Kaiser Aluminum Corp (KALU) 2008 Q2 法說會逐字稿

Good day, and welcome, everyone, to the Kaiser Aluminum second quarter 2008 earnings results conference call. Today's call is being recorded.

At this time for opening remarks and introductions, I would like to turn the call over to Melinda Ellsworth, Vice President and Treasurer. Please go ahead.

Good afternoon, everyone, and welcome to Kaiser Aluminum's second quarter 2008 earnings conference call. If you have 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 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 would like to remind the audience that the information contained in this presentation includes statements based on management's current expectations, estimates and projections that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include statements regarding the company's anticipated financial and operating performance related to future events and expectations and involve known and unknown risks and uncertainties. For a summary of specific risk factors that could cause results to differ materially from those expressed in the forward-looking statements, please refer to the company's earnings release for the quarter end June 30, 2008, and reports filed with the Securities and Exchange Commission. All information in this presentation is as of the date of the presentation. 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.

Nonrun rate 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 the same level of underlying performance were to occur. These are certainly part of our business and operating environment, but are worthy of being highlighted for the benefit of the users of our financial statements. Management's intent is to neutralize the fabricated product segment from fluctuations in underlying metal prices. We characterize metal profits and LIFO charges as nonrun rate items that eventually offset to a great extent over the course of a full year. Further presentations, including such terms as net income or operating income before nonrun rate, are not intended to be and should not be relied on in lieu of the comparable caption under generally accepted accounting principles to which it is reconciled. Such presentations are soley intended to provide greater clarity of the impact of certain materially items on the GAAP measure and are not intended to imply such items should be excluded. At the conclusion of the company's presentation, we will allow for questions and answers. I would now like to turn the meeting over to Jack Hockema, who will provide overall commentary on Kaiser Aluminum. Jack?

Thanks, Melinda. As Melinda mentioned, you may follow our discussion by viewing the slide presentation on our website at Kaiseraluminum.com. My remarks begin with headline items on slide five in the presentation. Year to date heat treat plate shipments were a new record supported by strong demand for aerospace and defense applications and the outlook for commercial aircraft builds is very positive, which bodes well for long-term heat treat plate demand. Fabricated products first half results were negatively impacted by a margin squeeze, primarily from energy-related cost pressures. We have implemented a price surcharge that will soften the future impact of volatile energy costs. Our investment program continues on schedule and we have significant financial capacity to fund additional growth initiatives.

Slide six provides an overview of the first half results for fabricated products. Second quarter and year to date heat treat plate shipments set new records, although throughput was inhibited by the planned furnace outage for the Phase III expansion by production delays due to various bottleneck operations and by heavy gauge plate qualifications. The year-to-date results in fabricated products reflect a margin squeeze from higher energy-related costs, as well as unfavorable Canadian currency, higher costs in the inefficient rod and bar value stream, and higher depreciation and planned major project expenses. The energy price surcharge will address future volatility and energy costs and the Kalamazoo project will resolve inefficiencies in the rod and bar value stream.

Turning to slide seven, in the Trentwood expansion we are encouraged by the success on customer qualifications for heavy gauge plate. While a qualification process has proven to be more challenging than we expected, the difficulty reconfirms the barriers that new suppliers must clear to qualify for these very demanding applications. Construction for Phase III of the Trentwood expansion began in June and is scheduled to be completed by mid-October. In addition to converting one heat treat furnace from batch to continuous operation, the project will also address other bottleneck operations in Trentwood's heat treat plate flow. We expect to be fully operational at the projected 2009 throughput rate by the end of the year.

Slide eight illustrates the directional EBITDA impact of the heat treat plate expansion using 2006 EBITDA as the benchmark. The key variables in the chart are heat treat plate capacity utilization and price mix. The X axis displays a range of capacity utilizations to illustrate sensitivity to volume changes and the Y axis represents the incremental EBITDA compared to the 2006 benchmark. The lines on the chart display actual conditions experienced in both 2005 and 2007 to illustrate sensitivity to price and mix changes. While capacity utilization and price mix are key variables, the footnotes comment on additional considerations that may impact incremental EBITDA from heat treat plates.

Slide nine summarizes other major investment projects focused on efficiency, Kaiser select quality and capacity. The largest project is the new Kalamazoo plant addressing inefficiencies in our rod and bar value stream. Kalamazoo is expected to begin production in late 2009 and to be fully operational during the first half of 2010. Dan Rinkenberger will now provide details regarding the financial results.

Thanks, Jack. Turning to Slide 11, our net sales on a consolidated basis for the first half of 2008 totaled $813 million, but was 5% higher than the first half of 2007. Fabricated product shipments were 8% higher than the first half of 2007 on strong shipments of aerospace, defense and general engineering applications, including record plate shipments. This was partially offset by lower primary aluminum shipments and lower realized fabricated products pricing. Net income is highlighted on slide 12. Net income of $62 million for the first half of 2008 included approximately $34 million of pretax nonrun rate items, primarily related to mark-to-market gains on metal hedging positions. Earnings per share came to $3.04 fully diluted, of which approximately $0.97 per share was attributable to these nonrun rate items. Net income included an effective tax rate of 42% for the six-month period, the majority of which was noncash.

Operating income results are highlighted on slide 13. Year to date 2008 operating income of $106 million includes the $34 million of nonrun rate items that I mentioned previously. For the six months of 2008, operating income before nonrun rate items declined by $8 million to $72 million, reflecting cost pressures that offset the strong value-added sales in fabricator products and lower volume, as well as cost pressures in primary aluminum. Reviewing our fabricated product segment on slide 14, our segment operating income before nonrun rate items was $82 million in the first six months of 2008, down $5 million from the record level posted in 2007. Fabricated product shipments were up 8% overall and heat treat plate shipments set new records in the first half of 2008, with plate shipments up 5% over the six-month period versus the same period in 2007. The net favorable operating income impact of increased sales was $13 million, but this was more than offset by higher energy, freight and currency costs, higher manufacture costs largely related to our rod and bar value stream which our Kalamazoo investment will address and higher planned major maintenance and depreciation expense related to commissioning new production assets. Nonrun rate items were also approximately $1 million worse than the prior year.

