ITEM 1. BUSINESS
Company Overview
We are a global leader in aluminum recycling and the production of specification alloys and a leading manufacturer of common alloy sheet. We also are a recycler of zinc and a leading U.S. manufacturer of zinc oxide and zinc dust. We possess a combination of low cost and flexible recycling and manufacturing operations. Our facilities are strategically located and well-positioned to service our customers, which include a number of the world’s largest companies in the transportation, containers and packaging, building and construction and metal distribution industries. On a pro forma basis, revenues from our aluminum operations represented 91% of our total pro forma revenues of $2.3 billion for the year ended December 31, 2004.
We offer customers a wide range of metals recycling services and specification alloy products through our aluminum and zinc production facilities, which include both U.S. and international operations. Our aluminum recycling operations convert scrap and dross (a by-product of the aluminum melting process) and deliver the recycled aluminum in molten or ingot form. Our specification alloy operations purchase and convert aluminum
scrap and other metals into molten or ingot form. Our specification alloys provide specific properties (including increased strength, formability and wear resistance), as specified by our customers for their particular applications. In addition, we recycle zinc metal for use in the manufacture of galvanized steel and produce value-added zinc products, primarily zinc oxide and zinc dust, which are used in the vulcanization of rubber products, the production of corrosion-resistant paint, and in other specialty chemical applications. For the fiscal year ended December 31, 2004, 59% of the total pounds processed by our recycling and alloy operations (formerly IMCO Recycling Inc.) total pounds processed were under “tolling” arrangements, where we convert customer-owned scrap and dross and return the recycled metal to our customers for a fee. Tolling arrangements eliminate our commodity exposure and reduce our overall working capital requirements. Our recycling and alloy production network operates 24 strategically located production plants, 19 of which are located in the United States, two in Germany, and one in each of Brazil, Mexico and Wales. For the fiscal year ended December 31, 2004, we processed 3.4 billion pounds of recycled metal, specification alloys and zinc products, which accounted for 50% of our total pro forma 2004 revenues.
We are also one of North America’s leading manufacturers of common alloy aluminum sheet, which we produce using the continuous casting process as well as the direct-chill rolling ingot casting process. Substantially all of our aluminum sheet products are tailored in response to specific customer orders, including the incorporation of value-added coatings. We sell the majority of our products to end-users for use in building and construction products, transportation equipment and automotive parts, and consumer durables, as well as to distributors. We have four production facilities located in the U.S. that provide common alloy sheet to all of the major aluminum consuming regions in the U.S. and Canada. Shipments of common alloy sheet products for the fiscal year ended December 31, 2004 on a pro forma basis, totaled 1.0 billion pounds and accounted for approximately 50% of our total pro forma 2004 revenues.
Internet Address and SEC Filings
Our Internet website address is http://www.aleris.com. We make available on our Internet website for no charge our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after the materials are electronically filed with or furnished to the Securities and Exchange Commission (SEC). The SEC also maintains a website at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants, including our company.
Aluminum Industry Overview
The U.S. aluminum industry totaled 23.3 billion pounds of shipments in 2003 (the latest year for which industry information is available). Aluminum products include flat rolled sheet, castings and extrusions, serving a multitude of end uses. World growth in aluminum use has far exceeded that of competing metals. Since 1950, aluminum use has increased by a factor of 18 while uses of copper and steel have risen by factors of 13 and three, respectively. Today, aluminum is the world’s second most widely used metal. The U.S. aluminum industry has experienced significant growth as well. Annual U.S. aluminum supply (which includes primary, recycled and imported aluminum) increased 66% from 12.7 billion pounds in 1982 to 21.1 billion pounds in 2003, a compound annual growth rate of more than 2.5%.
In the U.S., transportation, containers and packaging and building and construction are the three largest industrial segments for aluminum. In 2003, these segments accounted for about 69% of total industry shipments. Increasing aluminum content in vehicles has made the transportation segment the largest and fastest growing aluminum segment in the U.S. In 2003, transportation consumed about 33% of total shipments while containers and packaging, mainly the production of beverage cans, comprised some 21% of annual shipments and building and construction accounted for approximately 15%. Exports, consumer durables, electricity, machinery and equipment are other important segments for aluminum.
Annual U.S. Aluminum Supply
(pounds in billions)
2003 Aluminum Shipments by End Use
Aluminum has several characteristics that provide value in many diverse applications. Compared to several substitute metals, it is light-weight, has a high strength-to-weight ratio and is resistant to corrosion. These and other qualities have made aluminum the material of choice for dozens of different industries and thousands of different products.
Aluminum’s greatest advantage, however, is that it can be recycled again and again without any material decline in performance or quality. About two-thirds of all aluminum ever produced-440 million tons of a total of 680 million tons manufactured since 1886-is still in use. Recycling of aluminum provides energy savings of approximately 95% compared to the production of the primary metal, and it lowers capital equipment costs by 90%. In addition, solid wastes associated with the primary production process (like bauxite residue and spent potlinings) are avoided. Due to these benefits, annual production of recycled aluminum has increased by 69%, from 3.7 billion pounds to 6.2 billion pounds over the last two decades. U.S. primary aluminum production has declined significantly over this period as well because of increases in energy, environmental and labor costs. As a result of this decline, primary aluminum’s role in total U.S. aluminum supply has decreased while those of recycled aluminum and imports have expanded. In 2003, the primary aluminum industry accounted for 28% of total domestic aluminum supply while recycled metal provided 30% and imports provided 42% of total domestic aluminum supply.
Competitive Strengths
Leading positions in attractive industrial segments
We are a global leader in aluminum recycling and the production of specification alloys and a leading manufacturer of common alloy sheet. Aluminum industry shipments in the U.S. have grown 2.5% per annum on average since 1982. We believe aluminum’s growth prospects remain attractive due to its superior strength to weight ratio, corrosion resistance and its ability to be recycled. Furthermore, in certain industrial segments, such as transportation, aluminum is being used as a substitute for other materials. For example, the amount of aluminum used in the average automobile has increased from 166 pounds in 1991 to 290 pounds in 2004.
Additionally, annual production of recycled aluminum has increased by 69%, from 3.7 billion pounds to 6.2 billion pounds, over the last two decades. We believe the trend toward aluminum recycling will continue, driven by its energy savings and lower capital equipment costs as compared to those of primary aluminum producers, and by what we expect will be lower output from domestic primary aluminum producers. We believe we will continue to benefit from growth opportunities both in our domestic and international businesses.
Flexible, efficient processing operations
We benefit from the flexibility and efficiency of our manufacturing and recycling operations. Our recycling operations rely on a network of facilities that have rotary and reverbatory melting furnaces which are among the lowest cost and most efficient furnaces in the industry. We have significant expertise in continuous casting of aluminum, which makes us one of the industry’s lowest cost common alloy sheet manufacturers. Additionally, our flexible direct chill process enables us to produce a wide breadth of products. We believe that the vertical integration of these lower-cost, efficient operations following the merger will allow for significant operating synergies.
Scrap recycling-based business model
Unlike the majority of U.S. common alloy sheet manufacturers and global specification alloy suppliers, we have the advantage of being able to use either primary or scrap aluminum. Historically, scrap aluminum has consistently been less expensive than primary aluminum. We believe that our use of scrap aluminum will continue to offer cost advantages for our rolled products business. Furthermore, assuming primary domestic aluminum production continues to decline, our aluminum recycling and spec alloy business units will offer our customers the logistical benefits of a domestic source of aluminum supply.
Geographically well-positioned manufacturing and distribution networks
Our U.S. facilities are strategically positioned in manufacturing regions where the majority of aluminum and zinc consumers are located. Moreover, we are situated within close proximity to a number of our large customers, which gives us the ability to provide superior service, including just-in-time delivery of molten metal. Our international operations benefit from similar strategic locations. Examples of our strategic positioning include the following:
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our domestic operations are located near major aluminum producers and fabricators, diecasters, automotive companies, steel companies and other processors;
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our German operations are positioned to serve the attractive European automotive segment, which is leading the increased use of aluminum in new vehicle designs;
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our Mexican operation is located near the largest aluminum cylinder head and engine block casting facility in the Western Hemisphere; and
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our Brazilian operation is located adjacent to the largest can sheet manufacturer in Brazil.
Reduced exposure to commodity price fluctuations
Our management seeks to mitigate the impact of metal price fluctuations by:
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pursuing tolling arrangements, which eliminate exposure to aluminum and zinc price fluctuations and which accounted for 59% of the total volumes processed in our recycling and alloy business for the fiscal year ended December 31, 2004;
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using formula pricing in our rolled products business, based on a market-based primary aluminum price plus a conversion fee;
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aligning metal purchases with metal sales; and
•
hedging open market positions with the use of financial derivatives.
These techniques minimize both margin and inventory risk consistent with the need to allow for continuous operation of production facilities. Additionally, we seek to mitigate the effects of natural gas volatility through the use of financial derivatives as well as through price escalators contained in many of our long-term supply agreements with our recycling customers.
Long-term customer relationships
We have long-standing relationships with many of our largest customers including Alcoa Inc. (“Alcoa”), General Motors Corporation (“GM” or “General Motors”), Novelis, Inc., DaimlerChrysler Corporation (DaimlerChrysler), NEMAK, Integris Metals, Ken-Mac Metals, and BMW. We believe these relationships are mutually beneficial, offer us a consistent base of customer demand and allow us to plan and manage our operations more effectively. Long-term customer relationships also allow us to be more effective in handling our customers’ needs, thereby providing our customers with superior service. Our close working relationships allow us to offer just-in-time inventory management to customers serving multiple industries. We believe these mutually beneficial relationships also lead to significantly higher customer switching costs. Furthermore, as our customer base has expanded globally, a number of our long-term customers have encouraged us to expand our operations to service them.
Experienced management team with proven new senior leadership
As a result of the merger we have the benefit of talented people from each organization, many of whom have a broad base of metals industry experience, to promote best practices and achieve efficiencies and growth within our company. Additionally, we are led by an executive management team with a prior record of achievement at Noveon International, Inc., a specialty chemical company with $1.2 billion in revenues in 2003. At Noveon, from approximately 2001 to mid-2004, this management team implemented cost saving initiatives that reduced manufacturing overhead by more than $20.0 million, de-layered the organization, reduced working capital as a percentage of sales by approximately 33%, refocused capital spending and introduced a Six Sigma-based productivity initiative.
Business Strategy
Achieve operating synergies through focused integration
We expect to achieve approximately $25.0 million of annual cost savings to be fully realized within 18 to 24 months. We anticipate that we will achieve these cost savings by adopting new metals sourcing initiatives, leveraging purchasing volume, eliminating duplicative costs resulting from shared services and integrating our recycling and alloy business with our rolled products business.
Focus on productivity improvements and capacity utilization
We believe there are significant opportunities to reduce our manufacturing costs by implementing Six Sigma-based initiatives, lean manufacturing practices and expanded preventative maintenance practices. We place considerable emphasis on maximizing capacity utilization rates at our plants as a means of increasing profitability. We seek to improve capacity utilization by pursuing long-term contractual arrangements with many of our largest customers, and additional recycling opportunities with new customers. In addition, our production network enables us to reallocate processing work among our various facilities, thereby maximizing capacity utilization and balancing demand. We believe these productivity processes will also enable us to optimize working capital and increase cash flow.
Enhance business and product mix
We believe we have numerous opportunities to improve our mix of business. We will seek to enhance the capabilities of our continuous casting operations through manufacturing improvements to produce higher value common alloy sheet. We believe that increasing the range of alloys produced by this aluminum rolling process
could significantly improve our competitiveness, since it is a lower cost manufacturing technique. We also intend to continue to supply higher value alloys targeting the transportation industry, taking advantage of increasing aluminum content per vehicle. Additionally, we will seek to expand our tolling business, which allows for meaningful profit growth potential without significant investment in working capital or exposure to commodity price risk.
Expand in selected international regions
As our customer base continues to expand globally, a number of our customers have encouraged us to expand our operations into these regions as well. We plan to selectively pursue these opportunities where we are able to secure long-term processing arrangements and where we believe we can achieve attractive returns. To date, our international expansion has been tied primarily to our largest customers. For example:
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our Wales facility supports Alcoa’s adjacent rolling mill;
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our German facilities support European automotive manufacturers such as DaimlerChrysler and BMW;
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our Mexican facility supports NEMAK, the largest caster of aluminum cylinder heads and engine blocks in the Western Hemisphere; and
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our Brazilian facility supports Novelis, Inc.’s beverage can stock operations.
We will continue to pursue expansion opportunities in this disciplined, deliberate manner. One opportunity we announced in late 2004 involves establishing a new facility near Stuttgart, Germany to support DaimlerChrysler and other European customers. Additionally, we believe that the combination of our efficient furnaces and processing techniques and our low cost continuous cast technologies provides us with a highly competitive business model that we might consider exporting to emerging economies.
Opportunistically pursue acquisition targets and strategic alliances
In recent years, the aluminum industry has seen significant global consolidation among the larger, primary producing suppliers. We believe that a number of potential consolidation opportunities exist in both the rolled products and recycling and alloy businesses. We will prudently evaluate these opportunities as potential enhancements to our existing operating platforms. We will also consider strategic alliances, where appropriate, to achieve operational efficiencies or expand our product offerings.
Business Segments
Our business is organized into four reportable operating segments: aluminum recycling, rolled products, international and zinc. See Note N-“Segment Information” of the Notes to Consolidated Financial Statements.
On a pro forma basis, the percentages of total revenues by segment for the last three fiscal years were as follows:
Following is a list of each segment’s principal products and services, end uses, major customers, and competitors:
Aluminum Recycling
We offer customers a wide range of metals recycling services and specification alloy products through our aluminum production facilities. Many of our plants in this segment are located near our major customers’ facilities. The close proximity of these plants to our customers’ facilities allows us to provide deliveries of molten aluminum by customized trucks with hot metal crucibles. The molten aluminum is then poured from the crucible into the customer’s furnace, saving the customer the time and expense of re-melting ingots. This delivery method lowers our customers’ energy and capital expenses as well as metal melt loss, thereby increasing their productivity. For the fiscal year ended December 31, 2004, 66% of our aluminum recycling segment’s pounds processed were under “tolling” arrangements, where we convert customer-owned scrap and dross and return the recycled metal to our customers for a fee. Additionally, for the fiscal year ended December 31, 2004, our aluminum recycling business processed 577 million pounds of aluminum pursuant to long- term contractual arrangements, which represented approximately 17% of its total pounds processed.
Rolled Products
Our aluminum sheet products are produced using the continuous casting process at our facilities located in Uhrichsville, Ohio, and Carson, California, and by the conventional, direct-chill rolling ingot casting process at our multi-purpose aluminum rolling mill at Lewisport, Kentucky, one of the largest in North America. We operate coating lines at the Lewisport mill and at our facilities in Bedford, Ohio, and Carson, California. Other than for depot sales, which are for standard size products, substantially all of our aluminum sheet products are produced in response to specific customer orders. For the fiscal year ended December 31, 2004, on a pro forma basis, our North American industry sales of aluminum sheet products were approximately 1.0 billion pounds.
International
Our German subsidiary, VAW-IMCO, supplies specification alloys to the European automobile industry and serves other European aluminum industries from two plants which have an annual processing capacity in excess of 700 million pounds. Our Swansea, Wales, facility supplies aluminum to a variety of customers. Our facility in Pindamonhangaba, Brazil supplies Brazil’s only can sheet rolling mill and recycles used beverage cans and production scrap for a facility owned by Brazil’s largest manufacturer of aluminum cans. Our facility in
Monterrey, Mexico recycles aluminum dross and scrap under a long-term agreement with NEMAK, the largest caster of aluminum cylinder heads and engine blocks in the Western Hemisphere. Each of these facilities has an annual processing capacity of approximately 100 million pounds of aluminum.
Zinc
We recycle zinc metal for use in the manufacture of galvanized steel and produce value-added zinc products, primarily zinc oxide and zinc dust, which are used in the vulcanization of rubber products, the production of corrosion-resistant paint, and in other specialty chemical applications.
Sales and Marketing
Aluminum Recycling and International
Principal customers of these segments’ operations use recycled aluminum to produce can sheet, building, automotive and other aluminum products. Customarily, agreements with customers in the aluminum recycling industry are short term. These usually result from a bidding process where aluminum producers and metal traders offer to sell materials or to have materials tolled. Consequently, we have historically maintained no significant backlog of orders in this segment.
However, we have long-term contractual arrangements for our aluminum recycling services with a number of our largest customers in these segments. The remaining terms of these arrangements as of December 31, 2004 ranged from one year to seven years, although many of them provide for extensions. The majority of our pounds processed under long-term contractual arrangements in these segments are subject to price escalators directly related to production costs such as labor, natural gas and supplies. Many of these contractual arrangements contain provisions obligating us to indemnify the customer for certain environmental liabilities that it may incur.
Sales of our products and services are made by our dedicated U.S. and international sales force, which continues to seek long-term arrangements with customers.
See Note N-“Segment Information” to the Notes to Consolidated Financial Statements for certain financial information by geographic area.
Rolled Products
Our aluminum sheet products manufactured by this segment are sold to distributors, as well as end-users, principally for use in building and construction, transportation and consumer durables. Building and construction is the largest industry sector for our common alloy aluminum sheet products. Many of the aluminum sheet end-uses for this segment are seasonal. Demand in the building and construction and transportation sectors is generally stronger in the spring and summer seasons than in the fall and winter seasons. Such factors typically result in higher operating income in the spring and summer months.
Sales of aluminum sheet products are made through the segment’s own sales force which is strategically located to provide North American coverage. The majority of our customer sales agreements in this segment are for a term of one year or less.
Zinc
Most of our zinc products are sold directly to end-users. Most of our agreements with zinc customers are for a term of one year or less. We historically have maintained no significant backlog of orders for zinc products.
