Kaiser Aluminum Corp (KALU) 2011 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kaiser Aluminum first-quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions). As a reminder, this program is being recorded. I would now like to introduce your host for today's program, Ms. Melinda Ellsworth. Please go ahead, ma'am.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's first-quarter 2011 earnings conference call. If you've not seen a copy of today's earnings release, please visit the investor relations page on our website at kaiseraluminum.com. We've also posted a PDF version of the slide presentation for this call. Joining me on the call today are Chairman, President and Chief Executive Officer, Jack Hockema; Senior Vice President and Chief Financial Officer, Dan Rinkenberger; and Chief Accounting Officer, Neal West.

Before we begin, I'd like to refer to you the first slide of our presentation and remind you that the statements made by management and the information contained in this presentation that constitute forward-looking statements are based on management's current expectations. For a summary of specific risk factors that could cause results to differ materially from those expressed in the forward-statements, please refer to the Company's earnings release and reports filed with the Securities and Exchange Commission, including the Company's Form 10-K for the full year-ended December 31, 2010. The Company undertakes no duty to update any forward-looking statements to conform the statement to actual results or changes in the Company's expectations. In addition, we've included non-GAAP financial information in our discussion. Reconciliations to the most-comparable GAAP financial measures are included in the earnings release and in the appendix of this presentation. At the conclusion of the Company's presentation, we'll open the call for questions.

I would now like to turn the call over to Jack Hockema. Jack?

Thanks, Melinda, and thanks to everyone joining us today. As we indicated on our year-end earnings call, improving demand across our end-market applications and the benefits from our recent acquisitions of Alexco and Nichols Wire drove increased sales and higher adjusted EBITDA in the first quarter. However, we did not fully realize our earnings potential during the quarter, as the timing and amount of spot price increases for high value-added products have been insufficient to recover sharply rising aluminum and alloy costs. While there's typically some lag in passing through metal costs on spot sales of high value-added products, there's been significant market resistance to spot price increases for general engineering plate, in particular, and for sheet and plate products, in general. More recently spot price increases have been sustained and have begun to recapture some of the margin squeeze. We believe that market conditions going forward will support more proactive spot pricing for these products.

Some of you may ask how this can happen when we are quote, Metal neutral, end quote. Let me take a minute to review how our products are priced. Essentially we have two categories of business; contract and noncontract. Contract business encompasses most of our aerospace and automotive OEM business and contract business is generally priced on formulas that either automatically pass through metal price changes, or permit us to hedge metal price exposure. All noncontract business is sold on a spot pricing basis. For most of our common alloy extrusion, general engineering and industrial business the industry norm is to unbundle the price into a metal price and a fabrication charge, also known as the value-added revenue. This practice results in a prompt metal pass-through.

That leaves a portion of our business where the industry practice is to bundle the metal and fab charges into a single price. This practice applies primarily to sales of high value-added products, such as sheet and plate, cold finished bar, aerospace extrusions and drawn tube sold to service centers. These products have a relatively high selling price and adjustments for metal typically have some lag time.

In the current instance, we've experienced a longer than normal lag time for general engineering plate, in particular. You'll recall that we've pointed out several times over the past two years that the one product where we were experiencing significant value-added price erosion was general engineering plate. The current lag in passing through the higher metal cost is another form of reducing the value-added revenue for this product. With metal prices rising sharply it's introduced a sharp reduction in the value-added price. There's potentially a silver lining to this cloud, however. We're encouraged that the recent spot -- spot price increases have stuck and there's evidence that the market psychology has changed to increasing, rather than decreasing prices, which bodes well for the future.

