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ALCOA INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) (dollars in millions, except per share amounts and ingot prices; production and shipments in thousands of metric tons [kmt]) Results of Operations Selected Financial Data: First quarter ended March 31, 2014 2013 Sales $ 5,454 $ 5,833Net (loss) income attributable to Alcoa common shareholders $ (178 ) $ 149 Diluted earnings per share attributable to Alcoa common shareholders $ (0.16 ) $ 0.13 Shipments of alumina (kmt) 2,649 2,457 Shipments of aluminum products (kmt) 1,156 1,224 Alcoa's average realized price per metric ton of primary aluminum $ 2,205 $ 2,398 Net loss attributable to Alcoa was $178, or $0.16 per diluted share, in the 2014 first quarter compared with Net income attributable to Alcoa of $149, or $0.13 per share, in the 2013 first quarter. The decline in earnings of $327 was primarily the result of restructuring and other charges related to capacity reductions at four smelters and two rolling mills and lower realized prices for aluminum in the upstream and midstream businesses. These negative impacts were partially offset by net productivity improvements, net favorable foreign currency movements, and a favorable change in income taxes due to a change from pretax income to a pretax loss. Sales for the 2014 first quarter declined $379, or 6%, compared to the same period in 2013. The decrease was mainly caused by lower primary aluminum volumes, including those related to curtailed and shutdown smelter capacity; unfavorable pricing and mix in the midstream segment; and a decline in realized prices for aluminum, driven by lower London Metal Exchange (LME) prices; slightly offset by higher volumes in the midstream and Alumina segments. Cost of goods sold (COGS) as a percentage of Sales was 82.4% in the 2014 first quarter compared with 83.1% in the 2013 first quarter. The percentage was positively impacted by net productivity improvements across all segments and net favorable foreign currency movements due to a stronger U.S. dollar. These items were mostly offset by the previously mentioned realized price impacts and higher input costs, including those related to bauxite mining and labor. Selling, general administrative, and other expenses (SG&A) decreased $15 in the 2014 first quarter compared to the corresponding period in 2013. The decline was primarily driven by lower expenses for professional and legal fees and contract services, partially offset by higher labor costs. SG&A as a percentage of Sales was unchanged at 4.3% both in the 2013 first quarter and the 2014 first quarter. Restructuring and other charges in the 2014 first quarter were $461 ($274 after-tax and noncontrolling interests), which were comprised of the following components: $336 ($189 after-tax and noncontrolling interest) for exit costs related to decisions to permanently shut down and demolish two smelters and two rolling mills (see below); $70 ($46 after-tax and noncontrolling interest) for the temporary curtailment of two smelters and a related production slowdown at one refinery (see below); $33 ($26 after-tax) for asset impairments related to prior capitalized costs for a modernization project at a smelter in Canada that is no longer being pursued; $13 ($8 after-tax) for layoff costs, including the separation of approximately 170 employees (110 in the Engineered Products and Solutions segment and 60 in Corporate); $15 ($9 after-tax) of charges for other miscellaneous items; and $6 ($4 after-tax and noncontrolling interests) for the reversal of a number of small layoff reserves related to prior periods. In the 2014 first quarter, management approved the permanent shutdown and demolition of the remaining capacity (84 kmt-per-year) at the Massena East smelter in New York and the full capacity (190 kmt-per-year) at the Point Henry smelter in Australia. The capacity at Massena East was fully shut down by the end of the first quarter of 2014 and the Point Henry smelter is expected to be shut down in August 2014. Demolition and remediation activities related to the Massena East and Point Henry smelters will 31 -------------------------------------------------------------------------------- begin in the second quarter of 2014 and second half of 2014, respectively, and are expected to be completed by the end of 2020 and 2018, respectively. The decisions on the Massena East and Point Henry smelters are part of a 15-month review of 460 kmt of smelting capacity initiated by management in the 2013 second quarter for possible curtailment. Through this review, management determined that the remaining capacity of the Massena East smelter was no longer competitive and the Point Henry smelter has no prospect of becoming financially viable. Management also initiated the temporary curtailment of the remaining capacity (62 kmt-per-year) at the Poços de Caldas smelter and additional capacity (85 kmt-per-year) at the São Luís smelter, both in Brazil. These curtailments are expected to be complete by the end of May 2014. As a result of these curtailments, production at the Poços de Caldas refinery will be reduced, which began near the end of the 2014 first quarter. Also in the 2014 first quarter, management approved the permanent shutdown of Alcoa's two rolling mills in Australia, Point Henry and Yennora. This decision was made due to the significant impact of excess can sheet capacity in both Australia