10-Q 1 a2q1210q.htm 2Q12 10Q


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2012
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number: 333-173180
________________________________________________________________________
 Aleris International, Inc.
(Exact name of registrant as specified in its charter)
________________________________________________________________________
Delaware
 
27-1539680
(State or other jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
25825 Science Park Drive, Suite 400
Cleveland, Ohio 44122-7392
(Address of principal executive offices) (Zip Code)
(216) 910-3400
(Registrant’s telephone number, including area code)
________________________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨   No   þ
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes þ    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨ 
 
Accelerated filer
¨
 
 
 
 
Non-accelerated filer
þ
(Do not check if smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  þ
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes þ    No¨
There were 100 shares of the registrant’s common stock, par value $0.01 per share, outstanding as of August 2, 2012.
 




ALERIS INTERNATIONAL, INC.
QUARTERLY REPORT ON FORM 10-Q
June 30, 2012
TABLE OF CONTENTS
 
 
 
 
 
 
Page No.
PART I – FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements:
 
 
Consolidated Balance Sheet (Unaudited) as of June 30, 2012 and December 31, 2011
 
Consolidated Statements of Comprehensive Income (Unaudited) for the Three and Six Months Ended June 30, 2012 and 2011
 
Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2012 and 2011
 
Notes to Consolidated Financial Statements (Unaudited)
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Item 4.
Controls and Procedures
 
 
PART II – OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
Item 1A.
Risk Factors
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.
Defaults Upon Senior Securities
Item 4.
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
Signatures



















2


PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
Aleris International, Inc.
Consolidated Balance Sheet
(Unaudited)
(in millions, except share and per share data)
ASSETS
 
June 30, 2012
 
December 31, 2011
Current Assets
 
 
 
 
Cash and cash equivalents
 
$
130.4

 
$
231.4

Accounts receivable (net of allowances of $9.2 and $8.7 at June 30, 2012 and December 31, 2011, respectively)
 
491.0

 
401.1

Inventories
 
626.3

 
585.7

Deferred income taxes
 
6.0

 
6.0

Prepaid expenses and other current assets
 
22.5

 
23.0

Total Current Assets
 
1,276.2

 
1,247.2

Property, plant and equipment, net
 
823.8

 
670.5

Intangible assets, net
 
46.6

 
47.7

Deferred income taxes
 
33.9

 
33.9

Other long-term assets
 
51.7

 
38.3

Total Assets
 
$
2,232.2

 
$
2,037.6

 
 
 
 
 
LIABILITIES AND STOCKHOLDER’S EQUITY
 
 
 
 
Current Liabilities
 
 
 
 
Accounts payable
 
$
357.2

 
$
287.4

Accrued liabilities
 
221.7

 
233.1

Deferred income taxes
 
6.2

 
6.2

Current portion of long-term debt
 
10.2

 
6.9

Total Current Liabilities
 
595.3

 
533.6

Long-term debt
 
660.3

 
595.1

Deferred income taxes
 
12.0

 
5.1

Accrued pension benefits
 
199.8

 
206.2

Accrued postretirement benefits
 
52.6

 
52.9

Other long-term liabilities
 
75.9

 
79.1

Total Long-Term Liabilities
 
1,000.6

 
938.4

Redeemable preferred stock; par value $.01; 5,000 shares authorized and issued
 
5.7

 
5.4

Stockholder’s Equity
 
 
 
 
Common stock; par value $.01; 5,000 shares authorized and 100 shares issued
 

 

Additional paid-in capital
 
568.6

 
563.2

Retained earnings
 
101.2

 
19.7

Accumulated other comprehensive loss
 
(44.6
)
 
(29.0
)
Total Aleris International, Inc. Equity
 
625.2

 
553.9

Noncontrolling interest
 
5.4

 
6.3

Total Equity
 
630.6

 
560.2

Total Liabilities and Equity
 
$
2,232.2

 
$
2,037.6


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




3



Aleris International, Inc.
Consolidated Statements of Comprehensive Income
(Unaudited)
(in millions)
 
 
 
For the three months ended
 
For the six months ended
 
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Revenues
 
$
1,170.7

 
$
1,328.3

 
$
2,311.2

 
$
2,519.6

Cost of sales
 
1,048.2

 
1,193.7

 
2,057.6


2,256.4

Gross profit
 
122.5

 
134.6

 
253.6


263.2

Selling, general and administrative expenses
 
64.6

 
68.4

 
128.5

 
130.1

Losses (gains) on derivative financial instruments
 
4.1

 
(4.2
)
 
2.0

 
(4.2
)
Other operating expense (income), net
 
1.2

 
1.5

 
1.3


(2.1
)
Operating income
 
52.6

 
68.9

 
121.8

 
139.4

Interest expense, net
 
11.4

 
14.0

 
23.1

 
22.4

Other income, net
 
(0.5
)
 
(6.0
)
 
(0.4
)
 
(6.9
)
Income before income taxes
 
41.7

 
60.9

 
99.1

 
123.9

Provision for income taxes
 
8.2

 
4.2

 
18.0

 
9.9

Net income
 
33.5

 
56.7

 
81.1

 
114.0

Net (loss) income attributable to noncontrolling interest
 
(0.6
)
 
0.2

 
(0.6
)
 
0.2

Net income attributable to Aleris International, Inc.
 
$
34.1

 
$
56.5

 
$
81.7

 
$
113.8

 
 
 
 
 
 
 
 
 
Comprehensive income
 
$
3.2

 
$
65.8

 
$
65.5

 
$
144.0

Comprehensive (loss) income attributable to noncontrolling interest
 
(0.6
)
 
0.2

 
(0.6
)
 
0.2

Comprehensive income attributable to Aleris International, Inc.
 
$
3.8

 
$
65.6

 
$
66.1

 
$
143.8














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




4




Aleris International, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(in millions)
 
 
 
For the six months ended
 
 
June 30, 2012
 
June 30, 2011
Operating activities
 
 
 
 
Net income
 
$
81.1

 
$
114.0

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
39.1

 
33.9

Provision for deferred income taxes
 
6.9

 
0.8

Stock-based compensation expense
 
5.3

 
4.5

Unrealized gains on derivative financial instruments
 
(3.8
)
 
(8.9
)
Unrealized currency exchange losses (gains) on debt
 
0.8

 
(6.3
)
Amortization of debt issuance costs
 
3.1

 
3.0

Other non-cash gains, net
 
(0.1
)
 
(6.4
)
Changes in operating assets and liabilities:
 
 
 
 
Change in accounts receivable
 
(97.6
)
 
(160.7
)
Change in inventories
 
(52.8
)
 
(62.0
)
Change in other assets
 
(1.7
)
 
(7.8
)
Change in accounts payable
 
69.8

 
72.0

Change in accrued liabilities
 
(14.6
)
 
48.5

Net cash provided by operating activities
 
35.5

 
24.6

Investing activities
 
 
 
 
Payments for property, plant and equipment
 
(188.8
)
 
(61.7
)
Other
 
(13.4
)
 
7.3

Net cash used by investing activities
 
(202.2
)
 