Competition
The worldwide aluminum and zinc industries are highly competitive. Aluminum also competes with other materials such as steel, plastic and glass for various applications.
Aluminum Recycling
The principal factors of competition in our aluminum recycling segment are price, metal recovery rates, proximity to customers, molten metal delivery capability, environmental and safety regulatory compliance and other types of services. Freight costs also limit the geographic areas in which we can compete effectively. Our largest domestic aluminum competitor is Wabash Alloys, a secondary aluminum processor, followed by several smaller competitors.
Rolled Products
Our aluminum rolled product business competes in the production and sale of common alloy aluminum sheet products. In the sectors in which we compete, the industry leaders include Alcoa, our company, Novelis, Quanex and Jupiter. In addition, we compete with imported products. We compete with other rolled products suppliers on the basis of quality, price, timeliness of delivery and customer service.
International
The international recycling business is highly fragmented and very competitive. However, we believe we will be able to compete effectively in certain international areas because of our processing technology.
Zinc
The principal factors of competition in the zinc segment are price, customer service and product quality. Competition is regionally focused due to high freight costs. The zinc recycling industry in the U.S. is concentrated among a small number of competitors. For zinc metal, we consider both primary and secondary zinc producers to be competitors.
Raw Materials and Supplies
Aluminum Recycling, International and Zinc
Aluminum and zinc scrap and dross represent the largest component of cost of sales for these segments. The availability and price of scrap and dross depend on a number of factors outside of our control, including general economic conditions, foreign demand for these materials and internal recycling activities by primary aluminum producers. Changes in domestic and worldwide supply and demand for aluminum and zinc scrap have had and will continue to have an effect on the prices that we pay for these raw materials.
The primary sources of aluminum scrap and dross for these segments’ activities include automotive component manufacturers, can stock producers, used beverage cans and aluminum smelters. Many of our aluminum suppliers are also our customers. We also buy aluminum scrap from metal scrap traders on the open market.
A significant portion of our zinc products are produced from zinc dross and other secondary materials provided by the galvanizing and scrap metals industries. In addition, we purchase primary zinc to produce high-grade zinc and for metals distribution purposes. We purchase our zinc raw materials from numerous suppliers. Many zinc galvanizers, which supply us with zinc raw materials, are also our customers. The availability of zinc dross is dependent upon the demand for galvanized steel, which has historically paralleled fluctuations in customer demand in the automotive, appliance and construction industries.
Rolled Products
A significant part of the aluminum metal used by this segment’s rolling mills is purchased, principally from or through aluminum scrap dealers or brokers, in the form of aluminum scrap. We believe that this segment is
one of the largest users of aluminum scrap (other than beverage can scrap) in the U.S. and that the volume of its purchases assists it in obtaining scrap at competitive prices. The remaining requirements of this segment are met with purchased primary metal, including metal produced domestically and internationally.
We have six years remaining on a 10-year supply agreement with Glencore Ltd., a leading diversified trading and industrial company, for the purchase of primary aluminum. Under the agreement, we committed to purchase a minimum of 120 million pounds of primary aluminum at current market prices from Glencore each year over the 10-year term, which began in January 2001. To date, we have met or exceeded the minimum purchase quantity for each year of the contract.
Energy Supplies
Our operations are fueled by natural gas, which represents the third largest component of our cost of sales, after metal and labor costs. We purchase the majority of our natural gas on a spot-market basis. However, in an effort to acquire the most favorable natural gas costs, we have secured some of our natural gas at fixed price commitments. We use forward contracts and options, as well as contractual price escalators, to reduce the risks associated with our natural gas requirements.
Seasonality
Many of our rolled products and aluminum recycling segment markets are seasonal. Demand in the rolled products segment is generally stronger in the spring and summer seasons due to higher demand in the building and construction and transportation markets. Our aluminum recycling segment experiences greater demand in the winter and spring seasons due to stronger automotive demand. Such factors typically result in higher operating income in the first half of the year.
Employees
As of December 31, 2004, we had a total of approximately 3,200 employees, consisting of approximately 900 employees engaged in administrative and supervisory activities and 2,300 employees engaged in manufacturing, production and maintenance functions. Collectively, approximately 1,000 of our domestic employees are covered by collective bargaining agreements. One of these agreements covering 16 employees will expire and require renegotiation in September 2005. Labor relations with employees have been satisfactory.
Environmental
Our operations are subject to federal, state, local and foreign environmental laws and regulations, which govern, among other things, air emissions, wastewater discharges, the handling, storage, and disposal of hazardous substances and wastes, the remediation of contaminated sites, and employee health and safety. Future environmental regulations may be expected to impose stricter compliance requirements on the industries in which we operate. Additional equipment or process changes at some of our facilities may be needed to meet future requirements.
We have been named as a potentially responsible party in certain proceedings initiated pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act and similar state statutes and may be named a potentially responsible party in other similar proceedings in the future. It is not anticipated that the costs incurred in connection with the presently pending proceedings will, individually or in the aggregate, have a material adverse effect on our financial condition or results of operations.
We are performing operations and maintenance (O&M) at two Superfund sites for matters arising out of past waste disposal activity associated with closed facilities. We are also under orders by agencies in four states for environmental remediation at five sites, two of which are located at our operating facilities.
Our aggregate loss contingency accrual for environmental matters was $6.4 million and $1.0 million at December 31, 2004 and 2003, respectively, which covered all environmental loss contingencies that we have determined to be probable and reasonably estimable. Although the outcome of any such matters, to the extent they exceed any applicable accrual, could have a material adverse effect on our consolidated results of operations or cash flows for the applicable period, we currently believe that any such outcome would not have a material adverse effect on our consolidated financial condition, results of operations or cash flows.
The processing of scrap generates solid waste in the form of salt cake and baghouse dust. This material is disposed of at off-site landfills or at permitted landfills at our Sapulpa, Oklahoma and Morgantown, Kentucky facilities. If salt cake were ever classified as a hazardous waste in the U.S., the costs to manage and dispose of it would increase, which could result in significant increased expenditures.
Our two landfill sites have finite lives and we incur costs related to retiring them. The amounts recognized for landfill asset retirement obligations, as of December 31, 2004, were $4.9 million for our Morgantown, Kentucky landfill and $0.8 million for our Sapulpa, Oklahoma landfill. The related asset retirement cost for each facility was capitalized as a long- lived asset (asset retirement cost), which is to be amortized over the remaining useful life of the landfills. We spent $2.4 million in 2004 and expect to spend approximately $2.5 million in 2005 for expansion of our landfill at Morgantown, Kentucky. Our accruals related to our landfills are not required by any government or court order or administrative action. See Note L-“Asset Retirement Obligations” of the Notes to Consolidated Financial Statements.
Our expected total expenditures for capital improvements regarding environmental control facilities for 2005 and 2006 are currently expected to be $7.5 million.
ITEM 2.
ITEM 2. PROPERTIES
Our production and manufacturing facilities are listed below by segment.
Segment
Location
Owned/Leased
Aluminum Recycling
Uhrichsville, Ohio
Owned
Coldwater, Michigan
Owned
Morgantown, Kentucky
Owned
Post Falls, Idaho
Owned
Shelbyville, Tennessee
Owned
Sapulpa, Oklahoma
Owned
Saginaw, Michigan
Owned
Loudon, Tennessee
Owned
Chicago Heights, Illinois
Owned
Goodyear, Arizona
Leased
Bedford, Indiana
Owned
Elyria, Ohio
Owned
Rock Creek, Ohio
Owned
Rolled Products
Lewisport, Kentucky
Owned
Uhrichsville, Ohio
Owned
Carson, California
Owned
Bedford, Ohio
Leased
International
Töging, Germany
Owned
Grevenbroich, Germany
Owned
Monterrey, Mexico
Owned
Swansea, Wales
Leased
Pindamonhangaba, Brazil
Owned
Zinc
Houston, Texas (2)
Owned
Clarksville, Tennessee
Owned
Millington, Tennessee
Owned
Coldwater, Michigan
Owned
Spokane, Washington
Leased
Substantially all of our real property, fixtures and equipment at our domestic aluminum recycling and zinc facilities are mortgaged to secure indebtedness under our 10.375% senior secured notes due 2010. See Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operation-Credit Facilities and Refinancing.”
The average operating rates for our wholly owned domestic aluminum recycling and zinc facilities for 2004, 2003 and 2002 were 84%, 73% and 79% of stated capacity. As a result of our Bedford, Indiana facility ceasing melting operations in 2001, certain of its assets were transferred to our other facilities. During 2002, we provisionally suspended operations at our Wendover, Utah facility, and during the fourth quarter of 2003, we permanently closed the facility. In addition, in August 2003, we provisionally suspended operations at our Rockwood, Tennessee plant, which we permanently closed in December 2004.
General Motors has an option to acquire our Saginaw, Michigan facility under its long-term supply agreement with us. This option is exercisable under certain conditions beginning in 2006. If the supply agreement with GM were terminated, GM would then have an option to acquire ownership of the Saginaw facility.
In Louisville, Kentucky, we currently lease approximately 26,000 square feet for our rolled products segment offices. In Irving, Texas, we currently lease approximately 40,000 square feet of office space for
financial, accounting and administrative support functions. In Houston, Texas, our zinc segment owns approximately 30,000 square feet of office space for financial and management functions for our zinc operations. We also have three zinc distribution and sales offices that we lease, which are located in Los Angeles, California, Chicago, Illinois and Pittsburgh, Pennsylvania.
In December 2004, we relocated our principal executive corporate offices to Beachwood, Ohio, and have leased approximately 20,000 square feet there for those purposes. Our aluminum recycling segment offices will also be based at that location while the rolled products segment will be moving to smaller commercial headquarters in Louisville, Kentucky in April 2005 when the current lease expires. It is anticipated that the Irving, Texas location will be consolidated to a smaller area through the course of 2005 and the remaining space is expected to be sublet.
We believe that our facilities are suitable and adequate for our operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are a party from time to time to what we believe are routine litigation and proceedings considered part of the ordinary course of our business. We believe that the outcome of such existing proceedings would not have a material adverse effect on our financial position or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
IMCO held a special meeting of stockholders on December 8, 2004. The IMCO stockholders approved the following proposals: (i) the issuance of shares of IMCO common stock to Commonwealth stockholders in connection with the Merger, (ii) the amendment to IMCO’s certificate of incorporation to increase the authorized number of shares of common stock, (iii) the IMCO 2004 Equity Incentive Plan and (iv) the IMCO 2004 Annual Incentive Compensation Plan.
The shares voted with respect to each such proposal were as follows:
1. Issuance of shares of IMCO common stock to Commonwealth stockholders in connection with the merger with Commonwealth:
For: 10,905,889
Against: 398,157
Abstain: 15,028
Broker Non-Votes: 4,276,422
2. Amendment to IMCO’s Certificate of Incorporation to increase the authorized number of shares of common stock:
For: 13,798,651
Against: 703,115
Abstain: 15,963
Broker Non-Votes: 1,077,767
3. The IMCO 2004 Equity Incentive Plan:
For: 8,080,015
Against: 3,183,925
Abstain: 55,134
Broker Non-Votes: 4,276,422
4. The IMCO 2004 Annual Incentive Compensation Plan:
For: 8,746,698
Against: 2,485,382
Abstain: 86,994
Broker Non-Votes: 4,276,422
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQU ITY SECURITIES
Our Common Stock trades on the New York Stock Exchange (trading symbol: ARS). The following table sets forth, for the fiscal quarters indicated, the high and low sales prices for our Common Stock, as reported on the New York Stock Exchange composite tape transactions from January 1, 2003 through December 31, 2004. No dividends were declared or paid for those periods.
Cash dividends and repurchases of Common Stock are currently restricted under the terms of our senior credit facilities. See Item 7 - “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources” and “-Credit Facilities and Refinancing.”
On March 1, 2005, our outstanding shares of Common Stock were held of record by 386 stockholders.
During the fourth quarter of 2004, we made no unregistered sales of our equity securities and did not repurchase any shares of our Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Our financial position and results of operations have been affected by acquisitions of facilities and companies during certain periods presented. For more information, see Note B-“Acquisitions / Joint Venture Formation” and Note G-“Long Term Debt” of the Notes to Consolidated Financial Statements. See Note P-“Goodwill” of the Notes to Consolidated Financial Statements regarding the goodwill impairment charge recorded in 2002 as a cumulative effect of an accounting change.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion of our financial condition and results of operations for the periods presented. This discussion should be read in conjunction with the financial statements and notes and other financial information appearing elsewhere or incorporated by reference in this Annual Report on Form 10-K. Our discussion of our financial condition and results of operations includes various forward-looking statements about our markets, the demand for our products and services and our projected results. These statements are based on certain assumptions that we consider reasonable. For information about these assumptions and other risks relating to our businesses and our company, you should refer to our section entitled “-Risk Factors.”
Executive Summary
We are a global leader in aluminum recycling and the production of specification alloys and a leading manufacturer of common alloy sheet. We also are a recycler of zinc and a leading U.S. manufacturer of zinc oxide and zinc dust. Our December 2004 acquisition of Commonwealth Industries, Inc. created a vertically integrated aluminum recycler and sheet manufacturer having 28 facilities worldwide with combined pro forma revenues for 2004 of $2.3 billion. Revenues from our aluminum operations represented approximately 91% of our total combined pro forma revenues for the year ended December 31, 2004.
During 2004, primarily as a result of increased worldwide demand for aluminum and zinc, our total consolidated volume of pounds of metal processed increased by 14% over 2003’s volumes, and our total consolidated revenues increased from $892.0 million in 2003 to $1.2 billion in 2004, representing a 38% increase. Total 2004 revenues were impacted by the addition of $95.1 million in December revenues from the Commonwealth acquisition. Gross profits for 2004 improved by $23.4 million, or 43%, over 2003’s gross profits.
Positive factors on Aleris’ results of operations and financial condition during 2004 included:
•
improved volumes at all business segments;
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margin improvements and more stable scrap prices due to less buying pressure on scrap supplies from foreign buyers;
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higher prevailing aluminum and zinc market prices;
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improved results from our international operations; and
•
inclusion of the results of operations from VAW-IMCO for the full year.
However, negatively impacting Aleris’ results of operations for 2004 were the following:
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fourth-quarter impairments recorded for underperforming plant facilities and the decision to permanently close our Rockwood, Tennessee facility;
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higher interest expense due to our 2003 debt refinancing and the acquisition of Commonwealth;
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amortization of the write-up of acquired inventory of Commonwealth to fair value;
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increased selling, general and administrative expenses, due principally to the full year impact of VAW-IMCO’s consolidation, compliance with regulations under the Sarbanes-Oxley Act of 2002, and costs associated with the retirement of our former chairman and chief exective officer;
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significant restructuring charges relating to the Commonwealth acquisition;
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increased income tax expense due to the establishment of a valuation allowance against certain deferred tax assets; and
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the bankruptcy of a significant customer which prohibited us from recognizing $3.2 million of revenues from shipments to this customer.
In December 2004, following our acquisition of Commonwealth, we began evaluating and reviewing our results of operations based on four reportable business segments:
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Our aluminum recycling segment represents all of our aluminum melting, processing, alloying, trading and salt cake recovery activities within the United States; within this segment are two product lines - specification alloys and aluminum recycling - which have been aggregated for financial reporting purposes into one reportable business segment. See Note N-“Segment Information” of the Notes to the Consolidated Financial Statements;
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Our international segment represents all of our aluminum melting, processing, alloying, and trading activities outside of the United States; within this segment are two reporting units - Europe and Latin America;
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Our rolled products segment manufactures aluminum sheet for distributors and end-users in the transportation, construction and consumer durables industries; and
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Our zinc segment represents all of our zinc melting, processing and trading activities.
During the fourth quarter of 2004, we determined that the future cash flows expected to be generated by our Shelbyville, Tennessee aluminum recycling facility were insufficient to support its book value and, as a result, we recorded a $3.7 million impairment charge to reduce the affected assets to their estimated fair values at December 31, 2004. In addition, we wrote down the realizable value of our Mexican dross pile by $0.7 million and we decided to permanently close our Rockwood, Tennessee aluminum recycling plant, resulting in a $0.4 million impairment charge. Both impairment charges were recorded as additional depreciation expense in the aluminum recycling segment.
As a result of the acquisition of Commonwealth, we announced plans to relocate our corporate headquarters from Irving, Texas to Beachwood, Ohio and restructure and consolidate certain duplicative administrative functions. The charges related to these restructuring initiatives, including the termination of certain executives concurrently with the completion of the merger, totaled $10.8 million. The charges cover the reduction of corporate personnel and the retirement of our former interim chief executive officer and former chief financial officer.
Interest expense was higher in 2004, as a result of the refinancing of our debt in October 2003 which resulted in higher overall indebtedness as well as higher interest rates. We expect to incur increased interest expense in 2005 due to the higher levels of indebtedness that we have incurred related to the merger. In November 2004 we issued $125 million of new senior unsecured notes to refinance indebtedness in connection with the merger. We also refinanced outstanding indebtedness under our senior revolving credit facility and amended and restated the terms of that facility. As a result, we now have additional sources of capital available for growth and for our capital expenditures. However, the terms of our new senior unsecured notes, our existing senior secured notes and our amended and restated senior revolving credit facility contain a number of provisions that impose limitations on our ability to grow and expand our businesses.
The following provides our overview of key fiscal 2004 financial metrics, for Aleris as a whole, and our four reportable business segments (in thousands, except per share amounts and percentages):
* Not applicable
(1) Reflects only one month’s results of operations because we acquired this business segment, which represented all of Commonwealth’s operations, in December 2004.
(2) Represents pounds shipped at our rolled products segment plants.
