in Inventories of $37.5 million to better align with operations; (ii) a decrease in Accounts payable of $24.5 million driven by reductions in the quantity and price of metal purchases; and (iii) a decrease in Trade and other receivables of $20.2 million driven primarily by improved collection efforts and a lower metal price.
See Statements of Consolidated Cash Flows included in this Report for further details on our cash flows from operating, investing and financing activities for the years ended December 31, 2020 and December 31, 2019.
Sources of Liquidity
We believe our available cash and cash equivalents, borrowing availability under the Revolving Credit Facility and funds generated from operations are our most significant sources of liquidity, and that our Revolving Credit Facility and unsecured notes have covenants that allow us to operate our business with limited restrictions and significant flexibility for the foreseeable future. While we believe these sources will be sufficient to finance our working capital requirements, planned capital expenditures, investments, debt service obligations and other cash requirements (including the pending Warrick Rolling Mill acquisition and acquisition-related costs) for at least the next twelve months, and while we also believe that alternative sources of liquidity will remain available in the event we seek to add liquidity for opportunistic or other reasons in the future, our ability to fund such cash requirements will depend upon our future operating performance (which will be affected by prevailing economic conditions) and financial, business and other factors, some of which are beyond our control.
We do not believe that covenants contained in the Revolving Credit Facility are reasonably likely to limit our ability to raise additional debt or equity should we choose to do so during the next 12 months, nor do we believe it is likely that during the next 12 months we will trigger the availability threshold that would require measuring and maintaining a fixed charge coverage ratio.
See Note 9 of Notes to Consolidated Financial Statements included in this Report for a description of our Revolving Credit Facility.
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Debt
See “Contractual Obligations, Commercial Commitments and Off-Balance Sheet Arrangements - Contractual Obligations and Commercial Commitments” below for mandatory principal and cash interest payments on the outstanding borrowings under the 4.625% Senior Notes and 6.50% Senior Notes. See Note 9 of Notes to Consolidated Financial Statements included in this Report for further details with respect to the 4.625% Senior Notes, 6.50% Senior Notes and the redemption of our 5.875% Senior Notes due 2024 (“5.875% Senior Notes”).
We do not believe that covenants in the indenture governing the 4.625% Senior Notes and 6.50% Senior Notes are reasonably likely to limit our ability to obtain additional debt or equity financing should we choose to do so during the next 12 months.
Capital Expenditures and Investments
We strive to strengthen our competitive position across our end markets through strategic capital investment. Significant investments over the past decade have positioned us well with increased capacity and expanded manufacturing capabilities while more recent capital projects have focused on further enhancing manufacturing cost efficiency, improving product quality and promoting operational security, which we believe are critical to maintaining and strengthening our position in an increasingly competitive market environment. A significant portion of our capital spending over the past several years related to the modernization project at our Spokane, Washington (“Trentwood”) facility, which focused on equipment upgrades throughout the process flow to reduce conversion costs, increase efficiency and further improve our competitive cost position on all products produced at our Trentwood facility. In addition, a significant portion of the investment also focused on modernizing legacy equipment and the process flow for thin gauge plate to achieve KaiserSelect® quality enhancements for these Aero/HS and GE products. These improvements have allowed us to gain incremental manufacturing capacity to enable future sales growth. Total capital expenditures were $51.9 million and $60.2 million for 2020 and 2019, respectively.
On November 30, 2020, we entered into a Purchase Agreement with Alcoa to purchase the Warrick Rolling Mill for a purchase price of approximately $670.0 million, consisting of approximately $587.0 million in cash and approximately $83.0 million of assumed other post-employment benefits liabilities. The transaction is anticipated to close on or about March 31, 2021. The Warrick Rolling Mill acquisition is subject to a number of closing conditions and there can be no assurance that such conditions will be satisfied or that we will be able to complete the Warrick Rolling Mill acquisition within the planned timeframe or at all. See Note 4 of Notes to Consolidated Financial Statements included in this Report for additional information.
As a response to the COVID-19 pandemic and in order to preserve liquidity, in April 2020 we adjusted our capital spending plans to focus on critical sustaining projects and modest investment opportunities to further support our automotive growth and enhance efficiencies throughout our operations. As such, our $375.0 million multi-year expansion and operational security investment project at our Trentwood facility has been deferred pending changes in market conditions and demand for our Aero/HS products. We anticipate that total capital spending in 2021 will be approximately $50.0 million to $60.0 million primarily focused on sustaining capital investment, with some growth projects expected to be implemented as our key markets improve. We will reassess our capital expenditure requirements for organic growth opportunities in our served markets for capacity, quality and efficiency after we have completed the acquisition of the Warrick Rolling Mill.
Capital investments will be funded using cash generated from operations, available cash and cash equivalents, short-term investments, borrowings under the Revolving Credit Facility and/or other third-party financing arrangements. The level of anticipated capital expenditures may be adjusted from time to time depending on our business plans, our price outlook for fabricated aluminum products, our ability to maintain adequate liquidity and other factors. No assurance can be provided as to the timing of any such expenditures or the operational benefits expected therefrom.
Dividends
We have consistently paid a quarterly cash dividend since the second quarter of 2007 to holders of our common stock, including holders of restricted stock, and have increased the dividend in each year since 2011. Nevertheless, as in the past, the future declaration and payment of dividends, if any, will be at the discretion of our Board of Directors and will depend on a number of factors, including our financial and operating results, financial position and anticipated cash requirements and contractual restrictions under our Revolving Credit Facility, the indentures for our 4.625% Senior Notes and 6.50% Senior Notes or other indebtedness we may incur in the future. We can give no assurance that dividends will be declared and paid in the future.