(54.4
)
Financing activities
 
 
 
 
Proceeds from issuance of Senior Notes, net of discount of $10.0
 

 
490.0

Proceeds from China Loan Facility
 
64.4

 
5.7

Net proceeds from long-term debt
 
2.2

 
3.0

Debt issuance costs
 
(0.3
)
 
(6.8
)
Contributions from noncontrolling interests
 

 
4.1

Dividends paid to Aleris Corporation
 

 
(400.0
)
Other
 
(0.1
)
 
2.2

Net cash provided by financing activities
 
66.2

 
98.2

Effect of exchange rate differences on cash and cash equivalents
 
(0.5
)
 
5.7

Net (decrease) increase in cash and cash equivalents
 
(101.0
)
 
74.1

Cash and cash equivalents at beginning of period
 
231.4

 
113.5

Cash and cash equivalents at end of period
 
$
130.4

 
$
187.6










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




5



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(amounts in millions, except share data)





1. BASIS OF PRESENTATION
The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The operating results for interim periods contained herein are not necessarily indicative of the results that may be expected for any other interim period or for the full year. The accompanying Consolidated Financial Statements include the accounts of Aleris International, Inc. and all of its subsidiaries (collectively, except where the context otherwise requires, referred to as “we,” “us,” “our,” “Company” or similar terms). Aleris International, Inc. is a wholly owned subsidiary of Aleris Corporation (our parent company), a holding company whose assets, liabilities and operations consist solely of those of Aleris International, Inc.
2. INVENTORIES
The components of our “Inventories” as of June 30, 2012 and December 31, 2011 are as follows: 
 
 
June 30, 2012
 
December 31, 2011
Finished goods
 
$
160.3

 
$
175.6

Raw materials
 
250.9

 
226.5

Work in process
 
191.8

 
162.5

Supplies
 
23.3

 
21.1

Total inventories
 
$
626.3

 
$
585.7

3. LONG-TERM DEBT
Our debt as of June 30, 2012 and December 31, 2011 is summarized as follows:
 
 
June 30, 2012
 
December 31, 2011
ABL Facility
 
$

 
$

Senior Notes, net of discount of $8.0 and $8.8 at June 30, 2012 and December 31, 2011, respectively
 
492.0

 
491.2

Exchangeable Notes, net of discount of $0.8 and $0.9 at June 30, 2012 and December 31, 2011, respectively
 
44.2

 
44.1

China Loan Facility, net of discount of $1.1 and $1.0 at June 30, 2012 and December 31, 2011, respectively
 
120.4

 
55.9

Other
 
13.9

 
10.8

Total debt
 
670.5

 
602.0

Less: Current portion of long-term debt
 
10.2

 
6.9

Total long-term debt
 
$
660.3

 
$
595.1

ABL Facility
In connection with our emergence from bankruptcy, we entered into an asset backed multi-currency revolving credit facility (the “ABL Facility”). On June 30, 2011 we amended and restated the ABL Facility. The amended and restated ABL Facility is a $600.0 revolving credit facility which permits multi-currency borrowings up to $600.0 by our U.S. subsidiaries, up to $240.0 by Aleris Switzerland GmbH (a wholly owned Swiss subsidiary), and up to $15.0 by Aleris Specification Alloy Products Canada Company (a wholly owned Canadian subsidiary). We and certain of our U.S. and international subsidiaries are borrowers under this ABL Facility. The availability of funds to the borrowers located in each jurisdiction is subject to a borrowing base for that jurisdiction, and the jurisdictions in which certain subsidiaries of such borrowers are located, calculated on the basis of a predetermined percentage of the value of selected accounts receivable and U.S., Canadian and certain European inventory, less certain ineligible accounts receivable and inventory. The level of our borrowing base and availability under the ABL Facility fluctuates with the underlying London Metal Exchange (“LME”) price of aluminum and




6



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



the euro to U.S. dollar exchange rate which impact both accounts receivable and inventory values included in our borrowing base. Non-U.S. borrowers also have the ability to borrow under the ABL Facility based on excess availability under the borrowing base applicable to the U.S. borrowers, subject to certain sublimits. The ABL Facility provides for the issuance of up to $75.0 of letters of credit as well as borrowings on same-day notice, referred to as swingline loans that are available in U.S. dollars, Canadian dollars, euros, and certain other currencies. As of June 30, 2012, we estimate that our borrowing base would have supported borrowings up to $503.6. After giving effect to outstanding letters of credit of $44.7, we had $458.9 available for borrowing as of June 30, 2012.
Borrowings under the ABL Facility bear interest at a rate equal to the following, plus an applicable margin ranging from 0.75% to 2.50%:
in the case of borrowings in U.S. dollars, a LIBOR rate or a base rate determined by reference to the higher of (1) Bank of America’s prime lending rate, (2) the overnight federal funds rate plus 0.5% or (3) a eurodollar rate determined by Bank of America plus 1.0%;
in the case of borrowings in euros, a euro LIBOR rate determined by Bank of America; and
in the case of borrowings in Canadian dollars, a Canadian prime rate.
As of June 30, 2012 and December 31, 2011, we had no amounts outstanding under the ABL Facility.
In addition to paying interest on any outstanding principal under the ABL Facility, we are required to pay a commitment fee in respect of unutilized commitments of 0.50% if the average utilization is less than 33% for any applicable period, 0.375% if the average utilization is between 33% and 67% for any applicable period, and 0.25% if the average utilization is greater than 67% for any applicable period. We must also pay customary letters of credit fees and agency fees.
The ABL Facility is subject to mandatory prepayment with (i) 100% of the net cash proceeds of certain asset sales, subject to certain reinvestment rights; (ii) 100% of the net cash proceeds from issuance of debt, other than debt permitted under the ABL Facility; and (iii) 100% of net cash proceeds from certain insurance and condemnation payments, subject to certain reinvestment rights.
In addition, if at any time outstanding loans, unreimbursed letter of credit drawings and undrawn letters of credit under the ABL Facility exceed the applicable borrowing base in effect at such time, the Company is required to repay outstanding loans or cash collateralize letters of credit in an aggregate amount equal to such excess, with no reduction of the commitment amount. If the amount available under the ABL Facility is less than the greater of (x) $50.0 and (y) 15.0% of the lesser of the total commitments or the borrowing base under the ABL Facility or an event of default is continuing, we are required to repay outstanding loans with the cash we are required to deposit in collection accounts maintained with the agent under the ABL Facility.
We may voluntarily reduce the unutilized portion of the commitment amount and repay outstanding loans at any time upon three business days prior written notice without premium or penalty other than customary “breakage” costs with respect to eurodollar, euro LIBOR and EURIBOR loans.
There is no scheduled amortization under the ABL Facility. The principal amount outstanding will be due and payable in full at maturity, on June 29, 2016 unless extended pursuant to the credit agreement.
The ABL Facility is secured, subject to certain exceptions (including appropriate limitations in light of U.S. federal income tax considerations on guaranties and pledges of assets by foreign subsidiaries, and certain pledges of such foreign subsidiaries’ stock, in each case to support loans to us or our domestic subsidiaries), by a first-priority security interest in substantially all of our current assets and related intangible assets located in the U.S., substantially all of the current assets and related intangible assets of substantially all of our wholly owned domestic subsidiaries located in the U.S., substantially all of the current assets and related intangible assets of the borrower located in Canada and substantially all of the current assets (other than inventory located outside the United Kingdom) and related intangibles of Aleris Recycling (Swansea) Ltd. and Aleris Switzerland GmbH and certain of its subsidiaries. The borrowers’ obligations under the ABL Facility are guaranteed by certain of our existing and future direct and indirect subsidiaries.
The ABL Facility contains a number of covenants that, among other things and subject to certain exceptions, restrict our ability and the ability of our subsidiaries to:




7



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



incur additional indebtedness;
pay dividends on our common stock and make other restricted payments;
make investments and acquisitions;
engage in transactions with our affiliates;
sell assets;
merge; and
create liens.
Although the credit agreement governing the ABL Facility generally does not require us to comply with any financial ratio maintenance covenants, if the amount available under the ABL Facility is less than the greater of (x) $45.0 or (y) 12.5% of the lesser of (i) the total commitments or (ii) the borrowing base under the ABL Facility at any time, a minimum fixed charge coverage ratio (as defined in the credit agreement) of at least 1.0 to 1.0 will apply. The credit agreement also contains certain customary affirmative covenants and events of default. We were in compliance with all of the covenants set forth in the credit agreement as of June 30, 2012.
Senior Notes
On February 9, 2011, we issued $500.0 aggregate original principal amount of 7 5/8% Senior Notes due 2018 under an indenture (the “Indenture”) with U.S. Bank National Association, as trustee, and on October 14, 2011, we exchanged the $500.0 aggregate original principal amount of 7 5/8% Senior Notes for $500.0 of our new 7 5/8% Senior Notes due 2018 that have been registered under the Securities Act of 1933, as amended (the “Senior Notes”). Interest on the Senior Notes is payable in cash semi-annually in arrears on February 15th and August 15th of each year. The Senior Notes mature on February 15, 2018.
The Senior Notes are jointly and severally, irrevocably and unconditionally guaranteed on a senior unsecured basis, by each direct and indirect restricted subsidiary that is a domestic subsidiary and that guarantees our obligations under the ABL Facility, as primary obligor and not merely as surety. The Senior Notes and the guarantees thereof are our unsecured senior obligations and rank (i) equally in right of payment to all of our existing and future debt and other obligations that are not, by their terms, expressly subordinated in right of payment to the Senior Notes; (ii) effectively subordinated in right of payment to all of our existing and future secured debt (including any borrowings under our ABL Facility), to the extent of the value of the assets securing such debt; (iii) structurally subordinated to all existing and future debt and other obligations, including trade payables, of each of our subsidiaries that is not a guarantor of the Senior Notes; and (iv) senior in right of payment to our existing and future debt and other obligations that are, by their terms, expressly subordinated in right of payment to the Senior Notes, including our 6% Senior Subordinated Exchangeable Notes.
We are not required to make any mandatory redemption or sinking fund payments with respect to the Senior Notes other than as set forth in the Indenture relating to certain tax matters, but under certain circumstances, we may be required to offer to purchase Senior Notes as described below. We may from time to time acquire Senior Notes by means other than redemption, whether by tender offer, in open market purchases, through negotiated transactions or otherwise, in accordance with applicable securities laws.
From and after February 15, 2014, we may redeem the Senior Notes, in whole or in part, upon not less than 30 nor more than 60 days’ prior notice at a redemption price equal to 105.7% of the principal amount, declining annually to 100.0% of the principal amount on February 15, 2017, plus accrued and unpaid interest, and Additional Interest (as defined in the Indenture), if any, thereon to the applicable redemption date.
Prior to February 15, 2013, we may, at our option, subject to certain conditions, redeem up to 35% of the original aggregate principal amount of the Senior Notes at a redemption price of 107.6% of the aggregate principal amount thereof, plus accrued and unpaid interest, and Additional Interest, if any, thereon to the redemption date, (plus the aggregate principal amount of any additional notes issued after the issue date) with the net cash proceeds of one or more equity offerings of ours or any direct or indirect parent of ours to the extent such proceeds are contributed to us provided that at least 65% of the sum of the aggregate principal amount of Senior Notes originally issued under the Indenture and the aggregate principal amount




8



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



of any additional notes issued under the Indenture after the issue date remain outstanding immediately after the occurrence of each such redemption and each such redemption occurs within 180 days of the date of closing of each equity offering. Prior to February 15, 2013, we also may, but not more than one time during each twelve month period, redeem, in the aggregate, up to 10% of the sum of the original principal amount of the Senior Notes (and the original principal amount of any additional notes) issued under the Indenture at a redemption price equal to 103% of the aggregate principal amount thereof, plus accrued and unpaid interest, and Additional Interest, if any, thereon to the applicable redemption date. At any time prior to February 15, 2014, we may redeem all or a part of the Senior Notes, upon not less than 30 nor more than 60 days prior notice, at a redemption price equal to 100% of the principal amount of Senior Notes redeemed plus an applicable premium, as provided in the Indenture, as of, and accrued and unpaid interest and Additional Interest, if any, to the redemption date.
Upon the occurrence of a change in control (as defined in the Indenture), each holder of the Senior Notes has the right to require us to repurchase some or all of such holder’s Senior Notes at a price in cash equal to 101% of the aggregate principal amount thereof plus accrued and unpaid interest and Additional Interest, if any, to the purchase date.
If we or our restricted subsidiaries engage in an asset sale (as defined in the Indenture), we generally must either invest the net cash proceeds from such sales in our business within a specified period of time, permanently reduce senior debt, permanently reduce senior subordinated debt, permanently reduce debt of a restricted subsidiary that is not a subsidiary guarantor or make an offer to purchase a principal amount of the notes equal to the net cash proceeds, subject to certain exceptions. The purchase price of the notes will be 100% of their principal amount, plus accrued and unpaid interest.
The Indenture contains covenants that limit our ability and certain of our subsidiaries’ ability to:
incur additional debt;
pay dividends or distributions on our capital stock or redeem, repurchase or retire our capital stock or subordinated debt;
issue preferred stock of restricted subsidiaries;
make certain investments;
create liens on our or our subsidiary guarantors’ assets to secure debt;
enter into sale and leaseback transactions;
create restrictions on the payment of dividends or other amounts to us from our restricted subsidiaries that are not guarantors of the notes;
enter into transactions with affiliates;
merge or consolidate with another company; and
sell assets, including capital stock of our subsidiaries.
These covenants are subject to a number of important limitations and exceptions.
The Indenture also provides for events of default, which, if any of them occurs, would permit or require the principal, premium, if any, interest and any other monetary obligations on all outstanding Senior Notes to be due and payable immediately. We were in compliance with all covenants set forth in the Indenture as of June 30, 2012.
We used a portion of the net proceeds from the sale of the Senior Notes to pay cash dividends of approximately $500.0 to Aleris Corporation during the year ended December 31, 2011, which were then paid as dividends, pro rata, to the stockholders of Aleris Corporation.
Exchangeable Notes
In connection with our emergence from bankruptcy, we issued $45.0 aggregate principal amount of 6.0% Senior Subordinated Exchangeable Notes (the “Exchangeable Notes”). The Exchangeable Notes are scheduled to mature on June 1, 2020. The Exchangeable Notes have exchange rights at the holder’s option, after June 1, 2013, and are exchangeable for Aleris Corporation common stock at a rate equivalent to 47.20 shares of Aleris Corporation common stock per $1,000 principal amount of Exchangeable Notes (after adjustment for the payment of the dividends in 2011), subject to further




