Kaiser Aluminum Corp (KALU) 2007 Q1 法說會逐字稿

Good day, everyone, and welcome to the Kaiser Aluminum first quarter 2007 earnings results conference call. Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Mr. Geoff Mordock. Please go ahead, sir.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's first quarter earnings conference call. If you have not seen a copy of today's earnings release, please visit the Investor Relations page on our kaiseraluminum.com Website. We've also posted a PDF version of the slides that acCompany this call. Joining me today are Chairman, President and Chief Executive Officer, Jack Hockema; Executive Vice President and Chief Financial Officer, Joe Bellino; Chief Accounting Officer, Lynton Rowsell; and Vice President and Treasurer, Dan Rinkenberger.

Before we begin, I would like to remind the audience that the information contained in this presentation includes statements based on management's current expectations, estimates, and projections that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include statements regarding the Company's anticipated financial and operating performance, relates to future events and expectations and involve known and unknown risks and uncertainties.

For a summary of specific risk factors that could cause results to differ materially from those expressed in the forward-looking statements, please refer to the Company's earnings release for the quarter ended March 31, 2007, and reports filed with the Securities and Exchange Commission, including the Company's Form 10-Q for the quarter ended March 31, 2007, and Form 10-K for the year ended December 31, 2006. All information in this presentation is as of the date of the presentation. The Company undertakes no duty to update any forward-looking statement to conform the statement to actual results or changes in the Company's expectations.

Nonrun rate items to us are items that while they may recur period to period are; One, particularly material to results. Two, impact costs as a result of external market factors. And three, may not recur in future periods if the same level of underlying performance were to occur. These are certainly part of our business and operating environment, but are worthy of being highlighted for the benefit of the users of our financial statements. Management's intent is to neutralize the Fabricated Products segment from fluctuations in underlaying metal prices. We characterize metal profits and LIFO charges as nonrun rate items that eventually offset, to a great extent, over the course of the full year.

Further, presentations, including such terms as net income or operating income before nonrun rate are not intended to be and should not be relied on in lieu of the comparable caption under Generally Accepted Accounting Principles or GAAP to which it is reconciled. Such presentations are solely intended to provide greater clarity of the impact of certain material items on the GAAP measure and are not intended to imply such items should be excluded.

I would now like to turn the meeting over to Jack Hockema who will provide overall commentary on Kaiser Aluminum. At the conclusion of the Company's presentation, we will allow for questions and answers. Jack?

Thanks, Geoff. It's a pleasure to once again speak to you for our quarterly earnings call. Before Joe Bellino discusses recent financial results, I will provide some high level context. And to assist you in following our remarks, we've prepared a slide presentation, which may be viewed on our Website, kaiseraluminum.com. You may follow my remarks beginning on page five of the slide presentation.

We had strong operating income of $32 million for the first quarter of 2007. Excluding nonrun rate items, our operating income was up 24% compared to a very strong result in the first quarter last year. In our core Fabricated Products business, underlying profitability received a strong boost from the fifth consecutive quarter of record shipments for heat treat plate. The record shipments were supported by very strong demand for aerospace and defense applications and increased throughput, enabled by the Trentwood expansion and capacity creep.

A significant offset to the favorable impact from heat treat plate was weakness in ground transportation and other industrial markets. The depth of the industry-wide weakness is illustrated by a 16% decline in aluminum association reported shipments of extruded products in the first quarter compared to prior year.

Turning to other matters on page six. The Trentwood expansion remains on schedule and the first two furnaces are fully operational. And our liquidity remains strong, even while we fund the Trentwood expansion. Joe Bellino will now review the financial results in more detail. Joe?

Thanks, Jack. Turning to slide eight. Net sales on a consolidated basis in the first quarter were up 17% to $392 million. The first quarter benefited from favorable product mix and value-added pricing as well as underlying metal price, which we passed through to customers. Total Fabricated Products shipments were up 2% for the quarter. Shipments of heat treated plate were up significantly compared to the first quarter of 2006, and this was the major contributor to the richer product mix.

