UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
| [X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended March 31, 2006
OR
| [ ] | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ACT OF 1934 |
For the transition period from to
Commission file number:
WISE METALS GROUP LLC
(Exact name of Registrant as specified in its charter)
| | |
| Delaware | | 52-2160047 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
857 Elkridge Road, Suite 600
Linthicum, Maryland 21090
(Address of principal executive offices and zip code)
(410) 636-6500
(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 x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
2
FORWARD-LOOKING STATEMENTS
Certain of the matters discussed in this report, including, without limitation, matters discussed under Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Certain of these forward-looking statements can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “approximately,” “intends,” “plans,” “estimates,” or “anticipates” or the negative of these terms or other comparable terminology, or by discussions of strategy, plans or intention. Statements contained in this report that are not historical facts are forward-looking statements. Without limiting the generality of the preceding statement, all statements in this report concerning or relating to estimated and projected earnings, margins, costs, expenditures, cash flows, growth rates and financial results are forward-looking statements. In addition, through the Company’s senior management, forward-looking statements are made concerning expected future operations, performance and other developments. Such forward-looking statements are necessary estimates reflecting management’s best judgment based upon current information and involve a number of risks and uncertainties. Other factors may affect the accuracy of these forward-looking statements and actual results may differ materially from the results anticipated in these forward-looking statements. While it is impossible to identify all such factors, factors that could cause actual results to differ materially from those estimated include, but are not limited to, those factors or conditions described under this Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
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PART I. FINANCIAL INFORMATION
| ITEM 1. | FINANCIAL STATEMENTS |
Wise Metals Group LLC
Condensed Consolidated Balance Sheets
(In thousands)
| | | | | | | | |
| | | March 31,
2006 | | | December 31,
2005 | |
| | | (Unaudited) | | | | |
Assets | | | | | | | | |
Current assets: | | | | | | | | |
Cash and cash equivalents | | $ | 2,077 | | | $ | 6,456 | |
Restricted cash | | | 250 | | | | 250 | |
Accounts receivable, less allowance | | | 69,277 | | | | 73,326 | |
Inventories | | | 181,432 | | | | 142,151 | |
Other current assets | | | 28,209 | | | | 24,562 | |
| | | | | | | | |
Total current assets | | | 281,245 | | | | 246,745 | |
Non-current assets: | | | | | | | | |
Property and equipment, net | | | 87,245 | | | | 86,557 | |
Other assets | | | 8,998 | | | | 8,492 | |
Goodwill | | | 283 | | | | 283 | |
| | | | | | | | |
Total non-current assets | | | 96,526 | | | | 95,332 | |
| | | | | | | | |
Total assets | | $ | 377,771 | | | $ | 342,077 | |
| | | | | | | | |
Liabilities and members’ deficit: | | | | | | | | |
Current liabilities: | | | | | | | | |
Accounts payable | | $ | 54,923 | | | $ | 54,493 | |
Current portion of long-term debt | | | 2,180 | | | | 1,477 | |
Borrowing under revolving credit facility | | | 161,485 | | | | 137,730 | |
Accrued expenses, payroll and other | | | 27,209 | | | | 18,247 | |
| | | | | | | | |
Total current liabilities | | | 245,797 | | | | 211,947 | |
Non-current liabilities: | | | | | | | | |
Term loans, less current portion | | | 773 | | | | 826 | |
Senior secured notes | | | 150,000 | | | | 150,000 | |
Other liabilities | | | 12,990 | | | | 14,593 | |
| | | | | | | | |
Total non-current liabilities | | | 163,763 | | | | 165,419 | |
Members’ deficit: | | | (31,789 | ) | | | (35,289 | ) |
| | | | | | | | |
Total liabilities and members’ deficit | | $ | 377,771 | | | $ | 342,077 | |
| | | | | | | | |
See accompanying notes.
4
Wise Metals Group LLC
Condensed Consolidated Statements of Operations
(In Thousands)
(Unaudited)
| | | | | | | | |
| | | Three months ended
March 31, | |
| | | 2006 | | | 2005 | |
Sales | | $ | 216,276 | | | $ | 221,561 | |
Cost of sales | | | 207,394 | | | | 215,461 | |
| | | | | | | | |
Gross margin | | | 8,882 | | | | 6,100 | |
Operating expenses: | | | | | | | | |
Selling, general, and administrative | | | 2,973 | | | | 2,696 | |
| | | | | | | | |
Operating income | | | 5,909 | | | | 3,404 | |
Other income (expense): | | | | | | | | |
Interest expense and fees, net | | | (7,120 | ) | | | (6,019 | ) |
Unrealized gain (loss) on derivative instruments | | | 4,711 | | | | (3,619 | ) |
| | | | | | | | |
Net income (loss) | | $ | 3,500 | | | $ | (6,234 | ) |
| | | | | | | | |
See accompanying notes.