Our reported primary aluminum operating income is presented on slide 15, was $49 million in the first six months of 2008. This included approximately $33 million of nonrun rate items, primarily unrealized gains on the metal hedging positions. Operating income before nonrun rate items of $15 million for the six-month period was $4 million lower than the prior year, due to lower volume from the outage at Anglesey after the fire in June, higher power costs, unfavorable currency exchange rates, and higher ocean freight costs. However aluminum pricing was $9 million favorable as compared to the prior year. Turning to slide 15 on the situation at Anglesey, on June 12th the production rate was reduced to approximately 1/3 of the total rated capacity as a consequence of a failure in a power transformer and subsequent fire. The first pot line was restored to full production in late July and Anglesey expects to restart the second pot line later this month and be fully operational by the end of November. We believe the unfavorable impact could range from $25 million to $30 million in the second half of 2008. That's Kaiser's share, depending on the restart timing and other factors. Anglesey insurance is expected to cover financial losses of Anglesey and it's owners although the timing of the insurance recoveries is uncertain. Regarding the long-term operation of this smelter Anglesey continues to pursue affordable power beyond the September 2009 expiration of the current power agreement.

On slide 17, we show the corporate expenses that are not allocated to the operating segments. Cash corporate expenses before nonrun rate in the first have of 2008 improved by $2 million as compared to the first half of 2007. On slide 18, we highlight our financial strengths to fund our growth initiatives, as well as cash returns to shareholders. At June 30, we had $27 million of cash, which was lower than March 31, as we funded a planned increase in inventories to let us continue to serve our customers through production outages at several of our plants, the heavy equipment upgrades scheduled in the third quarter. We had no debt and over $250 million of borrowing availability on a revolving credit facility. Our operating cash flow remains healthy and we benefit from sizable tax attributes. With the solid financial position to fund growth initiatives, in June our board declared a dividend of $0.24 per share, which was a 33% increase over prior quarters, and also approved a $75 million stock repurchase program. And next, I'll ask Jack to provide some concluding comments.

Thanks, Dan. Slide 20 addresses the market environment for our fabricated products business. Demand for aerospace plate is robust and is growing. The recently updated airline monitor forecast anticipates record commercial aircraft production this year and next year. Also notable is that the outlook anticipates no downturn at any time through the entire next decade. Industry supply for heat treat plate has grown to a level that supports these build rates and we do not anticipate a heat treat plate supply shortage as we move forward. This condition may create future pressure on spot prices.

Soft ground transportation demand continues with very weak truck and trailer builds and declining domestic auto builds. Restocking of rod and bar continues for service centers and has created strong demand on the mills for rod and bar products. Slide 21 summarizes Kaiser's near-term outlook for fabricated products. Phase III of the Trentwood expansion is scheduled to be completed mid-October. Our current outlook is for third quarter heat treat plate production to be down slightly from the first half pace and to ramp up to the full Phase III capacity during the fourth quarter.

Overall demand remains strong and we anticipate a relatively modest third quarter seasonal impact with fabricated product shipments down a few percentage points from the first half run rate. We have implemented a price surcharge to soften the impact of volatile energy costs and we are encouraged by acceptance in the marketplace. The benefit will be relatively small in the third quarter, but we anticipate that the surcharge could mitigate up to 70% of incremental energy costs by the end of the year. Significant planned project work is underway and we anticipate that third quarter major maintenance and project expense will be approximately $6 million higher than the first half run rate. While management, time and attention will be concentrated on execution of these projects, we are well prepared to support our customers while we upgrade our operations.

Slide 22 recaps today's report. Business conditions remain strong, especially for aerospace applications and the company's long-term outlook is very positive. Volatile energy costs are squeezing margins, but our price surcharge should begin to soften the impact later this year. The investment program is on track, with Phase III of the heat treat plate expansion and several other improvement projects scheduled for implementation during the third and fourth quarters. Our strong financial condition provides us with the capability to fund additional investments and we continue to explore new opportunities for profitable growth. We will now accept questions.

Thank you. The question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS) We'll pause for a moment to give everyone an opportunity to signal. We'll go first to Timna Tanner of UBS.

Hi, how are you doing?

Great, Timna.

I apologize in advance because I know you have a lot of detail in your slides and I'm sure there's more in the Q, but the few things that I missed and they are probably in there. Can you talk to us about your cash tax rate and how many shares you might have bought back in the quarter?

Sure. The cash tax rate, I think that's going to be the basically the same zip code as where with he had been before. The cash taxes are primarily the foreign tax, as well as a little bit of US state taxes, or AMT. It's not going to be much different than where we've been before. It's probably single-digit percentages.

Okay. I thought maybe with less Anglesey it might be a little lower, but maybe 10% or a little lower than that?

Well, to your point, the effective tax rate of 42% is lower. That's really because of lower statutory taxes this year in both the UK and Canadian jurisdictions.

Okay. All right. Then did you buy back shares in the second quarter?

We really don't want to comment and won't comment on the program. In the second quarter, I guess the fair point if that was your question --

Yes.

-- we haven't because we didn't launch it and wouldn't launch it until the first part of July at the minimum.

Okay.

At the earliest.

You don't want to talk about the criteria you would think for buying back shares?

We actually are just going to be looking at that in context of all the rest of the cash applications that we may have and the requirements.

Okay. SG&A went up a bit for the quarter. Can you talk to us about how you're seeing that progress?

Well, SG&A, and when you say it went up a pit for the quarter, you're probably looking at consolidated SG&A.