On slide nine, we discuss net income results. As reported earlier today, our strong underlying performance in Fabricated Products resulted in net income of $17 million in the first quarter. Net income included an effective tax rate of 48%, primarily as a result of the tax treatment of our Anglesey joint venture. Taking into account the use of tax attributes in the income statement, the cash tax rate would have been approximately 15%. We expect this rate to range between 15% and 20% over the balance of the year.

On slide 10, we discuss the operating income results, which we believe provides a more meaningful metric to period-to-period comparison. Our operating income before nonrun rate items improved 24% year over year as it grew to $38 million in Q1 '07, from $31 million in the first quarter of '06. On the slides which follow, we'll discuss the financial performance of the three reporting segments in more detail.

Our core Fabricated Products business segment is the engine that drives the Company's results. As you can see on slide 11, our reported segment operating income for the Fab Products unit was $41 million in the first quarter of 2007. This $41 million compares to $45 million that we reported in the first quarter of 2006, which included a $9 million benefit from nonrun rate items. If we look at operating income before nonrun rate items, our underlying Fabricated Products business performance was stronger in Q1 '07 as operating income increased 15% to $42 million in the first quarter versus $36 million in the first quarter of '06.

The driver for this improved performance was a richer product mix, led by record heat treat plate shipments. This was partially offset by lower shipments for ground transportation and industrial applications. In addition, cost performance was unfavorable in Q1 '07 compared to the prior year. The first quarter of '07 also benefited from a $2 million lower amount of depreciation due in part to the adoption of Fresh Start accounting.

Turning to our primary products segment. Operating income before nonrun rate was $8 million compared to $4 million a year ago. This was due primarily to higher prices for primary aluminum, somewhat offset by higher alumina costs. On a reported basis, operating income for the primary products segment was $4 million in the first quarter of 2007, compared to $9 million for the prior-year period. The $9 million in unfavorable nonrun rate comparisons that you'll see on the chart reflects the unrealized mark-to-market adjustments for metal and currency derivatives.

Anglesey's power contract expires in late 2009 and alternatives are being reviewed to allow to operate beyond the expiration of this contract. This review includes identifying the potential costs of a partial or permanent shutdown. The temporary suspension of dividends continues, while Anglesey studies future cash requirements.

On slide 13, we present the corporate expenses, which are not allocated to the business units. In the first quarter of 2007, we incurred corporate and other expenses of approximately $12 million, of which, approximately $2 million was non-cash stock compensation expense. Excluding this non-cash compensation expense, our corporate and other expenses were approximately the same as they were in the first quarter last year.

And with that, I would like next to ask Jack to provide some concluding remarks.

Thanks, Joe. I'm turning to slide 15 now. While our second quarter demand for extruded products remains weak, we continue to enjoy strong demand in aerospace and defense applications and we continue to believe that this aerospace cycle has legs. The Trentwood expansion remains on schedule and liquidity is expected to remain strong while funding our organic growth initiatives. This concludes our formal remarks and we will now accept questions.

Thank you, sir. (OPERATOR INSTRUCTIONS) We'll take our first question from Timna Tanners of UBS.

Hi. I wanted to follow up a little bit on a few of the items that you touched on. Particularly, starting out with the mention of an unfavorable cost performance. Can you describe for us what you mean by that?

Yes. We measure what we characterize as controllable cost, which excludes things like energy, for example, that are market-related changes in cost. And our controllable costs, while were unfavorable compared to the first quarter last year, we were really pretty much on the same track of cost performance as we ran second half of last year. The first quarter of '06 with cost performance and several other factors was a very, very positive quarter. So, when we talk about an unfavorable comparison, it's an unfavorable comparison to a very, very strong period. And it's pretty much on track with where we were second half of last year.