We also pay quarterly dividend equivalents to the holders of certain restricted stock units. Holders of performance shares are not paid a quarterly dividend equivalent, but instead are entitled to receive, in connection with the issuance of underlying shares of common stock for performance shares that ultimately vest, a one-time payment equal to the dividends such holder would have received if the number of such shares of common stock so issued had been held of record by such holder from the date of grant of such performance shares through the date of such issuance.
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See our Statements of Consolidated Stockholders’ Equity andNote 18 of Notes to Consolidated Financial Statements included in this Report for information regarding dividends declared during 2020 and 2019 and subsequent to December 31, 2020.
Repurchases of Common Stock
In response to prevailing economic conditions, we suspended repurchases of common stock as of March 18, 2020.
See our Statements of Consolidated Stockholders’ Equity included in this Report for information regarding: (i) repurchases of common stock in 2020 and 2019; (ii) the amounts authorized and available for future repurchases of common stock under our stock repurchase program; and (iii) minimum statutory tax withholding obligations arising during 2020 and 2019 in connection with the vesting of non-vested shares, restricted stock units and performance shares.
Environmental Commitments and Contingencies
See Note 10 of Notes to Consolidated Financial Statements included in this Report for information regarding our environmental commitments and contingencies.
Contractual Obligations, Commercial Commitments and Off-Balance Sheet Arrangements
Contractual Obligations and Commercial Commitments
The following table and discussion summarizes our significant contractual obligations and commercial commitments as of December 31, 2020 (in millions of dollars):
Payments Due by Period
Total Less than 1 year 1-3 years 3-5 years More than 5 years
On-Balance Sheet:
Standby letters of credit 7.8 6.7 1.1 — —
Employer payroll tax deferrals 7.0 3.5 3.5 — —
Uncertain tax liabilities 1.8 — — — —
Deferred compensation plan liability 9.6 — — — —
Salaried VEBA variable contributions 1.7 1.7 — — —
Off-Balance Sheet:
VEBA administrative fees 1.5 0.3 0.6 0.6 —
Commitment fees on Revolving Credit Facility 3.6 0.9 1.9 0.8 —
Principal and Interest on 4.625% Senior Notes and 6.50% Senior Notes. Cash outlays related to our 4.625% Senior Notes and 6.50% Senior Notes consist of our principal obligations and interest obligations based on scheduled interest payments.
Standby Letters of Credit. The $7.8 millionrepresents letters of credit issued under our Revolving Credit Facility. The letters of credit provide financial assurance of our payment of obligations, primarily related to workers’ compensation. The specific timing of payments with respect to such matters is uncertain. The letters of credit generally automatically renew every 12 months and terminate when the underlying obligations no longer require assurance or upon the maturity of our Revolving Credit Facility in October 2024.
Employer Payroll Tax Deferrals. As of December 31, 2020, we recognized $7.0 millionin employer payroll tax deferrals under the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), of which, 50% will be paid in 2021 and 50% will be paid in 2022.
Uncertain Tax Liabilities. At December 31, 2020, we had uncertain tax positions which ultimately could result in tax payments. As the amount of ultimate tax payments beyond 2020 is contingent on the tax authorities’ assessment, it is not practical to present annual payment information.
33
Deferred Compensation Plan Liability. The deferred compensation liability amount relates to our deferred compensation plan for certain key employees. As the distribution amount is contingent upon investment performance, vesting and other eligibility requirements, including retirement dates, it is not practical to present annual payment information unless timing of disbursement is known.
Operating Leases. Operating lease liabilities represent multi-year obligations for certain manufacturing facilities, warehouses, office space and equipment.
Finance Leases. Finance lease liabilities represent non-cancelable capital commitments as of December 31, 2020. We expect finance leases to be funded through available cash generated from our operations, cash and cash equivalents, borrowings under our Revolving Credit Facility and/or other third-party financing arrangements.
Salaried VEBA Variable Contributions. See Note 5 of Notes to Consolidated Financial Statements included in this Report for additional information regarding our variable cash contributions to the voluntary employees’ beneficiary association (“VEBA”) that provides benefits for certain eligible retirees and their surviving spouses and eligible dependents (“Salaried VEBA”).
VEBA administrative fees. We are required to pay $0.3 million in annual administrative fees related to the VEBA that provides benefits for eligible retirees represented by certain unions and their surviving spouses and eligible dependents through September 2025.
Purchase Obligations. Cash outlays for purchase obligations consist primarily of commitments to purchase primary aluminum, recycled scrap aluminum, other metals, energy and equipment. We have various contracts with suppliers of metals that require us to purchase minimum quantities of these metals in future years at a price to be determined at the time of purchase based primarily on the underlying metal price at that time. Amounts included in the table are based on minimum required purchase quantities at the metal price at December 31, 2020. We believe the minimum required purchase quantities are lower than our current requirements for these metals. Actual quantities and actual metal prices at the time of purchase could be different. Physical delivery commitments with energy companies are in place to cover our exposure to fluctuations in electricity and natural gas prices and are based on fixed contractual rates and quantities. Equipment purchase obligations are based on scheduled payments to equipment manufacturers.
Commitment Fees on Revolving Credit Facility. Future commitment fees on our Revolving Credit Facility are estimated based on the amount of unused credit under the facility at December 31, 2020 and assuming no extension of terms beyond the current maturity date of our Revolving Credit Facility, which is in October 2024. No borrowings were outstanding under our Revolving Credit Facility either throughout the year or as of December 31, 2020.