With that, I'll shift gears to other topics. The Kalamazoo ramp up continues to gain momentum, and we've set new production records each month this year. The 6,000-ton press is progressing well in the ramp-up process, and the 4,000-ton press is on a similar trajectory, having initiated production approximately four months later than the 6,000 ton press. Our near-term outlook for Aerospace plate is progressively more positive. Since the year-end call we have gained increased visibility as it applies to Kaiser's aerospace plate order book and we anticipate an increased level of shipments of these products in the second half of 2011. We also have initial indications that the higher aerospace plate shipments will continue into 2012. Looking ahead, improving spot prices, increasing Kalamazoo benefits and a stronger aerospace plate order book are expected to have a positive impact on our EBITDA margin as the year unfolds.

Dan will now provide details our first-quarter results, and I'll follow with some additional perspective on our near-term and long-term outlook. Dan?

Thanks, Jack. As slide five shows, value-added revenue in the first quarter exceeded each of the prior four quarters and was sequentially up 16% compared to the fourth quarter of 2010. Further detail on value-added revenue by sales application can be found in the appendix on slides 18 and 19. Consistent with our prior earnings call outlook, higher value-added revenue reflects the benefit of additional sales from our acquisitions of Alexco and Nichols Wire, as well as organic growth from improving demand and higher shipments across virtually all products and end-market applications. Value-added revenue for aerospace and high strength improved in the first quarter compared to all quarters of 2010, primarily reflecting the benefit of higher volume, as well as the higher value-added product offering from the acquisitions.

Value-added revenue for automotive extrusions also improved in the first quarter compared to all quarters of 2010, reflecting stronger build rates and continued ramp up of new automotive aluminum extrusion programs. The first quarter also reflected normal seasonal strength in the automotive industry as compared to the last half of 2010. For general engineering applications, value-added revenue was driven by higher rod and bar shipments, as demand for that product category improved and the Kalamazoo facility continued to ramp up production.

Slide six shows the trailing five quarters of consolidated adjusted EBITDA. Although the first quarter adjusted EBITDA was higher than the sequential and year-over-year comparables, it did not reflect the full earnings potential due to the margin increase on spot sales of our higher value-added products, as Jack mentioned. This negatively impacted adjusted EBITDA by approximately $3 million for the quarter. Adjusted EBITDA margin, as a percent of value added revenue of 15% in the first quarter of 2011, was comparable to the average in 2010 and showed improvement over the second half of 2010. We expect our adjusted EBITDA margin will increase through the rest of 2011, with improving operating efficiencies as Kalamazoo continues its ramp up, recovery of the price squeeze from higher metal costs, and later in the year stronger aeroplace -- aerospace plate shipments.

Slide seven shows key consolidated financial metrics, which primarily reflect the results of the fabricated products segment, as our interest in Anglesey is no longer material to our overall results. Net sales, value-added revenue and all income measures improved in the first quarter of 2011 compared to virtually all quarters of 2010. Consolidated operating income, excluding non-run-rate items, increased to $17 million in the first quarter of 2011 compared to $10 million of 2010, primarily reflecting the impact of our recent acquisitions, as well as higher value-added revenue across our end markets. As noted earlier, the first-quarter 2011 operating income reflected an unfavorable impact of $3 million from the metal price squeeze on spot sales of our higher value-added products, which we expect to begin to recover in the second quarter, as we pass rising metal costs onto our customers.

Depreciation and amortization ran at a slightly higher rate in the first quarter, reflecting the investments placed in service over the last year. Consolidated operating income, as reported, of $21 million in the first quarter was also up compared to all quarters of 2010; in part due to more favorable non-run-rate adjustments in the first quarter. Non-run-rate adjustments were primarily non-cash items and are shown in the appendix on slides 20 and 21.

Reported net income for the first quarter was $11 million, or $0.59 of earnings per diluted share. Adjusting for non-run-rate items, net income was $9 million, or $0.47 of earnings per diluted share. Our effective tax rate for the first quarter of 2011 was approximately 36%. However, with our net operating less carry forwards and other tax attributes of approximately $900 million, applicable mostly to pretax US income, our cash tax rate continued to be in the low single-digit percentages. And now, I'll turn the call back over to Jack to discuss current industry trends and our overall outlook. Jack?