(3) Excludes unallocated general administrative expenses, interest expense, other (income) expense, net and restructuring charges.
(4) Pro forma results for this segment, or Commonwealth’s historical operations, for the twelve months ended December 31, 2004 compared to the twelve months ended December 31, 2003, were as follows:
Pro forma Rolled Product Segment (formerly Commonwealth) operating results:
Volumes (pounds) shipped
1,006,384
Year over year net % increase in total pounds shipped
28%
2004 revenues
$1,139,824
Year over year net % change in revenues
39%
Loss from continuing operations
$(2,215)
Cash and cash equivalents for the fiscal year ended December 31, 2004 totaled $17.8 million, an increase from the December 31, 2003 balance of $14.8 million. We generated positive operating cash flow of $2.1 million during 2004, primarily due to improved operating results, excluding non-cash charges.
On a combined pro forma basis, assuming that Aleris and Commonwealth had been operating together on a consolidated basis since January 1, 2003, and after giving effect to our 2004 financing transactions as if they had occurred at that time, our total pro forma revenues for 2004 would have increased over total pro forma 2003 revenues by $581.5 million, and pro forma gross profits for 2004 would have increased over pro forma 2003 gross profits by $52.5 million. However, the pro forma net loss for 2004 would have increased by $20.1 million over 2003’s pro forma net loss, principally due to merger-related costs. See, “-Effects of Merger with Commonwealth Industries, Inc.” below.
We anticipate improvement in our results of operations in 2005 as compared to pro forma 2004 results, largely driven by our rolled products segment which is expecting higher margins in 2005 compared to 2004. We are forecasting improvements in all of our business segments for 2005, assuming continued improvement in the U.S. manufacturing sector and higher metal prices in 2005.
We intend that the discussion of our financial condition and results of operations that follows will provide information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our consolidated financial statements.
For a discussion of factors that could impact our future operating results and financial condition, see the section entitled “Risk Factors” below.
Effects of Merger with Commonwealth Industries, Inc.
In December 2004, we acquired all of the outstanding common stock of Commonwealth Industries, Inc., with Commonwealth merging with an indirect wholly-owned subsidiary of Aleris. We also changed our name from IMCO Recycling Inc. to Aleris International, Inc. The merger created a vertically integrated aluminum recycler and sheet manufacturer with combined pro forma revenues for 2004 in excess of $2 billion, approximately 3,200 employees and 28 facilities worldwide. Our corporate headquarters are now located in Beachwood, Ohio, a suburb of Cleveland. Activities at our former corporate headquarters in Irving, Texas and Louisville, Kentucky, will be reduced accordingly. As a result of the acquisition, operations from the former businesses of Commonwealth have been included in a fourth reportable business segment, rolled products.
Under the terms of the merger, we issued approximately 13.6 million shares of Aleris common stock to former Commonwealth stockholders (based on an exchange ratio of 0.815 Aleris shares for each share of Commonwealth). In connection with the merger, we recognized approximately $10.8 million of employee severance and other charges associated with the reduction of corporate personnel at our former headquarters in Irving, Texas and the retirement of our former interim chief executive officer and former chief financial officer. Additionally, interest expense increased with the assumption of debt associated with the rolled products business and because of additional debt incurred to finance costs associated with the merger.
As a result of the merger, we expect to benefit from the adoption of best practices company-wide (particularly in metal melting), procurement savings due to our greater size, the elimination of redundant selling, general and administrative costs, greater technological capabilities and improved access to lower-cost capital. We anticipate that annual cost savings of $25 million as a result of the merger could be realized over the next 18 to 24 month period.
The following table presents certain pro forma condensed combined operating results of our company as if the merger and related financing transactions had occurred on January 1, 2003 (in thousands):
Effects of Consolidation of VAW-IMCO
Prior to 2003, the share capital of VAW-IMCO had been 50% owned by us and 50% by Hydro Aluminium Deutschland GmbH (and its predecessors). In March 2003, we entered into an agreement under which VAW-IMCO became obligated to redeem the shares owned by Hydro Aluminium Deutschland. The redemption liability was to be paid over a period of years. As a result of this agreement, we acquired voting control of
VAW-IMCO, and effective March 1, 2003, the financial condition and results of operations of VAW-IMCO were consolidated with ours. Prior to March 1, 2003, the results of operations of VAW-IMCO were reflected in our consolidated financial statements under the equity method of accounting.
In November 2003, we funded VAW-IMCO’s prepayment to Hydro Aluminium Deutschland of this redemption obligation. VAW-IMCO paid Hydro Aluminium Deutschland a total of approximately $28.3 million in exchange for the payment in full of the outstanding share redemption liability, plus an aluminum recycling furnace, related assets, and real estate located on and adjacent to a VAW-IMCO facility.
General
For the year ended December 31, 2004, approximately 59% of our aggregate recycling volumes in our aluminum recycling, international and zinc segments, consisted of products tolled for our customers. Tolling revenues reflect only our processing costs and profit margin. Our recycling activities also involve processing, recovery and alloying of aluminum and zinc metal and the production of value-added zinc products for sale by us. The revenues from these sales transactions include the cost of the metal, as well as the processing cost and our profit margin. Accordingly, tolling business produces lower revenues and costs of sales than product sales business. Variations in the mix between tolling and product sales business could cause revenue amounts to change significantly from period to period while not significantly affecting gross profit. As a result, in these three recycling segments, we consider processing volume to be a more important determinant of performance than revenues. In the rolled products segment, our activities include manufacturing common alloy aluminum sheet for distributors and customers in the transportation, construction and consumer durables end-use industries, and our comparable volume measure is packed pounds, or pounds produced, at these facilities.
In 2004, we experienced an increase in the percentage of metals tolled, compared to 2003. This increase was principally the result of increased tolling volume at our aluminum recycling facilities, and an increase in tolling volume at our Mexican and German international facilities.
In prior years, recycling volumes had been declining, and we took steps to counter reduced demand. We closed four aluminum recycling facilities and one zinc recycling facility, and have reduced the number of furnaces we operate at other aluminum recycling facilities. We have redeployed some of these assets to our other operations. As processing volumes increased in 2004, these steps resulted in higher segment profitability.
The following table shows information concerning total pounds processed, percentage of total pounds processed under tolling agreements, total rolled products packed pounds, total revenues and total gross profits (in thousands, except percentages):
In addition to our product sales business, we also enter into metal brokerage transactions under which we buy metal from primary and other producers and then sell the metal to end-users. These transactions involve buying and selling metal without processing it. Also, in order to facilitate acquiring metal for our production processing, we occasionally enter into metal “swap” transactions where we agree to exchange our recycled finished goods for scrap raw materials. As with the product sales business, the brokerage business increases our working capital requirements and subjects us to greater price risk associated with fluctuations in the metals commodities markets. See Item 7A
ITEM 7A. Q UANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of business, we are exposed to potential losses arising from changes in the price of aluminum, zinc and natural gas. Changes in currency values and the level of interest rates also expose our company to potential losses. We use derivative instruments, such as futures, options, swaps and interest rate caps to manage the effect of such changes. Because of the use of swap and forward contract hedging instruments, we are limited in our ability to take advantage of potential changes in aluminum, gas and zinc prices. The hedging instruments require us to exercise the hedging instrument at the settlement date regardless of the market price at that time. Therefore, in an effort to offset the effect of increasing prices, we have also limited our potential benefit of declining prices. See Note A-“Basis of Presentation and Summary of Significant Accounting Policies” of the Notes to Consolidated Financial Statements.
Risk Management
All derivative contracts are held for purposes other than trading, and are used primarily to mitigate uncertainty and volatility and cover underlying exposures. Our commodity and derivative activities are subject to the management, direction and control of our company’s Risk Management Committee, which is composed of our chief financial officer, treasurer, controller, head of metal procurement, and two business segment presidents. The Risk Management Committee reports to our company’s Board of Directors, which has supervisory authority over all of its activities.
Counter-parties
Our company is exposed to losses in the event of non-performance by the counter-parties to the derivative contracts discussed below. Although non-performance by counter-parties is possible, we do not currently anticipate any non-performance by any of these parties. Counter-parties are evaluated for creditworthiness and risk assessment prior to our initiating contract activities. The counter-parties’ creditworthiness is then monitored on an ongoing basis, and credit levels are reviewed to ensure that there is not an inappropriate concentration of credit outstanding to any particular counter-party.
Metal Commodity Price Risk
Aluminum and zinc ingots are internationally produced, priced, and traded commodities, with their principal trading market being the London Metal Exchange. As part of our efforts to preserve margins, we enter into futures and options and OTC swap contracts. In our aluminum recycling and zinc segments, most of the unrealized future gains and losses on these futures and options contracts qualify for deferred treatment under SFAS 133. As a result, unrealized gains and losses related to the effective portions of these hedges are recorded in other comprehensive income within our consolidated balance sheet until the underlying transaction impacts earnings. The futures and options contracts entered into by our rolled products and international segments have not met the requirements for the election to defer unrealized gains and losses under SFAS 133, resulting in the immediate recognition of amounts in the statement of operations.
Overview of Domestic Aluminum Recycling and Zinc Deferred Metal Hedging Activities
As of December 31, 2004, our aluminum recycling and zinc segments had net deferred losses of approximately $497,000 ($308,000 net of tax) related to metal commodity hedging activities. As of December 31, 2003, these segments had net deferred gains of approximately $1,595,000 ($988,000 net of tax) related to metal hedging activities. As of December 31, 2002, net deferred losses totaled approximately $1,069,000 ($663,000 net of tax). The majority of the change from 2003 to 2004 is due to the settlement of 2004 zinc and aluminum metal hedges and to the increase in zinc and aluminum prices. The majority of the change from 2002 to 2003 is due to our zinc forward purchases, which have moved from a deferred loss position to a deferred gain position, primarily as a result of the increase in the price of zinc towards the end of 2003.
Aluminum Recycling
We enter into futures sale contracts with metal brokers to fix the margin on a portion of the aluminum generated by our salt cake processing facility in Morgantown, Kentucky and a portion of the aluminum generated for sale from the processing of other scrap metal. These futures sale contracts are settled in the month of pricing of shipments.
Our deferred aluminum recycling hedging positions are summarized below:
As of December 31, 2004:
In 2004, our aluminum recycling segment’s revenue was higher by $332,000 for settled metal hedging contracts. In 2003 and 2002, our aluminum recycling segment’s revenue was lower by $185,000 and $421,000, respectively, for settled metal hedging contracts. The impact of a hypothetical 10% change in the December 31, 2004 LME price of aluminum ingot would be material to our estimated gross profit for the year ending December 31, 2005. We estimate that a hypothetical 10% increase in the price of aluminium would decrease our gross profits by approximately $2.2 million.
Accounting principles generally accepted in the United States require that our hedges be regularly assessed for their effectiveness. Hedges that are not highly effective do not qualify for deferred accounting treatment. In 2004, the ineffective portion of the aluminum recycling segment’s metal hedges resulted in unrealized non-cash losses of $430,000 which have been recorded as additional cost of sales.
Rolled Products
The rolled products segment conducts a substantial amount of hedging activity in an effort to eliminate the impact of movements in the price of aluminum from the time of order entry and acceptance through product shipment. However, unlike the aluminum recycling and zinc segments, the aluminum hedges entered into by the rolled products segment do not meet the required effectiveness criteria established in SFAS 133 for deferral of gains and losses. As a result, all aluminum hedges are marked-to-market each reporting period with the corresponding unrealized gains and losses reflected in the statement of operations. For December 2004, we recorded an unrealized gain of $2.6 million for open metal hedges. In addition, we recorded a $2.1 million gain for settled metal hedges in this segment.
We expect to record losses of $10.1 million for these contracts as they are settled. The impact of a hypothetical 10% change in the December 31, 2004 LME price of aluminum would be material to our estimated gross profit for the year ending December 31, 2005. At this time, we estimate a hypothetical 10% increase in the price of aluminum would decrease our gross profits for 2005 by approximately $7.7 million for this segment. However, it should be noted that any change in the fair value of these contracts would be significantly offset with an inverse change in the cost of metal purchased.
Zinc
In the normal course of business, we enter into fixed-price forward sales and purchase contracts with a number of our zinc customers. In order to hedge the risk of higher metal prices, we enter into long positions, principally using future purchase contracts. These contracts are settled in the month of the corresponding production or shipment.
Our deferred zinc hedging positions are summarized below:
As of December 31, 2004:
In 2004, 2003 and 2002 our zinc revenue was higher (lower) by $725,000, $(343,000) and $(2,117,000) respectively, due to settled zinc metal hedging contracts. The impact of a hypothetical 10% change in the December 31, 2004 LME price of zinc ingot would be material to our estimated gross profit for the year ending December 31, 2005. At this time, we estimate a hypothetical 10% increase in the price of zinc would decrease our gross profits for 2005 by about $374,000. However, it should be noted that any change in the fair value of these contracts would be significantly offset with an inverse change in the cost of metal purchased.
VAW-IMCO
For 2004, VAW-IMCO’s hedging program in Germany operated independent of the aluminum recycling segment. A large amount of VAW-IMCO’s operations are product sales, requiring it to take ownership of the materials processed and exposing it to more risk of changes in metal prices. To mitigate this risk, VAW-IMCO enters into LME high-grade and alloy aluminum forward sales and purchase contracts. VAW-IMCO does not hold or issue any derivative financial instruments for trading purposes. The functional currency of VAW-IMCO is the Euro; however, the derivatives utilized in hedging the market risk of changing prices of aluminum purchases and sales at VAW-IMCO’s facilities are based in U.S. Dollars. This results in foreign currency risk in addition to the risk of changing aluminum prices.
The unrealized gains and losses on VAW-IMCO’s derivative contracts do not qualify for deferred treatment under SFAS 133. As a result, VAW-IMCO’s derivative contracts are recorded at fair value with unrealized gains and losses recognized currently in the statement of operations. VAW-IMCO’s metal hedging positions are summarized below:
As of December 31, 2004:
The total effect of VAW-IMCO’s metal hedging activities on our cost of sales is as follows:
The impact of either a hypothetical 10% increase in the December 31, 2004 LME price of aluminum or a 10% increase in the value of the U.S. Dollar against the Euro would be material to our estimated gross profit. As of December 31, 2004 we estimate that a hypothetical 10% increase in the LME price of aluminum, holding currency rates constant, would increase our gross profits by $600,000. Separately, for the same period, we also estimate that a hypothetical 10% increase in the value of the U.S. Dollar against the Euro, holding metal prices constant, would increase our gross profits by $360,000. However, it should be noted that any change in the fair value of these contracts would be significantly offset with an inverse change in the cost of metal purchased.
Natural Gas
Natural gas is the principal fuel used in the processing operations of all our segments. Natural gas prices are volatile, and we attempt to manage this volatility through the use of derivative commodity instruments. Our natural gas financial derivatives are traded in months forward, and settlement dates are scheduled to coincide with gas purchases during those future periods. These contracts reference physical natural gas prices or appropriate NYMEX futures contract prices. Because of the high degree of effectiveness the derivatives instruments have in offsetting changes in natural gas purchase prices, substantially all of the unrealized gains and losses associated with these hedges are deferred until the physical purchase of the natural gas.
We have entered into forward pricing positions for a portion of our domestic natural gas requirements for 2005. We currently have contracts in place to cover approximately 80% of our natural gas requirements for the succeeding twelve months for our aluminum recycling, rolled products and zinc segments.
Under the terms of our natural gas swap contracts, we make or receive payments based on the difference between the month-end closing price on the NYMEX and the fixed price agreed to in the swap contracts. The impact of a hypothetical 10% change in the December 31, 2004 NYMEX closing price would be material to our estimated gross profit for the next twelve months. We estimate that a hypothetical 10% increase in the price of natural gas, as of December 31, 2004, would decrease our estimated gross profits for the year ending December 31, 2005 by approximately $2.3 million for the aluminum recycling and zinc segments. For the twelve month periods ended December 31, 2004, 2003 and 2002 natural gas hedging activities increased (decreased) cost of goods sold by the following amounts: ($3.7 million), ($3.4 million) and $3.1 million, respectively. However, it should be noted that any change in the fair value of these contracts would be significantly offset with an inverse change in the cost of gas purchased.
In addition, a portion of our natural gas cost is recovered through price escalation clauses in our long-term contracts.
Our natural gas hedging activities, for our aluminum recycling and zinc segments, are summarized in the table below:
Our natural gas hedge amounts by year are summarized below:
The rolled products segment hedges against natural gas price risk in a similar manner. As of December 31, 2004, natural gas hedging activity in this segment is as follows:
For the month of December 2004, the amounts of gains recorded in earnings for settled natural gas hedges in this segment were not material. Further, no material amounts were recognized in current earnings for open natural gas hedges in this segment. The impact of a hypothetical 10% change in the December 31, 2004 NYMEX price of natural gas would be material to our estimated gross profit for the year ending December 31, 2005. At this time, we estimate a hypothetical 10% increase in the price of natural gas would decrease our gross profits for 2005 by approximately $4.9 million for this segment.
Our grand total natural gas hedging activities are summarized in the table below:
Our international aluminum segment had no natural gas hedging activities for the year ended December 31, 2004.
Interest
We have historically funded our operations from our credit facilities. Subsequent to the financing activities in conjunction with our merger with Commonwealth, approximately 85% of our total debt is at fixed rates.
Our earnings are affected by changes in interest rates due to the impact those changes have on our interest expense from variable-rate debt instruments. If interest rates increased 10% from the rates prevailing as of December 31, 2004, interest expense for the next twelve months would increase by approximately $350,000. These amounts are determined by considering the impact of hypothetical interest rates on our variable-rate long-term debt outstanding as of December 31, 2004.