Other Off-Balance Sheet Arrangements
In addition to our off-balance sheet items discussed in the “Contractual Obligations and Commercial Commitments” section above:
Critical Accounting Estimates and Policies
Our consolidated financial statements are prepared in accordance with GAAP. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenue and expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates and such differences could be material.
In addition to the accounting estimates we discuss in Note 1 of Notes to Consolidated Financial Statements included in this Report, management believes that the following accounting estimates are critical to aid in fully understanding and evaluating our reported financial results and require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effects of matters that are inherently uncertain. Management has reviewed these critical accounting estimates and related disclosures with the Audit Committee of our Board of Directors.
34
Revenue Recognition.
35
Income Tax.
36
Acquisitions, Goodwill and Intangible Assets.
New Accounting Pronouncements
For a discussion of all recently adopted and recently issued but not yet adopted accounting pronouncements, see Note 1 of Notes to Consolidated Financial Statements included in this Report.
Item 7A.Quantitative and Qualitative Disclosures About Market Risk
Our operating results are sensitive to changes in the prices of primary aluminum, certain alloying metals, natural gas and electricity, and also depend to a significant degree upon the volume and mix of products sold to customers. As discussed more fully in Note 8 of Notes to Consolidated Financial Statements included in this Report, we have historically utilized hedging transactions to lock in a specified price or range of prices for certain products which we sell or consume in our production process, and to mitigate our exposure to changes in energy prices.
Aluminum
See Note 8 of Notes to Consolidated Financial Statements included in this Report for a discussion of our pricing of fabricated aluminum, firm-price arrangements and third-party hedging instruments.
In 2020 and 2019, settlements of derivative contracts covering 127.6 million pounds and 182.4 million pounds, respectively, hedged shipments sold on pricing terms that created metal price risk for us. At December 31, 2020, we had derivative contracts with respect to approximately 45.1 million pounds and 21.5 million pounds to hedge sales to be made in 2021 and 2022, respectively, on pricing terms that create metal price risk for us.
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Based on the aluminum derivative positions held by us to hedge firm-price customer sales agreements, we estimate that a $0.10per pound decrease in the London Metal Exchange (“LME”) market price of aluminum as of December 31, 2020andDecember 31, 2019, with all other variables held constant, would have resulted in an unrealized mark-to-market loss of $6.7 millionand$10.4 million, respectively, with corresponding changes to the net fair value of our aluminum derivative positions. Additionally, we estimate that a $0.01 per pound decrease in the Midwest premium for aluminum as of December 31, 2020 and December 31, 2019, with all other variables held constant, would have resulted in an unrealized mark-to-market loss of $0.7 million and $0.9 million, respectively, with corresponding changes to the net fair value of our aluminum derivative positions.
Alloying Metals
We are exposed to the risk of fluctuating prices of certain alloying metals, especially copper and zinc, to the extent that changes in their prices do not highly correlate with price changes for aluminum. Copper, zinc and certain other metals are used in our remelt operations to cast rolling ingot and extrusion billet with the proper chemistry for our products. From time to time, we enter into forward contract swaps with third parties to mitigate our risk from fluctuations in the prices of copper and zinc (“Alloying Metals”). As of December 31, 2020, we had forward swap contracts with settlement dates designed to align with the timing of scheduled purchases of Alloying Metals by our manufacturing facilities. See Note 8 of Notes to Consolidated Financial Statements included in this Report for additional information relating to these hedges. We estimate that a $0.10 per pound decrease in the LME market price of zinc as of December 31, 2020 and December 31, 2019, with all other variables held constant, would have resulted in an unrealized mark-to-market loss of $0.3 million and $1.0 million, respectively, with corresponding changes to the net fair value of our Alloying Metals hedges. We estimate that a $0.10 per pound decrease in the COMEX market price of copper as of December 31, 2020 and December 31, 2019, with all other variables held constant, would have resulted in an unrealized mark-to-market loss of $0.3 million and $0.6 million, respectively, with corresponding changes to the net fair value of our Alloying Metals hedges.
Energy
We are exposed to risk of fluctuating prices for natural gas and electricity. We, from time to time, in the ordinary course of business, enter into hedging transactions and/or physical delivery commitments with firm prices with third parties to mitigate our risk from fluctuations in natural gas and electricity prices.
See Note 8 of Notes to Consolidated Financial Statements included in this Report for information regarding the volume of our derivative and physical delivery commitments with energy companies in place to cover our exposure to fluctuations in natural gas and electricity prices as of December 31, 2020. We estimate that a $1.00 per mmbtu decrease in natural gas prices as of December 31, 2020 and December 31, 2019 would have resulted in an unrealized mark-to-market loss of $6.6 million and $8.6 million, respectively, with corresponding changes to the net fair value of our natural gas derivative positions. We estimate that a $5.00 per Mwh decrease in electricity prices as of December 31, 2020 and December 31, 2019, would have resulted in an unrealized mark-to-market loss of $2.4 millionas of each period, respectively, with corresponding changes to the net fair value of our electricity derivative positions.
Foreign Currency
Our primary foreign exchange exposure is the operating costs of our London, Ontario facility. We estimate that a 10% change in the Canadian dollar exchange rate as of December 31, 2020 and December 31, 2019 would have resulted in an annual operating cost impact of $1.7 million and $1.8 million, respectively.
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KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
Item 8.Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm 40
Consolidated Balance Sheets 43
Statements of Consolidated Income 44
Statements of Consolidated Comprehensive Income 45
Statements of Consolidated Stockholders’ Equity 46
Statements of Consolidated Cash Flows 47
Notes to Consolidated Financial Statements 48
39
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of
Kaiser Aluminum Corporation
Foothill Ranch, California
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Kaiser Aluminum Corporation and subsidiaries (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”). We also have audited the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.