Okay. And perhaps I misunderstood, but from your last conference call, there was a lot of discussion of your mix. And that the mix would become richer because of the increased proportion of your production that was going to come from the value-added heat treat and that the new furnace coming on. And I was a little confused to see that the gross margins in general were relatively flat from the fourth quarter. Can you provide us a little bit more color on what exactly happened there? Obviously, the extrusions business was softer than you'd expected. But to see the margins flat, even within amount of the new capacity, which you don't really disclose but imagining that it's a sizable increase, how do you explain that the marginsdidn't expand a little further?

Okay, well, first, let's get a consistent glossary of terms on margin.

Okay.

And I'm looking at operating income per pound from Fab Products, and that's before the nonrun rate items. And if you look at that, before nonrun rate items, our margin per pound in the first quarter was up $0.04 from the fourth quarter and was up $0.04 or $0.035 from the first quarter a year ago. So operating income per pound, if you squeeze out the nonrun rate to get it on an apples-and-apples basis is by far the strongest quarter that we've had over the past five quarters and that certainly would apply retrospectively.

The reasons behind that strong margin, the biggest component is we had a significant decline in shipments of the lower value-added products because of the soft automotive and industrial markets. So that's probably the largest impact. But the second impact, and we had identified some of this on the last call, is that we had an unusually rich mix of heat treat plate products as well. So we had -- heat treat plate in total was a larger percentage of the mix and unusually large because of the soft low value added in the first quarter but we had an unusually rich products within the heat treat plate mix.

Okay. And then, I'll hand it off after this. But if you could provide, like you did last time, a little bit of color on your mix outlook? We've got the MSCI data on aluminum, extruded shapes. I don't know if that's helpful to help guide us to what the second quarter might look like in that end of your product mix. But you said that it was an unsustainably rich mix you're expecting in the first quarter. Can you give us an outlook on the coming quarters and what they might look like?

The biggest impact I can give you is on the heat treat plate, which I said was a factor, we don't think we'll sustain the richness within the mix of shipments in heat treat plate that we had in the first quarter. We just had some very rich products in there that we don't believe will continue long-term. In terms of the broader product mix, which is really how much aerospace and defense -- how much heat treat products do we have versus how much common alloy products, at this point we're not seeing much change many market dynamics.

The ground transportation and the industrial markets haven't picked up much from what we saw in the first quarter, maybe a little better, but basically the same. And similarly, the first quarter we had -- the heat treat capacity expanded through essentially all of the first quarter. So we don't see much change in the total shipments mix of furnace heat treat products versus the common alloy products. So, the biggest factor we expect to see is some weakening from what was a very, very rich mix of heat treat products in the first quarter.

Not a decline in quantity, necessarily but in the quality of the value-added quantity that you sold?

Exactly. Yes, we had some unusual orders in the first half that propped up the mix in heat treat plate.

Okay, great. Thanks for the help.

(OPERATOR INSTRUCTIONS) We'll go next to Meryl Witmer with Eagle Capital.

Hi. This is a basic accounting question. And I got on the call a little late, so I apologize if you've answered it. The metal gain you talk about that we sort of take out to adjust your reported operating income to adjusted operating income, I just want to make sure my understanding of that's correct. Is that the valuation difference on the inventory that you're holding from quarter to quarter?

Yes. Meryl, this is Jack Hockema. You're referring to -- I'm paging through --?

The $5 million number in the first quarter.

In Fab Products?

'07. Yes.

The $5 million and this is "metal profits"?

Yes.

I'm going to give, at risk here, the accountants are all sitting here ready to jump up and down if I make misstatement here. But I'm going to give a business rationale for what it is and hope nobody's eyes roll back in their head. Essentially, what we do in the run rate that we measure for Fabricated Products, we're looking at plant-by-plant on a LIFO basis. So trying to factor out as much as possible the impact on earnings of fluctuations in metal prices.

And then what we show as metal profits is essentially what would happen on a FIFO basis. So it does roll through the impact of metal prices on a FIFO basis, which is how we reported earnings historically before emergence. You may recall that at emergence, we changed our accounting policy to put in a LIFO adjustment on a quarterly basis. Whereas historically, we generally didn't do it until the end of the year unless there was a major change that caused us to make a restatement on a quarterly basis.

