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Kaiser Aluminum Corporation (NASDAQ:KALU)

Q1 2010 Earnings Call Transcript

April 29, 2010 1:00 pm ET

Executives

Melinda Ellsworth – VP and Treasurer

Jack Hockema – President, CEO and Chairman

Dan Rinkenberger – SVP and CFO

Analysts

Phil Gibbs – KeyBanc Capital

Timna Tanners – UBS

Tony Rizzuto – Dahlman Rose

Adam France – 1492 Capital

Operator

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’ll conduct a question-and-answer session and instructions will be given at that. (Operator instructions) As a reminder, this conference call is being recorded. I would now like to hand the conference over to your host, Miss. Melinda Ellsworth. Ma’am, you may begin.

Melinda Ellsworth

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum’s first quarter 2010 earnings conference call. If you have not seen a copy of our earnings release, please visit the ‘Investor Relations’ page on our website at www.kaiseraluminum.com. We have also posted a PDF version of the slide presentation for this call.

Joining me today are President, CEO and Chairman, Jack Hockema; Senior Vice President and Chief Financial Officer, Dan Rinkenberger; and Vice President and Chief Accounting Officer, Neal West. Jack and Dan will review the results and at the conclusion of our presentation, we will then open the call for questions.

Before we begin, I’d 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, relate 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 first quarter of 2010 and reports we have filed with the Securities and Exchange Commission, including the Company’s form 10-K for the full-year ended December 31, 2009 and current report on Form 8-K filed with the Securities and Exchange Commission on March 29, 2010.

All information in this presentation is as of the date of the presentation and the Company undertakes no obligation or duty to update any forward-looking statement to conform the statement to actual results or changes in the Company’s expectations.

Non-run-items to us are items that, while they may recur from period-to-period, are particularly material to results, impact costs as a result of external market factors and 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 significantly neutralize the Fabricated Products segment from fluctuations in underlying metal prices. We characterize metal profits and LIFO charges as non-run-rate items that eventually offset to a great extent over the course of the full year.

Further, presentations including such terms as net income, operating income, before non-run rate or after adjustments or earnings before interest, tax, depreciation and amortization, EBITDA, are not intended to be and should not be relied on in lieu of the comparable caption under Generally Accepted Accounting Principles 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 call over to Jack Hockema. Jack?

Jack Hockema

Thanks, Melinda and good afternoon everyone. Thanks for taking the time again to listen to our conference call for the first quarter of 2010. My opening comments are summarized on slide number five. Our first quarter results improved compared to the past three quarters on higher valued-added revenue and additional improvements in our manufacturing efficiencies. While we’ve not yet seen meaningful improvement in real demand other than for automotive and semiconductor applications, supply chain inventories are reaching equilibrium, resulting in reduced destocking and improved pull for our products.

We continue to be encouraged by the progress at our new world-class rod and bar extrusion facility in Kalamazoo, Michigan, and the project remains on schedule to be fully operational late this year. We are also pleased to have secured a new revolving credit line and convertible debt offering to further enhance our financial strength and flexibility.

Dan will provide highlights regarding our first quarter results and the new capital structure. Dan?

Dan Rinkenberger

Thanks, Jack. The consolidated financial highlights are shown on slide seven. Consolidated operating income before non-run-rate items increased $7 million sequentially to $16 million in the first quarter 2010 compared to $9 million in the fourth quarter 2009. In addition to sequential – higher sequential operating income for our Fabricated Products segment, we also had more favorable realized hedging results in the Hedging business unit during the quarter.

Corporate costs were $2 million higher than the quarterly trend due to various non-cash reserve adjustment. We anticipate for the balance of 2010 that corporate costs will remain comparable to the level of recent quarters.

Reported net income was approximately $9 million or $0.44 per fully diluted share. Adjusting for non-run-rate items first quarter net income would have been slightly higher, and fully diluted EPS would have been $0.47 per share.

Our effective tax rate for the first quarter was approximately 41%. However, the cash tax rate remains in the mid-single digit percentages, reflecting the usage of net operating loss carryforwards and other tax attributes, which apply mainly against pre-tax U.S. income.