Market risk for fixed-rate long-term debt is estimated as the potential increase in fair value resulting from a hypothetical decrease in market interest rates. With respect to our fixed-rate long-term debt outstanding at December 31, 2004, a hypothetical 10% decline in market interest rates would have resulted in an increase to the fair value of our fixed-rate long-term debt of approximately $17.8 million. The fair values of our long-term debt were estimated using discounted future cash flows based on our incremental borrowing rates for similar types of borrowing arrangements.
Foreign Currency
We are increasingly subject to exposure from fluctuations in foreign currencies. When we consider it appropriate, we will utilize foreign currency exchange contracts to hedge the variability in cash flows from forecasted payment or receipts of currencies. However, no significant contracts were entered into during 2003, or were outstanding at December 31, 2004. Generally, we have not sought to mitigate foreign currency translation effects through the use of derivative instruments.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX OF FINANCIAL STATEMENTS
PAGE
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheet at December 31, 2004 and 2003
Consolidated Statement of Operations for the three years ended December 31, 2004
Consolidated Statement of Cash Flow for the three years ended December 31, 2004
Consolidated Statement of Changes in Stockholders’ Equity for the three years ended December 31, 2004
Notes to Consolidated Financial Statements
All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.
ALERIS INTERNATIONAL, INC.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of Aleris International, Inc.
We have audited the accompanying consolidated balance sheet of Aleris International, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Aleris International, Inc. at December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
As discussed in Note P of the Notes to Consolidated Financial Statements, effective January 1, 2002, the Company changed its method of accounting for goodwill and other intangibles as required by the Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets.”
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Aleris International, Inc.’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 11, 2005, expressed an unqualified opinion on management’s assessment of and an adverse opinion on the effectiveness of internal control over financial reporting.
/s/ Ernst & Young LLP
Dallas, Texas
March 11, 2005
ALERIS INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEET
(in thousands, except share data)
See Notes to Consolidated Financial Statements.
ALERIS INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(in thousands, except per share data)
See Notes to Consolidated Financial Statements.
ALERIS INTERNATIONAL INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
See Notes to Consolidated Financial Statements.
ALERIS INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
(in thousands, except share amounts)
See Notes to Consolidated Financial Statements.
ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
(dollars in thousands, except per share data)
NOTE A-BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of Aleris International, Inc. (formerly IMCO Recycling Inc.) and all of our majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated upon consolidation. Investments in affiliated companies, owned 50% or less, are accounted for using the equity method.
Our principal business involves the recycling of aluminum and production of specification alloys as well as the manufacture of common alloy aluminum sheet. We are also involved in the recycling of zinc and the manufacture of zinc oxide and zinc dust. Aluminum scrap material is also recycled for a fee and then the material is returned to our customers, some of whom are the world’s largest aluminum and automotive companies. Aluminum and zinc scrap is also purchased on the open market, recycled and sold.
The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Our most significant estimates relate to the valuation of property and equipment and goodwill, assumptions and methodology for assessing hedge effectiveness regarding aluminum, zinc and natural gas futures contracts, forward contracts and options, assumptions for computing pension and postretirement benefits workers’ compensation, medical and environmental liabilities as well as deferred tax valuation allowances and allowances for uncollectible accounts receivable.
Reclassification
Certain amounts in prior years have been reclassified to conform to the 2004 consolidated financial statement presentation.
Cash Equivalents
All highly liquid investments with a maturity of three months or less when purchased are considered cash equivalents. The carrying amount of cash equivalents approximates fair value because of the short maturity of those instruments.
Restricted Cash
Cash we have that is not free and clear of encumbrances is classified as restricted cash. As a result of our refinancing activities in the fourth quarter of 2003, we had $9,144 and $24,846 of restricted cash at December 31, 2004 and 2003, respectively, in a custodial account held by the indenture trustee for the benefit of the holders of our Senior Secured Notes. See Note G-“Long-Term Debt.” In addition, the proceeds from our 2.24% variable rate Morgantown, Kentucky Solid Waste Disposal Facilities Revenue Bonds are restricted as to use and must be expended for capital improvements at the facility. At December 31, 2004, $2,718 of these proceeds had not been expended and remain classified as restricted cash. We also have $4,145 of restricted cash at December 31, 2004 associated with our workers’ compensation programs.
ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Credit Risk
The majority of our accounts receivable are due from companies in the aluminum, zinc and automotive industries. Credit is extended based on evaluation of our customers’ financial condition; generally, collateral is not required. Accounts receivable are net of a valuation reserve that represents an estimate of amounts considered uncollectible. The valuation reserve is based upon our historical loss experience, current economic conditions within the industries we serve as well as our determination of the specific risk related to certain customers. Accounts receivable are charged off against the reserve when, in management’s estimation, further collection efforts would not result in a reasonable likelihood of receipt. Expense reflected in our consolidated statement of operations for such uncollectible amounts, and receivables that were written-off against the valuation reserve, are as follows:
We recorded additions to the allowance for doubtful accounts of $1,147 as of December 31, 2004 due to the acquisition of Commonwealth.
Inventories
Inventories are stated at the lower of cost or market. Cost is determined based on a specific identification method or a weighted average cost.
Property and Equipment
Property and equipment are stated at cost. Major renewals and improvements are capitalized, while maintenance and repairs are expensed when incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets.
For our landfills, we adopted as of January 1, 2003, Statement of Financial Accounting Standards No. 143 (SFAS 143) “Accounting for Asset Retirement Obligations” for the recognition of our asset retirement obligations and the associated asset retirement costs. See Note L-“Asset Retirement Obligations.” Used space in the landfill is determined periodically either by aerial photography or engineering estimates. The construction costs of the landfills are depreciated as space in the landfills is used.
We review our property and equipment for impairment when changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment is measured as the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset less disposal costs. See Note E-“Property and Equipment.”
Interest is capitalized in connection with the construction of major facilities. Capitalized interest costs are as follows:
Deferred Financing Costs
The costs related to the issuance of debt are capitalized and amortized over the lives of the related debt as interest expense using the effective interest method.
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Goodwill
Goodwill is tested for impairment annually as of December 31 of each year. Our reporting units consist of Rolled Products, Zinc, Domestic Specialty Alloy, Domestic Aluminum Recycling, VAW-IMCO and Other International Operations. See Note P-“Goodwill.”
Revenue Recognition and Shipping and Handling Costs
Revenues are recognized when title transfers or risk of loss passes, which is generally as orders are completed and shipped. Certain customer orders provide for transfer of title or risk of loss at the time the shipments are received at their facilities. We recognize revenues at the time shipments are received for these customers. For material that is tolled, revenue is recognized upon the performance of the tolling services for customers. Shipping and handling costs are included within cost of sales in the consolidated statement of operations.
Stock-Based Compensation
We follow the intrinsic value method of accounting for stock-based compensation proscribed by Accounting Principles Board Opinion No. 25 (APB 25) “Accounting for Stock Issued to Employees” and related interpretations. Under APB 25, if the exercise price of employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recorded. For grants of non-vested shares and units, compensation expense is determined based upon the fair value of the underlying stock at the date of grant and recognized over the vesting period. We have adopted the pro forma disclosure features of SFAS 123, “Accounting for Stock-Based Compensation”, as amended by SFAS 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”. Our net earnings (loss) and earnings (loss) per share would have been reduced to the pro forma amounts shown below if compensation cost had been determined based on the fair value at the grant dates.
The fair value of our outstanding stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions:
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Our pro forma information below is presented as if we had applied the fair value recognition provision of SFAS 123.
Market Risk Management Using Financial Instruments
We enter into derivatives to hedge the cost of energy and the sale and purchase price of certain aluminum and zinc products.
We are engaged in activities that expose us to various market risks, including the effects of natural gas prices and future selling prices of aluminum and zinc. These financial exposures are managed as an integral part of our risk management program, which seeks to reduce the potentially adverse effects that the volatility of the markets may have on operating results. We do not engage in speculative transactions, nor do we hold or issue financial instruments for trading purposes. We maintain a natural gas pricing strategy to minimize significant fluctuations in earnings caused by the volatility of gas prices. We also maintain a metal pricing strategy to minimize significant, unanticipated fluctuations in earnings caused by the volatility of aluminum and zinc prices. All derivative financial instruments are recorded at fair value. We measure the effectiveness of these cash flow hedges by formally assessing, at least quarterly, the historical and probable future high correlation of changes in the expected cash flows of the hedged items. The ineffective portions are recorded in cost of sales in the current period while the effective portions are included in other comprehensive income until the underlying transaction impacts income. See Note Q-“Market Risk Management Using Financial Instruments.”
Our company is exposed to losses in the event of non-performance by counter-parties to derivative contracts. Although non-performance by counter-parties is possible, we do not currently anticipate any non-performance by any of these parties. Counter-parties are evaluated for creditworthiness and risk assessment prior to our initiating contract activities. The counter-parties’ creditworthiness is then monitored on an ongoing basis, and credit levels are reviewed to ensure that there is not an inappropriate concentration of credit outstanding to any particular counter-party.
Foreign Currency Translation
Our foreign subsidiaries in the U.K., Germany, Netherlands, Mexico and Brazil use the local currency as their functional currency. Adjustments resulting from the translation of the assets and liabilities of our foreign operations into U.S. Dollars at the fiscal year end exchange rates are reflected as a separate component of
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stockholders’ equity, except for current intercompany accounts, which along with foreign currency transaction gains and losses are reflected in the statements of operations. Gains related to the translation of current intercompany accounts increased other income by $123, $1,880 and $0 in 2004, 2003 and 2002, respectively. Foreign currency translation adjustments are the result of translating a foreign entity’s functional currency to U.S. Dollars. Foreign currency translation adjustments accumulate in consolidated equity until the disposition or liquidation of the foreign entities.
Self Insurance
We are substantially self-insured for losses related to workers’ compensation and health claims. Losses are accrued based upon estimates of the aggregate liability for claims incurred based on experience and certain actuarial assumptions. Under the terms of certain of the workers’ compensation programs, we are required to maintain pre-determined amounts of cash security, restricted as to use. At December 31, 2004 and 2003, we had $4,145 and $0, respectively, of restricted cash related to these programs.
Income Taxes
We account for income taxes using the liability method, whereby deferred income taxes reflect the tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. In valuing deferred tax assets, we use judgment in determining if it is more likely than not that some portion or all of a deferred tax asset will not be realized and the amount of the required valuation allowance.
General Guarantees and Indemnifications
It is common in long-term processing agreements for us to agree to indemnify customers for tort liabilities that arise out of, or relate to, the processing of their material. Additionally, we typically indemnify such parties for certain environmental liabilities that arise out of or relate to the processing of their material.
In our equipment financing agreements, we typically indemnify the financing parties, trustees acting on their behalf and other related parties against liabilities that arise from the manufacture, design, ownership, financing, use, operation and maintenance of the equipment and for tort liability, whether or not these liabilities arise out of or relate to the negligence of these indemnified parties, except for their gross negligence or willful misconduct.
We expect that we would be covered by insurance (subject to deductibles) for most tort liabilities and related indemnities described above with respect to equipment we lease and material we process.
In financing transactions that include loans from banks in which the interest rate is based on LIBOR, we typically agree to reimburse the lenders for certain increased costs that they incur in carrying these loans as a result of any change in law and for any reduced returns with respect to these loans due to any change in capital requirements. We had $58,938 of floating rate debt outstanding at December 31, 2004.
Although we cannot estimate the potential amount of future payments under the foregoing indemnities and agreements, amounts paid under these guarantees and indemnifications have not been significant.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123(R), “Share-Based Payments”, that, upon implementation, will impact our net earnings and earnings per share, and change the classification of certain elements of the statement of cash flows. The provisions of SFAS 123(R) are similar to
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those of SFAS 123, however, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements as compensation cost based on their fair value on the date of grant. Fair value of share-based awards will be determined using option-pricing models (e.g. Black-Scholes or binomial models) and assumptions that appropriately reflect the specific circumstances of the awards. Compensation cost will be recognized over the vesting period based on the fair value of awards that actually vest.
Consistent with the provisions of the new standard, we intend to adopt SFAS 123(R) in the third quarter of 2005, implementing it on a prospective basis. We are in the process of evaluating the use of certain option-pricing models as well as the assumptions to be used in such models. We do not currently anticipate that the impact on net income on a full year basis of the adoption of SFAS 123(R) will be significantly different from the historical pro forma impacts as disclosed in accordance with SFAS 123. However, the 2004 pro forma disclosures include compensation expense for the December 2004 stock compensation awards and the unvested stock compensation awards we assumed from Commonwealth (see Note B-“Acquisitions and Joint Venture Information”) from the date of grant and acquisition, respectively to December 31, 2004. Had those awards been outstanding for all of 2004, the pro forma compensation cost would have increased by approximately $4,200. Future results will be impacted by the number and value of additional stock option grants as well as the value of existing unvested stock options.
In May 2004, the FASB issued FASB Staff Position (FSP) 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003”. This FSP provides specific authoritative guidance on the accounting for the federal subsidy to eligible sponsors of retiree health care benefits provided under this law. This guidance was used to determine the fair value of the acquired postretirement benefit obligations of Commonwealth Industries, Inc., resulting in a reduction in the accumulated benefit obligation of approximately $2,200 from the amount otherwise determined by our actuaries. Net periodic postretirement benefit expense for the period from the date of the acquisition of Commonwealth to December 31, 2004 was not materially affected.
In November 2004, the FASB issued SFAS 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4”. The amendments made by SFAS 151 clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted materials should be recognized as current-period charges and require the allocation of fixed production overhead to inventory to be based on the normal capacity of the underlying production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005. We are currently evaluating the impact that this Statement may have on our future financial position and results of operations.
In December 2004, the FASB issued FASB Staff Position No. 109-1, “Application of FASB Statement No. 109 (SFAS 109), ‘Accounting for Income Taxes,’ to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004” (FSP 109-1). FSP 109-1 provides that the manufacturer’s deduction created in the American Jobs Creation Act of 2004 (the Act) should be accounted for as a special deduction in accordance with SFAS 109 and not as a tax rate reduction. The manufacturer’s deduction had no effect on our 2004 results, as the deduction is first available to us in 2005. We are currently evaluating the effect that the manufacturer’s deduction will have on future results.
In December 2004, the FASB issued FSP 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision Within the American Jobs Creation Act of 2004.” The Act introduced a temporary incentive for U.S. multinationals to repatriate earnings accumulated outside the U.S. by providing a one time tax deduction of 85 percent for certain foreign earnings from controlled foreign corporations. FSP 109-2 provides accounting and disclosure guidance for the repatriation provision. We did not elect to apply this provision in 2004 and may elect to apply this provision to qualifying repatriations in 2005. Due to the complexity of the repatriation provision, we are still evaluating the effect of the provision, including a definitive calculation of qualifying dividends and the effect of any repatriation on our tax provision. We expect to complete our evaluation in 2005.
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NOTE B-ACQUISITIONS / JOINT VENTURE FORMATION
Acquisition of Commonwealth Industries, Inc.
On December 9, 2004, we acquired all of the shares of outstanding common stock of Commonwealth Industries, Inc. (“Commonwealth”). Commonwealth is a manufacturer of common alloy aluminum sheet, selling its products to end-users for use in building and construction products, transportation equipment and automotive parts, and consumer durables, as well as to distributors. We determined that the acquisition would improve the competitive position of the combined company by expanding our access to domestic and foreign capital markets, improving our position for future acquisition and growth opportunities and capitalizing on other vertical and horizontal opportunities. In addition, the acquisition is expected to provide opportunities to reduce costs through economies of scale in our operations as well as through shared services and technologies and the coordination of operations between facilities located near each other.
The aggregate purchase price was approximately $183,911, which consisted of $170,855 of our common stock, $1,247 in net fair value of our stock options and $11,809 of transaction costs, which primarily consisted of fees paid for financial advisory, legal and accounting services. We issued approximately 13.6 million shares of our common stock in exchange for the shares of Commonwealth then outstanding using an exchange ratio of .815 share of our common stock for each Commonwealth share. The fair value of the shares issued was based on a five-day average of the closing price two days before and two days after the terms of the acquisition were agreed to and publicly announced on June 17, 2004. We also assumed the outstanding stock options of Commonwealth using the above exchange ratio, which now evidence options to purchase up to 940,257 shares of our common stock. The fair value of the stock options assumed was estimated using a Black-Scholes option pricing model. The intrinsic value allocated to the unvested options and non-vested stock assumed in the transaction that had yet to be earned as of the transaction date was approximately $3,934 and has been recorded as deferred compensation, a component of stockholders’ equity.
The consolidated financial statements include the results of Commonwealth from the date of acquisition. The purchase price has been allocated based on estimated fair values as of the acquisition date. The purchase price allocation is preliminary and a final determination of required purchase accounting adjustments will be made upon the finalization of an independent appraisal of the fair value of acquired property and equipment, the determination of the fair value of certain other acquired assets and liabilities, and the completion of our integration plans and the final determination of the acquired federal and state net operating loss and tax credit carryforwards. The following represents the preliminary allocation of the purchase price:
Acquired net deferred tax assets totaled $21,300. A full valuation allowance against these deferred tax assets was recorded through purchase accounting due to the uncertainty as to our ability to realize the benefits of these assets. See Note F-“Income Taxes.” In connection with the acquisition of Commonwealth, we developed a plan to relocate our corporate headquarters and performed initial integration activities which have resulted in the involuntary termination or relocation of certain Commonwealth employees. We recorded a $7,796 liability for involuntary termination and relocation benefits in the preliminary allocation of the purchase price. The liability for involuntary termination benefits covers 54 Commonwealth employees, primarily in general and administrative functions. As of December 31, 2004, $4,089 had been paid to affected employees. We expect to
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pay the balance in 2005. We continue to develop other facets of our integration plan, including the elimination or consolidation of other administrative functions. We expect to complete our integration efforts by December 31, 2005.