Change in Accounting Principle
As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for leases in 2019 due to the adoption of Accounting Standards Update No. 2016-02, Leases (Topic 842).
Basis for Opinion
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (CONTINUED)
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Revenue Recognition—Refer to Note 1 to the financial statements
Critical Audit Matter Description
The Company recognizes revenue as it fulfills their performance obligations and transfers control of products to its customers. For products that have no alternative use and for which the Company has an enforceable right to payment (including a reasonable profit) throughout the production process, revenue is recognized over time. In general, a majority of the Company’s revenue for Aero/HS products and Automotive Extrusions are recognized over time, with the revenue for the remainder of its products recognized at a point in time. For contracts recognized over time, control transfer occurs incrementally during the Company’s production process as progress is made on fulfilling the performance obligation. The Company uses the input method of determining the progress, capturing direct costs beginning at the point that billet or cast ingot is introduced into production at either the extrusion phase or the rolling phase, respectively. For products in production, the Company recognizes revenue using the cost incurred to date plus an estimate of reasonable margin. As of December 31, 2020, net sales were $1,172.7 million, of which $481.8 million was recognized over time.
Given the volume of contracts that are recognized over time and the complexity of the determination of over time revenue, we identified revenue for over time contracts as a critical audit matter.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to revenue recognized over time, included the following, among others:
• We selected a sample of contracts with customers and performed the following:
Environmental Contingencies—Refer to Notes 1 and 10 to the financial statements
Critical Audit Matter Description
The Company is subject to a number of environmental laws and regulations, to potential fines or penalties assessed for alleged breaches of such laws and regulations and to potential claims based upon such laws and regulations. The Company records an environmental loss contingency whenever a contingency is probable and reasonably estimable. At December 31, 2020, the Company’s $18.7 million accrual for expected environmental costs is included in other accrued liabilities and long-term liabilities and represents the Company’s undiscounted estimate of costs reasonably expected to be incurred based on presently enacted laws and
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM (CONTINUED)
regulations, existing requirements, currently available facts, existing technology and its assessment of the likely remediation actions to be taken.
We identified environmental contingencies as a critical audit matter because auditing management’s estimate of the costs reasonably expected to be incurred for environmental contingencies involved especially subjective judgment and an increased extent of audit procedures, including the need to involve environmental specialists.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management’s estimate of the costs reasonably expected to be incurred for environmental contingencies included the following, among others:
o Information obtained directly from public domain searches.
/s/ Deloitte & Touche LLP
Costa Mesa, California
February 25, 2021
We have served as the Company’s auditor since 2002.
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KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEETS
As of December 31,
(In millions of dollars, except share and per share amounts)
ASSETS
Current assets:
Cash and cash equivalents $ 780.3 $ 264.3
Short-term investments — 78.7
Receivables:
Prepaid expenses and other current assets 28.6 19.4
Property, plant and equipment, net 627.2 622.0
Operating lease assets 26.5 25.8
Deferred tax assets, net — 11.8
Intangible assets, net 26.7 29.6
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accrued salaries, wages and related expenses 30.8 34.4
Other accrued liabilities 41.4 44.0
Long-term portion of operating lease liabilities 25.6 25.2
Net liabilities of Salaried VEBA 17.8 32.6
Deferred tax liabilities 13.9 4.5
Long-term liabilities 78.6 67.0
Commitments and contingencies – Note 10
Stockholders' equity:
Accumulated other comprehensive loss (18.7 ) (38.6 )
The accompanying notes to consolidated financial statements are an integral part of these statements.
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KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
STATEMENTS OF CONSOLIDATED INCOME
Year Ended December 31,
(In millions of dollars, except share and per share amounts)
Costs and expenses:
Selling, general, administrative, research and development 91.2 98.0 96.3
Goodwill impairment — 25.2 —
Restructuring costs 7.5 — —
Other operating (income) charges, net (0.6 ) 0.9 1.4
Other expense:
Other expense, net – Note 13 (1.4 ) (20.7 ) (0.9 )
Net income per common share:
Weighted-average number of common shares outstanding (in thousands):
The accompanying notes to consolidated financial statements are an integral part of these statements.
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KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
STATEMENTS OF CONSOLIDATED COMPREHENSIVE INCOME
Year Ended December 31,
(In millions of dollars)
Other comprehensive income (loss), net of tax – Note 11:
Defined benefit pension plan and Salaried VEBA 13.4 2.4 2.9
Available for sale securities (0.3 ) — (0.6 )
Foreign currency translation 0.1 — (0.1 )
Other comprehensive income (loss), net of tax 19.9 10.2 (11.7 )
The accompanying notes to consolidated financial statements are an integral part of these statements.
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KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
STATEMENTS OF CONSOLIDATED STOCKHOLDERS’ EQUITY
(In millions of dollars, except share and per share amounts)
Cumulative-effect adjustment1 — — — 10.7 — (0.4 ) 10.3
Other comprehensive loss, net of tax — — — — — (11.7 ) (11.7 )
Cash dividends declared3 — — — (37.7 ) — — (37.7 )
Amortization of unearned equity compensation — — 10.1 — — — 10.1
Other comprehensive income, net of tax — — — — — 10.2 10.2
Cash dividends declared3 — — — (39.4 ) — — (39.4 )
Amortization of unearned equity compensation — — 9.5 — — — 9.5
Other comprehensive income, net of tax — — — — — 19.9 19.9
Cash dividends declared3 — — — (43.4 ) — — (43.4 )
Amortization of unearned equity compensation — — 9.6 — — — 9.6
The accompanying notes to consolidated financial statements are an integral part of these statements.