5
Wise Metals Group LLC
Condensed Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
| | | | | | | | |
| | | Three months ended
March 31, | |
| | | 2006 | | | 2005 | |
Cash flows from operating activities | | | | | | | | |
| | |
Net income (loss) | | $ | 3,500 | | | $ | (6,234 | ) |
Adjustments to reconcile net income (loss) to net cash used in operating activities: | | | | | | | | |
Depreciation and amortization | | | 3,114 | | | | 3,299 | |
Amortization of deferred financing fees | | | 351 | | | | 304 | |
Unrealized (gains) losses on derivatives | | | (4,711 | ) | | | 3,619 | |
Changes in operating assets and liabilities: | | | | | | | | |
Restricted cash | | | — | | | | (3,148 | ) |
Accounts receivable | | | 4,049 | | | | (23,613 | ) |
Inventories | | | (39,281 | ) | | | 980 | |
Other current assets | | | 662 | | | | 733 | |
Accounts payable | | | 430 | | | | 1,951 | |
Accrued expenses, payroll and other | | | 6,904 | | | | 4,306 | |
| | | | | | | | |
Net cash used in operating activities | | | (24,982 | ) | | | (17,803 | ) |
| | |
Cash flows from investing activities | | | | | | | | |
Purchase of equipment | | | (3,802 | ) | | | (4,039 | ) |
| | | | | | | | |
Net cash used in investing activities | | | (3,802 | ) | | | (4,039 | ) |
| | |
Cash flows from financing activities | | | | | | | | |
Net issuance of short-term borrowings | | | 24,458 | | | | 16,093 | |
Payments on long-term obligations | | | (53 | ) | | | (59 | ) |
Purchase of members’ equity | | | — | | | | (906 | ) |
| | | | | | | | |
Net cash provided by financing activities | | | 24,405 | | | | 15,128 | |
| | | | | | | | |
Net decrease in cash and cash equivalents | | | (4,379 | ) | | | (6,714 | ) |
Cash and cash equivalents at beginning of period | | | 6,456 | | | | 7,669 | |
| | | | | | | | |
Cash and cash equivalents at end of period | | $ | 2,077 | | | $ | 955 | |
| | | | | | | | |
See accompanying notes.
6
Wise Metals Group LLC
Notes to Condensed Consolidated Financial Statements
March 31, 2006
(Unaudited)
(Dollars in thousands)
1. Organization
Wise Metals Group LLC is a holding company formed for the purpose of managing the operations of Wise Alloys LLC, Wise Recycling LLC and Listerhill Total Maintenance Company LLC (collectively, the Company). Wise Alloys LLC (Alloys) principally manufactures and sells aluminum can sheet to aluminum can producers and also serves the transportation and building and construction markets. Wise Recycling LLC (Recycling) is engaged in the recycling and sale of scrap aluminum and other non-ferrous metals. Listerhill Total Maintenance Company LLC (TMC) specializes in providing maintenance, repairs and fabrication to manufacturing and industrial plants all over the world ranging from small onsite repairs to complete turn-key maintenance.
2. Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements are presented in accordance with generally accepted accounting principles for interim financial information and with the requirements of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the disclosures normally required by accounting principles generally accepted in the United States of America for complete financial statements. The condensed consolidated financial statements have been prepared in accordance with the Company’s customary accounting practices and, in the opinion of management, all adjustments necessary to fairly present the financial position, results of operations and cash flows for the reported interim periods have been made and were of a normal recurring nature. Operating results for the three month period ended March 31, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, refer to the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. The accompanying condensed consolidated financial statements include the accounts of Wise Metals Group LLC and its subsidiaries. Intercompany transactions have been eliminated in consolidation.
Derivatives and Hedging Activity
The Company has entered into long-term contracts to supply can sheet to its largest customers. To reduce the risk of changing prices for purchases and sales of metal, including firm commitments under these supply contracts, the Company uses commodity futures and option contracts. In addition, the Company uses natural gas futures and option contracts.
In June 1998, the Financial Accounting Standards Board issued Statement No. 133 (FAS No. 133),Accounting for Derivative Instruments and Hedging Activity. The Statement requires companies to recognize all derivative instruments as either assets or liabilities on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through the statement of operations. The Company has elected not to designate any of its derivative instruments as hedges under FAS No. 133.
In determining fair value, the Company uses market quotes for contracts of similar maturity. The market quotes for the aluminum futures and options are adjusted for premiums/discounts for various product grades, locations, and the closing times for various terminal markets.
A summary of the fair value of the Company’s derivative instruments is as follows:
| | | | | | | | |
Description of Derivative Instrument | | Fair value at
March 31, 2006 | | | Fair value at
December 31, 2005 | |
Aluminum futures and options | | $ | 23,246 | | | $ | 16,394 | |
Natural gas futures and options | | | (2,758 | ) | | | (617 | ) |
| | | | | | | | |
| | $ | 20,488 | | | $ | 15,777 | |
| | | | | | | | |
The fair value asset or liability for the above noted derivatives is included in other assets, accrued expenses, payroll and other, or other liabilities as appropriate.
7
2. Significant Accounting Policies (continued)
Unrealized gain (loss) amounts recorded were as follows:
| | | | | | | | |
| | | Three months
ended March 31 | |
Description of Derivative Instrument | | 2006 | | | 2005 | |
Aluminum futures and options | | $ | 6,852 | | | $ | (5,258 | ) |
Natural gas futures and options | | | (2,141 | ) | | | 1,639 | |
| | | | | | | | |
| | $ | 4,711 | | | $ | (3,619 | ) |
| | | | | | | | |
In connection with the Company’s futures activity, the Company maintains lines of credit with brokers to cover unrealized losses on futures contracts and uses options to manage price exposure with respect to firm commitments to purchase or sell aluminum.