Thanks, Dan. Turning to slide eight, we continue to be very optimistic about the long-term prospects for aerospace and high-strength applications. We expect robust long-term aerospace demand growth for our products, driven by steadily increasing build rates, larger air craft and conversions to monolithic design. Currently we're experiencing strong demand throughout our extensive aerospace product offering, with the exception of aerospace plate, where shipments continue to be constrained by the overhang of excess inventory in the supply chain. On our last earnings call, we commented that industry aerospace plate order rates over the next two years might be choppy but that we expect very substantial long-term demand once supply chain inventories reach equilibrium.

As I indicated in my opening remarks, we're gaining increased visibility as it applies to Kaiser's order book and we anticipate that our aerospace plate shipments will ramp up in the second half of 2011. We also have initial indications that this strong order rate will continue into 2012. With this as background, we expect that our second quarter value-added revenue dollars for aerospace and high-strength applications will be similar to the strong first quarter, and we expect that a strong order book in the second half of the year should more than offset the typical seasonal weakness in these applications.

Turning to slide nine, our general engineering and automotive applications continue to experience slowly improving underlying demand, modest restocking in the supply chain, and growth in new aluminum extrusion automotive programs. Demand for our automotive and semiconductor applications has so far been unaffected by manufacturing disruptions in Japan.

Turning to slide ten, which summarizes our outlook, we expect that our second-quarter value-added revenue dollars will be similar to the first quarter as we continue to realize the incremental benefit of sales from Alexco and Nichols Wire, as well as improved industry demand. We're optimistic that we will get a strong second half boost from order rates for aerospace plate that could offset much or all of the typical seasonal weakness that we experience in the second half of the year. We also anticipate that as the year unfolds our adjusted EBITDA margin as a percentage of value-added revenue will increase as we benefit from improving operating efficiencies and we begin to recover from the margin squeeze caused by rising aluminum and alloy costs. Our current view is that the second-quarter EBITDA margin will improve sequentially by a point or two, although sharply-rising raw material costs and shrinking scrap discounts pose a significant short-term challenge. We expect further EBITDA margin improvement as we move into the second half of the year and gain increasing benefits from the higher aerospace plate shipments, the Kalamazoo ramp up and improved spot prices.

Turning to slide 11 and summarizing our remarks today, we generated improved results in the first quarter that were driven by additional sales from our recent acquisitions and improving underlying demand. We remain positive in our outlook for the remainder of 2011, as we anticipate improving underlying demand and expanding margins. We're encouraged by the prospects for a ramp up in shipments for aerospace plate in the second half of 2011 and we are increasingly optimistic that we will have a strong aerospace plate order book into 2012. Longer term we're very well positioned at attractive growing markets, and with stronger demand and the benefit from our organic and acquisition investments, our long-term earnings potential remains strong.

We will now open the call for questions.

Certainly. (Operator Instructions). Our first question comes from the line of Edward Marshall from Sidoti & Company. Your question, please.

Good a -- hello, guys.

Hi, Ed.

It's afternoon here but morning there, I think.

Right.

So you had some revised plate guidance and you talked about increased visibility, what signs point to this increased visibility that you're seeing?

Well, I was -- I stressed in my comments -- I don't know if everyone picked up on it, but I was very Kaiser-specific here. We don't know that the industry situation has changed that much. We're just getting better clarification, clearly, for the second half of the year and some indications into next year in terms of what our order book looks like from big OEMs. So that's really what's changed is just getting more and more visibility as we get closer going forward. So we're encouraged by those developments. We were hopeful that would be the case, but now it is much more solid than it was when we spoke to you a couple of months ago.

Is it order -- just to be clear, is it order inquiries? Is it actual orders?

No, no. This is on our contracts with big customers with them just clarifying how much take they'll have in the second half of the year and as we move into next year.

And you're shipping direct?