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KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
STATEMENTS OF CONSOLIDATED CASH FLOWS
Year Ended December 31,
(In millions of dollars)
Cash flows from operating activities:
Depreciation of property, plant and equipment 49.3 46.3 42.1
Amortization of definite-lived intangible assets 2.9 2.8 1.8
Amortization of debt premium and debt issuance costs 2.0 1.2 1.0
Non-cash equity compensation 10.0 9.8 10.3
Non-cash asset impairment charges 0.5 26.1 1.4
Loss on extinguishment of debt — 20.3 —
Loss (gain) on disposition of property, plant and equipment 0.2 — (0.2 )
Gain on disposition of short-term investments (0.7 ) (0.9 ) (2.9 )
Non-cash defined benefit net periodic postretirement benefit cost 5.2 7.0 6.6
Other non-cash changes in assets and liabilities (1.8 ) 8.6 21.9
Changes in operating assets and liabilities:
Prepaid expenses and other current assets (3.2 ) (1.7 ) (0.4 )
Accrued liabilities (3.9 ) (7.5 ) (2.6 )
Annual variable cash contributions to VEBAs (2.9 ) (2.1 ) (15.7 )
Long-term assets and liabilities, net 6.3 5.8 (4.1 )
Cash flows from investing activities1:
Purchase of short-term investments (39.1 ) (132.2 ) (135.2 )
Purchase of equity securities (0.5 ) (0.7 ) (0.9 )
Proceeds from disposition of short-term investments 118.1 91.1 283.9
Proceeds from disposal of property, plant and equipment 0.3 0.2 0.6
Net cash provided by (used in) investing activities 26.9 (101.8 ) 31.1
Cash flows from financing activities1:
Issuance of 4.625% Senior Notes — 500.0 —
Issuance of 6.50% Senior Notes 350.0 — —
Cash paid for debt issuance costs (6.2 ) (8.8 ) —
Repayment of finance lease (1.7 ) (1.4 ) (0.7 )
Repurchase of common stock (12.5 ) (44.2 ) (60.7 )
Cash dividends and dividend equivalents paid (43.4 ) (39.4 ) (37.7 )
Net cash provided by (used in) financing activities 281.9 8.5 (106.0 )
1 See Note 16 for supplemental disclosure of cash flow information.
The accompanying notes to consolidated financial statements are an integral part of these statements.
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Notes Index
KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTES INDEX
Note Page
Note 1 Summary of Significant Accounting Policies 49
Note 2 Supplemental Balance Sheet Information 54
Note 3 Leases 54
Note 4 Business Combinations, Goodwill and Intangible Assets 56
Note 5 Employee Benefits 57
Note 6 Multiemployer Pension Plans 62
Note 7 Employee Incentive Plans 63
Note 8 Derivatives, Hedging Programs and Other Financial Instruments 65
Note 9 Debt and Credit Facility 70
Note 10 Commitments and Contingencies 72
Note 11 Accumulated Other Comprehensive (Loss) Income 75
Note 12 Restructuring 76
Note 13 Other Expense, Net 76
Note 14 Income Tax Matters 77
Note 15 Net Income Per Share 79
Note 16 Supplemental Cash Flow Information 80
Note 18 Subsequent Events 81
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Notes Index
KAISER ALUMINUM CORPORATION AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
In this Annual Report on Form 10-K (this “Report”), unless the context otherwise requires, references in these notes to consolidated financial statements to “Kaiser Aluminum Corporation,” “we,” “us,” “our,” “the Company” and “our Company” refer collectively to Kaiser Aluminum Corporation and its subsidiaries.
Organization and Nature of Operations. Kaiser Aluminum Corporation specializes in the production of semi-fabricated specialty aluminum mill products, such as aluminum plate and sheet and extruded and drawn products, for the following end market applications: (i) aerospace and high strength (“Aero/HS products”); (ii) automotive (“Automotive Extrusions”); (iii) general engineering (“GE products”); and (iv) and other industrial (“Other products”). Our business is organized into one operating segment. See Note 17 for additional information regarding our business, product and geographical area information and concentration of risk.
Principles of Consolidation and Basis of Presentation. Our consolidated financial statements include the accounts of our wholly owned subsidiaries and are prepared in accordance with United States generally accepted accounting principles (“GAAP”) and the rules and regulations of the Securities and Exchange Commission (“SEC”). Intercompany balances and transactions are eliminated.
Coronavirus Disease 2019 (“COVID-19”) Pandemic. Beginning in March 2020, the COVID-19 pandemic significantly impacted our industry, causing demand for our products, primarily in our aerospace and automotive end markets, to decline. We instituted operational measures in response to financial impacts caused by the reduced demand. In March 2020, we suspended repurchases of our common stock. During the quarter ended June 30, 2020, we: (i) began limiting capital spending to critical sustaining projects (see Note 2 for discussion of idled projects); (ii) early settled firm commitments with corresponding fair value hedges and reduced forecasts with respect to purchase transactions with corresponding cash flow hedges (see Note 8 ); (iii) settled all outstanding available for sale securities (see Note 8); (iv) issued $350.0 million of new unsecured senior notes (see Note 9); and (v) initiated a plan of restructuring (see Note 12).