Inventories
Inventories consisted of the following:
| | | | | | | | |
| | | March 31
2006 | | | December 31
2005 | |
Manufacturing inventories: | | | | | | | | |
Raw materials | | $ | 67,150 | | | $ | 50,040 | |
Work in progress | | | 71,730 | | | | 64,941 | |
Finished goods | | | 74,283 | | | | 58,921 | |
LIFO reserve | | | (49,540 | ) | | | (49,540 | ) |
| | | | | | | | |
Total manufacturing inventories | | | 163,623 | | | | 124,362 | |
Supplies inventory | | | 17,809 | | | | 17,789 | |
| | | | | | | | |
Total inventories | | $ | 181,432 | | | $ | 142,151 | |
| | | | | | | | |
Manufacturing inventories are stated at lower of cost or market based on the last-in, first-out (LIFO) method. An actual valuation of inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations must necessarily be based on management’s estimates of expected year-end inventory levels and costs dependent upon prevailing aluminum costs and other factors which are beyond management’s control.
3. Financing Arrangements
Debt consists of the following at:
| | | | | | | | |
| | | March 31
2006 | | | December 31
2005 | |
Revolving and secured credit facility | | $ | 161,485 | | | $ | 137,730 | |
Senior secured 10.25% notes due 2012 | | | 150,000 | | | | 150,000 | |
Other notes payable | | | 2,953 | | | | 2,303 | |
| | | | | | | | |
| | | 314,438 | | | | 290,033 | |
Less current portion | | | (163,665 | ) | | | (139,207 | ) |
| | | | | | | | |
| | $ | 150,773 | | | $ | 150,826 | |
| | | | | | | | |
On March 3, 2006, the revolving line of credit was amended and increased from $150 million to $180 million and expires May 5, 2008. The interest rate on the revolving line of credit is a variable rate of prime plus a range of 0% to 0.50% or LIBOR plus a range of 2.25% to 2.75%.
8
3. Financing Arrangements (continued)
At March 31, 2006, the Company also has $2.7 million outstanding letters of credit with a financial institution. Substantially all of the assets of the Company are pledged as collateral for the financing arrangement.
The available borrowing base under the revolving credit facility is determined based on a borrowing base formula which accounts for collateral value of trade receivables and inventory on a basis approximating the lower of current cost (on a first-in first-out or FIFO basis) or fair market value. This borrowing base is then compared to the outstanding loan balance (including outstanding letters of credit) to determine a net amount available for additional borrowings.
In addition, the revolving credit facility (as well as the senior secured notes through cross-default provisions) is subject to customary compliance with financial covenants which include either attaining a minimum earnings before interest, taxes, and depreciation and amortization (EBITDA) adjusted for the effects of LIFO and FAS No. 133 (Adjusted EBITDA) or achieving a specified adjusted excess availability calculation. As of March 31, 2006, as a result of the March 3, 2006 amendment in which the facility was increased to $180 million, the Company is not required to comply with either the Adjusted EBITDA or adjusted excess availability calculation until the periods ending after March 31, 2006.
Effective March 31, 2006 the Company executed an asset sale agreement with a financial institution that allows the Company to sell certain accounts receivable up to $17 million on a non-recourse basis. This agreement expires December 31, 2006. Under the terms of the agreement, the Company agreed to sell on an ongoing basis and without recourse, a designated customer’s accounts receivable. On March 31, 2006 there had been no sales under this agreement. Subsequent to March 31, 2006, the Company sold approximately $17.0 million of receivables under this agreement.
4. Stock-Based Employee Compensation
On July 1, 2004, the Company issued a performance-based common membership option award to one employee that provides the employee with options to acquire 4 units of the common memberships’ equity upon attainment of pre-defined Company operating performance targets. Each unit is equal to a 1% interest in the common membership equity. Each of these 4 units has different vesting periods and performance measures and expire at various dates through June 2007. Generally, each option has a two year life in which the performance measure must be met in order for vesting to occur. Prior to January 1, 2006, the Company used the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation (FAS 123) to account for equity-based compensation. Effective January 1, 2006 the Company adopted the fair value recognition provisions of FAS 123R, Stock Based Compensation (FAS 123R), using the modified prospective transition method. Under this transition method, stock-based compensation expense for the first quarter of fiscal 2006 for all stock-based compensation awards granted prior to, but not yet vested as of, January 1, 2006 is based on the grant date fair value estimated in accordance with the original provisions of FAS 123. Stock-based compensation expense for all share-based payment awards granted after January 1, 2006 (for which there are none) will be based on the grant-date fair value estimated in accordance with the provisions of FAS 123R.