and Asia. The two rolling mills have a combined can sheet capacity of 200 kmt-per-year and will be closed by the end of 2014. Demolition and remediation activities related to the two rolling mills will begin in 2015 and are expected to be completed by the end of 2018. In the first quarter of 2014, costs related to the shutdown and curtailment actions included $133 for the layoff of approximately 1,830 employees (1,230 in the Primary Metals segment, 470 in the Global Rolled Products segment, 90 in the Alumina segment, and 40 in Corporate); asset impairments of $91 representing the write-off of the remaining book value of all related properties, plants, and equipment; accelerated depreciation of $59 related to the three facilities in Australia as they continue to operate during 2014; and $123 in other exit costs. Additionally, remaining inventories, mostly operating supplies and raw materials, were written down to their net realizable value resulting in a charge of $34 ($20 after-tax and noncontrolling interest), which was recorded in Cost of goods sold on the Statement of Consolidated Operations. The other exit costs of $123 represent $55 in asset retirement obligations and $38 in environmental remediation, both triggered by the decisions to permanently shut down and demolish the aforementioned structures in the U.S. and Australia, and $30 in supplier and customer contract-related costs. Additional charges of approximately $220 are expected to be recognized throughout 2014 related to these shutdown actions in Australia. Restructuring and other charges in the 2013 first quarter were $7 ($5 after-tax), which were comprised of the following components: $3 ($2 after-tax) for layoff costs, including a pension plan settlement charge related to previously separated employees and the voluntary separation of approximately 60 employees (Primary Metals segment), and a net charge of $4 ($3 after-tax) for other miscellaneous items. Alcoa does not include Restructuring and other charges in the results of its reportable segments. The pretax impact of allocating such charges to segment results would have been as follows: First quarter ended March 31, 2014 2013 Alumina $ 7 $ - Primary Metals 331 - Global Rolled Products 90 3 Engineered Products and Solutions 4 3 Segment total 432 6 Corporate 29 1 Total restructuring and other charges $ 461 $ 7 As of March 31, 2014, approximately 15 of the 2,000 employees associated with 2014 restructuring programs and approximately 1,260 of the 1,660 employees associated with 2013 restructuring programs were separated. The remaining separations for the 2014 and 2013 restructuring programs are expected to be completed by the end of 2014. In the 2014 first quarter, cash payments of $1 and $24 were made against the layoff reserves related to the 2014 and 2013 restructuring programs, respectively. Interest expense increased $5, or 4%, in the 2014 first quarter compared to the corresponding period in 2013. The increase was principally the result of lower capitalized interest ($13), partially offset by an 8% lower average debt level, which was mostly attributable to lower outstanding long-term debt due to 32 -------------------------------------------------------------------------------- the June 2013 repayment of $422 in 6.00% Notes and the March 2014 extinguishment of $575 in 5.25% Convertible Notes. Other expenses, net was $25 in the 2014 first quarter compared to Other income, net of $27 in the 2013 first quarter. The change was mainly the result of a higher equity loss related to Alcoa's share of the joint venture in Saudi Arabia due to restart costs for one of the potlines that was previously shut down due to a period of instability, as well as normal smelter start-up costs, a net unfavorable change in mark-to-market derivative aluminum contracts ($22), net unfavorable foreign currency movements ($14), and a decrease in the cash surrender value of company-owned life insurance. These items were somewhat offset by a gain on the sale of a mining interest in Suriname ($28). The effective tax rate for the first quarter of 2014 and 2013 was 28.1% (benefit on a loss) and 27.4% (provision on income), respectively. The rate for the 2014 first quarter differs from the U.S. federal statutory rate of 35% primarily due to a $56 unfavorable impact related to the interim period treatment of operational losses in certain foreign jurisdictions for which no tax benefit was recognized (impact is expected to reverse by the end of 2014), partially offset by the U.S. tax impact of deemed distributions from otherwise lower tax rate foreign jurisdictions. The rate for the 2013 first quarter differs from the U.S. federal statutory rate of 35% primarily due to a $19 discrete income tax benefit related to new U.S. tax legislation. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law and reinstated various expired or expiring temporary business tax provisions through 2013. Two specific temporary business tax provisions that expired in 2011 and impacted Alcoa are the look-through rule for payments between related controlled foreign corporations and the research and experimentation credit. The expiration of these two provisions resulted in Alcoa recognizing a higher income tax provision of $19 in 2012. As tax law changes are accounted for in the period of enactment, Alcoa recognized the previously mentioned discrete income tax benefit in the 2013 first quarter related to the 2012 tax year to reflect the extension of these provisions. Net loss attributable to noncontrolling interests was $19 in the 2014 first quarter compared with Net income attributable to noncontrolling interests of $21 in the 2013 first quarter. The change of $40 was due to lower earnings of Alcoa World Alumina and Chemicals (AWAC), which is owned 60% by Alcoa and 40% by Alumina Limited. The decline in AWAC's earnings was mostly driven by restructuring and other charges associated with management's decision to permanently shut down the Point Henry smelter in Australia (see Restructuring and other charges above and Primary Metals under Segment Information below). Alcoa has a master collective bargaining labor agreement with the United Steelworkers. This agreement covers 10 locations and approximately 6,100 employees in the United States and expires on May 15, 2014. Negotiations are underway to reach terms on a new long-term agreement. Management is currently undertaking business continuity actions in the event any disruption should occur. The costs of such business continuity preparation will negatively impact results in the second quarter of 2014. Segment Information Alumina First quarter ended March 31, 2014 2013 Alumina production (kmt) 4,172 3,994 Third-party alumina shipments (kmt) 2,649 2,457 Alcoa's average realized price per metric ton of alumina $ 314 $ 331 Alcoa's average cost per metric ton of alumina* $ 278 $ 306 Third-party sales $ 845 $ 826 Intersegment sales 510 595 Total sales $ 1,355 $ 1,421 ATOI $ 92 $ 58 * Includes all production-related costs, including raw materials consumed; conversion costs, such as labor, materials, and utilities; depreciation, depletion, and amortization; and plant administrative expenses. Alumina production increased 4% in the 2014 first quarter compared with the corresponding period in 2013. The improvement in the 2014 first quarter was due to higher production at every refinery in the 33 -------------------------------------------------------------------------------- global system, except for Poços de Caldas (Brazil), as a result of higher third-party demand. The Poços de Caldas refinery started to reduce production near the end of the 2014 first quarter in response to the decision to fully curtail the Poços de Caldas smelter by the end of May 2014 (see Primary Metals below). Management plans to reduce the alumina production at the Poços de Caldas refinery by approximately 100 kmt-per-year. Third-party sales for the Alumina segment rose 2% in the 2014 first quarter compared with the same period in 2013. The increase was primarily due to an improvement of 8% in volume, somewhat offset by a 5% decline in average realized price. The change in average realized price was driven by a 16% lower average LME price for those customer shipments still linked to the LME (39%), mostly offset by higher alumina index/spot pricing for all other customer shipments (61%). Intersegment sales decreased 14% in the 2014 first quarter compared to the corresponding period in 2013 due to lower demand from the Primary Metals segment and lower realized price. ATOI for this segment increased $34 in the 2014 first quarter compared to the same period in 2013. The improvement was primarily the result of net favorable foreign currency movements due to a stronger U.S. dollar, especially against the Australian dollar, net productivity improvements, and a gain on the sale of a mining interest in Suriname ($18). These positive impacts were partially offset by the previously mentioned decline in average realized price and cost increases for bauxite, mainly due to a new mining site in Suriname, and higher natural gas prices in Australia and the U.S. In the second quarter of 2014, alumina production is expected to decline due to the reduction at the Poços de Caldas refinery. Also, net productivity improvements are anticipated while a higher equity loss related to the joint venture in Saudi Arabia due to the ramp-up of pre-operational activities is expected. The previously mentioned expiration of a labor agreement in the United States (see Results of Operations above) will affect one refinery in this segment. Primary Metals First quarter ended March 31, 2014 2013 Aluminum production (kmt) 839 891 Third-party aluminum shipments (kmt) 617 705 Alcoa's average realized price per metric ton of aluminum* $ 2,205 $ 2,398 Alcoa's average cost per metric ton of aluminum** $ 2,156 $ 2,284 Third-party sales $ 1,424 $ 1,758 Intersegment sales 734 727 Total sales $ 2,158 $ 2,485 ATOI $ (15 ) $ 39 * Average realized price per metric ton of aluminum includes three elements: a) the underlying base metal component, based on quoted prices from the LME; b) the regional premium, which represents the incremental price over the base LME component that is associated with the physical delivery of metal to a particular region (e.g., the Midwest premium for metal sold in the United States); and c) the product premium, which represents the incremental price for receiving physical metal in a particular shape (e.g., coil, billet, slab, rod, etc.) or alloy. ** Includes all production-related costs, including raw materials consumed; conversion costs, such as labor, materials, and utilities; depreciation and amortization; and plant administrative expenses. At March 31, 2014, Alcoa had 675 kmt of idle capacity on a base capacity of 3,953 kmt. In the 2014 first quarter, idle capacity increased by 20 kmt compared to December 31, 2013 due to the temporary curtailment of 23 kmt combined at two smelters in Brazil (see below), slightly offset by a 3 kmt pot adjustment in Spain. Base capacity declined 84 kmt between March 31, 2014 and December 31, 2013 due to the permanent closure of the two remaining potlines at a smelter in the U.S (see below). In May 2013, Alcoa announced that management will review 460 kmt of smelting capacity over a 15-month period for possible curtailment. This review is aimed at maintaining Alcoa's competitiveness despite falling aluminum prices and will focus on the highest-cost smelting capacity and those plants that have long-term risk due to factors such as energy costs or regulatory uncertainty. 