So what we're doing now, post emergence, just to -- so you have a reasonable comparison of what's happening post emergence versus how we reported pre-emergence, we're still showing those FIFO-related metal profits. And if you go back to first quarter a year ago, that's really what happened. The metal market, the underlying price of aluminum was going up about, as I recall $0.10 to $0.15 every quarter and it did that over a period of three quarters. And so there was a long lag of the current metal cost running through the inventory.

And so we had very favorable metal profits fourth quarter of '05, first quarter of '06, and first quarter of '07. So, that was a long answer. Did that get to the gist of requester question, Meryl?

Okay, well -- it's something different than what I thought. So, the number I thought it was did sort of put out to. What we did is we took if value of your inventory and divided it by the ending aluminum price per pound and got a number of pounds in inventory. And then we did the change from the end of Q4 to the end of Q1 and got whatever it was, $0.04. And multiplied that times the number of pounds and we got $5 million. But it's not that, it's what you just said?

Yes. I do my own back-of-the-envelope calculations too, my sanity checks. And I can't ever come up with exactly we have. And the reason is, it depends on how much inventories are changing and in which plants it's changing. We have some plants that are turning inventory in less than a month and we have some plants that are several months. And so, you get into all kinds of mixes here in terms of what's happening inside the inventory.

Meryl, this is Joe Bellino, in addition to that, we provided some supplemental, just the numerics on page 20 and the description on 21. And the reason we go through this nonrun rate, Jack mentioned, is because prior to the second quarter of '06, we would always do the LIFO reserve at the end of the year, fiscal '04, fiscal '05. And we took a large LIFO adjustment of $22 million in the second quarter of '06. And it's over time metal profits -- the increase in those should be offset in general by the LIFO reserve adjustment.

So as we look at that in the first quarter of '06, last year we had $9 million of [LIFO] profits -- excuse me, of metal profits and no LIFO adjustment. In the second quarter of '06, we had $7 million of metals profits and we took a year-to-date $22 million of LIFO adjustment. And so the underlying is that we provide the details to look at nonrun rate items to give you a clearer picture of really what's going on underlying the basic business.

Well, so, you reported operating income of $41.4 million. To that we took away the energy hedge loss. We added the LIFO charge. And we took away the metal profit. Is that --?

And then the other component is, because we don't do hedge accounting, we market-to-market, in the first quarter there was another $3 million of gains from market-to-market.

She mentioned the energy.

Is that the energy, or is that something else?

Yes, she mentioned it.

Okay, so I didn't miss $3 million. So that $2.7 handles that.

Yes.

So then, if make those adjustment, that sort of -- if I owned the whole business myself, which would be nice, that would be the way I would look at it after all these adjustments?

Yes.

If I were smart.

That's how I view it. When I'm managing the business, I'm really focused on that before nonrun rate.

Okay.

So in our presentation on both slides 10 and 11, we present those, say, example the Fab Products business, we show before nonrun rate, it increased from $36 million to $42 million. Although, we caveated that by saying the depreciation is $2 million lower this year than last year.

Okay. All right, terrific. Thank you.

And we have time for a couple of more questions. (OPERATOR INSTRUCTIONS) We'll go next to [Lee Ligna of Blakely Capital]

Two quick questions for you. Which of first, was with regards to starting up the first and second furnaces, can you talk about any potential start-up costs involved with that last quarter?

I don't have anything specific but they certainly were not material.

Okay.

They were pretty much up and running in the first quarter.

Okay. And then second question with regards to the second phase of the expansion, when was that furnace up and running and actually producing plate?

The second furnace it was early in the up and running, I don't remember exactly when. But we got most of the impact of the second furnace in the first quarter. If the question is; Will you see a big uptick in the second quarter versus first quarter? The answer is, no.

Okay, thank you.

And we now have a follow-up question from Timna Tanners of UBS.