Use of Estimates in the Preparation of Financial Statements. 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 our consolidated financial statements; accordingly, it is possible that the actual results could differ from these estimates and assumptions, which could have a material effect on the reported amounts of our consolidated financial position and results of operations. The severity, magnitude and duration, as well as the economic consequences of the COVID-19 pandemic, are uncertain, rapidly changing and difficult to predict. Therefore, our accounting estimates and assumptions may change over time in response to the COVID-19 pandemic and may change materially in future periods.
Fair Value Measurements. We apply the fair value hierarchy established by GAAP for the recognition and measurement of certain financial assets and liabilities. An asset or liability’s fair value classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. In determining fair value, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible and consider counterparty risk in our assessment of fair value.
We also review the underlying inputs that are significant to the fair value measurement of financial instruments to determine if a transfer among hierarchy levels is appropriate. We historically have not had significant transfers into or out of each hierarchy level.
Financial assets and liabilities that we measure at fair value each period include our derivative instruments, equity investments related to our deferred compensation plan and debt investment securities classified as available for sale securities (see Note 5 and Note 8). Additionally, we measure at fair value once each year at December 31 our Canadian defined benefit pension plan and the plan assets of the Salaried VEBA (defined in Note 5). In determining the fair value of the plan assets at an annual period end, we utilize primarily the results of valuations supplied by the investment advisors responsible for managing the assets of each plan, which we independently review for reasonableness. We record our remaining financial assets and liabilities at carrying value.
Goodwill is tested for impairment during the fourth quarter on an annual basis, as well as on an interim basis, as warranted, at the time of relevant events and changes in circumstances. Intangible assets with definite lives are initially recognized at fair value and subsequently amortized over the estimated useful lives to reflect the pattern in which the economic benefits of the intangible assets are consumed. In the event the pattern cannot be reliably determined, we use a straight-line amortization method. Whenever events or changes in circumstances indicate that the carrying amount of the intangible assets may not be recoverable, the intangible assets are reviewed for impairment. See Note 4 for a discussion of our business acquisition in 2018 and the goodwill impairment charges we recorded during 2019.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For a majority of our remaining non-financial assets and liabilities, which include inventories, debt issuance costs and property, plant and equipment, we are not required to measure their fair value on a recurring basis. However, if certain triggering events occur, an evaluation of the affected non-financial asset or liability will be required, which could result in a reduction to the carrying amount of such asset or liability. See “Property, Plant and Equipment, Net” below for a discussion of impairment charges on idled assets recorded during 2020, 2019 and 2018.
Cash and Cash Equivalents. We consider only those short-term, highly liquid investments which, when purchased, have maturities of 90 days or less to be cash equivalents. Our cash equivalents consist primarily of funds in commercial paper, money market funds and other highly liquid investments, which are classified within Level 1 of the fair value hierarchy with the exception of commercial paper, which is classified within Level 2 of the fair value hierarchy (see Note 8).
Restricted Cash. We are required to keep on deposit certain amounts that are pledged or held as collateral relating to workers’ compensation and other agreements. We account for such deposits as restricted cash (see Note 16). From time to time, such restricted funds could be returned to us or we could be required to pledge additional cash.
Available for Sale Securities. We account for investments in certain marketable debt securities as available for sale securities. Such securities are recorded at fair value (see Note 8), with net unrealized gains and losses, net of income taxes, reflected in Accumulated other comprehensive loss as a component of Stockholders’ equity. Realized gains and losses from the sale of marketable debt securities, if any, are determined on a specific identification basis. Debt investment securities with an original maturity of 90 days or less are classified as Cash and cash equivalents (see Note 2). Debt investment securities with an original maturity of greater than 90 days are presented as Short-term investments on our Consolidated Balance Sheets. In addition to debt investment securities, we also hold assets in various investment funds managed by a third-party trust in connection with our deferred compensation program (see Note 5).
Trade Receivables and Allowance for Credit Losses. Trade receivables primarily consist of amounts billed to customers for products sold. Accounts receivable are generally due within 30 to 90 days. For the majority of our receivables, we establish an allowance for credit losses based upon collection experience and other factors including, but not limited to, customer credit ratings, bankruptcy filings, published or estimated credit default rates, age of receivables, expected loss rates and collateral exposures. On certain other receivables where we are aware of a specific customer’s inability or reluctance to pay, an allowance for credit losses is established against amounts due, to reduce the net receivable balance to the amount we reasonably expect to collect. However, if circumstances change, our estimate of the recoverability of accounts receivable could be different. Circumstances that could affect our estimates include, but are not limited to, customer credit issues and general economic conditions. Accounts are written off once deemed to be uncollectible. Any subsequent cash collections relating to accounts that have been previously written off are typically recorded as a reduction to total bad debt expense in the period of payment. Write-offs for 2020, 2019 and 2018 were immaterial to our consolidated financial statements.
Inventories. Inventories are stated at the lower of cost or market value. Finished products, work-in-process and raw material inventories are stated on the last-in, first-out (“LIFO”) basis. At December 31, 2020 and December 31, 2019, the cost of our inventory on a first-in, first-out (“FIFO”) basis, which approximates the current replacement cost, exceeded its stated LIFO value by $8.4 million and $11.9 million, respectively. During the year ended December 31, 2020, we decremented a prior year, lower cost LIFO layer, which resulted in a benefit of $0.2 million. During the year ended December 31, 2019, we decremented a prior year, higher cost LIFO layer which resulted in a charge of $3.6 million. Other inventories are stated on the FIFO basis and consist of operating supplies, which are materials and supplies to be consumed during the production process. 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 (see Note 2 for the components of inventories).