34 -------------------------------------------------------------------------------- As part of this review during the remainder of 2013, management initiated the permanent shutdown of 146 kmt of combined capacity at the Baie Comeau smelter in Quebec, Canada and the Massena East smelter in New York, as well as a temporary curtailment of 131 kmt of combined capacity at the São Luís and Poços de Caldas smelters, both in Brazil. All of these actions were completed in 2013. During the first quarter of 2014, management initiated three additional actions resulting in the permanent shutdown of an additional 274 kmt of capacity and the temporary curtailment of an additional 147 kmt of capacity. The permanent shutdowns are comprised of the remaining capacity (84 kmt-per-year) at the Massena East smelter and the full capacity (190 kmt-per-year) at the Point Henry (Australia) smelter. The remaining capacity of the Massena East smelter represented two Soderberg potlines that were no longer competitive. This shutdown was completed by the end of the 2014 first quarter. For Point Henry, management determined that the smelter has no prospect of becoming financially viable. The shutdown of the Point Henry smelter will be completed in August 2014. The temporary curtailments are comprised of the remaining capacity (62 kmt-per-year) at the Poços de Caldas smelter and additional capacity (85 kmt-per-year) at the São Luís smelter. The process of curtailing this additional capacity began in March 2014, resulting in 23 kmt coming offline by the end of the 2014 first quarter. These curtailments are expected to be complete by the end of May 2014. See Restructuring and other charges under Results of Operations above for a description of the associated charges. Aluminum production decreased 6% in the 2014 first quarter compared with the corresponding period in 2013. The decline was the result of lower production at the four smelters impacted by the 2013 capacity reductions described above (began subsequent to the 2013 first quarter). Third-party sales for the Primary Metals segment decreased 19% in the 2014 first quarter compared with the same period in 2013. The decline was mostly the result of lower volumes, including from the four smelters impacted by the 2013 capacity reductions, and an 8% decrease in average realized price. The change in average realized price was driven by a 15% lower average LME price (on 15-day lag), somewhat offset by higher regional premiums, which increased by an average of 69% in the U.S. and 20% in Europe. Intersegment sales increased 1% in the 2014 first quarter compared to the corresponding period in 2013 due to higher demand from the midstream business, mostly offset by a decrease in realized price, driven by a lower LME price. ATOI for this segment decreased $54 in the 2014 first quarter compared to the same period in 2013. The decline was primarily due to a drop in the average realized price, a higher equity loss related to the joint venture in Saudi Arabia due to restart costs for one of the potlines that was previously shut down due to a period of instability, as well as normal smelter start-up costs, ($19), and a write-off of inventory related to the decisions to permanently shut down the Point Henry and Massena East smelters ($14). These items were partially offset by net productivity improvements; lower costs for alumina, energy, and carbon; net favorable foreign currency movements due to a stronger U.S. dollar against the Australian dollar, Brazilian real, and Canadian dollar; and a favorable impact related to the absence of a planned power plant maintenance outage at Rockdale, TX that occurred in the 2013 first quarter. In the second quarter of 2014, aluminum shipments are expected to decline due to the closure of the Massena East smelter and the curtailments at the smelters in Brazil. Also, the average realized price is expected to follow a 15-day lag to LME prices and net productivity improvements are anticipated. ATOI will be negatively impacted by a higher equity loss related to the joint venture in Saudi Arabia due to the restart of the one potline that was previously shut down. The full restart of this one potline should be achieved by the end of the 2014 second quarter. The previously mentioned expiration of a labor agreement in the United States (see Results of Operations above) will affect three smelters in this segment. 