Okay.

That's the combination of both the SG&A that we talked about on the corporate segment on slide probably 17 as well as G&A that's within the business unit for fabricated products. Fabricator products, we have shown some increase there as we're growing the business and probably that's not going to be unexpected. Within corporate, especially if you look at the cash G&A, that's a decline on the first half.

Okay, great. Then just a few more. On the energy surcharge, can you give us a little more color on what percent of the business that might be applied. I know Jack talked about how it's not going to have as much of an immediate impact, but how it's going to progress over time. Can you explain that a little bit further, please?

Yes, Timna, as I said in my remarks, I know we covered a lot in these slides, but we think we'll be up around a 70% pace by the end of the year and then that will continue to grow in the future as contracts roll over and we get it implemented on new contracts.

Okay. So more -- still conceptually, it's going to be applied right away to your spot tons and then it's going to be progressively applied as contracts are renewed?

Well, that's correct, with the caveat that it will roll in during the third quarter. It did not apply until orders were entered on July 1st. So orders that had already been entered prior to July 1st do not receive the surcharge. So the impact on the third quarter will be -- I would say maybe a third of the shipments at best, but we think it will be in the 70% range as we roll into the fourth quarter.

Okay. That's helpful. And then the last question I have is on heat treat. You made a comment that I wanted to ask you about a little bit more, about you don't see any supply shortages and that's something to watch. How far are you sold out on, or committed, on your plate supply at Trentwood and what's the -- are we worried about oversupply any time soon? What are you thinking on supply versus demand on heat treat?

Our order book is very solid through the third quarter and we anticipate that we're going to run at a very high capacity utilization certainly in the fourth quarter and into the early part of next year. However, we're beginning to hear rumblings from the marketplace that competitors are out there taking actions that we've not seen in the past three or four years, and so that relates to my comment that we're beginning to see and it may have an impact on spot prices as we go forward. And that could show up as soon as the fourth quarter. We're still booking some of our spot business for the fourth quarter.

But taking actions to discount their product or taking actions to add extra capacity?

No, we're hearing price -- competitive pricing actions, spot comments about competitive pricing actions in the marketplace.

And you had said in the past that you were capacity committed on Trentwood through 2011 or so. That's what I was referring to. Has that changed?

Yes, no -- but let me make sure the comment's clear for everyone who is listening. I know you understand this, but our comment has been that our capacity is committed to customers and the entire Phase II capacity was committed. When we brought on Phase III, we said roughly 50% of Phase III, so if you do the math, and we've converted our bar charts now rather than times of a baseline, we're showing percent of the ultimate capacity. Roughly 95% of the ultimate capacity is committed to customers. That doesn't mean that the customers will take their full allocations of capacity. And we know, for example, that some customers who have already identified their take for next year will not take their full allocation.

Okay, and some of that's going to the [MMap] market still, or is that still solid?

Yes, the armor plate business continues to have legs to it and we think this year will probably be a peak year for demand, but we still see strong demand for armor plate for at least the next couple of years and with a good tail of demand running for several years on armor plate. So we still expect demand is going to be solid going forward. I mean aerospace demand is going to continue to grow here and the airline monitor forecast is especially encouraging to us. It happens to represent our view, but it's nice to see a third party introduce the same concept that we see, which is good, steady demand through the next decade and then we've got armor plate and general engineering demand continues to be strong. So demand is very strong. The only change that we see in market dynamics is it appears that industry capacity has now caught up to the demand and where we've been in an undersupply situation for four years now, we don't think we'll be in that undersupply situation going forward.

Okay. Thank you very much.

Our next question is from Tony Rizzuto, Dahlman Rose & Company.

Thank you very much. I've got a couple questions here. First is a comment, though. On the share buyback program, am I understanding that you were basically precluded for a two-year period from the IPO. Is that correct? In other words, the authorization was there, but you're really precluded from the dividend and buying back stock for a two year period from an IPO point. Is that basically correct?

Well, Tony, I don't think it was related to the IPO. I believe what you're referring to is it was related to preserving the NOLs.

Okay.

So the two years, if we had done anything in terms of repurchasing shares that could have triggered a change in control, we would have lost all of the NOLs. But now as of July 6th or whatever the two-year anniversary was of our emergence from bankruptcy, at that point, now the -- if there's a change of control, the amount of NOLs that we use could be capped on an annual basis, but we would not lose the NOL. So therefore, the penalty for a change of control has been virtually eliminated here.

Understood. And in the past, you've talked about on the heat treat side, on the plate side, a level that you felt was achievable for the full year of about 15%. Do you still think that's attainable based on comments that you just made earlier?

15% of -- compared to prior year?

Yes.

I think that's right, but let me just say that our outlook has not changed and we've got numbers in the slide deck here that show, in terms of next year's capacity, we're expecting to be roughly the same in the third quarter as what we did in the first half and then close to 95% of next year's capacity in the fourth quarter and that still adds up to that same level as we've been forecasting all year along.

Okay. So I just want to make sure this is clear in my head. So you still believe that the 15% growth year on year in heat treat shipments is attainable for 2008?

I don't know if the 15% works, but all I can say is we'll have to do that math, but our forecast remains the same.

All right. Let me just pursue the issue about some of the tonnage obviously and some of the taker pay and the min/maxes, and all that kind of stuff. When you look at the defense market, what kind of changes, if any, do you anticipate, if there's a change in the administration with a democratic administration? How does that change your view?

Our view is that the demand will remain regardless of the administration. I mean the military, regardless of which party's in power, they will want to be able to move the troops and protect the troops, and there's been tremendous deterioration of equipment in the harsh environment, not only the combat environment, but also just the harsh conditions in Iraq. So there's tremendous pent-up demand just to replace vehicles for the next action for the military, wherever that may be. So we believe that there's going to be good strong demand from the armor plate segment, as I said, for the next couple of years and then with a pretty nice tail running out for a few years beyond that.