9



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



adjustment. The Exchangeable Notes may be redeemed at the Company’s option at specified redemption prices on or after June 1, 2013 or upon a fundamental change of Aleris Corporation.
The Exchangeable Notes are our unsecured, senior subordinated obligations and rank (i) junior to all of our existing and future senior indebtedness, including the ABL Facility; (ii) equally to all of our existing and future senior subordinated indebtedness; and (iii) senior to all of our existing and future subordinated indebtedness.
China Loan Facility
In March 2011, our subsidiary, Aleris Dingsheng Aluminum (Zhenjiang) Co., Ltd. (“Aleris Zhenjiang”), entered into a non-recourse multi-currency secured revolving and term loan facility with the Bank of China Limited, Zhenjiang Jingkou Sub-Branch (the “China Loan Facility”). The China Loan Facility originally consisted of a $100.0 term loan, an RMB 532.0 term loan (or equivalent to approximately $84.3) and a combined U.S. dollar/RMB revolving credit facility up to an aggregate amount equivalent to $35.0. In December 2011, the agreement was amended and now consists of a $30.0 term loan facility, an RMB 997.5 term loan facility (or equivalent to approximately $158.1) and an RMB 232.8 (or equivalent to approximately $36.9) revolving credit facility. The interest rate on the term U.S. dollar facility is six month U.S. dollar LIBOR plus 5.0% and the interest rate on the term RMB facility and the revolving credit facility is 110% of the base rate applicable to any loan denominated in RMB of the same tenor, as announced by the People’s Bank of China. As of June 30, 2012, $121.5 was drawn under the term loan facility. Draws on the revolving facility begin in 2013. The final maturity date for all borrowings under the China Loan Facility is May 21, 2021. Aleris Zhenjiang is an unrestricted subsidiary under the indenture governing the Senior Notes.
The China Loan Facility contains certain customary covenants and events of default. The China Loan Facility requires Aleris Zhenjiang to, among other things, maintain a certain ratio of outstanding term loans to invested equity capital. In addition, among other things and subject to certain exceptions, Aleris Zhenjiang is restricted in its ability to:
repay loans extended by Aleris Zhenjiang’s stockholders prior to repaying loans under the China Loan Facility or make the China Loan Facility junior to any other debts incurred of the same class for the project;
distribute any dividend or bonus to stockholders if its pre-tax profit is insufficient to cover a loss or not used to discharge principal, interest and expenses;
dispose of any assets in a manner that will materially impair its ability to repay debts;
provide guarantees to third parties above a certain threshold that use assets that are financed by the China Loan Facility;
permit any individual investor or key management personnel changes that result in a material adverse effect;
use any proceeds from the China Loan Facility for any purpose other than as set forth therein; and
enter into additional financing to expand or increase the production capacity of the project.
We were in compliance with all of the covenants set forth in the China Loan Facility as of June 30, 2012.
4. COMMITMENTS AND CONTINGENCIES
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 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, results of operations or cash flows.




10



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



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 to perform environmental remediation by agencies in four states and one non-U.S. country at seven sites.
Our reserves for environmental remediation liabilities totaled $35.9 and $36.5 at June 30, 2012 and December 31, 2011, respectively, and have been classified as “Other long-term liabilities” and “Accrued liabilities” in the Consolidated Balance Sheet. Of the environmental liabilities recorded at June 30, 2012 and December 31, 2011, $6.4 is indemnified by Corus Group Ltd.
In addition to environmental liabilities, we have recorded asset retirement obligations associated with legal requirements related primarily to the normal operation of our landfills and the retirement of the related assets. At June 30, 2012 and December 31, 2011, our total asset retirement obligations were $12.7 and $13.7, respectively. The amounts represent the most probable costs of remedial actions. We estimate the costs related to currently identified remedial actions will be paid out primarily over the next ten years.
Legal Proceedings
We are party to routine litigation and proceedings as part of the ordinary course of business and do not believe that the outcome of any existing proceedings would have a material adverse effect on our financial position, results of operations or cash flows. We have established accruals for those loss contingencies, including litigation and environmental contingencies, for which it has been determined that a loss is probable; none of such loss contingencies is material. For those loss contingencies, including litigation and environmental contingencies, which have been determined to be reasonably possible, an estimate of the possible loss or range of loss cannot be determined because the claims, amount claimed, facts or legal status are not sufficiently developed or advanced in order to make such a determination. While we cannot estimate the loss or range of loss at this time, we do not believe that the outcome of any of these existing proceedings would be material to our financial position, results of operations or cash flows.
5. STOCKHOLDERS EQUITY
The following table summarizes the activity within stockholder’s equity, including the components of other comprehensive loss, for the six months ended June 30, 2012:
 
 
Aleris International, Inc. Equity
 
Noncontrolling Interest
 
Total Equity
Total equity at January 1, 2012
 
$
553.9

 
$
6.3

 
$
560.2

Net income (loss)
 
81.7

 
(0.6
)
 
81.1

Other comprehensive loss, before tax:
 

 
 
 

Currency translation adjustments
 
(15.3
)
 

 
(15.3
)
Other
 
(0.3
)
 

 
(0.3
)
Other comprehensive loss, net of tax
 
(15.6
)
 

 
(15.6
)
Stock-based compensation
 
5.3

 

 
5.3

Other
 
(0.1
)
 
(0.3
)
 
(0.4
)
Total equity at June 30, 2012
 
$
625.2

 
$
5.4

 
$
630.6

6. SEGMENT INFORMATION
The Company’s operating structure includes two global business units, Global Rolled and Extruded Products and Global Recycling. This operating structure supports our growth strategies and provides the appropriate focus on our global markets, including aerospace and defense, automotive, commercial plate and heat exchangers, as well as on our regionally based products and customers. These global business units are divided into five operating segments based on the organizational structure that is used by the Company’s chief operating decision maker to evaluate performance, make decisions on resource allocations and for which discrete financial information is available.
The Company’s operating segments (each of which is considered a reportable segment) are:




11



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



Rolled Products North America (“RPNA”);
Rolled Products Europe (“RPEU”);
Extrusions;
Recycling and Specification Alloys North America (“RSAA”); and
Recycling and Specification Alloys Europe (“RSEU”).
Prior period amounts presented have been restated to conform to our current reportable segments, which were changed in the fourth quarter of 2011.
Measurement of Segment Profit or Loss and Segment Assets
The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in the Consolidated Financial Statements for the year ended December 31, 2011. Our measure of profitability for our operating segments is referred to as segment income and loss. Segment income and loss includes gross profits, segment specific realized gains and losses on derivative financial instruments, segment specific other income and expense, segment specific selling, general and administrative (“SG&A”) expense and an allocation of certain regional and global functional SG&A expenses. Segment income and loss excludes provisions for and benefits from income taxes, restructuring items, net, interest, depreciation and amortization, unrealized and certain realized gains and losses on derivative financial instruments, corporate general and administrative costs, start-up expenses, gains and losses on asset sales, currency exchange gains and losses on debt, gains and losses on intercompany receivables, reorganization items, net and certain other gains and losses. Intersegment sales and transfers are recorded at market value. Consolidated cash, long-term debt, net capitalized debt costs, deferred tax assets and assets related to our headquarters offices are not allocated to the segments. Prior period segment income and loss amounts presented have been restated to conform to the current definition of segment income and loss, which was changed in the fourth quarter of 2011.
Reportable Segment Information
The following table shows our revenues and segment income for the periods presented in our Consolidated Statements of Comprehensive Income:
Three months ended June 30, 2012
 
RPNA
 
RPEU
 
Extrusions
 
RSAA
 
RSEU
 
Intersegment Revenues
 
Total
Revenues to external customers
 
$
349.1

 
$
325.3

 
$
89.6

 
$
255.7

 
$
151.0

 
 
 
$
1,170.7

Intersegment revenues
 
0.2

 
13.8

 
2.7

 
2.1

 
8.6

 
$
(27.4
)
 

Total revenues
 
$
349.3

 
$
339.1

 
$
92.3

 
$
257.8

 
$
159.6

 
$
(27.4
)
 
$
1,170.7

Segment income
 
$
34.8

 
$
42.7

 
$
4.9

 
$
14.6

 
$
5.9

 
 
 
$
102.9

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three months ended June 30, 2011
 
RPNA
 
RPEU
 
Extrusions
 
RSAA
 
RSEU
 
Intersegment Revenues
 
Total
Revenues to external customers
 
$
378.0

 
$
407.7

 
$
110.5

 
$
253.8

 
$
178.3

 
 
 
$
1,328.3

Intersegment revenues
 
0.5

 
24.3

 
3.2

 
1.8

 
11.4

 
$
(41.2
)
 

Total revenues
 
$
378.5

 
$
432.0

 
$
113.7

 
$
255.6

 
$
189.7

 
$
(41.2
)
 
$
1,328.3

Segment income
 
$
31.0

 
$
34.9

 
$
2.6

 
$
23.7

 
$
11.8

 
 
 
$
104.0





12



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



Six months ended June 30, 2012
 
RPNA
 
RPEU
 
Extrusions
 
RSAA
 
RSEU
 
Intersegment Revenues
 
Total
Revenues to external customers
 
$
673.1

 
$
649.3

 
$
182.6

 
$
510.0

 
$
296.2

 
 
 
$
2,311.2

Intersegment revenues
 
1.4

 
28.9

 
5.1

 
3.3

 
17.8

 
$
(56.5
)
 

Total revenues
 
$
674.5

 
$
678.2

 
$
187.7

 
$
513.3

 
$
314.0

 
$
(56.5
)
 
$
2,311.2

Segment income
 
$
60.8

 
$
83.8

 
$
10.9

 
$
31.3

 
$
12.7

 
 
 
$
199.5

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2011
 
RPNA
 
RPEU
 
Extrusions
 
RSAA
 
RSEU
 
Intersegment Revenues
 
Total
Revenues to external customers
 
$
688.2

 
$
771.5

 
$
211.3

 
$
500.2

 
$
348.4

 
 
 
$
2,519.6

Intersegment revenues
 
1.0

 
43.9

 
6.0

 
3.0

 
22.1

 
$
(76.0
)
 

Total revenues
 
$
689.2

 
$
815.4

 
$
217.3

 
$
503.2

 
$
370.5

 
$
(76.0
)
 
$
2,519.6

Segment income
 
$
56.3

 
$
68.1

 
$
5.5

 
$
40.7

 
$
23.4

 
 
 
$
194.0

The following table reconciles total segment income to “Income before income taxes” as reported in our Consolidated Statements of Comprehensive Income:
 
 
For the three months ended
 
For the six months ended
 
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Total segment income
 
$
102.9

 
$
104.0

 
$
199.5

 
$
194.0

Unallocated amounts:
 
 
 
 
 
 
 
 
Depreciation and amortization
 
(19.7
)
 
(17.3
)
 
(39.1
)
 
(33.9
)
Corporate general and administrative expenses, excluding depreciation, amortization and start-up expenses
 
(12.7
)
 
(14.3
)
 
(29.7
)
 
(27.3
)
Interest expense, net
 
(11.4
)
 
(14.0
)
 
(23.1
)
 
(22.4
)
Unallocated (losses) gains on derivative financial instruments
 
(7.4
)
 
3.8

 
3.4

 
8.5

Unallocated currency exchange (losses) gains
 
(2.5
)
 
1.2

 
(1.0
)
 
3.9

Start-up expenses
 
(6.3
)
 
(3.0
)
 
(9.2
)
 
(4.3
)
Other (expense) income, net
 
(1.2
)
 
0.5

 
(1.7
)
 
5.4

Income before income taxes
 
$
41.7

 
$
60.9

 
$
99.1

 
$
123.9

The following table shows our reportable segment assets as of June 30, 2012 and December 31, 2011:
 
 
June 30, 2012
 
December 31, 2011
Assets
 
 
 
 
RPNA
 
$
552.4

 
$
514.7

RPEU
 
625.0

 
565.1

Extrusions
 
152.9

 
126.0

RSAA
 
316.7

 
277.4

RSEU
 
185.2

 
169.0

Unallocated assets
 
400.0

 
385.4

Total consolidated assets
 
$
2,232.2

 
$
2,037.6

7. STOCK-BASED COMPENSATION
On June 1, 2010, the Board of Directors of Aleris Corporation approved the 2010 Equity Incentive Plan (the “2010 Equity Plan”). Generally, stock options have a ten-year life and vest quarterly over four years. Generally, all restricted stock units and restricted shares also vest quarterly over four years. A portion of the stock options, as well as a portion of the restricted stock units and restricted shares, may vest upon a change in control event.