The fair value for our pre January 1, 2006 option award was estimated at the date of grant using a Black-Scholes option-pricing model, in accordance with FAS 123, with the following weighted-average assumptions:
| | |
Risk-free Interest Rate | | 4% |
Expected Dividend Yield | | 0% |
Expected Volatility | | 10% |
Expected Lives | | 10 years |
Range of Estimated Fair Value of Each Option Award | | $35 to $80 |
Exercise Price of Each Option | | $750 |
Remaining Contractual Life - 1 Option Each to Expire in: June, 2006, June, 2007 June, 2008, June, 2009 | | |
This common membership option award is a performance-based award, for which the recipient either receives the award at the time specified performance criteria has been met or the award lapses without vesting to the recipient if the performance criteria are not met. The Company has determined that the fair value of this award is approximately $230. However, prior to January 1, 2006 the Company had concluded that it was not probable that such awards would vest and thus
9
recognized no compensation expense in prior periods. In addition, in prior periods, the Company has concluded that none of this single employee’s award would be forfeited. However, subsequent to March 31, 2006 the employee’s employment was terminated and all awards were forfeited.
Since the award was never deemed probable of vesting based on the Company’s assessment of achievement of the performance condition, and subsequent to the quarter end the awards were forfeited, there was no impact of the adoption of FAS 123R, to the Consolidated Condensed Financial Statements for the three months ended March 31, 2006.
5. Pension and Post Retirement Benefits
The Company’s pension and other post retirement benefit plans are more fully disclosed in Note 8 of Notes to Consolidated Financial Statements included in Item 8 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. Effective April 1, 1999, the Company established a defined benefit pension plan that covers essentially all union employees. The plan provides certain levels of benefits based on years of service and wage levels, but does not provide benefits for any prior service. In addition, defined contribution plans for both union and nonunion employees were established.
In 2003 the Company negotiated defined contributions, for certain union employees, to multi-employer union pension plans. This was done in exchange for freezing service time and the pension factor in the aforementioned defined benefit plan as of the first quarter of 2004 and eliminating post retirement benefits for affected employees.
The Company also established post retirement benefit plans for all hourly and salaried employees effective April 1, 1999. The union employees who become eligible to retire under the defined benefit plan, and are not a part of the unions that have elected the multi-employer option, will retain health benefits and certain other benefits for life. Salaried employees who retire after age 60 with a combined 10 years service with Wise Alloys LLC and the previous owner of the Wise Alloys facilities will be eligible for medical benefits until age 65.
The Company’s funding policy for these plans is to contribute negotiated amounts to the multi-employer funds and amounts necessary to meet minimum funding requirements of the Employee Retirement Income Security Act for the defined benefit plans but not to exceed the maximum deductible amount allowed by the Internal Revenue Code. The Company contributed $1,649 to the multi-employer plans during 2005. Contributions to the defined benefit plan are expected to be $5,326 during 2006.
The 2006 and 2005 amounts shown below reflect the defined benefit pension and other postretirement benefit expense for the three month periods ended March 31 for each year:
| | | | | | | | | | | | | | | | |
| | | Three months ended March 31 | |
| | | Pension Benefits | | | Other Post Retirement Benefits | |
| | | 2006 | | | 2005 | | | 2006 | | | 2005 | |
Service cost | | $ | 325 | | | $ | 277 | | | $ | 385 | | | $ | 348 | |
Interest cost | | | 237 | | | | 194 | | | | 115 | | | | 115 | |
Expected return on plan assets | | | (175 | ) | | | (134 | ) | | | — | | | | — | |
Amortization of prior service cost | | | 9 | | | | 9 | | | | — | | | | — | |
Net gain recognition | | | 7 | | | | — | | | | (31 | ) | | | (6 | ) |
| | | | | | | | | | | | | | | | |
Net periodic benefit cost | | $ | 403 | | | $ | 346 | | | $ | 469 | | | $ | 457 | |
| | | | | | | | | | | | | | | | |
6. Contingencies
The Company is a defendant in an action brought by Merrill Lynch, Pierce, Fenner & Smith Incorporated pending in the New York Supreme Court, County of New York. In this action, Merrill Lynch seeks $932 for out-of-pocket costs and expenses allegedly incurred pursuant to a letter agreement between Wise Metals and Merrill Lynch dated January 31, 2002, in which Merrill Lynch alleges that Wise Metals agreed to reimburse Merrill Lynch for such costs and expenses. Wise Metals has hired counsel and is vigorously contesting this law suit and believes it has meritorious defenses. Wise Metals has filed an answer to the complaint denying the material allegations and alleging several affirmative defenses and counterclaims which exceed in amount the sum sought by Merrill Lynch. Merrill Lynch moved to dismiss the Wise Metals’ counterclaims and by an order dated December 30, 2004, the Court granted this motion, dismissed the counterclaims and permitted Wise Metals to
10
replead two of the counterclaims. Wise Metals appealed, which resulted in a reversal reinstating the dismissed counterclaims. Merrill Lynch has replied to the counterclaims. The action is proceeding and is presently in the discovery stages. The Company is a defendant in an action brought by a former executive pending in Alabama State Court. In this action, the plaintiff is suing to enforce an alleged settlement contract with the Company. The plaintiff alleges that a deal had been negotiated whereby in exchange for $2 million he would surrender his equity interests in the Company, forgo any claim for a $1 million severance that plaintiff alleges would otherwise come due on his 62nd birthday (payable in $50,000 quarterly installments), and provide a general release. The Company has hired counsel, is vigorously contesting this law suit and believes it has meritorious defenses.