Do you see that demand from defense actually accelerating from this point?

Not in the armor plate. We think this year was probably the peak for armor plate. It was really, really strong, but the next two years we think will be very strong as well, just not quite as strong as what it's been this past year.

So does that mean an actual decline in that overall market?

It means a decline in armor plate per se, but not in total heat treat plate. If you put together aerospace and general engineering and armor and all the applications, we think we'll continue to see strong and growing demand.

Okay. And I have a question also on your slide 14, on the fabricated products. You indicate the unfavorable impact of $10 million. I wonder if you could attribute that to energy, freight and currency. Wonder if you can give us a percentage breakdown of each and if we could just pursue that a little bit further.

Sure. The energy was $6 million of that $10 million and the freight was approximately $2 million and the currency was also about $2 million.

All right.

And we do that have -- that's also broken out the whole level of detail is broken out in greater detail in your 10Q and our MD&A.

All right. I didn't have a chance to go through that. I appreciate that. What was the sequential impact on energy?

Sequential quarter over quarter, I don't have that handy.

I actually think it was relatively even quarter to quarter.

Okay, okay. And you talked --

In terms of how it hit us from an expense standpoint. You get anomalies in how this all gets accounted for, but the bottom line, it was roughly the same in both quarters. And actually the energy, and these are comparing to prior year periods, the energy in the second quarter was $4 million, the full year as compared to last year. The half year was $6 million as compared to last year. So you got a sense of it, but again, those are references to prior year, not sequential.

Okay, and my next question is regarding the energy surcharge. Are you getting any resistance right now from the customers you've gone to?

Well, as you would expect, there was considerable resistance in the beginning and I might just add here, I did a little bit of research this morning because this isn't the first time. I've been responsible for the fab products business since the fall of 1996, and we've had four of these. There was one in 2000. There was another one in 2003, there was another one in 2005 and now we have this run-up in energy prices and we made moves in each one of those environments to try to pass through an energy surcharge and were unsuccessful. The industry just wouldn't mobilize around it. And that's part of the reason that for the first time, we announced a price increase with a press release that had my name in it and had quotes from me to send a very strong message to our customers that these costs were costs that we had to recover.

And so we've had a stiff upper lip on this through July and August and there were some competitors who didn't immediately follow as well as us getting a lot of resistance from the marketplace. But we've maintained a strong posture here and have sold hard to our customers and that resistance, and part of it I think is a function of what's going on in the entire economy. All the publicity on gasoline prices, on oil prices, there's a general tone of inflation in the environment everywhere in the country. And I think that's helped us this time to really persuade customers that this is an issue that had to be addressed. And at this point, after some weakness in terms of being able to get it through in July, we see a lot better acceptance here in August and we're very, very optimistic and confident at this point that it's going to stick.

Are you seeing, Jack, your competitors following along in this move also?

Well, I can't speak for the competitors. All I can say is that we got hammered pretty good by a lot of customers and we kept selling through it. We just persisted through the last six weeks really since we've introduced this and we're seeing that resistance weaken, which would suggest to us that competitors must be coming along in some similar fashion.

Okay. Just to follow up on the heat treat market a little bit, so generally speaking, I mean how are you finding inventories right now in the pipeline? Obviously some of the other metals, titanium, we've got quite a dislocation going on. What would you say about the heat treat aluminum heat and plate out there in the supply chain?

I think it's exactly what you would expect from a supply environment that's been on allocation for four years. And that is that every pound that's been produced and shipped basically is getting used. That's our view --

Okay.

-- at this point.

So it's still a relatively tight market compared --

Yes, in fact, we think that still this year there are extrusions being substituted for applications where people haven't been able to get plate.

Right. Basically that's a similar read to what we're getting. The final question I have right now is you talked a little bit about growth initiatives and it seemed like your voice perked up a little bit and kind of made me think that you've got some acquisitions in mind. Could you expand a little bit on your thought process there?

Boy, Tony. You didn't even see body language. I don't think my voice perked up. If I did, it was unintentional. We're basically the same place that we have been, which is we're really proactively and we're talking -- we got a lot of lines in the water. Let me characterize it that way. We're very optimistic that some things are going to happen over time, but I'm not suggesting that there's anything eminent.

All right. I guess my sense here, and just certainly my viewpoint on that, I think investors and analysts following your company would love to see you digest what you have on your plate right now before you dive into the acquisition market and would like to see that fully absorbed. Obviously you've had a lot of dislocation going on and will continue to do so and I think the market would feel better about seeing Kaiser operate on a more normalized rate.

I think that's a fair assessment and it's not out of line with management's assessment, nor the board's assessment, so while we have a lot of dry powder, as we say, in financial capacity to do acquisitions, we're looking very selectively at what we would do and before we would trigger -- pull the trigger on anything, we clearly will satisfy ourselves as management that it is clearly digestible and we have a very clear integration plan that we can execute, and I can assure you that our board will assist upon that same level of due diligence before they allow us to proceed with an acquisition.

All right.

So it's a fair comment, but that doesn't mean that there aren't opportunities out there that we couldn't digest at this point if we reach agreement with certain parties.

Right. Are these, are these opportunities -- they tend to be more maybe in the long products here? We know there's a lot of capacity and is it more around a strategy of maybe a roll-up strategy perhaps?

I think -- I wouldn't characterize it as a roll-up strategy. I think our strategy's more focused on complementary acquisitions, where there's a very clear strategic fit and where there's a very clear path for creation of value. The population of those kinds of acquisitions, especially those that are readily digestible, would tend to be more in the long products than would be in the flat roll products where you get much larger companies or much larger operations. But that doesn't preclude us having some things that would happen in the flat rolled side as well.

Can you comment if you are taking a close look at the Alcan engineered products division?