Replacement Parts. Replacement parts consist of preventative maintenance and capital spare parts, which are stated on the FIFO basis. Replacement parts are recorded within Prepaid expenses and other current assets or Other assets depending on whether or not the expected utilization of the replacement parts is to occur within the next 12 months.
Property, Plant and Equipment, Net. Property, plant and equipment, net, is recorded at cost and includes construction in progress (see Note 2). Interest related to the construction of qualifying assets is capitalized as part of the construction costs. The amount of interest expense capitalized as construction in progress was $1.0 million, $1.6 million and $1.7 million during 2020, 2019 and 2018, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Depreciation is computed using the straight-line method at rates based on the estimated useful lives of the various classes of assets. Finance lease assets and leasehold improvements are amortized on a straight-line basis over the shorter of the estimated useful lives of the assets or the lease term. The estimated useful lives are as follows:
Range (in years)
Land improvements 3-25
Buildings and leasehold improvements 2-45
Machinery and equipment 1-22
Finance lease assets 1-10
Depreciation expense is not included in Cost of products sold, but is included in Depreciation and amortization.
Property, plant and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset or group of assets may not be recoverable. We regularly assess whether events and circumstances with the potential to trigger impairment have occurred and rely on a number of factors, including operating results, business plans, economic projections and anticipated future cash flow, to make such assessments. We use an estimate of the future undiscounted cash flows of the related asset or asset group over the estimated remaining life of such asset(s) in measuring whether the asset(s) are recoverable.
We recorded impairment charges of $0.5 million, $0.9 million and $1.4 million in 2020, 2019 and 2018, respectively, to reflect the scrap value of idled assets we determined not to deploy for future use. Asset impairment charges are included in Other operating (income) charges, net, in our Statements of Consolidated Income.
We classify assets as held for sale only when an asset is being actively marketed and expected to sell within 12 months. Assets held for sale are initially measured at the lesser of the assets’ carrying amount and the fair value less costs to sell.
Derivative Financial Instruments. Consistent with guidelines established by management and approved by our Board of Directors, we use derivative financial instruments to mitigate our exposure to changes in the market price of aluminum, certain alloying metals, energy and, to a lesser extent, foreign currency exchange rates. We do not use derivative financial instruments for trading or other speculative purposes. Hedging transactions are executed centrally on behalf of all of our operations to minimize transaction costs, monitor consolidated net exposures and allow for increased responsiveness to changes in market factors.
We reflect the fair value of all of our derivative instruments on our Consolidated Balance Sheets. The fair value of hedges settling within one year is included in Prepaid expenses and other current assets or Other accrued liabilities. The fair value of hedges settling beyond one year is included in Other assets or Long-term liabilities. Cash flows related to all of our derivative instruments are reported in our Statements of Consolidated Cash Flows within the same category as the items being hedged. See Note 8 for additional information on our derivative financial instruments.
Self Insurance of Workers’ Compensation and Employee Healthcare Liabilities. We self-insure the majority of the costs of workers’ compensation benefits and employee healthcare benefits and rely on insurance coverage to protect us from large losses on individual claims. Workers’ compensation liabilities are based on a combination of estimates for: (i) incurred-but-not-reported claims and (ii) the ultimate expense of incurred claims. Such estimates are based on judgment, using our historical claims data and information and analysis provided by actuarial and claims advisors, our insurance carriers and other professionals. As of December 31, 2020, we revised our methodology of calculating our estimated workers’ compensation liabilities from a discounted basis to an undiscounted basis, resulting in a charge of $0.6 million and an ending liability of $29.8 million as of December 31, 2020. Our estimate for unpaid claim liabilities, gross of insurance recoverables on an undiscounted basis was $29.2 million at December 31, 2019, of which we recorded $26.6 million using a discount rate of 1.75%. Accrued liabilities for employee healthcare benefits, which are estimates of unpaid incurred medical and prescription drug costs as provided by our healthcare administrators, were $3.1 million and $3.5 million at December 31, 2020 and December 31, 2019, respectively.
Debt Issuance Costs. Costs incurred in connection with debt financing are deferred and amortized over the estimated term of the related borrowing. Such amortization is included in Interest expense and may be capitalized as part of construction in progress (see Note 9).
Conditional Asset Retirement Obligations (“CAROs”). We have CAROs at several of our manufacturing facilities. Our CAROs can be separated into two primary categories: (i) legal obligations related to the removal and disposal of asbestos and (ii) asset retirement obligations related to future lease terminations. The majority of our CAROs relate to the first category and consist of incremental costs that would be associated with the removal and disposal of asbestos (all of which is believed to be fully contained
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
and encapsulated within walls, floors, roof, piping or equipment insulation) of certain of our older facilities if such facilities were to undergo major renovation or be demolished. We estimate incremental costs for special handling, removal and disposal costs of materials that may or will give rise to CAROs and then discount the expected costs back to the current year using a credit-adjusted, risk-free rate. When it is unclear when or if CAROs will be triggered, we use probability weighting for possible timing scenarios to determine the probability-weighted liability amounts that should be recognized in our consolidated financial statements (see Note 10).
Environmental Contingencies. With respect to environmental loss contingencies, we record a loss contingency whenever a contingency is probable and reasonably estimable (see Note 10). Accruals for estimated losses from environmental remediation obligations are generally recognized no later than the completion of the remedial feasibility study. Such accruals are adjusted as information develops or circumstances change. Costs of future expenditures for environmental remediation obligations are not discounted to their present value. Accruals for expected environmental costs are included in Other accrued liabilities or Long-term liabilities, as appropriate (see Note 2). Environmental expense relating to continuing operations is included in Cost of products sold excluding depreciation and amortization and other items (“Cost of products sold” or “COGS”) in our Statements of Consolidated Income. Environmental expense relating to non-operating locations is included in Selling, general, administrative, research and development (“SG&A and R&D”) in our Statements of Consolidated Income.