The Company is a party to certain claims and litigation associated with employment related matters for which management believes that the ultimate resolution will not have a material adverse impact on the Company’s financial position.
There were no material changes from risk factors as previously disclosed in our Annual Report on Form 10-K as of December 31, 2005.
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview
We are the third largest producer of aluminum beverage can sheet in the world and one of the largest aluminum scrap recyclers in the United States. Beverage can sheet is aluminum sheet specifically designed and engineered for the production of aluminum beverage cans. Our customers include Ball, Crown, and Rexam. These customers produce aluminum cans for the largest brewers and carbonated soft drink makers in North America. In addition, we provide food container stock and semi-fabricated aluminum sheet for the transportations and other common alloy markets. In 2005, we supplied an estimated 14% of the North American market for aluminum beverage can sheet as measured by volume and we own one of only five beverage can sheet facilities in North America, providing valuable capacity to a consolidated industry. We further estimate that our market share for 2006 has remained consistent, while also increasing our market presence in the common alloy markets.
Unlike some of our principal competitors, we do not manufacture aluminum from bauxite. Instead, we process aluminum scrap and prime aluminum manufactured by third parties. As a result, we do not have the capital requirements and high fixed costs associated with the production on prime aluminum. Historically, prices of our aluminum can sheet and other products have been directly correlated to the prices of our metal costs due to the standard industry practice of passing through metal costs to customers. This correlation, subject to the impacts of metal ceiling or “price caps” has otherwise allowed us to maintain a relatively consistent conversion revenue, defined as net revenue less material costs, on a per pound basis. The impact of metal prices rising above the ceiling are expected to materially impact the second and third quarters as well as potentially the fourth quarter depending upon prevailing market conditions. This could lead to reductions in net conversion revenue and conversion margins.
Quarterly Information
Our quarterly revenues tend to fluctuate period to period based in large part on changes in aluminum prices. These changes generally do not affect our cash flow because we seek to match our hedging positions to our contractually-obligated sales agreements. We also pass aluminum cost increases to customers through an indexed pricing mechanism and/or by fixing the cost of metal through forward contracts on the London Metals Exchange (LME). Our net income may also fluctuate period to period based on the mark to market adjustment caused by our hedged position on aluminum and natural gas. Because we do not designate our forward contracts as hedges under Financial Accounting Standard No. 133 (FAS 133),Accounting for Derivative Instruments and Hedging Activity, we are required to recognize the non-cash mark to market adjustment in our current earnings and these may be material.
Critical Accounting Policies
We have prepared our financial statements in conformity with accounting principles generally accepted in the United States. These statements include some amounts that are based on informed judgments and estimates of management. Our critical accounting policies are discussed in Note 2 of the notes to our consolidated financial statements included in our Annual
11
Report on Form 10-K for the year ended December 31, 2005. Since the date of our 2005 Form 10-K, there have been no changes to our critical accounting policies or the methodologies and assumptions applied under them.
Operating Results
Conversion Revenue and Conversion Margin
Shipments of can sheet accounted for a substantial portion of our Listerhill facility’s output in 2005 and in the first quarter of 2006. There are two components to our pricing under industry standards for can sheet pricing. The first component of can sheet pricing is the market price for aluminum that we pass on to our customers, currently subject to an industry-wide ceiling price which did not materially affect first quarter pricing, but is expected to impact second and third quarter pricing. Subject to prevailing market conditions, the ceiling price may also adversely affect fourth quarter pricing. Under this industry formula, the metal transfer price is changed twice annually, on April 1 and on October 1. The metal transfer price for the period April 1 through September 30 is determined based on the average published Midwest P1020 aluminum price for the preceding six-month period ended the last day of February. Likewise, the metal transfer price for the period October 1 through the following March 31 is determined based on the average published Midwest P1020 aluminum price for the immediately prior six month period ended the last day of August. We reduce our exposure to aluminum price fluctuations by passing cost increases to customers through this indexed sales pricing mechanism and by fixing the cost of metal through forward contracts on the London Metals Exchange (LME). Although the spread differential between prime metal and scrap cannot be cost effectively hedged in the financial markets, we minimize market price risk with respect to scrap aluminum we receive from our customers and reprocess at a fixed conversion spread.
The second component is a fixed conversion, or value added, price. The fixed conversion price is calculated annually using Alcoa’s list price as a basis and, along with impacts of ceilings on metal price, is the most significant factor influencing our profitability. Conversion pricing under our supply agreement is subject to renegotiation each year as well as at such times that our major competitors change their published conversion prices. Because of the importance of the conversion price to our operating results, we measure conversion margin to evaluate our performance.