Hi, just wanted to follow-up with asking for a little more detail about your thinking about further CapEx into 2008 given your strong cash flow potential. You allude to you're still reviewing options, but can you give us some insight maybe into the types of things you're looking at or your thought process?

Sure, Timna. I'll address two issues. I'm sure there are a lot of other callers out there that want to ask about further heat treat plate capacity because we frequently get that question. And the answer to that is we continue to monitor the supply/demand balance in the industry, obviously our own monitoring with a lot of conversations with customers. And obviously we've not announced anything there. We just continue to monitor that very, very closely.

We've also said that we believe we have significant opportunities in the other aspects of our business outside of heat treat plate. We continue to believe that and we expect that there will be some significant investments. And I'm not going to quantify significant at this point, but significant investments addressing opportunities on the other side of the business. And to put a point on that as well, on previous calls that question has come up. And I've stressed that when we talk about organic growth opportunities, we're talking about bottom line growth opportunities. So we will have investments directed at the bottom line and some of that may be topline growth, but some of that may, as well, be to improve our cost position and get a better lower cost and margin from that, not just the top line.

With the consolidation that's happening in other parts of the aluminum industry, with some of the assets that might be available, for example, from north Hydro or from your peers Alco and Alcan, can you tell us if you'd be looking at any of those possible assets?

Well, I won't speculate on hypotheticals but I'll come back to the standard line here, and that is we have a lot of dry powder. We have significant financial capacity to fund both organic growth and acquisition growth. And we are proactively seeking complementary, synergistic acquisitions that would improve our position. So without talking specifics about what might be available or become available out there, we see ourselves as well positioned to be a buyer of assets that are attractive for our portfolio.

Okay, thank you.

And we'll go next to Timothy Hayes of Davenport.

Actually, I wanted to talk about the soft alloy extrusions market for a moment. What are you seeing in terms of your conversion pricing? Has that started to erode a bit given weaknesses in other markets? I know the residential market has been quite soft and you guys don't sell into that market, but are you seeing any ripple affect that's causing conversion prices on your products to come down a little bit?

No, our pricing was pretty solid in the first quarter. There may with be a little bit of fraying but it's very limited fraying in terms of pricing at this point. In this answer, let me go back and talk a little bit historically. I've commented to several people when they've asked about general pricing in the industry. When we went through the last recession, we had a -- we really went for a couple of years with very little price degradation and we didn't see much degradation really until the third year of the recession and that was a real grinder of a recession.

And we've seen some of that this time around as well. While prices did not recover during this expansion enough to recover increases that we had in energy costs and other costs, we did get back to price levels equivalent to where we were at the last peak. And at this point and we're relatively short-term into this volume downturn compared to that last recession, we've seen pretty stable pricing. There's always the risk that as this goes on that we'll start to see some unravelling in the pricing but it's not been significant to this point.

Do you think there's a lot of excess capacity still in soft alloy extrusions in North America?

Yes. just look at the number, the aluminum association shipments were down 16% approximately in the first quarter. And building and construction, the whole housing aspect of that was hit more heavily than the markets that we're in but from our standpoint, we were looking at double digits in terms of declines in volume in that sector as well, percentage-wise. So there's significant weakness across the board in extrusions. And clearly, there's excess capacity at these very low levels of demand.

Okay. And just one final question on -- when you do look at potential acquisitions, what is your appetite for acquisitions outside of North America? Would you be willing to do something in Europe?

Short answer is yes. But in terms of the priority sequence, we're sitting on almost $1 billion worth of tax attributes that shelter U.S. income. So obviously, we get more pop if we buy U.S. income than we do if we buy foreign income.

Okay, thank you.

But the answer is, yes, we'll look at foreign as well as domestic.

Thanks.

That concludes our question-and-answer session. Mr. Mordock, I'd like to turn the call back over to you.

Thank you everyone, for joining with us today. A replay of this conference call will be available on the Investor Relations' page at the kaiseraluminum.com Website. Have a good afternoon.

And that will conclude today's conference call. Thank you for your participation. You may disconnect at this time.