Acquisition of VAW-IMCO
On March 14, 2003, a wholly-owned subsidiary of the Company entered into an agreement with Hydro Aluminium Deutschland GmbH (“Hydro”) and VAW-IMCO Guss und Recycling GmbH (“VAW-IMCO”), finalizing the terms and conditions under which VAW-IMCO would redeem its shares owned by Hydro.
VAW-IMCO owns and operates two aluminum recycling foundry alloy facilities in Grevenbroich and Töging, Germany, that together have an annual melting capacity in excess of 700 million pounds. VAW-IMCO supplies specialty alloys to the European automobile industry and serves other European aluminum markets. The acquisition of the remaining 50% interest in VAW-IMCO is an important step in the on-going expansion of our international operations.
Under the redemption agreement, the redemption price for Hydro’s share interest was 30,408 Euros (approximately U.S. $32,300), payable in Euros in five installments, plus interest. The first installment of 6,082 Euros, plus interest of 613 Euros, was paid by VAW-IMCO to Hydro on March 18, 2003. The remaining annual installments were to have been paid beginning in December 2003. In conjunction with the refinancing of substantially all our debt in the fourth quarter of 2003, we fully paid the VAW-IMCO redemption liability. The subsequent settlement of the redemption liability and purchase of certain other recycling assets owned by our former joint venture partner for $28,300 resulted in a reduction of $5,432 of goodwill recorded related to the acquisition of the remaining 50% interest in VAW-IMCO. As a result of this agreement, voting control of VAW-IMCO was effectively vested in a wholly-owned subsidiary of our company, and effective March 1, 2003, the accounts of VAW-IMCO were consolidated with those of the company’s and reflected within our consolidated financial statements. Prior to that date, the accounts of VAW-IMCO were reflected in our financial statements under the equity method of accounting.
The consideration described above plus the obligations assumed were allocated to the following assets at their fair value: approximately $22,400 in cash, $34,200 in accounts receivable net of an allowance for doubtful accounts, approximately $19,300 in inventories, and approximately $36,334 in property and equipment.
We also included in our consolidated financial statements all of the obligations of VAW-IMCO which were recorded at their fair value. These include accounts payable and other accrued liabilities totaling approximately $33,300, as well as approximately $23,000 in current maturities of long-term debt and approximately $500 in long-term debt. We assumed a $10,000 liability for accrued pension costs and a deferred tax liability of almost $4,200.
The redemption price allocation described above resulted in our recording approximately $12,518 in goodwill. This goodwill is not deductible for tax purposes.
Unaudited Pro forma Information
The following table summarizes unaudited pro forma financial information assuming the Commonwealth and VAW-IMCO acquisitions had occurred as of the beginning of the earliest period presented. The unaudited pro forma information is not necessarily indicative of the operating results that would have occurred had the
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acquisitions been made at the beginning of the periods presented nor are they necessarily indicative of any future operating results.
The pro forma operating results include the following charges and costs recorded by us and Commonwealth in 2004 and 2003:
The restructuring and other charges recorded by Commonwealth related to their efforts to improve profitability by eliminating under-performing operations and streamlining overhead, as well as costs associated with the merger.
NOTE C-SALE OF RECEIVABLES
During the fourth quarter of 2003, in connection with the issuance of our 10 3/8% senior secured notes and the establishment of our senior secured revolving credit facility (see Note G-“Long-Term Debt”), we repurchased the remaining balance of $46,300 in receivables sold under the receivables sale facility and terminated the receivables sale facility in October 2003. This facility was scheduled to expire in November 2003.
The amounts of receivables sold and the associated fees paid are shown below:
NOTE D-INVENTORIES
The components of our consolidated inventories are:
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NOTE E-PROPERTY AND EQUIPMENT
The components of our consolidated property and equipment are:
Our depreciation and repair and maintenance expense was as follows:
Estimated useful lives for buildings and improvements range from 5 to 39 years, machinery and equipment range from 2 to 20 years and office furniture and equipment range from 3 to 10 years.
Due to the continuing operating losses experienced by our Shelbyville, Tennessee facility, we performed an impairment evaluation of the related assets in the fourth quarter of 2004. As a result, we recorded a $3,717 impairment charge to write down the assets to their estimated fair values at December 31, 2004. We based fair value on appraisals of the land and buildings and a discounted cash flow analysis of the machinery and equipment. Also during the fourth quarter of 2004, we decided to permanently close our Rockwood, Tennessee facility, which had been idled since August 2003. We recorded a $441 impairment charge to write down the affected assets to their estimated fair values. These impairment charges have been included as depreciation expense within costs of sales in the consolidated statement of operations.
During the fourth quarter of 2003, we decided to permanently close our Wendover, Utah facility due to the continued shutdown of primary smelter capacity in the Pacific Northwest. As a result we evaluated the assets associated with this facility for impairment. We recorded a $3,061 impairment charge to write-down the Wendover, Utah assets to fair value. We based fair value upon the fact that certain assets would be relocated to other aluminum recycling operations. The impairment charge was recorded as depreciation expense in cost of sales.
Due to adverse market conditions in the domestic aluminium segment, in the fourth quarter of 2003 management commenced a review of our assets held for sale. Based upon the net book value of certain of the assets reviewed exceeding their estimated fair value, we recorded additional depreciation expense of $879 in cost of sales and $1,965 in other (income) expense, net in the fourth quarter of 2003.
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NOTE F-INCOME TAXES
The provision for (benefit from) income taxes, including income taxes on minority interests, was as follows:
The income tax expense, computed by applying the federal statutory tax rate to earnings before income taxes, differed from the provision for (benefit from) income taxes as follows:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
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Significant components of our deferred tax liabilities and assets at December 31, 2004 and 2003 are as follows:
At December 31, 2004, and 2003 we had valuation allowances of $48,604 and $8,987, respectively, to reduce certain deferred tax assets to amounts that are more likely than not to be realized. The valuation allowances relate to our potential inability to utilize U.S. federal and state net operating loss and tax credit carry forwards and certain foreign net operating loss carry forwards. Based on the available evidence, except for the deferred tax assets related to a portion of the foreign tax credit that can be carried back to prior years, a full valuation allowance has been established in 2004 for all other deferred tax assets related to domestic operations. The acquisition of Commonwealth resulted in $21,356 of additional net deferred tax assets. We have recorded a full valuation allowance against these net deferred tax assets in purchase accounting. If these net deferred tax assets are ultimately realized, the reversal of the tax valuation allowances established in purchase accounting would result in a reduction of the income tax expense because there is no goodwill or other noncurrent intangible assets related to this acquisition. The valuation allowance also increased by $1,338 in 2004 due to the benefit generated from the current year exercise of stock options. This amount was recorded to stockholders’ equity.
At December 31, 2004, we had approximately $18,600 of unused net operating loss carry forwards for foreign tax purposes, which do not expire, $286 of foreign net operating loss carry forwards that expire starting in 2013 and $90,286 in U.S. federal income tax net operating loss carry forwards that expire starting in 2005, of which $48,666 is subject to a limitation as to its use in any given year under U.S. income tax regulations regarding change in ownership. The company also had a significant amount of net operating losses for state purposes, all of which have been provided a full valuation allowance.
At December 31, 2004, we had $13,899 unused U.S. federal tax credit carry forwards, of which $10,823 are subject to a limitation as to use in any given year under U.S. income tax regulations regarding change in ownership. We also had a significant amount of unused state tax credit carry forwards, all of which have been provided a full valuation allowance.
For U.S. federal income tax, at December 31, 2004 and 2003, we had a $500 receivable and a $380 payable for U.S. federal income tax, respectively.
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For 2004, 2003 and 2002, we had earnings (loss) before income taxes, minority interests and cumulative effect of accounting change from domestic operations of $(38,289), $(17,845) and $8,019, respectively, and from foreign operations of $22,423, $16,348 and $3,249, respectively.
Undistributed earnings for all non-U.S. investments are considered permanently reinvested and, accordingly, no additional U.S. income taxes or non-U.S. withholding taxes have been provided. As of December 31, 2003, the undistributed earnings are estimated at $37,131 for all our foreign entities.
NOTE G-LONG-TERM DEBT
Our long-term debt is summarized as follows:
9% Senior Notes
In November 2004, we issued $125,000 of 9% senior unsecured notes (“Senior Notes”) in anticipation of the acquisition of Commonwealth. The proceeds from the offering were used to repay an equivalent amount of senior secured notes of Commonwealth, as required under the “change of control” provisions of that indenture, upon the consummation of the acquisition on December 9, 2004. Interest is payable semi-annually, on November 15 and May 15 of each year, commencing on May 15, 2005. Fees and expenses of the senior notes were $4,994 and are being amortized as additional interest expense over the term of the senior notes.
The Senior Notes are guaranteed, jointly and severally, by certain of our existing and future domestic subsidiaries on a senior unsecured basis. The Senior Notes are not guaranteed by our foreign subsidiaries. The Senior Notes and the guarantees are effectively subordinated to our existing 10 3/8% Senior Secured Notes and will be subordinated to our and our guarantor subsidiaries’ future secured debt and rank equal in right of payment with all of our other senior indebtedness.
We cannot redeem the Senior Notes until November 15, 2009. Thereafter, we may redeem some or all of the Senior Notes at any time, and from time to time, on or after November 15, 2009 at redemption prices ranging from 104.5% in 2009 to 100% in 2012 and thereafter plus accrued interest. On or before November 15, 2007, up
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to 35% of the Senior Notes may be redeemed with the proceeds of one or more equity offerings of our common shares at a redemption price of 109% of the principal amount plus accrued interest.
Upon the occurrence of a “change of control” (as defined under the indenture governing the Senior Notes), we are required to offer to purchase the Senior Notes at a price equal to 101% of the principal amount of the outstanding Senior Notes plus accrued interest.
The indenture governing the Senior Notes, among other things, contains covenants limiting our ability and the ability of our restricted subsidiaries to incur additional debt or grant preferred stock; grant liens; make restricted payments, including paying dividends or making investments; sell or otherwise dispose of assets, including capital stock of subsidiaries; and consolidate merge or transfer all of our or our subsidiaries’ assets.
10 3/8% Senior Secured Notes
In October 2003, we issued $210,000 principal amount of 10 3/8% Senior Secured Notes (“Senior Secured Notes”) as part of a refinancing of our debt facilities. The issue was priced at 99.383% to yield 10.50% and provided $208,704 of gross proceeds, after offering discount. Interest is payable semi-annually, on April 15 and October 15 of each year. In addition, in October 2003 we established a new four-year $120,000 senior secured revolving credit facility (“Senior Credit Facility”). Our former senior credit facility and former receivables sale facility, which were both scheduled to expire by their terms in the fourth quarter of 2003, were replaced by the senior secured notes and the new Senior Credit Facility.
The proceeds from the Senior Secured Note offering and initial borrowings under the new Senior Credit Facility were used as follows: repayment of the former credit facility, $122,500; repurchase of receivables outstanding under the receivables sales facility and termination of such facility, $46,300; repayment of certain Brazilian loans, $7,541. Additionally, approximately $51,400 in proceeds were applied toward outstanding loans and obligations owed by VAW-IMCO to commercial banks and to Hydro Aluminium Deutschland GmbH (Hydro), our former joint venture partner, with regard to VAW-IMCO’s redemption liability.
Of the approximately $51,400 in proceeds referred to above, $27,376 was used to pay all amounts owed under the VAW-IMCO redemption liability. We paid 23,750 Euros (approximately $28,300) to Hydro for the share redemption liability and an aluminum recycling furnace and related assets and real estate located at, and adjacent to, a VAW-IMCO facility.
Fees and expenses of the Senior Secured Note offering and the establishment of the new Senior Credit Facility were $11,553. The fees are being amortized as additional interest expense over the terms of the Senior Secured Notes and the amended term of the Senior Credit Facility. During the fourth quarter of 2003, due to the extinguishment of our former senior revolving credit facility, we recognized a loss of $753 due to the write-off of unamortized debt costs related to the former senior revolving credit facility.
The Senior Secured Notes are redeemable at our option, in whole or in part, at any time after October 15, 2007. At any time prior to October 15, 2006, we may redeem up to 35% of the aggregate principal amount of the Senior Secured Notes with the proceeds of one or more equity offerings of our common shares at a redemption price of 110.375% of the principal amount of the Senior Secured Notes, together with accrued and unpaid interest, if any, to the date of the redemption.
The Senior Secured Notes are jointly and severally, unconditionally guaranteed on a senior basis by all of our existing 100% owned domestic subsidiaries that are co-borrowers under the Senior Credit Facility and by any future domestic restricted subsidiaries. The Senior Secured Notes are not guaranteed by any of our current foreign subsidiaries. See Note O-“Condensed Consolidated Financial Statements.” The Senior Secured Notes and guarantees are secured by first-priority liens, subject to permitted liens, on the real property, fixtures and
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equipment relating to our wholly-owned domestic operating plants and on the fixtures and equipment relating to substantially all of our leased domestic operating plants. The liens securing the senior secured notes do not extend to any of our inventory, accounts receivable and related property (which secure the senior credit facility) or to any of our foreign real or personal property.
Upon the occurrence of a “change of control” (as defined under the indenture governing the Senior Secured Notes), we are required to offer to purchase the Senior Secured Notes at a price equal to 101% of the principal amount of the outstanding Senior Secured Notes plus accrued interest.
The indenture governing the Senior Secured Notes, among other things, contains covenants limiting our ability and the ability of our restricted subsidiaries to incur additional debt; grant liens; make restricted payments, including paying dividends or making investments; sell or otherwise dispose of assets, including capital stock of subsidiaries; engage in sale-leaseback transactions; create liens on our or our subsidiaries’ assets; receive distributions; engage in transactions with affiliates; and merge or sell substantially all of our or our subsidiaries’ assets.
Amended and Restated Senior Credit Facility
In conjunction with the acquisition of Commonwealth, we amended and restated our Senior Credit Facility to increase the borrowing capacity from $120,000 to $325,000, reduce the margin spread for borrowings under the federal funds rate and to extend the term of the facility to December 2008. Under the amended terms of the Senior Credit Facility, we pay interest, at our option, at rates per annum equal to: (1) the greater of (a) the prime rate or (b) a federal funds rate plus ½%, in each case plus an applicable margin spread; or (2) a LIBOR-based rate plus an applicable margin spread. The applicable margin spread ranges from 100 to 175 basis points for base rate and federal funds rate loans and from 200 to 275 basis points for LIBOR-based loans. At December 31, 2004, the weighted average interest rate was 5.47%.
We are also subject to a borrowing base limitation based on eligible domestic inventory and receivables. As of December 31, 2004, we estimated that our borrowing base would have supported additional borrowings of $193,967 after giving effect to outstanding borrowings of $50,798 and outstanding letters of credit of $14,444. As of December 31, 2004, our total borrowing base was approximately $259,209.
Fees and expenses associated with amending the terms of the Senior Credit Facility totaled $5,380 and are being amortized to interest expense over the amended term.
The amended terms of our Senior Credit Facility include, among other covenants, (i) prohibitions against incurring certain indebtedness and granting liens, (ii) limitations on dividends and repurchases of shares of capital stock, and (iii) limitations on capital expenditures, investments and acquisitions. Under the amended terms of the Senior Credit Facility, we are permitted to pay dividends of up to $5,000 per year. The indebtedness under the senior secured credit facility is secured by the Company’s and its co-borrowers’ inventories, receivables, general intangibles and the proceeds thereof. If at any time during specified periods, our undrawn availability under this facility is less than $50,000, we will also be required to maintain a minimum fixed coverage ratio of 1.1 to 1.0, calculated based on our parent entity and wholly-owned domestic subsidiaries.
Borrowings under the facility must be repaid at the termination date of the facility in 2008. However, upon the occurrence of certain events, including a continuing “event of default”, as defined, and a reduction of our undrawn availability under the revolver to $65.0 million for five consecutive days or $60.0 million on any day, all of our cash receipts would be deposited into a lockbox that would be applied against outstanding borrowings.
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VAW-IMCO credit facilities
Our German subsidiary, VAW-lMCO Guss und Recycling GmbH (VAW-IMCO), has two lines of credit available for its working capital needs and two additional term loan facilities for the construction of a new manufacturing facility in Deizisau, Germany. The total amount of credit available under these facilities is 15,000 Euros for working capital and 10,000 Euros for capital needs. The working capital lines of credit expire in April and May 2006. One term loan facility expires in September 2005 and provides for a loan that matures five years from the date of borrowing. The other term loan facility expires in March 2009. Both facilities bear interest based on EURIBOR pricing plus a margin of 1.15%. As of December 31, 2004, no amounts were outstanding under the working capital lines of credit and 6,000 Euros (approximately $8,140) were outstanding under the capital lines of credit, bearing interest at an average rate of 3.31%.
Other
As of December 31, 2004, we were in compliance with all applicable debt covenants.
In February 2004, VAW-IMCO paid Aleris approximately 20,000 Euros ($24,846, including interest), repaying in full its indebtedness owed to Aleris under an intercompany note that Aleris had pledged in October 2003 as part of the collateral security for the Senior Secured Notes. The prepayment of this intercompany note, which was denominated in U.S. Dollars, resulted in a recognized gain of $278 for the first quarter of 2004. The funds were deposited in a collateral account held by the trustee under the indenture governing the Senior Secured Notes, which permitted us to use these funds through January 2005 for acquisitions and construction of assets and properties to be used in our domestic business, which were added to the collateral security for the Senior Secured Notes. Because the funds were designated for additional property and equipment, the funds were classified as non-current restricted cash on our balance sheet as of December 31, 2003. During 2004, we utilized approximately $15,702 of these restricted funds to acquire property and equipment. At December 31, 2004, approximately $9,144 remained restricted and was classified as non-current restricted cash. In February 2005, we made an offer to repurchase outstanding Senior Secured Notes in an amount of up to $5,500, the extent of the amount of the unused funds remaining in the collateral account. This offer resulted in our repurchase of $1,200 in Senior Secured Notes. We may use the balance of the excess funds for our general corporate purposes.