13



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



During the six months ended June 30, 2012, Aleris Corporation granted 77,500 stock options and 7,400 restricted stock units to certain members of our senior management and a nonemployee director.
During the three and six months ended June 30, 2012, we recorded $2.8 and $5.3 of compensation expense, respectively, associated with stock options, restricted stock units and restricted shares under the push down accounting provisions of ASC 718, “Compensation - Stock Compensation.” During the three and six months ended June 30, 2011, we recorded $2.1 and $4.5 of compensation expense, respectively. At June 30, 2012, there was $22.2 of unearned compensation that is expected to be recorded over the next four years pertaining to the stock options, restricted stock units and restricted shares.
8. INCOME TAXES
Our effective tax rate was 19.8% and 18.2% for the three and six months ended June 30, 2012, respectively, and 6.9% and 8.0% for the three and six months ended June 30, 2011, respectively. The effective tax rate for the three and six months ended June 30, 2012 and 2011 differed from the federal statutory rate applied to income and losses before income taxes primarily as a result of the mix of income, losses and tax rates between tax jurisdictions and valuation allowances.
We have valuation allowances recorded to reduce certain deferred tax assets to amounts that are more likely than not to be realized. The valuation allowances relate to the potential inability to realize our deferred tax assets associated with amortization, pension and postretirement benefit liabilities in the U.S., and depreciation and net operating loss carryforwards in non-U.S. jurisdictions. We intend to maintain our valuation allowances until sufficient positive evidence exists (such as cumulative positive earnings and estimated future taxable income) to support their reversal.
As of June 30, 2012, we have $16.8 of unrecognized tax benefits. We recognize interest and penalties related to uncertain tax positions within the “Provision for income taxes” in the Consolidated Statements of Comprehensive Income. As of June 30, 2012, we had approximately $2.1 of accrued interest related to uncertain tax positions.
The 2005 through 2011 tax years remain open to examination. A non-U.S. jurisdiction commenced an examination in the fourth quarter of 2009 that is anticipated to be completed within six months of June 30, 2012.
9. EMPLOYEE BENEFIT PLANS
Defined Benefit Pension Plans
The components of the net periodic benefit expense are as follows:
 
 
U.S. pension benefits
 
 
For the three months ended
 
For the six months ended
 
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Service cost
 
$
0.7

 
$
0.6

 
$
1.5

 
$
1.3

Interest cost
 
1.8

 
1.9

 
3.6

 
3.7

Amortization of net loss
 
0.1

 

 
0.2

 

Expected return on plan assets
 
(2.1
)
 
(2.0
)
 
(4.2
)
 
(4.0
)
Net periodic benefit expense
 
$
0.5

 
$
0.5

 
$
1.1

 
$
1.0

 
 
European pension benefits
 
 
For the three months ended
 
For the six months ended
 
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Service cost
 
$
0.6

 
$
0.6

 
$
1.3

 
$
1.2

Interest cost
 
1.8

 
1.8

 
3.5

 
3.7

Expected return on plan assets
 

 

 

 
(0.1
)
Net periodic benefit expense
 
$
2.4

 
$
2.4

 
$
4.8

 
$
4.8





14



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



Other Postretirement Benefit Plans
The components of net postretirement benefit expense are as follows:
 
 
For the three months ended
 
For the six months ended
 
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Service cost
 
$

 
$

 
$

 
$
0.1

Interest cost
 
0.6

 
0.7

 
1.2

 
1.3

Amortization of net loss
 
0.1

 

 
0.2

 

Net postretirement benefit expense
 
$
0.7

 
$
0.7

 
$
1.4

 
$
1.4

10. DERIVATIVE AND OTHER FINANCIAL INSTRUMENTS
We use forward contracts and options, as well as contractual price escalators, to reduce the risks associated with our metal, natural gas and other supply requirements and certain currency exposures. Generally, we enter into master netting arrangements with our counterparties and offset each type of net derivative position with the same counterparties against amounts recognized for the right to reclaim cash collateral or the obligation to return cash collateral under those arrangements in our Consolidated Balance Sheet. For classification purposes, we record the net fair value of each type of derivative position that is expected to settle in less than one year with each counterparty as a net current asset or liability and each type of long-term position as a net long-term asset or liability. At June 30, 2012, no cash collateral was posted. At December 31, 2011, we had posted cash collateral totaling approximately $0.5, of which $0.3 related to counterparties in a net asset position, and therefore, was recorded within “Prepaid expenses and other current assets” on the Consolidated Balance Sheet. The amounts shown in the table below represent the fair value of individual contracts, regardless of the net position presented in the Consolidated Balance Sheet:  
 
 
Fair Value of Derivatives as of
 
 
June 30, 2012
 
December 31, 2011
Derivatives by type
 
Asset
 
Liability
 
Asset
 
Liability
Metal
 
$
25.9

 
$
(36.9
)
 
$
20.8

 
$
(33.7
)
Natural gas
 

 
(2.4
)
 

 
(4.2
)
Currency
 

 

 
0.3

 

Total
 
25.9

 
(39.3
)
 
21.1

 
(37.9
)
Effect of counterparty netting
 
(23.3
)
 
23.3

 
(20.1
)
 
20.1

Effect of cash collateral
 

 

 

 
0.2

Net derivatives as classified in the balance sheet
 
$
2.6

 
$
(16.0
)
 
$
1.0

 
$
(17.6
)
     The fair value of our derivative financial instruments at June 30, 2012 and December 31, 2011 are recorded in the Consolidated Balance Sheet as follows: 
Asset Derivatives
 
Balance Sheet Location
 
June 30, 2012
 
December 31, 2011
Metal
 
Prepaid expenses and other current assets
 
$
2.6

 
$
0.5

 
 
Other long-term assets
 

 
0.2

Currency
 
Prepaid expenses and other current assets
 

 
0.3

Total
 
 
 
$
2.6

 
$
1.0

 
 
 
 
 
Liability Derivatives
 
Balance Sheet Location
 
June 30, 2012
 
December 31, 2011
Metal
 
Accrued liabilities
 
$
10.1

 
$
10.1

 
 
Other long-term liabilities
 
3.5

 
3.5

Natural gas
 
Accrued liabilities
 
2.4

 
4.0

Total
 
 
 
$
16.0

 
$
17.6





15



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



Derivative contracts are recorded at fair value under ASC 820, “Fair Value Measurements and Disclosures,” using quoted market prices and significant other observable inputs. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:
Level 1—Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2—Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (e.g., interest rates); and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3—Inputs that are both significant to the fair value measurement and unobservable.
We endeavor to utilize the best available information in measuring fair value. Where appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads, and credit considerations. Such adjustments are generally based on available market evidence and unobservable inputs. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The following table sets forth our financial assets and liabilities that are accounted for at fair value on a recurring basis as of June 30, 2012 and the level in the fair value hierarchy: 
 
 
Fair value measurements at June 30, 2012 using:
Description
 
Total carrying value
in the Consolidated
Balance Sheet
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant
other observable
inputs (Level 2)
 
Significant
unobservable
inputs
(Level 3)
Derivative assets
 
$
25.9

 
$

 
$
25.9

 
$

Derivative liabilities
 
(39.3
)
 

 
(39.3
)
 

Net derivative assets
 
$
(13.4
)
 
$

 
$
(13.4
)
 
$

Both realized and unrealized gains and losses on derivative financial instruments are included within “Losses (gains) on derivative financial instruments” in the Consolidated Statements of Comprehensive Income. Realized (gains) and losses on derivative financial instruments totaled the following: 
 
 
For the three months ended
 
For the six months ended
 
 
June 30, 2012
 
June 30, 2011
 
June 30, 2012
 
June 30, 2011
Metal
 
$
(5.8
)
 
$
(0.3
)
 