I wouldn't comment on speculation about that. I'll let Rio and Alcan comment on whatever sales process they have one. I'll comment that there are a lot of assets in the entire marketplace that we believe would be complementary to us and we continue to look at all avenues for a complementary acquisitions that can create value for us within our strategy.

Thanks, Jack.

We'll go next to Tim Hayes, Davenport Company.

Hey. Good afternoon.

Hi, Tim.

Hi, Tim.

I have several questions, starting with just clarifying heat treat shipments, did you get any increase in heat treat shipments in Q1 from the Phase II expansion?

We were up about 5% in the full half year, and we actually, I think we commented in our last call that we were slightly higher than the prior year first quarter. In the first quarter of '07 was the peak, the highest quarter that we had realized at that point in time. So to your point, it was slightly higher, but it was not hugely higher.

All right. And then you made mention about production could be down a little bit in Q3 for heat treat. What about shipments, though? You were building inventory ahead of that just so you can keep satisfying customers. How would shipments look?

That's a good question, Tim. We expect shipments are pretty much going to match production. We did not get as much past the heat treat furnaces as we had hoped to prior to taking the furnace down, but still, the shipments, we've changed the numbers here to express it as percentage of capacity. In the first half we ran like around 82% of next year's -- the Phase III full capacity and we will be within a few percentage points of that, if not at that rate for the third quarter. So we'll be shipping very close to the same pace in the third quarter as we did the first two quarters, maybe down slightly, but not materially.

Right, and then in terms of spot pricing for the nonaerospace plate, how has that trended, the spot pricing, say Q1 to Q2 and how is it shaping up so far from what you can tell in Q3?

I won't talk about spot specifically, because there are so many varieties of spot. The answer is it depends. I'll just say that when we look at our total basket of customer mix and product mix and spot and contract, we've been at a very steady level comparable to that 2007 rate since the fourth quarter of 2006, so we're really -- and it's basically held at those levels through the first two quarters and we expect the third quarter's going to be the same level. So we basically got eight quarters or two full years operating at the kind of pricing that we saw through 2007.

Okay, and then in terms of the smelter, we heard from reports from Rio, questioning about restarting that third pot line. If the smelter's going to be shut down in September, does it make sense, or does it make cost sense to restart the third pot line if it's going -- if the whole smelter's going to be taken down in less than a year, what's your opinion on the -- you said the third pot line is up in November. Are you quite confident that that will occur?

Yes, it's actually the second pot line. There are two pot lines at Anglesey and we think the odds are extremely high that that will proceed as we stated.

Okay, and then in terms of finding available or alternative power for that smelter, we're under the impression that just nuclear facility would be the only alternative power to source the smelter. Is there some other source that's possible?

Well, in the near term, I think that's correct, but in the long-term, there could be other sources of power.

Any -- just kind of curious, what might those be?

I can't comment. I'm not that close to the Anglesey situation. I can just tell you that our people who are on the board there report that they are looking at alternative sources of power for the long term, beyond when we will be in operation.

Very good. Thank you.

We'll go next to Seaver Wang, Utendahl Capital.

Hi, good afternoon. Got a few questions. You said you thought you would be about 70% caught up with pricing by fourth quarter. That, of course, assumes that prices, energy prices stay flat?

No, that -- on our website, we have a detailed analysis of how we apply the energy surcharge and it's very transparent, which is part of how we've sold this to the marketplace. We actually take the department of energy numbers for gas -- natural gas prices for electricity prices and for diesel fuel prices and roll those into a specific calculation of the energy surcharge. So, for example -- and we apply it two months after the fact. So in the month of August, we are working on an energy surcharge for our 6000 series alloys, our common alloys of $0.048 per pound, and that is a reflection of actual natural gas price, electricity price, and diesel fuel price from the month of June. And every month, we recalculate based on the new prices and change the surcharge either up or down.

Okay.

These are numbers that are compared to the average price of 2007. So it's increases in those prices versus the benchmark of '07 that give rise to the surcharge.

And then to get caught up 100%, are we looking at second quarter?

No, the 70% issue, let me explain how that happens. We're passing through on a cost per pound base numbers that are designed to cover all of our incremental energy costs compared to a 2007 baseline, as Dan said. The reason that we'll only have approximately 70% coverage by the end of the year is that we do have some contracts that, where we're not able to pass through the energy prices.

I see, I see.

So, but as those contracts roll over, over time we will install energy price escalators and other price escalators as part of new contracts.

Okay, so basically by the beginning of the next year with the roll over that should --

No, we have some contracts that run several years. So it will begin to creep up -- it could be -- I've done some rough calculations that it potentially could be in the 80% range next year, but it would take a few years to get beyond 80%.

Okay. Can you give us a year-over-year estimate of aerospace-related products, what the growth was?

You're talking the growth --

Any aerospace related products you had, because aerospace is kind of the strongest market right now for you guys.

Yes.

Well, honestly I think the biggest impact is because of the capacity increase, not necessarily because -- for a plate that we've put in place over the last couple years. And the other parts of our business are essentially the aerospace type of products. We're running relatively close to our capabilities there, but if you're trying to get a sense of demand increase, I think you can pick that off of the information you see from the airline monitor demand drivers that we see. Jack's got the slide in front of him, for the new airline monitor forecast.

Yes.

A good sense of what's going on with the growth in aerospace demand.

We can supply that information. It's public information, I believe the airline monitor forecast. yes, we can tell you what those builds are. We just don't have them at our fingertips.

Okay, and just last question on the dividend. Do you have a target for that going forward in terms of maybe percentage of net income or EBIT?

No, we've not determined it in that fashion. We look at it every year, actually every quarter, but really take a hard look at it every year to determine if the level's appropriate or if it should be changed. As you know we just in June made a decision to bump it 33% and that was after a thorough analysis that we felt that was sustainable for the long-term.

Okay. All right. Thank you.