During the quarter, we implemented a new financing structure comprised of a $200 million revolving credit facility and a $175 million convertible debt offering to further finance – to further our financial strength and flexibility. The financings and the concurrent repurchase of shares were completed in March of 2010, and had very little impact on our first quarter results. However, net income and earnings per share will be impacted as a result of these transactions beginning in the second quarter. And I will provide some further details on the financing transactions later in the presentation.

Slide eight focuses on our Fabricated Products results, excluding non-run-rate items. Fabricated Products operating income improved by $4 million on a sequential basis to $27 million in the first quarter of 2010, from $23 million in the fourth quarter 2009. The increase in operating income reflected higher value-added revenue and the benefit of continued improving trends in manufacturing efficiencies.

Higher demand in select market segments, and lower levels of inventory destocking were the primary drivers of the increase in value-added revenue. As we had mentioned in our fourth quarter earnings call, operating income in the first quarter was negatively impacted by approximately $3 million related to start-up costs for the Kalamazoo extrusion facility and the one-time signing bonus associated with the new five-year labor agreement with the United Steel Workers that was ratified earlier this year.

Non-run-rate items within the Fabricated Products segment during the quarter were primarily related to non-cash mark-to-market losses on natural gas hedge transactions. Non-run-rate items are shown in detail on slide 28 in the appendix.

Slide nine provides a summary of the quarterly sales analysis by end market application. In the first quarter it was encouraging to see both value added revenue and shipments increase sequentially for each of our end market segments. Shipments for aerospace and high strength applications increased slightly from the fourth quarter as service center destocking abated for these products.

As Jack mentioned previously, increased demand in select market segments drove higher shipments and value-added revenue for general engineering and automotive products. However, we have not yet seen any meaningful improvements real underlying demand.

Slide 10 discusses the financing transactions we completed at the end of March. Our primary objective related to our financing activities was to arrange a new revolving credit at to replace the facility maturing in July 2011. In conjunction with the new revolver, we sought to obtain flexible terms and conditions, use our assets more efficiently to collateralize existing and future financing arrangements and maintain or enhance our liquidity.

We entered into a $200 million four-year revolving credit facility secure by working capital assets, with overall terms and a covenant structure that significantly improved our flexibility. In addition, since we eliminated property, plants, and equipment from the collateral pool for the revolver, the size of the revolver commitment and borrowing availability were also reduced.

In order to maintain a comparable level of liquidity, we arranged funded debt through an offering of cash convertible senior notes with a five-year maturity. The convertible debt market provided desired covenants flexibility, enabled us to diversify our funding sources, allowed us to manage the issuance size and the amount of balance sheet leverage, and offered a reasonable cost of financing.

The note offering was extremely well received in the market, which allowed us to upsize the issuance from the original amount of $130 million to $175 million, including the overall augment [ph] exercised by the initial purchasers.

Simultaneously with the note issuance, we entered into to option transactions that effectively increased the conversion premium from Kaiser’s perspective from 26% to 60% for a conversion price of $61.36 per share. In addition, as a result of the increased amount of the offering, we chose to apply $44 million of the net proceeds to concurrently repurchase approximately 1.2 million shares through privately negotiated off-market transactions with purchasers of the notes. The remaining $108 million of net proceeds increased cash to be used for general corporate purposes.

Cash interest payments will be based on the note’s 4.5% coupon rate. However, since the balance sheet will reflect a sizable issuance discount for the notes, interest expense will also include non-cash amortization of that discount. We’ve provided more detail on the GAAP accounting treatment for the financing transactions on slides 24 and 25 in the appendix.

Overall, we are very pleased with the results of the financings. With enhanced financial flexibility and a moderate degree of leverage, we are well-positioned to continue to support our ongoing business needs and longer term strategic growth objective.

And now, I’ll turn the call back over to Jack to provide some additional comments.