$
0.6

 
$
3.9

Natural gas
 
2.2

 

 
4.3

 
0.8

Currency
 
0.6

 

 
0.8

 

Metal Hedging
The selling prices of the majority of the orders for our rolled and extruded products are established at the time of order entry or, for certain customers, under long-term contracts. As the related raw materials used to produce these orders are purchased several months or years after the selling prices are fixed, margins are subject to the risk of changes in the purchase price of the raw materials used for these fixed price sales. In order to manage this transactional exposure, LME future or forward purchase contracts are purchased at the time the selling prices are fixed. As metal is purchased to fill these fixed price sales orders, LME future or forward contracts are then sold. We also maintain a significant amount of inventory on-hand to meet anticipated and unpriced future sales. In order to preserve the value of this inventory, LME future or forward




16



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



contracts are sold at the time inventory is purchased. As sales orders are priced, LME future or forward contracts are purchased. These derivatives generally settle within three months. We can also use call option contracts, which function in a manner similar to the natural gas call option contracts discussed below, and put option contracts for managing metal price exposures. Option contracts require the payment of a premium which is recorded as a realized loss upon settlement or expiration of the option contract. Upon settlement of a put option contract, we receive cash and recognize a related gain if the LME closing price is less than the strike price of the put option. If the put option strike price is less than the LME closing price, no amount is paid and the option expires. As of June 30, 2012 and December 31, 2011, we had 0.2 and 0.2 metric tons of metal buy and sell forward contracts, respectively.
Natural Gas Hedging
To manage our price exposure for natural gas purchases, we fix 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 contractual hedge price. We also enter into call option contracts to manage the exposure to increasing prices while maintaining our ability to benefit from declining prices. Upon settlement of call option contracts, we receive cash and recognize a related gain if the NYMEX closing price exceeds the strike price of the call option. If the call option strike price exceeds the NYMEX closing price, no amount is received and the option expires. Option contracts require the payment of a premium which is recorded as a realized loss upon settlement or expiration of the option contract. Natural gas cost can also be managed through the use of cost escalators included in some of our long-term supply contracts with customers, which limits exposure to natural gas price risk. As of June 30, 2012 and December 31, 2011, we had 3.5 trillion and 2.3 trillion, respectively, of British thermal unit forward buy contracts.
Currency Exchange Hedging
The construction of an aluminum rolling mill in China has increased our exposure to fluctuations in the euro as certain of the contracts to purchase equipment are denominated in euros while our source of funding is the U.S. dollar and RMB denominated China Loan Facility. Our equity contributions are primarily made in euros to mitigate this exposure. In addition, we have entered into euro call option contracts to manage this exposure if the U.S. dollar weakens while maintaining the benefit if the U.S. dollar strengthens. As with all of our other derivative financial instruments, these call option contracts are not accounted for as hedges and, as a result, the changes in fair value are recorded immediately in the Consolidated Statements of Comprehensive Income. These call option contracts cover periods consistent with known or expected exposures through 2012. As of June 30, 2012 and December 31, 2011, we had euro call option contracts covering a notional amount of $20.6 and $48.5, respectively.
Credit Risk
We are exposed to losses in the event of non-performance by the counterparties to the derivative financial instruments discussed above; however, we do not anticipate any non-performance by the counterparties. The counterparties are evaluated for creditworthiness and risk assessment prior to initiating trading activities with the brokers and periodically throughout each year while actively trading.
 Other Financial Instruments
The carrying amount and fair value of our other financial instruments at June 30, 2012 and December 31, 2011 are as follows: 
 
 
June 30, 2012
 
December 31, 2011
 
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Cash and cash equivalents
 
$
130.4

 
$
130.4

 
$
231.4

 
$
231.4

ABL Facility
 

 

 

 

Exchangeable Notes
 
44.2

 
105.1

 
44.1

 
107.4

Senior Notes
 
492.0

 
507.5

 
491.2

 
490.0

China Loan Facility
 
120.4

 
121.5

 
55.9

 
56.9





17



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



The following table sets forth our other financial instruments for which fair value is disclosed and the level in the fair value hierarchy within which the fair value measurements are categorized as of June 30, 2012: 
 
 
Fair value measurements at June 30, 2012 using:
Description
 
Total estimated fair value
 
Quoted prices in
active markets for
identical assets
(Level 1)
 
Significant
other observable
inputs (Level 2)
 
Significant
unobservable
inputs
(Level 3)
Cash and cash equivalents
 
$
130.4

 
$
130.4

 
$

 
$

Exchangeable Notes
 
105.1

 

 

 
105.1

Senior Notes
 
507.5

 
507.5

 

 

China Loan Facility
 
121.5

 

 

 
121.5

The fair value of our Exchangeable Notes was estimated using a binomial lattice pricing model based on the fair value of Aleris Corporation common stock, a risk-free interest rate of 1.3% to 1.7% and expected equity volatility of 50%. Expected equity volatility was determined based on historical stock prices and implied and stated volatilities of our peer companies. The fair value of our Senior Notes was estimated using market quotations. The carrying amount of the China Loan Facility approximates fair value because the interest rate paid is variable, is set for periods of six months or less and there have been no significant changes in the credit risk of Aleris Zhenjiang subsequent to the inception of the China Loan Facility.
11. RELATED PARTY TRANSACTIONS
As discussed in Note 7, “Stock-Based Compensation,” we recorded $2.8 and $5.3 of compensation expense for the three and six months ended June 30, 2012, respectively, and $2.1 and $4.5 of compensation expense for the three and six months ended June 30, 2011, respectively, associated with the 2010 Equity Plan, the beneficiaries of which are members of our senior management and our nonemployee directors.
12. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
Certain of our subsidiaries (the “Guarantors”) are guarantors of the indebtedness under our Senior Notes. Each of the Guarantors has fully and unconditionally guaranteed, on a joint and several basis, to pay principal and interest related to the Senior Notes and each of the Guarantors are directly or indirectly 100% owned subsidiaries of the Company. 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 Notes (the “Non-Guarantors”). The condensed consolidating balance sheets are presented as of June 30, 2012 and December 31, 2011. The condensed consolidating statements of comprehensive income are presented for the three and six months ended June 30, 2012 and 2011. The condensed consolidating statements of cash flows are presented for the six months ended June 30, 2012 and 2011.