35 -------------------------------------------------------------------------------- Global Rolled Products First quarter ended March 31, 2014 2013 Third-party aluminum shipments (kmt) 467 450 Alcoa's average realized price per metric ton of aluminum $ 3,591 $ 3,953 Third-party sales $ 1,677 $ 1,779 Intersegment sales 43 51 Total sales $ 1,720 $ 1,830 ATOI $ 59 $ 81 In February 2014, management approved the permanent shutdown of Alcoa's two rolling mills in Australia, Point Henry and Yennora. This decision was made due to the significant impact of excess can sheet capacity in both Australia and Asia. The two rolling mills have a combined can sheet capacity of 200 kmt-per-year and will be closed by the end of 2014. See Restructuring and other charges under Results of Operations above for a description of the associated charges. Third-party sales for the Global Rolled Products segment decreased 6% in the 2014 first quarter compared with the corresponding period in 2013. The decline was principally the result of unfavorable pricing, due to a decrease in metal prices, and unfavorable product mix, somewhat offset by increased demand. Volume improvements were mostly due to the packaging, automotive, building and construction, and commercial transportation end markets. ATOI for this segment declined $22 in the 2014 first quarter compared to the same period in 2013. The decrease was primarily driven by unfavorable pricing; higher input costs, including metal premiums in Europe and Russia and energy in North America and Russia; and a write-off of inventory related to the decision to permanently shut down the Point Henry and Yennora rolling mills ($9). These items were partially offset by net productivity improvements across most businesses. In the second quarter of 2014, demand in the automotive end market is expected to remain strong while pricing pressure in the packaging and industrial end markets will continue. Also, net productivity improvements are anticipated. The previously mentioned expiration of a labor agreement in the United States (see Results of Operations above) will affect three rolling mills in this segment. Engineered Products and Solutions First quarter ended March 31, 2014 2013 Third-party aluminum shipments (kmt) 58 55 Third-party sales $ 1,443 $ 1,423 ATOI $ 189 $ 173 Third-party sales for the Engineered Products and Solutions segment increased 1% in the 2014 first quarter compared with the corresponding period in 2013, mostly due to higher volumes related to the aerospace and commercial transportation end markets, partially offset by lower volumes in all other end markets, particularly industrial gas turbines. ATOI for this segment improved $16 in the 2014 first quarter compared to the same period in 2013, mainly the result of net productivity improvements across all businesses, partially offset by higher costs, primarily labor. In the second quarter of 2014, the aerospace end market is expected to remain strong, while the non-residential building and construction end market will continue its recovery (slowing decline in Europe, 36 -------------------------------------------------------------------------------- gradual recovery in North America). Continued net productivity improvements and share gains through innovation are anticipated. The previously mentioned expiration of a labor agreement in the United States (see Results of Operations above) will affect two extrusion facilities in this segment. Reconciliation of ATOI to Consolidated Net (Loss) Income Attributable to Alcoa Items required to reconcile total segment ATOI to consolidated net (loss) income attributable to Alcoa include: the impact of LIFO inventory accounting; interest expense; noncontrolling interests; corporate expense (general administrative and selling expenses of operating the corporate headquarters and other global administrative facilities, along with depreciation and amortization on corporate-owned assets); restructuring and other charges; discontinued operations; and other items, including intersegment profit eliminations, differences between tax rates applicable to the segments and the consolidated effective tax rate, the results of the soft alloy extrusions business in Brazil, and other nonoperating items such as foreign currency transaction gains/losses and interest income. The following table reconciles total segment ATOI to consolidated net (loss) income attributable to Alcoa: First quarter ended March 31, 2014 2013 Total segment ATOI $ 325 $ 351 Unallocated amounts (net of tax): Impact of LIFO (7 ) (2 ) Interest expense (78 ) (75 ) Noncontrolling interests 19 (21 ) Corporate expense (67 ) (67 ) Restructuring and other charges (321 ) (5 ) Other (49 ) (32 ) Consolidated net (loss) income attributable to Alcoa $ (178 ) $ 149 The significant changes in the reconciling items between total segment ATOI and consolidated net (loss) income attributable to Alcoa for the 2014 first quarter compared with the corresponding period in 2013 consisted of: • an increase in Interest expense, principally caused by lower capitalized interest ($8), partially offset by an 8% lower average debt level, which was mostly attributable to lower outstanding long-term debt due to the June 2013 repayment of $422 in 6.00% Notes and the March 2014 extinguishment of $575 in 5.25% Convertible Notes; • a change in Noncontrolling interests, due to lower earnings at AWAC, principally driven by restructuring and other charges associated with management's decision to permanently shut down the Point Henry smelter in Australia; • an increase in Restructuring and other charges, primarily the result of various costs due to decisions to permanently shut down and demolish two smelters and two rolling mills ($233), as well as the temporary curtailment of two other