Jack Hockema

Thanks, Dan. Slide 12 provides context for a discussion of our outlook for aerospace and high strength applications. We remain bullish on the long term fundamentals for commercial and defense aerospace. The order backlog for commercial aircraft if robust and as many of you know, both Boeing and Airbus have announced plans to begin ramping up production later this year and in 2011. In addition, service center destocking pressure is lessening for aerospace and high strength products and we expect that significant destocking by large airframe manufacturers this year will abate in 2011.

In the near term, we are also encouraged by the fact that our first quarter volume for aerospace and high strength applications improved more than 10% compared to the run rate established during the last three quarters of 2009, and we expected our shipments in the second quarter will be similar to the first quarter for these applications.

Our outlook for general engineering and automotive applications is summarized on the next slide, number 13. Service center inventories for our general engineering products have stabilized and automotive build rates are improving. Our shipments and value-added revenue trends for these applications have shown steady improvement from the bottom that was established in the first quarter of 2009, and this trend accelerated in the first quarter of 2010. At this point, we anticipate that the second quarter demand will be similar to the first quarter for these applications.

As those of you who have been the Company are aware, supply chain destocking has been generating downward pressure on our shipments for several quarters and we’re glad to see this pressure subside. We look forward to the inevitable phase in the economic recovery when demand is sufficient to stimulate re-stocking throughout the supply chain.

Slide 14 summarizes our second quarter outlook for the Fabricated Products business. We expect that volume and value-added revenue will be similar to the first quarter and startup cost for Kalamazoo will also continue at a pace similar to the first quarter. In addition, as we continue to bring equipment on line related to the Kalamazoo investment, quarterly depreciation expense will increase approximately $1 million beginning in the second quarter.

While our short term visibility remains limited due to the still soft broader economic environment, we remain optimistic about the Company’s future both in the near and the long term. The long term fundamentals for aerospace are excellent and the full benefit from our Trentwood expansion has yet to be realized in light of recent soft market conditions. Our new Kalamazoo facility is an important next-step in advancing our competitive cost position and it will also provide capacity to facilitate profitable sales growth for automotive applications driven by increasing use of aluminum extrusions to achieve more fuel-efficient vehicles.

The Kalamazoo project in combination with capital improvements recently completed at Trentwood and several other facilities round out our platform of focused facilities to position Kaiser Aluminum as a supplier of choice and a low-cost producer for aerospace, automotive, and general engineering applications. With attractive markets and a strong financial and competitive profile, Kaiser is well-positioned for profitable growth.

We will now open the call for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Phil Gibbs from KeyBanc Capital.

Phil Gibbs – KeyBanc Capital

Hi, good afternoon, guys.

Jack Hockema

Good afternoon.

Dan Rinkenberger

Good afternoon.

Phil Gibbs – KeyBanc Capital

Just had a question on the automotive and the general engineering markets and what you’ve seen I think is a pretty decent pickup in results from a volume standpoint. And, Jack, you’ve said that you believe that the underlying demand was kind of now in line with the shipment. Would that be accurate at this point in time, we kind of saw a snap back the last couple of quarters.

Jack Hockema

Yes, that’s correct, Phil. We’ve not seen – certainly from a service center standpoint, restocking, it looks like their inventories are holding fairly constant at this point and we don’t believe there is significant destocking beyond the service center. So, that all relates back to yes, we think we are seeing real demand at this point in general engineering and automotive.

Phil Gibbs – KeyBanc Capital

Okay. And then the startup costs should be somewhat minimized going forward for Kalamazoo, how should we think about that?

Jack Hockema

Well, in the first quarter we – and I am comparing to the run rate last year. So, in the first quarter we had a couple of million dollars of additional drag at Kalamazoo when we had roughly a million dollars due to the signing bonus on the labor agreement. The signing bonus won't occur in the second quarter, but we think our startup costs are going to be order of magnitude the same at Kalamazoo in the second quarter, hopefully, a little bit less, but basically in the same ballpark. And then hopefully by the second half, we’ll see that go away.