Conversion margin is determined as conversion revenue (sales less metal cost and the effect of LIFO) less conversion cost (cost of sales less metal costs). The following table is a reconciliation of these non-GAAP financial measures to their related GAAP basis measures.
| | | | | | | | |
| | | Three months
ended March 31 | |
| | | 2006 | | | 2005 | |
Sales | | $ | 216,276 | | | $ | 221,561 | |
Less: | | | | | | | | |
Metal costs | | | (148,675 | ) | | | (155,558 | ) |
LIFO adjustment | | | — | | | | — | |
| | | | | | | | |
Conversion revenue | | $ | 67,601 | | | $ | 66,003 | |
| | | | | | | | |
Cost of sales | | $ | 207,394 | | | $ | 215,461 | |
Less: | | | | | | | | |
Metal costs | | | (148,675 | ) | | | (155,558 | ) |
| | | | | | | | |
Conversion costs | | $ | 58,719 | | | $ | 59,903 | |
| | | | | | | | |
Conversion revenue | | $ | 67,601 | | | $ | 66,003 | |
Conversion costs | | | (58,719 | ) | | | (59,903 | ) |
| | | | | | | | |
Conversion margin | | $ | 8,882 | | | $ | 6,100 | |
| | | | | | | | |
Shipments (000s) | | | 169,918 | | | | 196,539 | |
Conversion margin per pound shipped | | | .0523 | | | | .0310 | |
| | | | | | | | |
Three months ended March 31, 2006 and 2005
Sales.Our sales decreased from $221.6 million in the three months ended March 31, 2005, to $216.3 million in the comparable period in 2006, a decrease of $5.3 million or 2.4%. The decrease was primarily a result of lower shipments which
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decreased from 196.5 million pounds in the first three months of 2005 to 169.9 million pounds in 2006, a decrease of 26.6 million pounds or 14%. First quarter shipments were reduced due mostly to can sheet customers reducing inventory quantities from year-end levels combined with the effect of slightly lower contractual volumes which resulted from negotiations to improve pricing. Offsetting the decrease in shipment volumes were price increases that were enacted on January 1, 2006. These higher prices which include both metal and conversion lead to a resulting increase in conversion revenue per pound. Conversion revenue which was $66.0 million in the first three months on 2005, increased to $67.6 million in the first three months of 2006 despite the 14% decrease in shipments. On a per pound basis, conversion revenue increased from 33.6 cents per pound in the first three months of 2005 to 39.8 cents per pound, an increase of 6.2 cents per pound or approximately 18%. Shipments by Wise Recycling to third parties increased approximately 9% for the quarter due to higher recycling activity associated with higher metal prices.
Cost of Sales. Cost of sales decreased from $215.5 million in the three months ended March 31, 2005, to $207.4 million in the three months ended March 31, 2006, a decrease of $8.1 million or 4%. Metal costs, representing 72% of cost of sales in both the first quarter of 2005 and 2006, decreased from $155.6 million in 2005 to $148.7 million in 2006, a decrease of $6.9 million or 4%. The decrease is attributable to the 14% decrease in shipments offset by higher metal prices. Conversion costs, which exclude metal, but include employment, energy, materials and other costs decreased from $59.9 million in the first quarter of 2005 to $58.7 million in 2006, a decrease of $1.2 million or 2%. On a per pound basis, conversion costs increased from 30.5 cents per pound in the first quarter of 2005 to 34.6 cents per pound in 2006, an increase of 4.1 cents per pound or 13%. The cost increase is primarily attributable to the higher price paid for natural gas during the three months ended March 31, 2006, which was approximately 64% higher than the same period in 2005, resulting in an approximate $5.5 million increase in natural gas costs. Resulting conversion margin increased from $6.1 million in 2005 to $8.9 million in 2006, an increase of 46%.
Selling, General and Administrative. Selling, general and administrative expenses increased from $2.7 million in the first quarter of 2005 to $3.0 million in the first quarter of 2006, an increase of $0.3 million or 11% due to higher legal and accounting costs.
Interest Expense and Fees. Interest expense and fees increased from $6.0 million in the first quarter of 2005 to $7.1 million in 2006 due to higher outstanding amounts on our line of credit which increased from $117.8 million at March 31, 2005, to $161.5 million at March 31, 2006. The increase was due to higher working capital needs caused by higher metal prices.
Mark-to-Market for Contracts under FAS No. 133.This income (expense) represents the non-cash gain (loss) we recognized pursuant to FAS No. 133. The unrealized gains (losses) were primarily a result of forward contracts entered into to hedge the cost of natural gas and aluminum. The fair value decrease during the first quarter of 2005 was ($3.6) million compared to an increase of $4.7 million during the first quarter of 2006.
Liquidity and Capital Resources
Our principal sources of cash to fund liquidity needs are net cash provided by operating activities and availability under our revolving senior secured facility. We anticipate that our primary liquidity needs will be for debt service, working capital and capital expenditures. Our debt service costs have increased as a result of increased aluminum prices. We believe that cash generated from operations, available borrowings under our senior secured credit facility, as amended and restated, and other indebtedness will be sufficient to enable us to meet our liquidity requirements in the foreseeable future.
As of March 31, 2006, the outstanding balance on our revolving line of credit was $161.5 million. In addition, we had approximately $2.7 million of outstanding letters of credit against our $180 million revolving credit line. We are also able to enter into lease transactions and sale-leaseback transactions up to $20 million that also would result in reducing our outstanding balance under the revolving credit line. Furthermore, we frequently offer cash discounts for early payment against receivables from our major can sheet customers which can also significantly decrease outstanding debt and increase overall liquidity.