Yes, these are direct shipments.

Okay. And how are the overall inventories? I imagine they haven't changed much from the last time we spoke, but how are the overall inventories of plate in the market in general?

Well, it's hard to tell but it goes back to the comments a quarter ago. We think there's till a lot of inventory there. I think what this all gets down to is what strategy that the end users use in reducing that inventory; whether it's the dilemma of whether they reduce it extremely rapidly, or whether they reduce it more slowly, and that has implications on supply chain readiness and those things. We were hopeful that given the very, very robust demand that we all see looking out over the longer term that they would feather off that inventory drawdown, and it seems to us, at least what we're seeing of it, that's what's happening.

Okay. And then on the value-added revenue per pound, as I look at the general engineering business and first quarter of 2011 saw the pinch there on the value-added revenue per pound, but it seems like you had the same pinch in first quarter of 2010. Is there anything I should assume from seasonality, or anything in that business, maybe buying patterns at distributors or something like that, that may cause that aside from just what's going on with the aluminum under the input costs?

The general engineering, there's a lot of mix inside that big general engineering basket. We've probably got 20 or 25 different product lines in there that -- and the value-added revenue per pound on those could range from $0.50 to $1.75 or $2. So depending on which particular buckets are strong or weak that mix will move it. But then the other issue that moved it in the first quarter, the biggest impact we had from this margin squeeze was on general engineering plate that falls in that category. So a portion of the squeeze in the value-added revenue is coming from the margin squeeze on GE plate.

So is it just the underlying materials are going up because the market has quite a bit of inventory out there it's harder to pass on the cost, or is it something more complex than that?

No, it's -- if you go back to comments really over the last two years -- I don't know that you've been following us that long -- but really, since the recession started -- well, let me just go back in history here for a minute. We went through four or five years where global plate capacity was sold out from 2005, 2006 clear out until the recession started in the second half of 2008. And during that period, spot prices for general engineering plate and for the small amount of aerospace plate, actually, that get sold on a spot price basis, those prices got to astronomical levels, as you would expect with a prolonged shortage. So as we got into the recession it was no surprise to us that we started to see some compression in those prices. And on these calls, when there have been questions about what's pricing look in the industry, I've consistently said that generally our pricing held up, with the one exception being general engineering plate. So we've been seeing price erosion for two years on that product and they've gotten down to relatively normal, or a little bit below relatively normal levels, early last year.

What's happened now, though, is with the rapid spike in metal prices over the last six to nine months, we haven't been getting price increases after going through two years of price reductions, we're not getting price increases -- after going through two years of price reductions we're not getting price increases to recover those sharply-rising prices. So the end result is the total price has remained stable because we've not been able to get price increases through from an ind -- in the industry environment and we've gotten a squeeze then from the cost. The flip side of that is, in the past couple of months, we've begun to be able to enforce those price increases, and that's happening with more regularity, which led to my comments in the prepared remarks that we're encouragingly optimistic here, we're encouraged and optimistic. We think that the market psyche has changed here and it needs to because these prices are too low now on general engineering plate. We're optimistic that we're going to start to see some expansion of the value-added revenue on general engineering plate. The market certainly supports that and it looks like that will happen.

Okay. And to be clear it's on all new orders or all new shipments after a specific date, the price increases?

It's been on shipments. I think the most recent price increase was on shipments as of a certain date.

Okay.

We, frankly, believe that that time period needs to be compressed, as well. In a strong market -- this is price and effect business, and we have the ability to announce that the price increase takes effect on orders tomorrow, if we wish, and we're actually contemplating ourselves whether we start to move in that direction, as well, because with these rapidly increasing price increases, the industry needs to make a move. We need to make a move to get these prices back sooner.

Now the -- thanks for taking all my questions, I have one last one, if I can make one quickly. Will you announce any additional price increases publicly through press releases or anything else like that?

We haven't done that typically.

Okay.