Scheduled maturities of our long-term debt subsequent to December 31, 2004 are as follows:
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NOTE H-RESTRUCTURING AND MERGER RELATED COSTS
As a result of the acquisition of Commonwealth, we announced plans to relocate our corporate headquarters from Irving, Texas to Cleveland, Ohio and restructure and consolidate certain duplicative administrative functions. The charges related to these restructuring initiatives, including the termination of certain executives of Aleris concurrent with the acquisition, totaled $10,754. The charges cover the reduction of 47 corporate personnel, including our former interim chief executive officer and former chief financial officer. Of those 47 individuals, approximately 40 have not left their positions as of December 31, 2004. The restructuring and consolidation plan will be completed by December 31, 2005. The pre-tax restructuring and merger related costs, which are not allocated to a particular segment, are composed of the following:
NOTE I-NET EARNINGS (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except share and per share data):
The following stock options and non-vested shares and units were excluded from the computation of diluted earnings per share because the effect would have been anti-dilutive:
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NOTE J-EMPLOYEE BENEFIT PLANS
Defined Contribution Pension Plans
We sponsor a profit-sharing retirement plan covering most of our employees in the Aluminum Recycling and Zinc segments as well as certain corporate employees who meet defined service requirements. Contributions are determined annually by the Board of Directors and may be as much as 15% of covered salaries. Our profit sharing contributions are as follows:
Subject to certain dollar limits, our employees may contribute a percentage of their salaries to this plan, and we match a portion of the employees’ contributions. Our match of employee’s contributions was as follows:
In addition, as part of the acquisition of Commonwealth, we sponsor defined contribution plans covering certain employees of the Rolled Products segment as well as certain corporate employees. In one of the plans, we match 30% of a participant’s voluntary contributions up to a maximum of 6% of a participant’s compensation. In the other plan, we match 100% of the first 3% of a participant’s voluntary contributions to the plan. Our match of employees’ contributions was approximately $100 for the period from acquisition to December 31, 2004.
Employee Stock Purchase Plan
Effective July 1, 1999, we adopted a qualified, non-compensatory employee stock purchase plan, which allows employees to acquire shares of common stock through payroll deductions over a six-month period. The purchase price is equal to 85% of the fair market value of the common stock on either the first or last day of the offering period, whichever is lower. Purchases under the plan are limited to 15% of an employee’s eligible compensation. A total of 800,000 shares are available for purchase under the plan. We issued 20,431, 23,547, and 29,902 shares under the plan in 2004, 2003 and 2002, respectively.
Defined Benefit Pension Plans
Our non-contributory defined benefit pension plans cover substantially all salaried and non-salaried employees formerly employed by Commonwealth. The plan benefits are based primarily on years of service and employees’ compensation during employment for all employees not covered under a collective bargaining agreement and on stated amounts based on job grade and years of service prior to retirement for non-salaried employees covered under a collective bargaining agreement.
VAW-IMCO maintains a defined benefit pension plan for its employees. This plan is based on final pay and service, but some VAW-IMCO senior officers are entitled to receive enhanced pension benefits. The plan is a book reserve plan, i.e. no plan assets are provided and the employer sets up a book reserve (pension accrual) for payment of the benefits. Under SFAS 87, “Employers’ Accounting for Pensions,” a book reserve plan under German law is an unfunded plan and a liability has to be recognized as an unfunded accrued pension cost. This amount is covered by a German pension insurance association under German law if VAW-IMCO is unable to fulfill its obligations. As of April 1, 2004 benefit payments are financed, in part, by contributions to a relief fund which establishes a life insurance contract to secure future pension payments.
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Components of the net periodic benefit expense were as follows:
The changes in projected benefit obligation and plan assets during the year, using December 1 and September 30 measurement dates for the U.S. and European pension plans, respectively, are as follows.
The accumulated benefit obligation of the U.S. and European pension plans was $123,100 and $17,056, respectively, at December 31, 2004.
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We are required to make assumptions regarding such variables as the expected long-term rate of return on plan assets and the discount rate applied to determine service cost and interest cost. For our domestic pension plans, we base the discount rate used on Moody’s Aa bond index. This rate is adjusted for the underlying duration of the plans’ liabilities. The rates of returns on assets used is determined based upon an analysis of the plans’ historical performance relative to the overall markets and mix of assets. The Company assesses the expected long-term rate of return on plan assets assumptions for each plan based on relevant market conditions and makes adjustments to the assumptions as appropriate. The weighted average assumptions used to determine benefit obligations at December 31 and net pension expense for the period from the date of acquisition to December 31 are as follows:
The U.S. pension plan assets consist primarily of equity securities, guaranteed investment contracts and fixed income pooled accounts. The Company’s plan asset allocation at December 31, 2004 and target allocation for 2005 are as follows:
The Company’s policy for the U.S. pension plans is to make contributions equal to or greater than the requirements prescribed by the Employee Retirement Income Security Act of 1974. We expect to make $3,000 of contributions in the year ending December 31, 2005.
The following benefit payments for the U.S. pension plans, which reflect expected future service, as appropriate, are expected to be paid for the periods indicated:
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As a result of the acquisition of Commonwealth, we also contribute to a union sponsored defined benefit multi-employer pension plan for certain of Commonwealth’s non-salaried employees. The Employee Retirement Income Security Act of 1974, as amended by the Multi-Employers Pension Plan Amendment Act of 1980, imposes certain liabilities upon employers who are contributors to multi-employer plans in the event of the employers’ withdrawal from such a plan or upon a termination of such a plan. Management does not intend to take any action that would subject the Company to any such liabilities. Our expense relating to the multi-employer pension plan was approximately $200 for the period from the date of acquisition to December 31, 2004.
Other Postretirement Benefit Plans
As a result of the acquisition of Commonwealth, we acquired a health care and life insurance benefit plan covering certain employees hired by Commonwealth on or before September 1, 1998. The Company accrues the cost of postretirement benefits within the covered employees’ active service periods. The financial status of the plan at December 31, using a December 1 measurement date, is as follows:
The components of net postretirement benefit expense for the period from the date of acquisition to December 31, 2004 are as follows:
We are required to make an assumption regarding the discount rate applied to determine service cost and interest cost. We base our discount rate used on Moody’s Aa bond index. This rate is adjusted for the underlying
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duration of the plan’s liabilities. The weighted average discount rate used to determine benefit obligations at December 31 and net postretirement benefit expense for the period from the date of acquisition to December 31, 2004 was 5.5%.
For measurement purposes, there is an employer cap on the amount paid for retiree medical benefits. At December 31, 2004, the employer cap had not yet been reached. In addition, the health care cost trend rate assumption is projected to increase in 2005 at an annual rate of 8.5% for retirees under age 65 and 10% for retirees 65 years and older and is assumed to decrease gradually to 5% by 2011 for retirees under age 65 and by 2014 for retirees 65 years and older and remain constant thereafter. If the health care cost trend rate assumption is increased by 1%, the postretirement benefit obligation as of December 31, 2004 and the combined service and interest cost components of postretirement benefit expense for the period from the date of acquisition to December 31 would be increased by approximately $200 and $1, respectively, and if the health care cost trend rate assumption is decreased by 1%, the postretirement benefit obligation as of December 31, 2004 and the combined service and interest cost components of postretirement benefit expense for the period from the date of acquisition to December 31 would be decreased by approximately $200 and $1, respectively.
Our policy for the plan is to make contributions equal to the benefits paid during the year.
The following benefit payments, net of the annual Medicare Part D subsidy of approximately $200 beginning in 2006, are expected to be paid for the periods indicated:
NOTE K-STOCKHOLDERS’ EQUITY
On December 8, 2004, an amendment to our certificate of incorporation was approved by our shareholders that increased the number of our authorized shares from 40 million to 80 million shares.
In December 2004, our shareholders approved the 2004 Equity Incentive Plan. This plan provides for the grant of stock options and other stock awards to eligible employees. There are 1,100,000 shares of common stock reserved for issuance pursuant to awards granted under this plan. No awards may be granted under this plan after September 22, 2014. All options granted under this plan, once vested, are exercisable for a period of up to 10 years from the date of grant, although options may expire earlier because of termination of employment or service. In December 2004, we granted 243,700 stock options and 52,400 non-vested shares of our common stock to certain employees. The options vest in one-third increments over a three year period from the date of grant. One-half of the non-vested shares will vest three years from the date of grant while the remaining shares will vest in five years but may vest in three years subject to certain performance goals being met. At December 31, 2004, the non-vested shares had not been issued from our treasury stock. Upon issuance, the grant date fair value of these awards will be shown as a reduction to treasury stock with a corresponding adjustment to deferred compensation in the consolidated balance sheet. The grant date fair value is being amortized over the vesting period.
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In connection with the acquisition of Commonwealth, we have assumed the historical stock option plans of Commonwealth. These plans cover certain officers, key employees and directors. The plans provide for the grant of options to purchase common stock, the award of non-vested shares and, in the case of non-employee directors, the award of shares of common stock. The total number of shares authorized under the plans is 2,404,250. In December 2004, we granted 565,700 stock options and 115,200 non-vested shares of our common stock to certain employees under these plans. 593,922 shares were available for grants and awards at December 31, 2004.
In 1990, we adopted an Amended and Restated Stock Option Plan. This plan expired in 1997, and no further grants of options may be made under the plan. This plan provided for the granting of nonqualified and incentive stock options. The number of shares of common stock authorized for issuance under the plan was 1,200,000 shares. Options granted under the plan had various vesting periods and are exercisable for a period of 10 years from the date of grant, although options may expire earlier because of termination of employment.
In 1992, we adopted the 1992 Stock Option Plan, which provides for the granting of nonqualified and incentive stock options to employees, officers, consultants and non-employee members of the Board of Directors. This plan expired in December 2002, and no further grants of options may be made under the plan.
In 1996, we adopted our Annual Incentive Program, which provided certain of our key employees with annual incentive compensation tied to the achievement of pre-established and objective performance goals. This plan also provides for the granting of stock options to key management employees on a discretionary basis. Nonqualified and incentive stock options may be granted. Options granted to employees under this plan have various vesting periods. Annually, non-employee directors will be granted nonqualified stock options exercisable after six months from the date of grant, equal to the number of shares determined by dividing the annual retainer fee amount by the fair market value of a share of common stock as of the date of grant. All options granted under this plan, once vested, are exercisable for a period of up to 10 years from the date of grant, although options may expire earlier because of termination of employment or service.
The 1992 Stock Option Plan and the 1996 Annual Incentive Program allow for the payment of all or a portion of the exercise price and tax withholding obligations in shares of our common stock delivered and/or withheld. Such payment or withholding will be valued at fair market value as of the date of exercise. Participants making use of this feature will automatically be granted a reload stock option to purchase a number of shares equal to the number of shares delivered and/or withheld. When a reload stock option is granted, a portion of the shares issued to the participant will be designated as restricted stock for a period of five years, although the restrictions may lapse earlier under certain circumstances. Reload stock options have an exercise price equal to the fair market value of the underlying stock as of the date of grant (i.e, the date of exercise of the original options) and will expire on the same date as the original options.
In March 1998, we adopted the Executive Option Exercise Loan Program in order to encourage option exercises and share retention by management employees holding certain options under our Amended and Restated Stock Option Plan and to provide such management employees with a long-term capital accumulation opportunity. This program provided loans to permit the exercise of certain stock options under the Amended and Restated Stock Option Plan and to pay federal and state taxes realized upon such exercises. As of January 1, 2002, we had extended $2,266 in executive loans to these individuals ($1,624 of which represented a reduction to additional paid-in capital and $642 of which was included in other long-term assets).
The terms of the Executive Option Exercise Loan Program provided that the loans extended could be repaid in shares of the Company’s common stock, so long as the Compensation Committee of the Company’s Board of Directors approved that repayment method. In May 2002, following approval of the Compensation Committee,
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substantially all of the outstanding loans and accrued interest under the program were repaid by the participants surrendering to the Company 205,439 shares of common stock held by the Company as collateral for the loans. The shares surrendered to our Company were valued as of the date of transfer (May 9, 2002) at $2,321, based upon the closing price per share on the New York Stock Exchange on that date ($11.30 per share). In December 2002, the remaining outstanding loans held by one executive officer were repaid in accordance with the terms of the Program by his surrendering 9,001 shares of common stock. The shares surrendered to the Company were valued as of the date of transfer (December 12, 2002) at $75, based upon the closing price per share on the New York Stock Exchange on that date ($8.31 per share).
Transactions under these plans are as follows:
The weighted average grant date fair value per share of all stock option awards granted in 2004, 2003, and 2002 was $6.48, $3.13 and $3.74, respectively.
The weighted average grant date fair value of all non-vested stock awards granted in 2004, 2003 and 2002 was $14.51, $7.50 and $5.49, respectively. Compensation expense is recognized over the vesting periods for these awards. Total compensation expense recognized in selling, general and administrative expense was $2,248, $841 and $100 in 2004, 2003 and 2002, respectively. In addition, $3,619 of compensation expense was recognized during 2004 related to the accelerated vesting of non-vested shares and share units held by certain executives whose employment terminated upon the consummation of the merger. This amount has been classified in restructuring and merger related charges in the consolidated statement of operations.
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Information related to options outstanding at December 31, 2004, is summarized below:
NOTE L-ASSET RETIREMENT OBLIGATIONS
Effective January 1, 2003, we adopted SFAS No. 143, “Accounting for Asset Retirement Obligations.” This statement establishes standards for accounting for obligations associated with the retirement of tangible long-lived assets. Under the provisions of this standard, we recorded the estimated fair value of liabilities for existing asset retirement obligations, as well as associated asset retirement costs, which were capitalized as increases to the carrying amounts of related long-lived assets. The amounts recorded are for legal obligations associated with the normal operation of our landfills and the retirement of those assets. Our asset retirement obligations consist primarily of environmental compliance costs associated with our landfills.
Asset retirement costs are currently estimated to be approximately $8,500 and are being expensed as space in the landfills is used. Used space in the landfill is determined either by aerial photography or engineering estimates. The construction costs of the landfills are depreciated as space in the landfills is used. As of December 31, 2004 and 2003 our total asset retirement obligations for our landfills was $5,699 and $5,285, respectively, which have been classified within other long-term liabilities in the consolidated balance sheet.
Prior to our adoption of SFAS 143, accrued landfill closure costs were $3,100 as of December 31, 2002. The adoption of SFAS 143 required us to recognize approximately $2,000 in asset retirement obligations. An equal amount was recorded as an asset for asset retirement costs. The asset retirement costs will be expensed over the lives of the landfills.
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NOTE M-COMMITMENTS AND CONTINGENCIES
Operating leases
We lease various types of equipment and property, primarily the equipment utilized in our operations at our various plant locations and at our headquarters facility. The future minimum lease payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2004, were:
Rental expense under cancelable and noncancelable operating leases for 2004, 2003 and 2002 was $7,310, $6,021 and $3,986, respectively.
Purchase Obligations
Our noncancellable purchase obligations are principally for materials, such as metals and fluxes. These materials are used in our manufacturing operations. Our purchase obligations are as follows:
Amounts recognized in cost of sales related to these purchase obligations totaled $65,667, $67,023 and $65,491 in 2004, 2003 and 2002, respectively.
Environmental Proceedings
Our operations are subject to environmental laws and regulations governing air emissions, wastewater discharges, the handling, disposal and remediation of hazardous substances and wastes and employee health and safety. These laws can impose joint and several liabilities for releases or threatened releases of hazardous substances upon statutorily defined parties, including us, regardless of fault or the lawfulness of the original activity or disposal. Given the changing nature of environmental legal requirements, we may be required, from time to time, to take environmental control measures at some of our facilities to meet future requirements.
We have been named as a potentially responsible party in certain proceedings initiated pursuant to the Comprehensive Environmental Response, Compensation, and Liability Act and similar stated statutes and may
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be named a potentially responsible party in other similar proceedings in the future. It is not anticipated that the costs incurred in connection with the presently pending proceedings will, individually or in the aggregate, have a material adverse effect on our financial position or results of operations.
We are performing operations and maintenance at two Superfund sites for matters arising out of past waste disposal activity associated with closed facilities. We are also under orders by agencies in four states for environmental remediation at five sites, two of which are located at our operating facilities.
Our reserves for environmental remediation liabilities totaled $6,396 and $1,036 at December 31, 2004 and 2003, respectively, and have been classified as other long-term liabilities in the consolidated balance sheet. These amounts are in addition to our asset retirement obligations discussed in Note L-”Asset Retirement Obligations.” In connection with the acquisition of Commonwealth, we have recorded obligations of $5,159, which represents our preliminary estimate of the fair value of the acquired environmental remediation liabilities, through purchase accounting.
Legal Proceedings
We are a party from time to time to what we believe are routine litigation and proceedings considered part of the ordinary course of our business. We believe that the outcome of such existing proceedings would not have a material adverse effect on our financial position or results of operations.
NOTE N-SEGMENT INFORMATION
Description of the Types of Products and Services from which Each Reportable Segment Derives its Revenues
With the acquisition of Commonwealth in 2004, we now have the following operating segments: Rolled Products, Aluminum Recycling, Specialty Alloy, Zinc and International.