Revenue Recognition. We recognize revenue as we fulfill our performance obligations and transfer control of products to our customers. For products that have an alternative use and/or for which we do not have an enforceable right to payment (including a reasonable profit) during the production process, we recognize revenue at a point in time. For products that have no alternative use and for which we have an enforceable right to payment (including a reasonable profit) throughout the production process, we recognize revenue over time. In general, a majority of our Aero/HS products and our Automotive Extrusions are recognized over time, with the remainder of our products recognized at a point in time.
For the majority of our business, contracts with customers begin when we acknowledge a purchase order for a specific customer order of product to be delivered in the near term. These purchase orders are short term in nature, although they may reference a longer term “blanket purchase order” or a “terms and conditions” agreement, both of which may span multiple years. For revenue recognized at a point in time, transfer of control usually occurs upon shipment or upon customer receipt of the product, depending on shipping terms. For contracts recognized over time, control transfer occurs incrementally during our production process as progress is made on fulfilling the performance obligation. We use the input method of determining our progress, capturing direct costs beginning at the point that billet or cast ingot is introduced into production at either the extrusion phase or the rolling phase, respectively. We believe the input method more accurately reflects the transfer of control as it represents the best information available of work completed to date for which we have an enforceable right to payment. For products in production, we recognize revenue using estimates of the cost incurred to date plus a reasonable margin. As the duration of our contracts for accounting purposes is typically less than one year, we do not present quantitative information about the aggregate transaction price allocated to unsatisfied performance obligations at the end of the reporting period.
We adjust the amount of revenue recognized on all products, regardless of timing of revenue recognition, for variable price consideration, which could include metal market price adjustments, volume rebates and sales discounts. We estimate rebate and discount values based on forecasted order data and historical payment trends for specific customers, adjusted as necessary at each reporting period. Accounts receivable is recorded when our right to consideration becomes unconditional. Payment terms for a majority of our domestic customers are 30 days after invoice date. To accommodate shipping time to overseas locations, payment terms for foreign customers are typically several weeks longer than domestic terms. As such, we do not adjust the promised amount of consideration for the effects of a significant financing component as we do not expect the period between the transfer of control of products to our customers and receipt of payment will be greater than one year.
Contract assets primarily relate to our enforceable right to consideration for work completed but not billed at the reporting date on contracts for products recognized over time. Contract assets also include amounts related to our contractual right to consideration for finished goods recognized over time that were in transit as of period end.
Incremental Costs of Obtaining a Contract. We expense the costs of obtaining a contract as incurred as the amortization period of the asset that we otherwise would have recognized is one year or less.
Shipping and Handling Activities. We account for shipping and handling activities that occur after the customer has obtained control of a product as fulfillment activities (i.e., an expense) rather than as a promised service (i.e., a revenue element).
Advertising Costs. Advertising costs, which are included in SG&A and R&D, are expensed as incurred. Advertising costs for 2020, 2019 and 2018 were $0.2 million, $0.4 million and $0.3 million, respectively.
Research and Development Costs. Research and development costs, which are included in SG&A and R&D, are expensed as incurred. Research and development costs for 2020, 2019 and 2018 were $9.1 million, $10.5 million and $9.8 million, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Major Maintenance Activities. All major maintenance costs are accounted for using the direct expensing method.
Stock-Based Compensation. Stock-based compensation in the form of service-based awards is provided to executive officers, certain employees and non-employee directors and is accounted for at fair value. We measure the cost of services received in exchange for an award of equity instruments based on the grant-date fair value of the award and the number of awards expected to ultimately vest. The grant-date fair value is determined based on the stock price on the date of grant, adjusted for expected dividends or dividend equivalents to be paid during the vesting period.
We also grant performance-based awards to executive officers and other key employees. The methodology used to value these performance-based awards is based on the nature of the performance conditions within those awards. Awards that are subject to performance conditions pertaining to total shareholder return (market-based awards) are valued on the date of grant using a Monte Carlo valuation model. The key assumptions in applying this model are an expected volatility and a risk-free interest rate. Awards with certain other performance conditions (non-market-based awards) are valued based on our stock price at the date of grant. Our non‐market-based awards have performance conditions pertaining to our cost performance, economic value added performance and adjusted EBITDA margin performance, which is measured by our adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”) as a percentage of value added revenue. Holders of performance-based awards receive a one-time payment at the time of issuance of vested shares based on the total dividends they would have received if the vested shares had been held of record from the date of grant through the date of issuance. For more information on our stock-based compensation (see Note 7).
The cost of service-based awards, including time-vested restricted stock and performance shares, is recognized as an expense over the requisite service period of the award on a straight-line basis. Adjustments to expense related to forfeitures are recorded in the period in which they occur. For performance shares with performance conditions pertaining to our cost performance, economic value added performance and Adjusted EBITDA margin performance, the related expense is updated quarterly by adjusting the estimated number of shares expected to vest based on the most probable outcome of the performance condition (see Note 7).
Adoption of New Accounting Pronouncements
ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), was issued in June 2016. Under ASU 2016-13, existing guidance on reporting credit losses for trade and other receivables and available for sale debt securities have been replaced with a new forward-looking “expected loss” model that has resulted in the earlier recognition of allowances for losses. Our adoption of ASU 2016-13 during the quarter ended March 31, 2020 using the modified retrospective transition approach did not result in a material impact on our consolidated financial statements.