We do it directly with our customers.

Okay. Thank you, guys.

Thank you. Our next question comes from the line of Mark Parr from KeyBanc Capital. Your question, please.

Hey, thanks a lot. Hey, good morning.

Hey, Mark.

Hey, Mark.

Hey, just a question. Jack, you had indicated regarding your second quarter commentary on margins that there was challenges related to reduction in scrap discounts and continued higher aluminum prices. Just -- I was wondering, are you saying that in the context that this is one of the things that hit us in the first quarter and we think it'll perhaps ease off a bit in the second quarter but we're not sure as to timing, or just -- what additional color can you give on that comment relative to where you were in 1Q?

Yes, good question. There are actually two points here. One point is that the price of aluminum has gone up another dime just since the end of April, so we're really having to chase hard to recover those prices and we'll be very, very aggressive in pushing through price increases. But again, we aren't the only players in the marketplace here, so it's just a question of how rapidly we're able to capture those price increases. The second piece of this, which is the scrap side of it, we're in that typical phase of the cycle where demand continues to pick up, and especially on the billit side, there's been a lot of conversation about the billit supply shortages and the secondary billit producers are strong, extrusions are strong, and so scrap has become tighter in this phase of the cycle, and when it tightens up, typically we see some compression in scrap discounts. We've seen that over the past few weeks, but whether it lasts through the full quarter or lasts five or six months or one or two months, we don't know yet. But right now we're seeing a little bit of compression there that could have some impact on margins here in the second quarter, as well. So that's why we're -- at this point we believe we're going to pick up a point or two in terms of total margin, but there are lot of moving parts here yet and it's really tough to pin it down. We don't think we'll lose any margin and we think we'll pick some up, we just don't know how much yet.

Okay. And so you're -- the way you've handicapped these two issues is that we'll -- I think what you're saying is we think we'll be able to get through a fair amount of this cost increase in terms of pricing over the May/June timeframe but if we can't then profitability could be maintained to -- at 1Q levels. Is that the way to think about that?

Yes. Or said another way, we're very confident that we will gain margin in terms of our pricing compared to prime. We are regaining margin there and any ground on that squeeze. However, at this point in our forecast, we've got a little bit of margin loss just because of the squeezing of the price discounts, these scrap spreads, and that actually is a point or so. So if the scrap spreads loosen up back to normal levels here in the next couple of weeks, we could do better than that. If they continue to be tight, it'll tighten us up. So -- but that's a phenomenon and you know how that works in steel. It works the same way in aluminum. Those scrap discounts ebb and flow and we think -- we're confident this is a very short-term phenomenon, it'll eventually come back in the equilibrium to normal levels..

Okay. Appreciate the color. Thanks, Jack, very much and good luck on the second quarter.

Thanks.

Thank you. (Operator Instructions). Our next question comes from the line of Tony Rizzuto from Dahlman Rose. Your question, please.

Hi, everybody.

Hi, Tony.

Just have a couple questions here, and I just wanted to go back to an earlier question about your confidence level for increased volumes from the aerospace heat treat side and should we think about this in terms of the OEMs? Boeing and Airbus are actually coming to you and they're increasing the amount of physical material -- the amount of material they want from you second half of the year?

Yes, the amount of material that we will deliver on some specific contracts will be higher in the second half than the first half.

Okay. So in accordance with the min/max so would say the rising levels of volumes now may be moving up toward the upper ends of those ranges now on the contracts?

Yes, it's moving up from where it's been is how I would characterize it.

Okay. I was wondering, also, if you could talk a little bit about the complexion of the plate market from more of a supply standpoint. A comment was made earlier today by a large service center -- I think also an important customer for you guys -- but about one of the plate mills doing some significant work on a plate stretcher, so that facility's out. That may be impacting some of the order activity right now. But generally, could you discuss a little bit about where you see the utilization rate for the plate mills at this point in time? I know it's been a bit of a sensitive subject for you past, but any color you could provide us would be very helpful.