Our liquidity has been directly impacted by aluminum prices which have increased steadily and dramatically since 2002. Average aluminum prices in 2002 were 65.4 cents per pound and have risen over 40% to average 91.7 cents per pound for 2005. In December 2005, aluminum prices had risen to average $1.07 per pound and risen still further to average $1.16 per pound in March 2006. These price increases have and are continuing to impact our working capital requirements resulting in higher outstanding debt supported by higher levels of receivables and inventory. Our net liquidity is determined based on a standard borrowing base formula which accounts for the collateral value of inventory and receivables on a basis
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approximating the lower of current cost (on a FIFO basis) or fair market value. This borrowing base is then compared to the outstanding loan balance including outstanding letters of credit to determine a net amount available for additional borrowings.
However, our liquidity could be hampered if aluminum prices were to substantially increase or if we incurred significant unexpected increases in necessary capital expenditures. Significant increases in volumes could also impact our liquidity. See “Risk Factors” included in our 2005 Annual Report Form 10-K filed with the Securities and Exchange Commission for certain circumstances that could adversely affect our liquidity. In particular, a default under our senior secured credit facility (which through cross-defaults would result in a default of our senior secured notes) or decreased sales or lower margins from our sales customers and other competitive factors could have a material adverse effect on our liquidity.
Our senior secured credit facility contains covenants that include an adjusted EBITDA or an adjusted excess availability test that measures our liquidity as a means of monitoring debt compliance. As a result of the March 3, 2006 amendment, the Company was not required to comply with either the adjusted EBITDA or adjusted excess availability calculation until periods ending after March 31, 2006. While debt compliance cannot be assured, managements expects that all debt compliance measures will be met for the foreseeable future through a combination of the expected results of operations and various liquidity enhancement projects planned for the upcoming year. These projects include, but are not limited to, further amendments to our credit facility, continued accounts receivable asset sales, sale-leasebacks of certain equipment, discounted cash terms to customers, the combination of some or all of which is expected to result in debt compliance for the foreseeable future.
Should aluminum prices continue to rise, we expect that the collateral value of our working capital would continue to rise sufficiently to warrant further increases to the senior secured credit facility should required borrowings and conditions dictate. As such, we believe our available sources of credit will be sufficient to meet our liquidity needs.
Three months ended March 31, 2006 and 2005.
Operating Activities. During the three months ended March 31, 2006, net cash used in operating activities was $25.0 million as compared to $17.8 million during the three months ended March 31, 2005. Fluctuations in cash used in and provided by operating activities are subject to changing working capital requirements especially for accounts receivable and inventories. During the three months ended March 31, 2005, accounts receivable increased from $46.3 million at December 31, 2004, to $69.9 million at March 31, 2005, representing an increase of $23.6 million. This increase was a result of seasonality whereby shipments and corresponding accounts receivable are generally lower around the year-end holidays. This, however, was not the case in the first quarter of 2006 as receivables actually decreased from $73.3 million at December 31, 2005, to $69.3 million at March 31, 2006, a decrease of $4.0 million. The receivables at December 31, 2005, were relatively high as a result of a significant can sheet customer who had curtailed shipments during the third quarter, increased its order rate significantly at the end of the year leading to a temporary increase in accounts receivable and a corresponding decrease in inventory levels. This also contributed to a $39.3 million increase in inventory from December 31, 2005 to March 31, 2006. Higher aluminum prices, which rose from an average of $1.07 per pound in December to an average of $1.16 per pound in March 2006, also contributed significantly to the increase.
Investing Activities. In the three months ended March 31, 2006, our capital expenditures were $3.8 million as compared to $4.0 million during the same period in 2005. Both first quarter periods included some significant projects leading to relatively higher expenditures in the quarter. First quarter 2005 projects included a significant furnace rebuild and installation of an advanced reclamation melter process. First quarter 2006 projects included expansion of one of our recycling facilities and a major project to upgrade one of our furnaces.
Financing Activities. Net cash provided by financing activities was $24.4 million in the three months ended March 31, 2006, compared with $15.1 million in the first three months of 2005. Net cash provided by financing activities was related to increased borrowings from the revolving line of credit to fund increased working capital needs due primarily to higher aluminum prices and capital expenditures.
Effective March 31, 2006 we executed an agreement with a financial institution that allows the Company to sell certain accounts receivable up to $17 million on a non-recourse basis. This agreement expires December 31, 2006. As of March 31, 2006, there had been no sales under this agreement. Subsequent to March 31, 2006, the Company sold approximately $17 million of receivables under this agreement.
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Quantitative and Qualitative Disclosures About Market Risk
Cost of Aluminum. As a condition of sale for a substantial majority of our sales, our customers require us to enter into short and long-term fixed price commitments. Under these agreements, the pricing terms of the aluminum component can be based on “band” pricing which contains an industry standard six-month lag formula and may contain an upper and lower limit, a fixed price or an upper limit only. Accordingly, the price of the aluminum component can be set as much as six months or more prior to the actual sale date, leaving us exposed to the risk of fluctuating aluminum prices between the time the price on the order is determined and the time that the order is fulfilled.
Our aluminum commodity risk management policy is to hedge the aluminum price risk associated with these fixed-price firm commitments. At March 31, 2006, these LME options and futures contracts covered approximately 98,700 metric tons with an unrealized fair value gain of approximately $23.2 million.
We do not enter into derivative contracts for speculative purposes.