smelters and a related production slowdown at one refinery ($46); and • a change in Other, mostly driven by an unfavorable tax impact related to the interim period treatment of operational losses in certain foreign jurisdictions for which no tax benefit was recognized ($56), the absence of a discrete income tax benefit related to the American Taxpayer Relief Act of 2012 ($19), a net unfavorable change in mark-to-market derivative aluminum contracts ($15), and net unfavorable foreign currency movements ($9), partially offset by a tax benefit representing the difference between Alcoa's consolidated estimated annual effective tax rate and the statutory rates applied to restructuring and other charges ($72). Environmental Matters See the Environmental Matters section of Note G to the Consolidated Financial Statements in Part I Item 1 of this Form 10-Q. 37 -------------------------------------------------------------------------------- Liquidity and Capital Resources Cash From Operations Cash used for operations was $551 in the 2014 three-month period compared with $70 in the same period of 2013. The decline in cash from operations of $481 was principally due to a negative change of $566 associated with working capital, slightly offset by higher operating results (net (loss) income plus net add-back for noncash transactions in earnings). The components of the negative change in working capital were as follows: a favorable change of $66 in receivables, primarily related to lower levels of outstanding customer receivables due to fewer sales; a negative change of $120 in inventories, largely attributable to inventory build for the ramp-up of automotive production at the Davenport, IA plant, delayed shipments caused by severe winter weather in North America, and business continuity planning due to the May 2014 expiration of Alcoa's largest U.S. labor agreement; an unfavorable change of $12 in prepaid expenses and other current assets; a negative change of $310 in accounts payable, trade, principally the result of timing of payments; an unfavorable change of $9 in accrued expenses, mainly caused by an $88 payment to the United States government due to the resolution of a legal matter, partially offset by the absence of a $64 (€50) payment to the Italian government related to a November 2009 European Commission decision on electricity pricing for certain energy-intensive industries; and a negative change of $181 in taxes, including income taxes, mostly driven by a change from net income to a net loss. Financing Activities Cash provided from financing activities was $10 in the 2014 three-month period, a decrease of $37 compared with $47 in the corresponding period of 2013. The source of cash in the 2014 three-month period was primarily due to $621 in additions to debt, virtually all of which was the result of borrowings under certain revolving credit facilities (see below), and $71 in proceeds from employee exercises of eight million stock options. These items were mostly offset by $631 in payments on debt, mostly related to $620 for the repayment of borrowings under certain revolving credit facilities (see below) and $6 for previous borrowings on the loans supporting the Estreito hydroelectric power project in Brazil; $33 in dividends paid to shareholders; and net cash paid to noncontrolling interests of $15, all of which relates to Alumina Limited's share of AWAC. In the 2013 three-month period, the source of cash was primarily due to $625 in additions to debt, all of which was the result of borrowings under certain credit facilities, and net borrowings of $104 in commercial paper. These items were mostly offset by $639 in payments on debt, mainly related to $625 for the repayment of borrowings under certain credit facilities and $7 for previous borrowings on the loans supporting the Estreito hydroelectric power project in Brazil; $33 in dividends paid to shareholders; and net cash paid to noncontrolling interests of $10, most of which relates to Alumina Limited's share of AWAC. At the end of 2013, Alcoa had ten revolving credit facilities (excluding Alcoa's Five-Year Revolving Credit Facility), each with a different financial institution, providing a combined capacity of $1,190 and expiration dates ranging from February 2014 through December 2015. A credit facility ($150 capacity) that was due to expire in February 2014 was extended to March 2015 in the first quarter of 2014. Another credit facility ($150 capacity) expired in March 2014 (a new agreement with the same financial institution was entered into in April 2014). Also in the first quarter of 2014, Alcoa entered into an eleventh revolving credit agreement, providing a $50 credit facility with an expiration date of February 2016. The purpose of any borrowings under all eleven arrangements is to provide for working capital requirements and for other general corporate purposes. The covenants contained in all eleven arrangements are the same as Alcoa's Five-Year Revolving Credit Agreement (see the Credit Facilities section of Note K to the Consolidated Financial Statements included in Alcoa's 2013 Form 10-K). During the first quarter of 2014, Alcoa borrowed and repaid $620 under these credit arrangements. The weighted-average interest rate and weighted-average days outstanding of the borrowings during the first quarter of 2014 were 1.53% and 49 days, respectively. In the first quarter of 2014, holders of $575 principal amount of Alcoa's 5.25% Convertible Notes due March 15, 2014 (the "Notes") exercised their option to convert the Notes into 89 million shares of Alcoa common stock. The conversion rate for the Notes was 155.4908 shares of Alcoa's common stock per $1,000 (in whole dollars) principal amount of notes, equivalent to a conversion price of $6.43 per share. The difference between the $575 principal amount of the Notes and the $89 par value of the issued shares increased Additional capital on the Consolidated Balance Sheet. This transaction was not reflected in the Statement of Consolidated Cash Flows as it represents a noncash financing activity. 