We'll go next to Dan [Walen], Dahlman Rose.

Hi, everyone.

Hi, Dan.

In the past -- I think in the past quarter, you mentioned that you had new programs offsetting the lower build rates in North American auto. Is it fair to say that you could possibly, from your auto business, stay flat for the year?

Yes, it's actually a combination of two factors, but let me answer the second question first. The -- yes, we believe that the combination of new programs and exports, we have new export opportunities, the combination of the two will offset the decline in the domestic build rate and our total automotive shipments will be equal to or greater than prior year.

Okay, and roughly speaking, that's maybe 5% of your overall revenue?

Automotive is closer to 10%.

10%, okay. And then is there any similar programs that -- on the truck and trailer perspective? How are you tracking relative to the overall truck and trailer industry?

Well, unfortunately, we're tracking right with it, which is in the toilet.

Right.

Yes, I mean truck and trailer have just -- they were hammered already last year and there were a lot of projections they were going to pick up this year and it's just persistently down. It is really -- we've been through a lot of these. I mean it's the nature of that truck and trailer business, but this one is lasting longer than any I remember, maybe just because it's the last one. But this has sure been a long one.

Right. Can we see some stabilization next year?

Well, it's -- fortunately it's stabilized now, but it's stabilized in the gutter. It's really down. I think we're down approximately 50% from the prior rates and we've been there for a couple of years.

Okay. So --

We think we'll start to see some heavy truck builds pick up later -- is it later this year? Later next year when there's a change in the emissions standards, but the latest forecast that we get from the forecasting services that we use really don't project it picking up until second half of next year.

All right. So --

In truck and trailer we're not seeing any real forecast of upticks either, of consequence. There may be a little bit of growth, but nothing significant.

All right. So there's no real downside potential here, but you could --

Well, there's always downside, but, boy, I think this is about as bad as it gets.

Right. In ballpark, in terms of total revenue, what's the exposure there?

A little less than 5%.

So we're talking 15% overall.

Ground trans, yes.

Ground transportation, flattish.

Mid to high teens.

I got you. I got you. And then just in terms of taking a step back in terms of -- if you could give us an update in terms of your spot versus your contractor business, give to give us a sense of how much exposure you really have to the spot business right now.

Well, we have significant exposure to spot business, so we have historically, and we continue to have. I mentioned in my comments that a lot of this year has been spent on qualifications of our heavy gauge plate for aerospace applications, so a lot of that contract volume has not yet kicked in. So we'll see the contract business growing as we go forward, but it always will be a variable depending on -- for our contract customers, many of them are not on a firm volume basis. So it can be variable demand. At a maximum, I think we could get up in the 75% to 80% of contract business if everyone took their full capacity allocations, but that's not happening. So our spot business will be north of that 30% or so as we go forward.

Okay, and that's firm-wide or just the heat treat?

I'm sorry?

That's company-wide or just --

No, no, no, I'm just talking about heat treated plate.

Just wanted to make sure.

Company-wide, it's much -- well, company-wide, you can go back to the numbers that I used on the surcharge, where I said we expect to be 70% by the end of the year. That basically covers our spot business.

Okay.

And then we have short -- we have contracts, for example, some of our automotive customers are one, two or three-year contracts, those kinds of things. So those begin to roll over as we move forward.

Great. Well thank you very much.

We'll go next to Brett Levy, Jefferies & Company.

Most of my questions have been answered. What portion of your business is exposed to housing?

Virtually none.

Got it. As you look at some of the guys that are in these businesses that are exposed to trucking or auto or housing, do you think there's going to be some bankruptcies, and are you guys kind of watching out for what's going on in that space?

Yes, we watch that, but that's -- we really have not seen that as a market that we want to participate in. We prefer the more demanding applications, where it's easier to create a defensible competitive position, whereas most of those markets are pretty pure commodity markets, is our view. So, yes, we watch it, but are they high on our shopping list? The answer to that would be no.

All right. Thanks very much, guys.

That's housing. Were there automotive suppliers that are in demanding applications similar to ours, we certainly would consider those.

Okay. Thanks for the clarification.

We'll go next to Matt Teplitz, Quaker Capital Management.

Hello, gentlemen.

Hi, Matt.

Hi. Few questions for you. You spoke about challenges in terms of qualifying or at least taking longer perhaps than expected. Can you shed a little light there? Is that in terms of new customers or just new parts of your mill having brought on the capacity?

No, it's really a function of our change in capabilities. We historically have supplied light gauge plate and now with the phase II expansion, putting in the stretcher that now gives us the qualification to supply that thick plate to the various aerospace customers, not just Boeing and Airbus, but every aerospace customer has very rigorous qualification procedures required. So it's really a multitude of customers and a multitude of applications within each of those customers where we've had to develop and demonstrate capability to very demanding standards.

And we knew it was going to be difficult, but it's proven to be an even greater hurdle than what we anticipated. That's the bad news. The good news is that we've established tremendous credibility with our customers in terms of how promptly we've been able to deal with these issues and get qualified, and we also have developed capabilities that are beyond what we anticipated, both in the cross sectional area that we can provide for our customers, but also the quality attributes of the plate that we're producing. So our technical people have done just a terrific job at Trentwood with this and it's really enhanced our image in the marketplace and has created capabilities beyond what we thought we would have from the expansion.

And is this a large dollar number at least in terms of what, I guess, taking longer to qualify?

No, it's virtually impossible to quantify it. The real issue is that it's consumed our brain trust for most of this year, and at the same time, we're expanding capacity and we're running at capacity while our brain trust is basically preoccupied with the qualifications. So as issues develop and come up, it was a distraction and more of a nuisance rather than a big dollar item. It's tough to put your arms around it other than it was a distraction for the operation.