Backlog of Customer Business
We maintain long-term supply agreements with our key customers in the aluminum can sheet market and we believe the general terms of our customer contracts are standard for the industry. These contracts are supply arrangements whereby specific quantities and product pricing are negotiated and agreed to on an annual basis under the terms of the multi-year master supply agreement.
Under the terms of our customer contracts, we use an industry standard for pricing the metal component of all aluminum can sheet sold. This standard is described above in “—Conversion Revenue and Conversion Margin.” Accordingly, at any given point of time, we may have seven months of delivery priced under the master contract, the exact specifications and delivery locations to be specified as described below.
We receive orders from our customers which provide detailed specifications as to metal characteristics and specific plant location. Although all orders are placed pursuant to the contract, quantities and specifications will vary by plant and more specifically by production line within the plant. These orders are generally provided with a two to three month lead time. The majority of all orders, specifically can sheet orders, that are processed by Alloys are made to a specific customer order. Due to seasonal considerations, the first and second quarters are generally the highest sales volume for Alloys.
We earlier announced and received conversion price increases effective January 1, 2006, as well as our intent to begin moving away from providing ceiling coverage, or price caps, on the metal transfer price offered to can sheet customers. For the second and third quarters of 2006 the metal transfer price will be above the ceiling, as a result the Company expects to incur losses for the second and third quarter. Confidential discussions are ongoing and are continuing with customers on implementing these and other changes. These discussions resulted in contractual price increases that were effective January 1 and again with new price increases in the conversion price effective April 1, 2006. Current discussion are focusing on implementing further pricing relief for the fourth quarter of 2006 and beyond which include the elimination of all metal price ceilings or caps; however, we can give no assurances as to the outcomes of these discussions. Other can sheet suppliers have also made announcements regarding similar intentions and discussions.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
See Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of this report and Item 7 of the Company’s annual report on Form 10-K for the year ended December 31, 2005.
| ITEM 4. | CONTROLS AND PROCEDURES |
The Company, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer, President and Chief Operating Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (the “Evaluation”) as of the end of the period covered by this Report. Based upon the Evaluation, the Company’s Chief Executive Officer, President and Chief Operating Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in our periodic reports filed with the Securities and Exchange Commission is recorded, processed, summarized and reported as and when required. In addition, they concluded that there were no significant deficiencies or material weaknesses in the design or operation of internal controls which could significantly affect the Company’s ability to record, process, summarize and report financial information. It should be noted that the design of any system of controls is based in part upon certain assumptions about the
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likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.
There were no changes in the Company’s internal control over financial reporting during the quarterly period ended March 31, 2006, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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PART II. OTHER INFORMATION
We are a defendant from time to time in various legal actions arising in the normal course of business, the outcomes of which, in the opinion of management, neither individually nor in the aggregate are likely to result in a material adverse effect on our business, results of operations or financial condition.
We are a defendant in an action brought by Merrill Lynch, Pierce, Fenner & Smith Incorporated pending in the New York Supreme Court, County of New York. In this action, Merrill Lynch seeks $931,893 for out-of-pocket costs and expenses allegedly incurred pursuant to a letter agreement between Wise Metals and Merrill Lynch dated January 31, 2002, in which Merrill Lynch alleges that Wise Metals agreed to reimburse Merrill Lynch for such costs and expenses. Wise Metals has hired counsel and is vigorously contesting this law suit and believes it has meritorious defenses. Wise Metals has filed an answer to the complaint denying the material allegations and alleging several affirmative defenses and counterclaims which exceed in amount the sum sought by Merrill Lynch. Merrill Lynch moved to dismiss the Wise Metals’ counterclaims and by an order dated December 30, 2004, the Court granted this motion, dismissed the counterclaims and permitted Wise Metals to replead two of the counterclaims. Wise Metals appealed, which resulted in a reversal reinstating the dismissed counterclaims. Merrill Lynch has replied to the counterclaims. The action is proceeding and is presently in the discovery stages. The Company is a defendant in an action brought by a former executive pending in Alabama State Court. In this action, the plaintiff is suing to enforce an alleged settlement contract with the Company. The plaintiff alleges that a deal had been negotiated whereby in exchange for $2 million he would surrender his equity interests in the Company, forgo any claim for a $1 million severance that plaintiff alleges would otherwise come due on his 62nd birthday (payable in $50,000 quarterly installments), and provide a general release. The Company has hired counsel, is vigorously contesting this law suit and believes it has meritorious defenses. The Company is a party to certain claims and litigation associated with employment related matters for which management believes that the ultimate resolution will not have a material adverse impact on the Company’s financial position.
There were no material changes from risk factors as previously disclosed in our Annual Report on Form 10-K as of December 31, 2005.
| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
None.
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None.
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
None.
None.
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10.1 Separation Agreement and Release between Randall R. Powers and Wise Metals Group LLC. |
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31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14 of the Securities Exchange Act. |
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31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14 of the Securities Exchange Act. |
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32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | |
| | | WISE METALS GROUP LLC |
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Dated: May 15, 2006 | | /s/ David D’Addario |
| | David D’Addario |
| | Chairman and Chief Executive Officer |
| |
| | /s/ Danny Mendelson |
| | Danny Mendelson |
| | Executive Vice President, Chief Financial Officer and Secretary |
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