Well, I think that there still is plenty of available capacity there from an industry standpoint, but the capacity utilization has picked up here over the past few months. From our standpoint, and I won't just put it into the contempt of plate, but in general, if you just take the first quarter level of activity and look at what a normal strong market would be, our total value-added revenue across everything would be anywhere from 20% to 30% higher than what it was here in the first quarter. And I won't go specifically into plate, but it gives some indication of where we are in the cycle across the board.

To your knowledge, jack, are there any further supply increases? Obviously, the underutilized capacity but are there any other programs in terms of melting capacity that you guys are aware of throughout any of the players at this time? I'm not aware of any right now. We had a period of expansion several years ago.

In teri -- I'm sorry, (inaudible) --

In terms of the heat treat plate capacity.

Yes, we're not aware of any consequence that's happened here.

Okay. And the other thing I wanted to ask you is, could you quantify the impact of those acquisitions in your results in the first quarter to give us an idea of maybe what they contributed?

No, we're not going to separate it out from that standpoint, but I'll just go back to the comments we made when we did the acquisitions and I think we made it on the year-end call, as well, that we expected an impact year over year of order magnitude $15 million from our M&A activity, and we were -- our results were consistent with that outlook in the first quarter.

Okay, okay. All right. Listen, I appreciate that. Thanks very much for the color, jack.

Okay, Tony.

Thank you. Our next question comes from the line of Tim Hayes from Davenport & Company. Your question, please.

Hello, everyone.

Hi, Tim.

Hey, Tim.

First question, is Kalamazoo guidance still maintained? I think, the last we left off it was going to do EBITDA of, what, $8 million, $9 million this year?

No. Our comment was that we believe that Kalamazoo will have the full year-over-year impact of roughly $15 million.

That's right.

And we're on track for that. It'll be rear-end loaded rather than front-end loaded but we're still on track for that.

Right, that's right, that's right. And with these [countervailing] duties on extrusions, where do those stand and would you -- well, first off, would you even benefit in the type of products that you are making on the extrusion side?

Not directly, Tim. That's a good question. Not directly but indirectly. Even though the amount of impact that minor players have -- smaller players have on the rod and bar part of the market isn't that significant, there is some impact there. So their business activity certainly has picked up, you know that better than I, I'm sure, but the impact for general extr -- or the business for general extruders is strong and that just creates a generally strong environment in the entire industry. So we're actually pleased with the price levels in that particular marketplace in contrast to what we were saying about general engineering plate, general engineering rod and bar prices were at good solid levels here and have potential to go even beyond that. I attribute some of that, obviously, to the economy but I think some of it has to do with the impact of duties on the extrusion industry as a whole.

And then on the -- still on the extrusion category here, there's been a lot of announcements of new press capacity going in so far this year, is any of that in some of the niche markets that you are participating in, or is it more just common alloy extrusions -- soft extrusions?

We think it's common alloys. Some of the announcements we read would indicate that they could make any product that the world uses. We're not so sure of that. We focus on very demanding applications. People may try to come into our markets, but we think we've got very strong quality delivery and technological attributes that give us very strong position there. So we don't see a big impact.

The last question, [Daveva's] shareholders been selling lately, where is there -- how much do they own right now and will there be any further shares sold here maybe in the next couple weeks? Where are they -- trying to get an idea of what restrictions that they have right now?

Sure, the -- all of their activity has been reported in Form 4's for the last month or so. They sold approximately 800,000 shares or so. They have about -- of their annual allotment under our agreement with them, they have about half a million additional shares that they can sell in this year. And so that's the status as we saw as of this morning. They are around 14% as of their shares that they've -- after the sales that they've made to date.

All right, thank you.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to turn the program back to management for any further remarks.

Okay, thanks, everyone, for joining us on the call today and we look forward to updating you on the second quarter on our call in July. Thank you.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.