And just curious, what would the brain trust have been doing if it hadn't been distracted here, or where would it have --

These are the people that run the processes in the plant. It's all the [metalergists], it's the process engineers, it's the manufacturing people. So they run a plate through and they look and determine did we get the attributes that we expected? And if not, then we go back to the lab and tweak the process and run it right back through the operations. So you've got all of those people -- that's all they are doing, is working on qualifications and meantime, there may be a problem that a manufacturing guy has out somewhere in the plant and his metalergist is preoccupied working on a qualification. It's just the amount of work load applied to the resources that are available. It's a distraction and it's hard to quantify, but it certainly was a factor in the first six months of this year.

Okay, understood. I guess one other thing I was hoping you would clarify, and I think maybe a few people are sort of trying to get at the same thing, when you talk about your capacity and the percent I guess, again, of the heat treat that will be under some form of contract, but obviously not necessarily a mandatory take, there is generally a perception that you're protected by take or pay contracts. And I don't know whether that perception is accurate or not.

That perception would not be accurate. We have some of that, but to characterize our mix as take or pay contracts would be a mischaracterization.

Okay. So I guess trying to get at this again, if you have the 75% to 80% that in theory I guess most would best be characterized as your customers are entitled to, should they so want a plate, how much of that 75% to 80% I guess are they obliged, or are you protected?

I don't have that number, but it's not a significant percentage. Let me just say that. If you talk about the total volume going through the plant. So is that guaranteed? No, but as we said on the slide, I don't know that I had it in my script notes here, but we expect that we're going to operate at a very high capacity utilization. We have a number of dimensions in the marketplace where we are a major supplier, so we believe, as long as total demand holds up that we will have robust capacity utilization in our operations.

Okay. For instance I guess the perception has been -- I'm speaking for myself, but I don't think it's uniquely me, that commitments were made to you by Boeing and Airbus as part of your willingness to invest and expand Trentwood significantly. Were those commitments ultimately more that if there's demand, you're going to get a large part of it, or is it more that you will get some sort of absolute amounts?

There are certain agreements that our firm volumes that would amount to a take or pay. There are certain agreements that are min/max, where the customer has a range within which he can order and we would price a min/max agreement where it's basically an option on capacity differently from how we would price a firm take or pay type agreement.

Okay, and it sounds like the min/max was probably the more prevalent form here, is that --

When you look at that total capacity, there's a blend. There's a large blend of spot business of min/max business and then of firm volume business and the firm volume would be the smallest proportion of the three, I believe. I don't have any numbers in front of me. But we'll see, we'll see swings in our mix and we've tried to communicate this throughout this whole process of the expansion that the pricing that we've seen and the mix that we've seen is subject to changes as we go forward. And we've also indicated that contrary to what some people suggest to us we've been in a sold-out position in the industry for four years and when the entire industry is on allocation for four years, that has a tendance to create high spot prices. And when you negotiate a very long-term agreement with very large customers, it could be at prices that are not as high as what the spot prices have been in a sold-out industry market over the past four years. So we can't say with clarity what the price and mix and the volume looked like over the long-term and that's why we've inserted a chart here that shows a variety of conditions.

We've been operating at capacity for four years and for the past two years at prices similar to the 2007 level, but there will be variability over the long-term in terms of what the price and mix will be and what the capacity utilization will be.

Okay, and as it relates to the spot market for your heat-treated plate, I'm assuming that -- what are the largest end market applications, presumably some is aerospace, some is the defense?

Yes, aerospace and defense is a very large segment of the market. The total global heat treat market. And then for us we have, in contrast to some of the other aerospace suppliers, we historically have been a major supplier of general engineering plate that's used for tooling plate, it's used in the electronics industry, but it's really broadly used for industrial applications in North America. And for us, that's been at least half of our business historically. So it's always been a major portion of our business. We've been the major player in that business in North America and it will continue to be a big segment.

Okay. Could you talk a little bit about the -- what you're seeing in terms of your export opportunity and how large it might become?

Are you speaking specifically to any product, or is that a general question?

I guess it's general just because of comments you made here about how you're getting some upside there relative to weak North American auto and just also hearing a lot of North American manufacturers talk about the opportunity to --

Yes, we've been a global supplier of heat treat sheet and plate products for many, many years, and we expect that profile to increase given the capabilities that we've introduced at Trentwood. And given the exchange rate and the competitive position that we think we'll have in the marketplace from a quality and capabilities standpoint, we think we'll have good opportunities offshore in sheet and plate. We've also had opportunities in our cold finish bar. While it's not a big segment of our business, it still is a segment that has export opportunities, has had historically and we think those will continue to grow. Same thing for our heat-treated drawn tubing. All of these -- the cold finish and the drawn tubing are similar to the sheet and plate in that they are primarily aerospace, high tech, demanding applications.

What's relatively new is the development of opportunities, for example, such as the automotive that we talked about where we have world -- a world class facility in London Ontario that's a premier producer of ABS blocks, antilock brake system blocks, which is a global market. It's relatively low value-added, and while we think we're the lowest cost producer in the world of those products, it hasn't made sense in the past to export those, but the exchange rate has evolved to the point where it's created export opportunities for us that we're beginning to act upon. So, yes, we've had a presence, a relatively small presence other than sheet and plate. It's growing and if the exchange rates stay where they are, we anticipate that it will continue to grow.

Can I ask one other question here as it relates somewhat, it's not so much export, but just again, the currency discrepancies in the world? Not that it's the company strategy, but on a sort of euro or yen basis, any other foreign currency, the company I should think looks quite cheap to a potential foreign buyer. What, I guess, issues would a foreign buyer run into in terms of your end markets served in terms of defense? Would that be a major impediment to someone?

Yes, depending on who it would be, I would think so.

Okay.

We don't spend a lot of time contemplating that, but, yes, in a hypothetical case, defense would be a major consideration.

Okay. And on the cost you cited in Q3 for I guess maintenance, which I guess was as much as, like, is it $6 million relative --

Yes, yes.