Phil Gibbs – KeyBanc Capital

Okay. And what are the – just lastly here on the commercial aerospace side, what are your service center customers telling you about their needs as we move through the year? Would you expect that to firm at this rate of – this kind of shipment rate kind of foreseeable until 2010?

Jack Hockema

Yes, that’s how it looks at this point. We’ve been pleased that the service centers for aerospace that those, the destocking we saw appears to have abated. I think there are still some pockets of destocking going there, so we are not at full equilibrium, but I think this pace is sustainable.

Phil Gibbs – KeyBanc Capital

Perfect. Thanks guys. Good luck.

Jack Hockema

Thank you.

Dan Rinkenberger

Thanks, Phil.

Operator

Our next question comes from Timna Tanners from UBS.

Timna Tanners – UBS

Hi, good afternoon.

Jack Hockema

Hi, Timna.

Dan Rinkenberger

Hi, Timna.

Timna Tanners – UBS

The details are really helpful. I was just wondering on the next potential sale by VEBA Trust.

Dan Rinkenberger

Sure. Well, as you may have seen, if you look at the Form 4s that are filed in the last couple of weeks, VEBA has been selling shares, part of the 1.3 million that they – or roughly 1.3 million that they are entitled to sell during the course of 2010, roughly. I think at this point they are – they have sold about 800,000 shares and of that 1.3 million that remains about a half a million shares that they can sell. And I think that goes between now and March of 2011.

Timna Tanners – UBS

Okay. Great. So, then there will be maybe another allocation after that?

Dan Rinkenberger

Well, the mechanism really is 1.3 – I think it’s 1.32 million shares that can be sold over any rolling 12-month period without Board approval for something beyond that.

Timna Tanners – UBS

Okay, that’s helpful. Thank you. Why don’t I just take a step back and ask you about if you think there will be any potential problems with ownership Raven [ph] whether there will be SEC violations given your position with Chatwell [ph]?

Jack Hockema

You mean will there be FTC implications–?

Timna Tanners – UBS

Exactly.

Jack Hockema

–if we were to acquire Ravenswood?

Timna Tanners – UBS

Exactly.

Jack Hockema

We don’t know for sure, but I think there most likely would be some FTC implications, but we’ve not done that math.

Timna Tanners – UBS

Okay. And then finally, I mean I think the – we’ve talked about the refinancing that you did, put some – yourself in a better position. Some of that I imagine would go to working capital when you do ramp up your operations with a recovering economy, but can you just give us an update on kind of how you are thinking about uses of cash please?

Dan Rinkenberger

Sure. We had approximately little over $100 million of increased cash as a result of the transactions, but part of that was actually just to keep this on a level playing field with our liquidity position before the financings. The revolving credit that we now have is smaller and we have a lower amount of availability under that revolver. Just to keep on a level playing, we needed to have some funded debt in order to stay where we needed to be. I think broadly speaking there, we need to remember that we need to have a liquidity cushion that some amount of cash and our borrowing availability in that revolver gives us to manage through and actually would be strong in a downturn. We don’t think there is a double [ph] different offering, but it could happen and that’s what we have to have the cash for. We also need to be able to have somewhat little cash for low community prices, because that could impact our margin positions. Broadly speaking, not that we have any specific uses for the cash beyond that at this point.

Timna Tanners – UBS

Understood. Thank you very much.

Operator

(Operator instructions) Our next question comes from Tony Rizzuto from Dahlman Rose.

Tony Rizzuto – Dahlman Rose

Thank you very much. Hi, good afternoon or good morning.

Jack Hockema

Good afternoon, Tony.

Tony Rizzuto – Dahlman Rose

I’ve got a couple of questions. The first question I have is the guidance for basically demand, second quarter demand to be in line or steady with first quarter demand. How should we read that form a volume standpoint. Should I read that be volume is kind of flattish or is that – you’ve been pretty conservative in the past – should we read that to be a modest uptick in the 5% range or thereabouts?