The Aluminum Recycling and Specialty Alloy operating segments have been aggregated into one reporting segment for financial reporting purposes, the aluminum recycling segment. This segment represents all of our aluminum melting, processing, alloying, trading and salt cake recovery activities within the United States. We have aggregated these businesses because the products produced are identical (except for minor differences in chemical composition), are delivered in the same manner (either molten or in bars), the raw materials used are very similar, the production processes and equipment used are identical, and they report to the same member of executive management. Our international segment represents all of our aluminum melting, processing, alloying, and trading activities outside of the United States. Our zinc segment represents all of our zinc melting, processing and trading activities. Our rolled products segment represents the acquired aluminum rolling operations of Commonwealth.
Measurement of Segment Profit or Loss and Segment Assets
The accounting policies of the reportable segments are the same as those described in Note A-“Basis of Presentation and Summary of Significant Accounting Policies.” We evaluate the performance of each segment based on operating income or loss. Provisions for income taxes, interest, corporate general and administrative costs, including depreciation of corporate assets and amortization of capitalized debt costs, are not allocated to the reportable segments. Intersegment sales and transfers are recorded at market value; net profits on intersegment sales and transfers were immaterial for the periods presented. Consolidated cash, long-term debt, net capitalized debt costs, net current deferred tax assets and assets located at our headquarters office are not allocated to the reportable segments. Segment information of the Rolled Products segment reflects the period from the date of the acquisition of Commonwealth to December 31, 2004.
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Factors Management Used to Identify the Company’s Reportable Segments
Our reportable segments are business units that offer different types of metal products and services. The reportable segments are each managed separately, because they produce distinct products and services and sell to different types of customers.
Reportable Segment Information
Selected reportable segment disclosures for the three years ended December 31, 2004 are as follows:
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Reconciliations of total reportable segment disclosures to our consolidated financial statements are as follows:
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Geographic Information
The following table sets forth the geographic breakout of our revenues (based on customer location) and property and equipment (net of accumulated depreciation):
With the consolidation of VAW-IMCO in March 2003, most of our foreign property and equipment are located in Germany. In addition, we have operations at our facilities in Swansea, Wales, Monterrey, Mexico and Pindamonhangaba, Brazil.
Revenues and earnings from foreign operations, before interest income and expense, and before provision for income taxes, minority interests and extraordinary items, including foreign joint ventures, for the fiscal years ended 2004, 2003 and 2002 are as follows:
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Major Customers
During 2004 and 2003, no single customer accounted for more than 10% of our consolidated revenues. In 2002 one customer accounted for approximately 11% of our consolidated revenues.
NOTE O-CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Certain of the subsidiaries (the “Guarantor Subsidiaries”) of Aleris International, Inc. are guarantors of the indebtedness of Aleris International, Inc. under its senior secured notes due 2010 and senior notes due 2014. For purposes of complying with the reporting requirements of the Guarantor Subsidiaries, presented below are condensed consolidating financial statements of Aleris International, Inc., the Guarantor Subsidiaries, and those subsidiaries of Aleris International, Inc. that are not guaranteeing the indebtedness under the senior secured notes or the senior notes (the “Non-Guarantor Subsidiaries”). The condensed consolidating balance sheets are presented as of December 31, 2004 and 2003, the condensed consolidating statements of operations are presented for the years ended December 31, 2004 2003 and 2002 and the condensed consolidating statements of cash flows are presented for the years ended December 31, 2004, 2003 and 2002.
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NOTE P-GOODWILL
Effective January 1, 2002, we adopted SFAS No. 142 “Goodwill and Other Intangible Assets” (SFAS 142). Under this standard, goodwill and intangibles with indefinite useful lives are no longer amortized. Instead, SFAS 142 requires that goodwill and intangible assets deemed to have an indefinite useful life be reviewed for impairment upon adoption of SFAS 142 and, at a minimum, annually thereafter.
Goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. For the 2002 goodwill impairment charge, in connection with our adoption of SFAS 142, we engaged a third-party valuation firm to estimate the fair value of our reporting units. The valuation firm used a discounted cash flow model to determine the fair value of our reporting units with a discount rate based on a risk-adjusted weighted average cost of capital for each unit. Because the fair value of our reporting units, as determined by the valuation firm, was less than the carrying value of the reporting unit net assets, we performed the second step of the impairment test as required and determined that an impairment charge was required for each reporting unit. The cumulative effect adjustment recognized as a result of the impairment charge was $58,730 (after tax), consisting of write offs for the impairment of goodwill in the aluminum recycling and zinc segments. We perform our annual impairment review as of December 31 of each year. No impairment of goodwill was indicated as of December 31, 2004 or 2003.
The goodwill impairment charge primarily reflected the decline in our stock price over the previous several years. This decline was the result of several unforeseen factors which reduced our earnings. These factors included increased competition in the specification alloys business, increases in the supply of zinc over the past several years which has led to severe price declines in the selling prices for zinc, and energy related closures in the U.S. Pacific Northwest which has caused capacity reductions for some of our major customers.
Our goodwill by segment is shown below.
NOTE Q-MARKET RISK MANAGEMENT USING FINANCIAL INSTRUMENTS
We enter into derivatives to hedge the cost of energy and the sales price of certain aluminum and zinc products. We evaluate and document each hedge item when entered into. It is our policy not to speculate in hedging activities.
We are engaged in activities that expose us to various market risks, including the effects of natural gas prices and future selling prices of aluminum and zinc. These financial exposures are managed as an integral part of our risk management program, which seeks to reduce the potentially adverse effects that the volatility of the markets may have on operating results. We do not engage in speculative transactions, nor do we hold or issue
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financial instruments for trading purposes. We maintain a natural gas pricing strategy to minimize significant fluctuations in earnings caused by the volatility of gas prices. We also maintain a metal pricing strategy to minimize significant, unanticipated fluctuations in earnings caused by the volatility of aluminum and zinc prices.
Certain of our deferred gains and losses accumulate on our balance sheet (in other comprehensive income (loss)) until the maturity of our respective hedging agreements. As of December 31, 2004, over the next twelve months, we estimate that we will recognize in earnings deferred gains or (losses) from the settlement of our hedging instruments of $(864), $(470), and $(62) for natural gas, aluminum and zinc, respectively. Actual amounts realized will inevitably differ from our estimates. We further emphasize that our deferred hedging activities reduce, but do not eliminate, the effect of volatile aluminum, zinc and natural gas prices on our operations.
Natural Gas: In order to manage our price exposure for natural gas purchases, we have fixed the future price of a portion of our natural gas requirements by entering into financial hedge agreements. Under these agreements, payments are made or received based on the differential between the monthly closing price on the New York Mercantile Exchange (NYMEX) and the actual hedge price. These contracts are accounted for as cash flow hedges, with all gains and losses recognized in cost of sales when the gas is consumed. In addition, we have cost escalators included in some of our long-term supply contracts with customers, which limit our exposure to natural gas price risk. At December 31, 2004, we had outstanding swap agreements to hedge our anticipated domestic natural gas requirements for approximately 10,330,000 Mmbtus of natural gas, which represents approximately 80% of our expected 2005 natural gas fuel needs. At December 31, 2004, the fair value loss of these contracts was $1,320 ($1,890 net of tax). At December 31, 2003, these contracts totaled 2,910,000 Mmbtus with a fair value gain of $1,537 ($953 net of tax). In 2004, 2003 and 2002, natural gas hedging activities increased (decreased) cost of goods sold by the following respective amounts: $(3,735), $(3,401) and $3,105, respectively.
Aluminum-aluminum recycling segment: The aluminum recycling segment enters into futures sale contracts with metal brokers to fix the margin on a portion of the aluminum generated by our salt cake processing facility in Morgantown, Kentucky and some of the aluminum generated for sale from the processing of other scrap metal. These futures sale contracts are settled in the month of shipment. Estimated 2005 total production covered under these futures sale contracts as of December 31, 2004 was 9,060 metric tonnes (mt) with a fair value deferred loss of $483 ($299 net of tax). As of December 31, 2003, total production covered under these futures sale contracts was 1,420 mt with a fair value loss of $117 ($73 net of tax).
We also enter into forward purchase contracts. As of December 31, 2004, we had contracts for 2,190 mt with a fair value deferred gain of $13 ($8 net of tax). As of December 31, 2003, we had contracts for 5,720 mt with a fair value gain of $376 ($233 net of tax).
In 2004, 2003 and 2002, our aluminum recycling segment revenue increased (decreased) by $332, $(185) and $(421), respectively, for settled metal hedging contracts.
Aluminum-rolled products segment: The rolled products segment enters into futures contracts to manage exposure to price risk related to aluminum purchases. We have designated these futures contracts as cash flow hedges of anticipated aluminum raw material purchases. These contracts do not meet certain “effectiveness” requirements set forth in SFAS 133, as amended. Accordingly, the derivative instruments used as hedges were marked-to-market and the gains and losses from the period from the date of acquisition to December 31, 2004 were recorded in the consolidated statement of operations rather than being deferred in other comprehensive income (loss).
ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
As of December 31, 2004, we held open aluminum futures contracts having maturity dates extending through December 2005 with a fair value gain of $10,352 classified as accounts receivable in the consolidated balance sheet. A net gain of $2,554 from the period from the date of acquisition to December 31, 2004 was recognized in cost of sales representing the amount of the hedges’ ineffectiveness.
Zinc: In the normal course of business, we enter into fixed-price forward sales and purchase contracts with a number of our zinc customers. At December 31, 2004, 2005 estimated total production covered under these futures sale contracts was 8,571 mt with a fair value deferred loss of $1,399 ($867 net of tax). At December 31, 2003, 2004 estimated total production covered under these futures sale contracts was 4,075 mt with a fair value loss of $349 ($217 net of tax).
In order to hedge the risk of higher metal prices, we enter into long positions, principally using future purchase contracts. These contracts are settled in the month of the corresponding production or shipment. At December 31, 2004, 2005 estimated total production covered under these futures purchase contracts was 6,082 mt with a fair value deferred gain of $1,337 ($829 net of tax). At December 31, 2003, 2004 estimated total production covered under these futures purchase contracts was 10,227 mt with a fair value deferred gain of $1,571 ($974 net of tax).
In 2004, 2003 and 2002 our zinc revenue increased (decreased) by $725, $(343) and $(2,117), respectively, due to settled zinc metal hedging contracts.
VAW-IMCO: VAW-IMCO has a significant metal hedging program. The majority of VAW-IMCO’s operations are product sales, requiring it to take ownership of the materials processed and exposing it to more risk to changes in metal prices. In order to mitigate this risk, VAW-IMCO enters into LME high-grade and alloy aluminum forward sales and purchase contracts. VAW-IMCO does not hold or issue any derivative financial instruments for trading purposes. The functional currency of VAW-IMCO is the Euro; however, the derivatives utilized in hedging the market risk of changing prices of aluminum purchases and sales at VAW-IMCO facilities are based in U.S. Dollars. This results in foreign currency risk in addition to the risk of changing aluminum prices.
The unrealized gains and losses on VAW-IMCO’s derivative contracts do not qualify for deferred treatment under SFAS 133, as amended. VAW-IMCO’s derivative contracts are recorded at fair value with unrealized gains and losses recognized currently in the financial statements.
As of December 31, 2004, VAW-IMCO had forward purchase contracts for high-grade aluminum for 34,325 mt with a fair value of $(63,478). Also as of December 31, 2004, VAW-IMCO had forward sales contracts for 31,250 mt with a fair value of $59,491.
VAW-IMCO’s losses on metal hedging transactions, as reflected in our consolidated cost of goods sold, was approximately $4,394 for the year ended December 31, 2004 and $(1,479), for the ten months of March through December 2003.
We are exposed to losses in the event of non-performance by the counter-parties to the financial hedge agreements and futures contracts discussed above; however, we do not anticipate any non-performance by the counter-parties. The counter-parties are evaluated for creditworthiness and risk assessment prior to initiating trading activities with the brokers. We do not require collateral to support broker transactions.
ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
NOTE R-OTHER COMPREHENSIVE INCOME (LOSS)
The following table presents the components of other comprehensive income (loss), which are items that change equity during the reporting period, but are not included in earnings:
We translate the balance sheets of our foreign subsidiaries using fiscal period-end exchange rates. The consolidated statements of earnings are translated using the average exchange rates for the period. The cumulative effect of such translations is included in shareholders’ equity, other than for current intercompany accounts, as a component of other comprehensive income (loss), as shown above.
During 2004 and 2003, we incurred an unrealized foreign currency translation gains of $6,259 and $3,587, respectively. The weakening of the U.S. Dollar against the Euro was responsible for most of this gain. To a lesser degree, the strengthening of the British Pound also contributed to this gain. Offsetting these gains was the weakening of the Mexican Peso. As of December 31, 2003, our accumulated foreign currency translation adjustment totaled $505. On average, for 2004 the Euro increased in value by roughly 8% against the U.S. Dollar, and the British Pound increased in value by approximately 7% against the U.S. Dollar.
In 2002 we incurred an unrealized foreign currency translation loss of $5,384. Of this amount, $4,900 was due to our operations in Brazil, and of this, $4,200 of this loss occurred during the third quarter of 2002. During this time, the Brazilian currency lost 23% of its value against the U.S. Dollar.
ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
NOTE S-FINANCIAL INSTRUMENTS
At December 31, 2004 the carrying amount and fair value of our other financial instruments are as follows:
The fair value of our outstanding indebtedness under the Amended and Restated Senior Credit Facility, the 2.24% Morgantown industrial revenue bonds and the VAW-IMCO term loans approximates carrying value due to their floating interest rates. The current fair value of our Senior Notes, Senior Secured Notes and fixed rate revenue bonds were based on market quotations, discounted cash flows and incremental borrowing rates. The fair value of the derivative financial instruments was based on broker quotations. The fair value of accounts receivable, accounts payable and accrued liabilities approximate carrying value.
NOTE T-QUARTERLY FINANCIAL DATA (Unaudited)
Special items relating to our 2004 financial statements and operations
During the fourth quarter of 2004, we recorded asset impairments totaling $4,158 in the Aluminum Recycling segment. The impairments were non-cash charges. See Note E-“Property and Equipment”.
Also during the fourth quarter we recorded restructuring and merger related costs totaling $10,754 related to the initial phases of our plans to integrate the operations of Commonwealth. These charges have not been allocated to a particular segment. See Note H-“Restructuring and Merger Related Costs”.
ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
As a result of INTERMET Corporation’s bankruptcy filing in the third quarter, we did not recognize approximately $3,200 in revenues from shipments to this customer.
During the second quarter of 2004, we recorded $4,512 related to the merger as well as the departure of our chairman of the board, president and chief executive officer.
Special items relating to our 2003 financial statements and operations
During the refinancing of almost all of our debt in the fourth quarter of 2003, we realized a non-cash loss in regards to our deferred charges associated with the establishment of our previous revolving credit facility. This realized non-cash loss was $753. See Note G-“Long-Term Debt.”
During the fourth quarter of 2003, we incurred a write down and impairment of certain of our assets in the Aluminum Recycling segment. The writedowns and impairments were non-cash charges. Our total write downs were $3,940 and our total impairments were $1,965. These writedown and impairment charges were included in our Aluminum Recycling results of operations. See Note E-“Property and Equipment.”
For the fourth quarter of 2003, an unrealized foreign currency gain of $1,880 was recognized on the intercompany note between VAW-IMCO and the Company.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures
An evaluation was performed under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation, as of December 31, 2004, of our disclosure controls and procedures, as that term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act). Our disclosure controls and procedures have been designed to ensure that information we are required to disclose in our reports that we file with the SEC under the Exchange Act is recorded, processed and reported on a timely basis.
Based upon this evaluation, our chief executive officer and our chief financial officer concluded that, for the reasons set forth below under “Management’s Report on Internal Control Over Financial Reporting,” our disclosure controls and procedures were not effective as of December 31, 2004.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining effective internal control over financial reporting, as that term is defined in Rule 13a-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our company’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted a review, evaluation and assessment of the effectiveness of our internal control over financial reporting as of December 31, 2004, based upon the criteria set forth in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness as 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 policies or procedures may deteriorate.
In reliance on the guidance set forth in Question 3 of a “Frequently Asked Questions” interpretive release issued by the staff of the Securities and Exchange Commission’s Office of the Chief Accountant and the Division of Corporation Finance in June 2004 (and revised on October 6, 2004), our management determined that it would exclude Commonwealth Industries, Inc. and its consolidated subsidiaries (“Commonwealth”) from the scope of its assessment of internal control over financial reporting as of December 31, 2004. The reason for its exclusion is that Commonwealth was acquired by our company in a purchase business combination that was completed in December 2004, and it was not possible for management to conduct an assessment of Commonwealth’s internal control over financial reporting in the period between the date the combination was completed and the date of management’s assessment. Commonwealth is now a wholly-owned subsidiary of Aleris International, Inc. The total and net assets of Commonwealth as of December 31, 2004 were approximately $489 million and $328 million, respectively, as of December 31, 2004 and revenues and loss before income taxes were approximately $95 million and $3 million, respectively, for the year then ended. Unaudited Commonwealth pro forma revenues and loss before income taxes for the year ended December 31, 2004 were approximately $1.14 billion and $2.2 million, respectively. See Note B - “Acquisitions/Joint Venture Formation - Unaudited Pro forma Information” of the Notes to Consolidated Financial Statements.
As defined in the Public Company Accounting Oversight Board’s Auditing Standard No. 2, a material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote
likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. In connection with our year-end financial statement closing process, two material weaknesses were identified as of December 31, 2004. The nature of these material weaknesses is further described below.
Our management has identified a material weakness for insufficient controls relating to the accounting for derivative instruments. The insufficient controls include inadequate procedures regarding: (i) documentation for hedge accounting treatment as required by Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” with respect to certain commodity purchase and sale agreements (ii) certain calculations of hedge effectiveness, and (iii) the application of purchase accounting principles to certain derivative instruments acquired in the business combination with Commonwealth. This material weakness resulted in adjustments recorded during the fourth quarter of 2004 to derivative assets and liabilities, other comprehensive income and cost of sales.