Is that primarily just disruptions caused for the significant capital expenditures and upgrades you're making?

Well, yes. It's not really disruptions. Most of it is at Trentwood. Some of it is related to moving an extrusion press from our Richland,Washington plant to Chandler, Arizona. But most of it is upgrading equipment and bringing some more upstream capacity online around the hotline at Trentwood.

Okay, but these are actual costs that will be expensed, right? These are not --

Yes, yes, it's expensed, but we may have a soaking pit furnace that heats metal for the hotline that has to be rebuilt and brought back into service to supply the increased throughput. We have those kinds of projects. We've got other equipment that's been idle in the past that we're not bringing back up to speed to introduce it into the operation. We've got handling equipment that we're moving around, just a variety of operations at Trentwood where we've become bottlenecked now on the hotline. That will be our new bottleneck. So expense-type operations just bringing some capacity into service to fund the heat treat plate flow.

Okay. And last question, the surcharge that you've introduced, does that apply at all to the, I guess, the contract sales under -- for heat treat plate, or is this for the rest of your products?

I won't speak to individual contracts because there are some contracts that we have that enable us to pass through these costs, but most cases it does not. So in most of the heat treat plate contracts, we do not have a specific energy escalation clause. In the future, as we enter into contracts, we intend to have those.

Okay. Well, one last suggestion, but if the stock stays anywhere near these levels, I would strongly encourage you to buy back what you've authorized. Thank you.

No one else has mentioned that to us.

We'll go next to Tim Hayes, Davenport Company.

A follow-up on the contract business that have max/min provisions, just want to get a better sense of what the gap might be between the maximum and the minimum. I know this can be a sensitive issue, but if I were to put an index for maximum at 100%, what would be the minimum generally be around? Would that be 90% of the maximum or like 50% of the maximum?

It could be either. It just depends on the agreement and the customer and the product. It could vary by product, so there are a variety of dimensions to it.

Could there be contracts where it's below 50%?

Yes, there are some that can be below 50%. I'm looking at a resource here. I'm getting hand signals. But, yes, I think -- yes, there are some that could be below 50%, yes.

And -- but then if you could just take an overall average, weighted by volume, can you get a feel for what the overall --

No, no, can't -- I don't have it, but, again, it gets back to -- it's a very diverse mix of spot business, of contract business that's not take or pay and of contract business that is take or pay.

Very good. Thank you.

(OPERATOR INSTRUCTIONS) We'll go back to Tony Rizzuto, Dahlman Rose.

-- what percent of your shipments and revenues overall today are defense-related?

We have that number, but I don't have it at my fingertips. It's -- I would guess it's in the teens. That's just a guess.

All right. So maybe 10%, 15% type of thing?

Yes.

Okay.

Yes. It may be a little higher than that even. Let's give it a broader band, maybe 10% to 20%.

Okay.

And don't hold me to that, but in terms of -- directionally, I think that's in the ballpark.

All right. My next question is, we've had discussions in the past about Airbus and the importance of the A380. Jack, where would you characterize the level of demand from the A380 program is today, compared to a more steady state or as it will ramp up to what the four per month over the next couple years?

Well, in reality, and this is going to contradict my answer to your prior question about inventories, but the one place where there was inventory I think was bringing in plate for the A380 where Airbus had anticipated build rates that they weren't able to meet. So I think the actual demand for the A380 was really fulfilled. We haven't seen very much of that, and as they begin to work off inventories, we'll start to see that demand ramp up. But right now in 2008, I think there's been very little mill demand supporting A380.

Well, that's what I mean. I'm just trying to get a better handle about where they are and chewing through some of that. Obviously they are doing better and they seem like they have come through those issues that plague the program.

I think we're going to start to see that ramping up. They have got to be getting fairly close to work that off. I don't know specifically, but we continue to believe that we're going to see very strong and growing demand from aerospace in total here.

And just correct me if I'm wrong, but it's been that demand particularly for the A380 with the very thick gauge plate, which really plays into your sweet spot, does it not?

Well, yes, the -- but again, we just -- from our standpoint, what's important is what's the size of the total market.

Got you.

Not necessarily which programs, but the A380 is a plate hog. It uses a lot of plates. So whether we supply plate or someone else supplies plate is less important to us than the fact that it's just the total demand for our products in the marketplace.

Okay. And the final point observation, whatever you want to call it, I like to look at how stock prices perform over a conference call and your stock as you began the call was down about 2.5%, roughly speaking. It's now down about 9.5%, was down more than 10% just a few moments ago. And the question, I think also related to a previous question, you guys have $1 billion of NOLs that's got some considerable value. You're in a weak commodity-based currency, or certainly a weak currency country. You've got enviable positions with certainly leading aircraft manufacturers and from a defense standpoint, I mean are you, are you feeling vulnerable here? Does it make sense to maybe leverage up the balance sheet, forget about other opportunities for growth, but maybe to take on some debt here and just buying your stock. What other use of capital could be a better return than buying your stock at these levels?

Well, let me -- I understand your point clearly, Tony. Let me just say, and we've stated this many times, that we really look at a hierarchy of three levels. One is good organic growth investments and acquisition investments, so good investments that grow the business. Our second hierarchy is share repurchases and the third is to get dividends to our shareholders. And we monitor those continuously. So -- and we review those continuously with our board as well. So, yes, we evaluate those and if something like that were to develop as a better use of our capital, than investments, then we certainly would consider that.

Okay, thank you very much.

That concludes the question and answer session today. At this time, Ms. Ellsworth, I would like to turn the conference back to you for any additional or closing remarks.

Thank you. Thank you, everyone, for joining us today. A replay of this conference call will be made available on our website on the Investor Relations page later today. Thank you, and have a good afternoon.

That does conclude today's conference. Thank you for your participation. You may disconnect at this time.