38 -------------------------------------------------------------------------------- In February 2014, Alcoa's automatic shelf registration statement with the Securities and Exchange Commission expired. Alcoa will file a new shelf registration statement at such time as it deems appropriate. Alcoa's cost of borrowing and ability to access the capital markets are affected not only by market conditions but also by the short- and long-term debt ratings assigned to Alcoa's debt by the major credit rating agencies. On May 29, 2013, Moody's Investors Service (Moody's) downgraded the following ratings for Alcoa: long-term debt from Baa3 to Ba1 and short-term debt from Prime-3 to Speculative Grade Liquidity Rating-1. Additionally, Moody's changed the current outlook from rating under review to stable. The following is a summary of Alcoa's liquidity position as it relates to the ratings downgrade by Moody's. Cash and letters of credit. As a result of the ratings downgrade by Moody's, certain power companies and counterparties to derivative contracts required Alcoa to post letters of credit and cash collateral, respectively, in the amount of $167 and $18, respectively, in June 2013. Since that time, the amount of letters of credit posted decreased by $3 and the amount of cash collateral posted declined to $10. Other vendors and third-parties may require Alcoa to post additional letters of credit and/or cash collateral in future periods. Outstanding debt. Alcoa's outstanding debt as of March 31, 2014 totaled $7,747. There were no ramifications to Alcoa as a result of the ratings downgrade and interest payments and fees related to the outstanding debt remain unchanged. Revolving credit facilities. Alcoa has a $3,750 revolving credit facility that expires in July 2017 and eleven other revolving credit facilities totaling $1,240. This $4,990 of borrowing capacity was also unaffected by the ratings downgrade, including the margins that would be applicable to any borrowings, and remains available for use by Alcoa at its discretion. Commercial paper.During the period since the downgrade, Alcoa was able to issue the desired level of commercial paper to support operations without difficulty. At the time of the downgrade, the spreads on commercial paper increased slightly, however, by one to three basis points, which did not result in a significant change to Alcoa's total interest costs. While Alcoa expects it can continue to issue commercial paper, there is no assurance about the amount or cost at which it could issue commercial paper. On April 11, 2014, Fitch Ratings (Fitch) downgraded the following ratings for Alcoa: long-term debt from BBB- to BB+ and short-term debt from F3 to B. Additionally, Fitch changed the current outlook from negative to stable. Management does not believe that this downgrade will have a significant impact on Alcoa's financing activities, including its ability to access the capital markets. The descriptions for outstanding debt and revolving credit facilities above remain unchanged as a result of the Fitch downgrade. Also, Alcoa is in full compliance with the project financing requirements for the Ma'aden-Alcoa joint venture project in Saudi Arabia, and does not need to post collateral as a result of the ratings downgrade. On April 23, 2014, Standard and Poor's Ratings Services (S&P) affirmed the following ratings for Alcoa: long-term debt at BBB- and short-term debt at A-3. Additionally, S&P maintained the current outlook as negative. Investing Activities Cash used for investing activities was $240 in the 2014 three-month period compared with $285 in the 2013 three-month period, resulting in a decrease in cash used of $45. In the 2014 three-month period, the use of cash was mainly due to $209 in capital expenditures, 44% of which related to growth projects, including the automotive expansions at the Alcoa, TN and Davenport, IA fabrication plants and the aluminum-lithium capacity expansion at the Lafayette, IN plant; and $62 in additions to investments, including equity contributions of $54 related to the aluminum complex joint venture in Saudi Arabia; slightly offset by $30 in sales of investments, mostly related to $28 in proceeds from the sale of a mining interest in Suriname. The use of cash in the 2013 three-month period was mainly due to $235 in capital expenditures, 34% of which related to growth projects, including the automotive expansion at the Davenport, IA fabrication plant, the aluminum-lithium capacity expansion at the Lafayette, IN plant, and the Estreito hydroelectric power project; and $121 in additions to investments, including equity contributions of $79 related to the aluminum complex joint venture in Saudi Arabia; slightly offset by a net change in restricted cash of $59, principally related to the release of funds to be used for capital expenditures of the automotive expansion at the Davenport, IA fabrication plant. 