Our management has identified certain other insufficient controls which, although individually would not have constituted a material weakness, when combined, constitute a material weakness. The insufficient controls include inadequate procedures: (i) to calculate certain interest expense on newly issued indebtedness, (ii) to calculate capitalized interest on certain capital expenditures at our German subsidiary in accordance with company policies, and (iii) to review and approve calculations in recording certain pension liabilities in Germany. This material weakness resulted in adjustments recorded during the fourth quarter of 2004 to property and equipment, accrued interest and interest expense.
As a result of the material weaknesses described above, our management concluded that, as of December 31, 2004, our internal control over financial reporting was not effective.
Our management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2004, has been audited by Ernst & Young LLP, the Company’s independent registered public accounting firm. Their report appears below.
Remediation of Material Weaknesses
As noted under “Management’s Report on Internal Control Over Financial Reporting” above, we identified certain material weaknesses as of December 31, 2004 that resulted in adjustments recorded during the fourth quarter of 2004. We note that these adjustments were mainly the result of calculation errors, and as a result of applying our judgment to accounting applications within the complex area of derivatives accounting, and were not as a result of any misconduct.
We have taken steps toward remediation of the material weaknesses identified above. As previously announced, in connection with the completion of our merger transaction, on December 9, 2004 we named a new chief executive officer and chief financial officer. As the 2004 year-end financial statement closing process progressed, our senior management made a number of assessments of particular areas in the combined companies in which certain improvements were needed. For example, in connection with the relocation of our corporate headquarters to Beachwood, Ohio, we have hired several qualified individuals to assist us in (i) addressing identified technical areas of controls process weakness and (ii) instilling financial accountability and adopting rigorous processes to improve our controls and procedures. These new positions include a director of accounting and financial reporting, a director of manufacturing finance, a rolled products segment finance manager and a director of global tax. We are currently in the process of filling a new derivatives accounting position, as well as certain other specialist roles in tax, tax accounting and other accounting-related areas. We have developed a timetable and plan for remediation of the weaknesses described above, and are implementing measures to improve our internal control over financial reporting.
Our new management has also implemented a business process design to ensure greater accountability across the organization. This process includes detailed monthly business reviews of operations and financial
position led by our chief executive officer, periodic pre-closing balance sheet reviews led by our controller, and ongoing reassessments of the internal controls and procedures for our company led by our director of internal audit, who will report his progress on a periodic basis to the audit committee of our board of directors. We are in the process of instituting additional educational and training programs to better familiarize our personnel with our existing and new controls and procedures and provide an effective controls infrastructure. However, in the process of continuing our integration of the operations of Aleris and Commonwealth and completing the process of relocating to our new corporate headquarters, we may identify additional internal controls issues. We expect that throughout 2005, additional internal controls processes and procedures will be developed and implemented.
Changes in Internal Control Over Financial Reporting
Except as described above, and except as required in connection with our business combination with Commonwealth, there were no changes in our internal control over financial reporting during the quarterly period ended December 31, 2004, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting
The Board of Directors and Shareholders of Aleris International, Inc.
We have audited management’s assessment, included in “Management’s Report on Internal Control Over Financial Reporting” appearing on pages 106 and 107 of this Annual Report on Form 10-K, that Aleris International, Inc. did not maintain effective internal control over financial reporting as of December 31, 2004, because of the effect of the two material weaknesses identified in management’s assessment, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Aleris International, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
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.
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.
A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weaknesses have been identified and included in management’s assessment:
The company has identified a material weakness for insufficient controls relating to the accounting for derivative instruments. The insufficient controls include inadequate procedures regarding: (i) documentation for hedge accounting treatment as required by Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” with respect to certain commodity purchase and sale agreements, (ii) certain calculations of hedge effectiveness, and (iii) the application of purchase accounting principles to certain derivative instruments acquired in the business combination with Commonwealth Industries, Inc. (“Commonwealth”). This material weakness resulted in adjustments recorded during the fourth quarter of 2004 to derivative assets and liabilities, other comprehensive income and cost of sales.
The company has identified certain other insufficient controls which, although individually would not have constituted a material weakness, when combined, constitute a material weakness. The insufficient controls include inadequate procedures: (i) to calculate certain interest expense on newly issued indebtedness, (ii) to calculate capitalized interest on certain capital expenditures at the Company’s German subsidiary in accordance with company policies, and (iii) to review and approve calculations in recording certain pension liabilities in Germany. This material weakness resulted in adjustments recorded during the fourth quarter of 2004 to property and equipment, accrued interest and interest expense.
These material weaknesses were considered in determining the nature, timing, and extent of audit tests applied in our audit of the 2004 financial statements, and this report does not affect our report dated March 11, 2005, on those financial statements.
As indicated in the accompanying “Management’s Report on Internal Control over Financial Reporting,” management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Commonwealth, which is included in the 2004 consolidated financial statements of Aleris International, Inc. and constituted approximately $489 million and $328 million of total and net assets, respectively, as of December 31, 2004 and approximately $95 million and $3 million of revenues and loss before income taxes, respectively, for the year then ended. Management did not assess the effectiveness of internal control over financial reporting at this entity because it was acquired by the Company in a purchase business combination on December 9, 2004, and management believes it was not possible for management to conduct an assessment of Commonwealth’s internal control over financial reporting in the period between the consummation date and the date of management’s assessment. Our audit of internal control over financial reporting of Aleris International, Inc. also did not include an evaluation of the internal control over financial reporting of Commonwealth.
In our opinion, management’s assessment that Aleris International, Inc. did not maintain effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO control criteria. Also, in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, Aleris International, Inc. has not maintained effective internal control over financial reporting as of December 31, 2004, based on the COSO control criteria.
/s/ Ernst & Young LLP
Dallas, Texas
March 11, 2005
ITEM 9B.
ITEM 9B. OTHER INFORMATION
In February 2005, certain actions regarding executive officer and directors and their compensation were taken:
Aleris Annual Incentive Compensation Plan Management Incentive Metrics for 2005. On February 22, 2005, the compensation committee of the board of directors of our company recommended, and our board of directors approved, the performance criteria and targets to be used for potential cash incentive payments to our senior executives and our employees for 2005 under the Aleris Annual Incentive Compensation Plan. Bonus payments will be calculated using target percentages (expressed as a percentage of base salary) and adjusted based on a combination of corporate, business unit and individual performance. The target bonus awards for senior officers range from 30% of annual base salary to 100% of annual base salary in the case of the chief executive officer. Performance criteria are based on corporate and business unit performance and are determined by two principal measures-earnings before interest, depreciation and amortization (EBITDA) and a formula to calculate reductions in working capital.
Retirement Benefit Restoration Plan. On February 23, 2005, the compensation committee of the board of directors recommended, and the board of directors approved, the adoption of the Aleris International, Inc. Retirement Benefit Restoration Plan. The Benefit Restoration Plan is an unfunded, unsecured pension benefit plan for a select group of management or highly compensated employees designed to work in conjunction with the Aleris International, Inc. Retirement Savings Plan, the Commonwealth Industries, Inc. 401(k) Plan and the Commonwealth Industries, Inc. Cash Balance Plan, employee benefit plans that are intended to be qualified under section 401(a) of the Internal Revenue Code. There are 14 participants in this plan, including our executive officers.
The Benefit Restoration Plan is designed to provide participants with the benefits that would otherwise be earned by them if they were participants in the same qualified plan and if their benefits were not limited by certain provisions of the Internal Revenue Code. The Benefit Restoration Plan generally provides for a benefit equal in value to the allocations that would have been made on behalf of the participant if they were all participants in the Savings Plan, except for certain limits imposed by the Internal Revenue Code. The allocations under the Benefit Restoration Plan would include pre-tax contributions that could have been made under the Savings Plan or 401(k) Plan, as applicable, if the annual IRS limit on pre-tax contributions did not apply, employer matching contributions that would have been made under the Savings Plan if the participant had elected to make the maximum pre-tax contributions to the Savings Plan or 401(k) Plan, as applicable, up to the maximum percentage of salary permitted under the terms of that plan, and an employer profit sharing contribution that would have been made under the Savings Plan, with each allocation taking into account the pre-tax, matching and profit sharing amounts actually allocated or credited (in the case of the Cash Balance Plan) under the retirement plan(s) in which the participant is currently participating. Under the Benefit Restoration Plan, a bookkeeping account has been established for each of the participants that will be credited with such allocations and with hypothetical investment earnings as if the amounts credited to the accounts were invested in certain investment funds that mirror the investment fund available under the Savings Plan or 401(k) Plan.
Resignation of Joseph M. Byers. Joseph M. Byers, 59, Senior Vice President and President of Aleris’ Aluminum Recycling business, has given notice to the company of his resignation from the company to be effective as of March 31, 2005. This business segment will report to our chief executive officer for the interim period until Mr. Byers’ successor is chosen.
Compensation for Directors for 2005. During 2005, we expect to pay compensation to our non-employee directors as follows:
The annual retainer for non-employee directors is payable in quarterly installments. A portion of the annual retainer will be paid in cash and a portion will paid in common stock of the company. Payments will be made quarterly in advance on the first trading day of each calendar quarter. Each non-employee director may elect to receive either 25% or 50% of his total retainer amount in shares of common stock. The number of shares will be determined by dividing the retainer dollar amount by the closing price per share of Aleris common stock on the first trading day of the applicable calendar quarter. The remaining amount of the retainer (either 75% or 50%) will be paid in cash on the first business or trading day of each calendar quarter.
The retainer for the chairmen of the board committees and the lead director is paid in cash in four quarterly installments, paid in advance on the first trading day of each calendar quarter.
Each of the non-management directors is also entitled to receive on an annual basis a grant of shares of restricted stock under the terms of the 2004 Equity Incentive Plan in an amount equal to $35,000. The number of shares will be determined by dividing the retainer dollar amount by the closing price per share of Aleris common stock on the first trading day of the applicable calendar year. In the case of 2005, this amount was determined as of February 23, 2005. The shares of restricted stock cliff vest on the third anniversary of the grant, or at such earlier time as the director is no longer a member of the board.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item with respect to directors and nominees for director of our company appears under the captions “Election of Directors,” “Executive Officers” and “Compliance with Section 16(a)” in our definitive Proxy Statement (herein so called) relating to our 2005 Annual Meeting of Stockholders, to be filed with the SEC under Regulation 14A of the Securities Exchange Act of 1934, which information is incorporated herein by reference. We anticipate that the definitive Proxy Statement will be filed with the SEC and mailed to stockholders in April 2005.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by Regulation S-K Item 402 under this item appears under the caption “Executive Officers” in our definitive Proxy Statement, which information is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Except as set forth below, the information required by this item appears under the caption “Voting and Principal Stockholders” in the definitive Proxy Statement, which information is incorporated herein by reference.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information as of December 31, 2004, as to our shares of common stock that may be issued under our equity compensation plans, including our 1990 Amended and Restated Stock Option Plan, the 1992 Stock Option Plan, the Annual Incentive Program, the Employee Stock Purchase Plan (ESPP), the Commonwealth Industries, Inc. 1995 Stock Incentive Plan (as amended), the Commonwealth Industries, Inc. 1997 Stock Incentive Plan (as amended), the Amended and Restated 2000 Restricted Stock Plan and the Aleris International, Inc. 2004 Equity Incentive Plan.
(1) Represents shares under the 1990 Amended and Restated Stock Option Plan, the 1992 Stock Option Plan, the ESPP, the Commonwealth Industries, Inc. 1995 Stock Incentive Plan (as amended), the Commonwealth Industries, Inc. 1997 Stock Incentive Plan (as amended), the Aleris International, Inc. 2004 Equity Incentive Plan and the Annual Incentive Program (except as described in note (2) below).
(2) Includes 1,506,227 shares of Aleris common stock that may be issued upon exercise of options granted under the Commonwealth Industries, Inc. 1995 Stock Incentive Plan and the Commonwealth Industries, Inc. 1997 Stock Incentive Plan that were assumed by Aleris in connection with the business combination with Commonwealth in December 2004. The weighted average exercise price per share of these outstanding options as of December 2004 under those two assumed plans was $12.23 per share.
(3) Consists of 24,000 shares under options granted under the Annual Incentive Program, as described below.
(4) Includes shares available for future issuance under the ESPP. As of December 31, 2004, an aggregate of 575,885 shares of common stock were available for issuance under the ESPP.
(5) The term of the 1992 Stock Option Plan expired on December 15, 2002. As of December 31, 2004, a total of 651,855 shares of common stock were issuable upon the exercise of outstanding options under this expired plan and are included under column (a).
(6) Includes 209,333 shares issuable under the Annual Incentive Program and 160,000 shares of common stock reserved for issuance under the Amended and Restated 2000 Restricted Stock Plan.
Amended and Restated 2000 Restricted Stock Plan. During 2000 our Board of Directors approved the IMCO Recycling Inc. 2000 Restricted Stock Plan. This plan granted our Compensation Committee the authority to make awards of restricted stock of up to 300,000 shares, in order to attract and retain key employees of the Company and its subsidiaries. In February 2004, our Board of Directors amended and restated the plan, granting the Compensation Committee the authority to grant restricted stock units as well as restricted stock out of the 300,000 available shares under the plan. In February and May 2004, we awarded a total of 197,000 restricted stock units to 14 employees. 57,000 of these restricted stock units have since been forfeited by two employees who have left the company. Any delivery or issuance of shares under this plan must be from shares of common stock held in our treasury or from shares we repurchased.
Under the terms of this plan, we will enter into individual award agreements with participants designated by the Compensation Committee specifying the number of shares of common stock (or restricted stock units) granted under the award, the price (if any) to be paid by the grantee for the restricted stock, the restriction period
during which the award is subject to forfeiture, and any performance objectives specified by the Compensation Committee. Participants will not be permitted to sell, transfer or pledge their restricted stock during their restriction period.
Upon termination of a participant’s employment with our company for any reason other than death, disability or retirement, all nonvested shares of nonvested restricted stock and nonvested restricted stock units will be forfeited. In addition, in the event of a “change in control” of our company (as defined in the plan), all restricted stock and restricted stock units will become fully vested. Unless sooner terminated, the Amended and Restated 2000 Restricted Stock Plan will terminate on December 13, 2010.
Annual Incentive Program. Our Annual Incentive Program was first adopted by our Board and approved by our stockholders in 1996. In 1998, the Board and stockholders approved an amendment to the Annual Incentive Program that increased the total number of shares of common stock reserved for issuance under the plan to 900,000 shares. During 2000, the Board again amended the Annual Incentive Program, authorizing an additional 300,000 shares reserved under the plan. However, this plan amendment provided that only treasury shares or shares repurchased by us could be used for options granted out of the additional 300,000 shares reserved. At December 31, 2004, options had been granted and were outstanding to purchase up to 209,333 shares from this additional 300,000 share reserve under the Annual Incentive Program. As of December 31, 2004, options to purchase a total of 24,000 shares of common stock had been granted and were outstanding under the Annual Incentive Program.
Eligible participants under the Annual Incentive Program are our key employees, consultants, officers and directors selected by the Compensation Committee from time to time.
Unless sooner terminated by action of our Board, the Annual Incentive Program will expire in February 2006. Our Compensation Committee may provide for the exercise of options in installments, and on such other terms, conditions and restrictions as it determines. The exercise price for nonqualified and incentive stock options granted under our Annual Incentive Program cannot be less than the fair market value of the common stock on the date of grant. The option period may not extend longer than ten years from the date the option is granted and, in the case of incentive stock options, is limited to five years from the date of grant for certain participants owning more than 10% of the outstanding common stock. The options granted under our Annual Incentive Program are not transferable other than by will or by the laws of descent and distribution or under the terms of a qualified domestic relations order.
The exercise price of options granted under our Annual Incentive Program may be paid in cash or in shares of common stock valued at their fair market value on the date of exercise (or in any combination of cash and shares). In the event that shares are delivered by a participant in payment of all of a portion of the exercise price, or shares are delivered to or withheld by us in payment of our tax withholding obligations upon exercise, the exercising participant will automatically be granted a “reload” stock option to purchase the number of shares delivered to or withheld by us. The exercise price for a reload stock option will be equal to the fair market value per share of common stock on the date of exercise of the primary option. The option period for a reload stock option will commence on the date of grant and expire on the expiration date of the original stock option.
In the event that a participant exercises a stock option and receives a reload stock option, the participant will be restricted from transferring or pledging a number of shares received by the participant upon exercise of the original stock option, equal to one-half of the total number of shares delivered to and withheld by us upon the exercise of the stock option. These restrictions will continue in effect for up to five years, but will earlier expire upon the participant’s retirement, death or disability, or upon a “change of control” of our company. In addition, the Compensation Committee may in its discretion waive these restrictions.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item appears under the caption “Executive Officers” in the definitive Proxy Statement, which information is incorporated herein by reference.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item appears under the caption “Principal Accountant Fees and Services” in our definitive Proxy Statement, which information is incorporated herein by reference.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)
(1) Consolidated Financial Statements: See Index to Consolidated Financial Statements and Financial Statement Schedules in Item 8 - “Financial Statements And Supplementary Data”.
(2) Consolidated Financial Statement Schedules: See Index to Consolidated Financial Statements and Financial Statement Schedules in Item 8 - “Financial Statements And Supplementary Data”.
* Filed herewith.
** Management contract or compensatory plan or arrangement.
(b) See sub-item (a) above
(c) See sub-item (a) above.
SIGNATUR ES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 16, 2005
Aleris International, Inc.
By:
/S/ ROBERT R. HOLIAN
Robert R. Holian, Senior Vice President, Controller and Assistant Secretary
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
EXHIBIT INDEX
* Filed herewith.
** Management contract or compensatory plan or arrangement.