Jack Hockema

I think at this point, Tony, I’d say it’s flat to up a little bit. It was a really strong first quarter, stronger than we anticipated and a lot of that surged at the end of March. So, while we don’t think anything got stolen from the first – second quarter into the first quarter, it is still yet to be determined. But I can say that April and May are strong, but again as we get into the second quarter, when you get into June, it becomes problematic because people start looking at summer shutdowns is July and those things. So, at this point, flat to slightly up would be the – our best estimate.

Tony Rizzuto – Dahlman Rose

Alright, Jack, and then – and just to – again the semantics in the comments you made about the destocking by the airframe manufacturers. You expect that that will abate in 2011. Could you be a little bit more precise? I know it’s very, very difficult, but obviously it’s so important for you guys more so than anyone else in terms of the timing. Do you expect that will see that cleaned out by year-end heading into 2011 or do you still expect that at this pace that this could linger into 2001 because I think it’s going to have – when I look at your volumes and you have to do also with the value-added revenue as well I think.

Jack Hockema

Yes. I would characterize it rather than specifically saying where I think their inventories are going to be because frankly I don’t know. But what we do anticipate at this point is we expect we’ll see stronger – let me say it a different way – we expect that 2010 will be the weakest volume that we’ll see for the OEMs. It’s down pretty significantly from where we were in 2009. We think that 2011 will be quite a bit better than 2010. And we think that by the time we get to 2012 that we’ll be seeing very, very robust demand.

Tony Rizzuto – Dahlman Rose

That’s very helpful. And if you could relate that to – in the past I’ve always had to ask you about that operating rate at Trentwood and how that might relate in 2011 to an operating rate, is that a level that – in that ’11 period you might be able to get back some more normal operating rate there, capacity utilization at Trentwood?

Jack Hockema

Yes, again, 2011 still is a long ways away and there are a lot of things that could happen, but if you push me for an outlook now, I would say 2011 would look similar to 2009, similar to or maybe even a little bit better, but in the same ballpark as 2009.

Tony Rizzuto – Dahlman Rose

Alright, Jack, that’s helpful. And I take that when I look at your value-added revenue on a price per pound basis, it looks like the reason that’s declining it appears that some of it has been mix related. But is there anything else going on in there in terms of that on a per pound basis?

Jack Hockema

Most of it is mix related and – Tony, just clarify, are you talking total value-added revenue or are you talking aerospace and high strength specifically?

Tony Rizzuto – Dahlman Rose

Really the aero and I think aero and high strength. Let me just go back here, yes.

Jack Hockema

Yes, the aero and high strength some of that is and most of that, frankly, is mix related, although we are getting some metal squeeze on some of the very high value-added products that don’t move so much in line with metal. And the second thing that we’ve seen there is still a substantial portion of aerospace and high strength that goes through service centers and there was quite a bit of spot business in there and there has been some degradation in some of the spot prices there. Most of it’s mix, a little bit of metal price squeeze, and a little bit of degradation in the spot pricing.

Tony Rizzuto – Dahlman Rose

Thank you, Jack.

Operator

(Operator instructions) Our next question comes from Adam France from 1492 Capital.

Adam France – 1492 Capital

Yes, thank you for taking my call. Jack, could you refresh my memory in terms of the overall capacity, in terms of shipments out of Kalamazoo and when that’s running as you hope it will how it’s going to change your mix of shipments or is it still little early on that one?

Jack Hockema

Well, we’ve not stated a capacity out of Kalamazoo, but what we have said is that Kalamazoo is not a capacity play other than what capacity might be allocated to automotive. Basically we’ll just be shifting our traditional rod and bar volume from other plants into the Kalamazoo facility.

Adam France – 1492 Capital

Okay. Thank you.

Operator

(Operator instructions) I am showing no further questions. I would like to turn the conference back over to Mr. Jack Hockema.

Jack Hockema

Thank you. Reiterating our comments today, we are encouraged by the positive momentum in our markets and our results and we are very excited about the future outlook. We have a well-positioned platform for growth in attractive markets and we have financial strength and flexibility to support continued growth. Thanks for joining us on the call. We look forward to updating you again on our second quarter call in three months. Thank you.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. Today conference will be available for replay. You may all disconnect. Have a wonderful day.

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