18



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



 
 
As of June 30, 2012
 
 
Aleris
International,
Inc. (Parent)
 
Guarantors
 
Non-
Guarantors
 
Eliminations
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
 
Current Assets
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
16.4

 
$

 
$
115.2

 
$
(1.2
)
 
$
130.4

Accounts receivable, net
 
1.3

 
197.9

 
291.8

 

 
491.0

Inventories
 

 
226.4

 
399.9

 

 
626.3

Deferred income taxes
 

 
1.4

 
4.6

 

 
6.0

Prepaid expenses and other current assets
 
0.1

 
9.6

 
12.8

 

 
22.5

Total Current Assets
 
17.8

 
435.3

 
824.3

 
(1.2
)
 
1,276.2

Property, plant and equipment, net
 

 
344.0

 
479.8

 

 
823.8

Intangible assets, net
 

 
30.7

 
15.9

 

 
46.6

Deferred income taxes
 

 

 
33.9

 

 
33.9

Other long-term assets
 
14.2

 
3.3

 
34.2

 

 
51.7

Investments in subsidiaries/intercompany receivables, net
 
1,138.6

 
295.4

 
0.2

 
(1,434.2
)
 

Total Assets
 
$
1,170.6

 
$
1,108.7

 
$
1,388.3

 
$
(1,435.4
)
 
$
2,232.2

 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDER’S EQUITY
 
 
 
 
 
 
 
 
Current Liabilities
 
 
 
 
 
 
 
 
 
 
Accounts payable
 
$
3.5

 
$
142.2

 
$
212.7

 
$
(1.2
)
 
$
357.2

Accrued liabilities
 

 
63.4

 
158.3

 

 
221.7

Deferred income taxes
 

 

 
6.2

 

 
6.2

Current portion of long-term debt
 

 

 
10.2

 

 
10.2

Total Current Liabilities
 
3.5

 
205.6

 
387.4

 
(1.2
)
 
595.3

Long-term debt
 
536.2

 

 
124.1

 

 
660.3

Deferred income taxes
 

 
1.4

 
10.6

 

 
12.0

Accrued pension benefits
 

 
61.4

 
138.4

 

 
199.8

Accrued postretirement benefits
 

 
52.6

 

 

 
52.6

Other long-term liabilities
 

 
32.7

 
43.2

 

 
75.9

Total Long-Term Liabilities
 
536.2

 
148.1

 
316.3

 

 
1,000.6

Redeemable preferred stock
 
5.7

 

 

 

 
5.7

Aleris International, Inc. equity
 
625.2

 
755.0

 
679.2

 
(1,434.2
)
 
625.2

Noncontrolling interest
 

 

 
5.4

 

 
5.4

Total Liabilities and Equity
 
$
1,170.6

 
$
1,108.7

 
$
1,388.3

 
$
(1,435.4
)
 
$
2,232.2





19



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



 
 
As of December 31, 2011
 
 
Aleris
International,
Inc. (Parent)
 
Guarantors
 
Non-
Guarantors
 
Eliminations
 
Consolidated
ASSETS
 
 
 
 
 
 
 
 
 
 
Current Assets
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
67.1

 
$

 
$
165.7

 
$
(1.4
)
 
$
231.4

Accounts receivable, net
 
1.3

 
150.5

 
249.3

 

 
401.1

Inventories
 

 
220.7

 
365.0

 

 
585.7

Deferred income taxes
 
1.4

 

 
4.6

 

 
6.0

Prepaid expenses and other current assets
 
0.9

 
9.5

 
12.6

 

 
23.0

Total Current Assets
 
70.7

 
380.7

 
797.2

 
(1.4
)
 
1,247.2

Property, plant and equipment, net
 

 
309.9

 
360.6

 

 
670.5

Intangible assets, net
 

 
31.8

 
15.9

 

 
47.7

Deferred income taxes
 

 

 
33.9

 

 
33.9

Other long-term assets
 
15.8

 
3.8

 
18.7

 

 
38.3

Investments in subsidiaries/intercompany receivables (payables), net
 
1,014.6

 
352.4

 
(26.4
)
 
(1,340.6
)
 

Total Assets
 
$
1,101.1

 
$
1,078.6

 
$
1,199.9

 
$
(1,342.0
)
 
$
2,037.6

 
 
 
 
 
 
 
 
 
 
 
LIABILITIES AND STOCKHOLDER’S EQUITY
 
 
 
 
 
 
 
 
Current Liabilities
 
 
 
 
 
 
 
 
 
 
Accounts payable
 
$
3.3

 
$
106.4

 
$
179.1

 
$
(1.4
)
 
$
287.4

Accrued liabilities
 
0.4

 
89.4

 
143.3

 

 
233.1

Deferred income taxes
 

 

 
6.2

 

 
6.2

Current maturities of debt
 

 

 
6.9

 

 
6.9

Total Current Liabilities
 
3.7

 
195.8

 
335.5

 
(1.4
)
 
533.6

Long-term debt
 
535.4

 

 
59.7

 

 
595.1

Deferred income taxes
 
2.1

 

 
3.0

 

 
5.1

Accrued pension benefits
 

 
65.4

 
140.8

 

 
206.2

Accrued postretirement benefits
 

 
52.9

 

 

 
52.9

Other long-term liabilities
 
0.6

 
32.4

 
46.1

 

 
79.1

Total Long-Term Liabilities
 
538.1

 
150.7

 
249.6



 
938.4

Redeemable preferred stock
 
5.4

 

 

 

 
5.4

Aleris International, Inc. equity
 
553.9

 
732.1

 
608.5

 
(1,340.6
)
 
553.9

Noncontrolling interest
 

 

 
6.3

 

 
6.3

Total Liabilities and Equity
 
$
1,101.1

 
$
1,078.6

 
$
1,199.9

 
$
(1,342.0
)
 
$
2,037.6


















20



ALERIS INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - (CONTINUED)
(amounts in millions, except share data)



 
 
For the three months ended June 30, 2012
 
 
Aleris
International,
Inc. (Parent)
 
Guarantors
 
Non-
Guarantors
 
Eliminations
 
Consolidated
Revenues
 
$

 
$
550.9

 
$
622.8

 
$
(3.0
)
 
$
1,170.7

Cost of sales
 

 
504.6

 
546.6

 
(3.0
)
 
1,048.2

Gross profit
 

 
46.3

 
76.2

 

 
122.5

Selling, general and administrative expenses
 

 
29.0

 
35.6

 

 
64.6

Losses on derivative financial instruments
 

 
0.9

 
3.2

 

 
4.1

Other operating expense, net
 

 
0.4

 
0.8

 

 
1.2

Operating income
 

 
16.0

 
36.6

 

 
52.6

Interest expense, net
 

 
11.0

 
0.4

 

 
11.4

Other (income) expense, net
 

 
(1.2
)
 
0.7

 

 
(0.5
)
Equity in net earnings of affiliates
 
(34.1
)
 
(0.5
)
 

 
34.6

 

Income before income taxes
 
34.1

 
6.7

 
35.5

 
(34.6
)
 
41.7

(Benefit from) provision for income taxes
 

 
(0.1
)
 
8.3

 

 
8.2

Net income
 
34.1

 
6.8

 
27.2

 
(34.6
)
 
33.5

Net loss attributable to noncontrolling interest
 

 

 
(0.6
)
 

 
(0.6
)
Net income attributable to Aleris International, Inc.
 
$
34.1

 
$
6.8

 
$
27.8

 
$
(34.6
)
 
$
34.1

 
 
 
 
 
 
 
 
 
 
 
Comprehensive income (loss)
 
$
3.8

 
$
5.6

 
$
(1.0
)
 
$
(5.2
)
 
$
3.2

Comprehensive loss attributable to noncontrolling interest
 

 

 
(0.6
)
 

 
(0.6
)
Comprehensive income (loss) attributable to Aleris International, Inc.