39 -------------------------------------------------------------------------------- Recently Adopted and Recently Issued Accounting Guidance See Note B to the Consolidated Financial Statements in Part I Item 1 of this Form 10-Q. Forward-Looking Statements This report contains statements that relate to future events and expectations and, as such, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include those containing such words as "anticipates," "believes," "estimates," "expects," "forecasts," "intends," "outlook," "plans," "projects," "should," "targets," "will," or other words of similar meaning. All statements that reflect Alcoa's expectations, assumptions, or projections about the future other than statements of historical fact are forward-looking statements, including, without limitation, forecasts concerning aluminum industry growth or other trend projections, anticipated financial results or operating performance, targeted or planned schedules for completion and start-up of growth projects, and statements about Alcoa's strategies, objectives, goals, targets, outlook, and business and financial prospects. Forward-looking statements are subject to a number of known and unknown risks, uncertainties, and other factors and are not guarantees of future performance. Actual results, performance, or outcomes may differ materially from those expressed in or implied by those forward-looking statements. Important factors that could cause actual results to differ materially from those in the forward-looking statements include: (a) material adverse changes in aluminum industry conditions, including global supply and demand conditions and fluctuations in London Metal Exchange-based prices, and premiums, as applicable, for primary aluminum, alumina, and other products, and fluctuations in index-based and spot prices for alumina; (b) global economic and financial market conditions generally, including the risk of another global economic downturn and uncertainties regarding the effects of sovereign debt issues or government intervention into the markets to address economic conditions; (c) unfavorable changes in the markets served by Alcoa, including automotive and commercial transportation, aerospace, building and construction, packaging, oil and gas, defense, and industrial gas turbine; (d) the impact of changes in foreign currency exchange rates on costs and results, particularly the Australian dollar, Brazilian real, Canadian dollar, euro, and Norwegian kroner; (e) increases in energy costs, including electricity, natural gas, and fuel oil, or the unavailability or interruption of energy supplies; (f) increases in the costs of other raw materials, including caustic soda or carbon products; (g) Alcoa's inability to achieve the level of revenue growth, cash generation, cost savings, improvement in profitability and margins, fiscal discipline, or strengthening of competitiveness and operations (including moving its alumina refining and aluminum smelting businesses down on the industry cost curves and increasing revenues and improving margins in its Global Rolled Products and Engineered Products and Solutions segments) anticipated from its restructuring programs, cash sustainability, productivity improvement, and other initiatives; (h) Alcoa's inability to realize expected benefits, in each case as planned and by targeted completion dates, from sales of non-core assets, or from newly constructed, expanded, or acquired facilities, including facilities supplying auto sheet capacity or aluminum-lithium capacity, or from international joint ventures, including the joint venture in Saudi Arabia; (i) political, economic, and regulatory risks in the countries in which Alcoa operates or sells products, including unfavorable changes in laws and governmental policies, civil unrest, imposition of sanctions, expropriation of assets, and other events beyond Alcoa's control; (j) the outcome of contingencies, including legal proceedings, government investigations, and environmental remediation; (k) the outcome of negotiations with, and the business or financial condition of, key customers, suppliers, and business partners; (l) adverse changes in tax rates or benefits; (m) adverse changes in discount rates or investment returns on pension assets; (n) the impact of cyber attacks and potential information technology or data security breaches; (o) unexpected events, unplanned outages, supply disruptions, or failure of equipment or processes to meet specifications; (p) risks associated with large infrastructure construction projects; (q) the impact of union disputes, strikes or work stoppages; and (r) the other risk factors summarized in Alcoa's Form 10-K, including under Part I, Item 1A, for the year ended December 31, 2013 and the following sections of this report: Note G and the Derivatives section of Note N to the Consolidated Financial Statements; the discussion included above under Segment Information; and the summary included above regarding Alcoa's liquidity position under Liquidity and Capital Resources - Financing Activities. Alcoa disclaims any intention or obligation to update publicly any forward-looking statements, whether in response to new information, future events, or otherwise, except as required by applicable law. 40 -------------------------------------------------------------------------------- |