Kaiser Aluminum Corp (KALU) 2009 Q2 法說會逐字稿

Good day, everyone. Welcome to the Kaiser Aluminum second quarter 2009 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, ma'am.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's second quarter 2009 earnings conference call. If you have not seen a copy of our earnings release, please visit the Investor Relations page on our website at kaiseraluminum.com. We have also posted a PDF version of the slide presentation for this call. Joining me today are President, CEO and Chairman, Jack Hockema, Senior Vice President and Chief Financial Officer, Dan Rinkenberger, and Chief Accounting Officer, Neal West. Jack and Dan will review the results and at the conclusion of our presentation, we will open the call for questions.

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 companies anticipated financial and operating performance, relate 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 second quarter of 2009 and reports filed with the Securities and Exchange Commission, including the Company's Form 10-K for the full year-ended December 31, 2008.

All information in this presentation is as of the date of the presentation. The Company undertakes no duty to update any forward-looking statement to conform the statements to actual results or changes in the companies expectations. Non run 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 if the same level of underlying performance were to occur.

These are certainly part of our business and operating environment, but are worthy of being highlighted for the benefit of the users of our financial statements. Management's intent is to significantly neutralize the fabricated product segment from fluctuations in underlying metal prices. We characterize metal profits and LIFO charges as non run rate items that eventually offset to a great extent over the course of a full year.

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

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

Thanks, Melinda, and good afternoon, everyone. As Melinda mentioned, you may follow our discussion by viewing the slide presentation on our website at kaiseraluminum.com. I'll begin with a high level review of the quarter and then turn the call over to Dan who will review some of the financial details and then I'll share some of our thoughts on the outlook before opening the call for questions.

My comments on Slide 5 focus on the sequential change in the second quarter from the first quarter. Underlying operating income of $20 million for fabricated products was down from the first quarter as a result of weaker business conditions, generally consistent with the outlook discussed during our first quarter earnings call. Shipments were the lowest since 2003, despite a modest improvement in shipments for general engineering applications. However aerospace and high strength shipments were off from the record first quarter as a consequence of heavy destocking throughout the aerospace supply chain. The impact from weaker aerospace market conditions was cushioned by our contracts for aerospace plate and by lower energy costs and improving manufacturing efficiency.

Despite the challenging market conditions, our net cash position has improved by $51 million since the end of 2008 while we have continued to pay quarterly dividends and make major investments in strategic projects. Our investment in the new world class extrusion plant in Kalamazoo remains on schedule to commence operations in early 2010. The updated forecast for the project anticipates capital investment of approximately $25 million higher than the original project plan for building modifications and auxiliary equipment.

That said, we're pleased to report that our vision for Kalamazoo has expanded from the original concept. While the primary focus of the facility continues to be extruded products for the distribution market, we also plan to utilize available capacity to facilitate sales growth in aluminum extrusions for automotive applications, thereby increasing the upside opportunity for this investment. The Kalamazoo facility continues to be a sound strategic investment that will enable more profitable sales growth and position us as a low cost producer of extrusions for general engineering and automotive applications. I'll now turn the call over to Dan who will go into more detail regarding the second quarter results and then I'll discuss industry trends and their implications for Kaiser.

Thanks, Jack. Our consolidated financial highlights are shown on Slide 7. Given the dramatic change in economic and market conditions relative to the prior year period, our financial comments will be focused on the sequential quarterly results which more appropriately compare performance trends for the second quarter.

Underlying operating income performance in the second quarter reflected continued weak end-user demand and challenging economic conditions. Excluding non run rate items which I'll discuss on the next slide, consolidated operating income was $13 million for the second quarter as compared to $28 million in the first quarter of 2009, as lower energy and currency costs, as well as improved manufacturing efficiencies partially offset the decline in shipments.

As we've mentioned in previous earnings calls, we anticipate that Anglesey will fully curtail its smelting operations when its power contract expires on September 30th. Since we do not expect to realize our share of Anglesey earnings through dividend payments, we fully impaired our share of Anglesey second quarter reported income. Operating income for the primary aluminum segment before non run rate items of approximately $3 million is related to earnings outside of the Anglesey partnership.

Reported net income was approximately $20 million or $0.97 per diluted share compared to net income of $4 million or $0.19 per diluted share for the first quarter. Adjusting for non run rate items, second quarter net income would have been approximately $7 million or $0.32 per diluted share. The effective tax rate for the second quarter was approximately 44%. As we indicated during our first quarter earnings call, we anticipate the effective income tax rate in 2009 will be approximately 40%. However, we expect some variation to that rate quarter by quarter. The cash income tax rate is expected to remain in the mid single digits, as we applied net operating loss carryforwards and other tax attributes against pre-tax US income.

On Slide 8, we review the non run rate items. While important to mention, these non run rate items are predominantly non-cash and we believe they don't reflect the true underlying performance of the Company. Therefore, as we continue our discussion in later slides, the presentation will focus on operating performance excluding these non run rate items. On a consolidated basis, non run rate items for the second quarter of 2009 totaled approximately $22 million, comprised primarily of $27 million of non-cash mark-to-market gains on a derivative positions, partially offset by $5 million of restructuring charges as announced in our May 2009 news release.

As a reminder, we manage our fabricated products business to be neutral to fluctuations in metal prices, passing along metal costs to customers through various pricing mechanisms. However during the term of derivative contracts, we record the variation in metal prices as non-cash income or expense until the underlying sales contract is fulfilled. The detail of non run rate items is presented on Slide 24 and in our Form 10-Q for the quarter ended June 30, 2009.

Slide 9 focuses on fabricated products results excluding non run rate items. As we indicated in our outlook for the second quarter 2009, shipments for aerospace and high strength applications trended downward from the first quarter as aggressive service center destocking of higher value added sheet, gold finished rod and bar, drawn tube, and plate sold to service centers took place as expected. Shipments of aerospace plate under OEM contracts were also lower in the first quarter, but higher than the prior year quarter reflecting creased production as a result of the Trentwood expansion. Shipments to general engineering, automotive and industrial markets reflected a modest increase in the second quarter compared to the first quarter 2009, due to deliveries under contracts for armor plate products. Although service center inventories of general engineering products are at the lowest levels in recent history and destocking trends appear to be moderating, we have not yet seen a clear indication of improvement in the underlying demand for these applications.

As we previously discussed in our first quarter earnings call, value added pricing declined on a sequential quarter bases as the second quarter product mix shifted away from the higher value added aerospace and high strength products and we experienced pricing pressure on our general engineering plate products. Overall, operating income for fabricated products was favorably impacted in the second quarter by lower energy and currency costs as well as continued improvement in manufacturing efficiencies, which served to partially mitigate the impact of lower shipments and a leaner mix.

Slide 10 shows the sales analysis by end market application, providing additional detail on fabricated product shipments and value-added pricing. Contractual aerospace plate shipments continued at a level higher than mid 2008, providing a base load of business which is a clear strength for us in this recessionary period. However, significant service center destocking of aerospace sheet, cold finish rod and bar and drawn tube began in the second quarter of 2009 with a corresponding effect on our shipments and value-added pricing.

We anticipate that this trend will continue in the third quarter. As a reminder, value-added revenue represents revenue less the hedged cost of alloy metal and we believe this measurement is helpful to understand the underlying financial performance of our business. Quarterly and annual volumes and value-added revenue by end use category for the periods 2007 through year-to-date 2009 are shown on Slides 26 and 27 in the appendix.

And turning to Slide 11. We continued to enhance our financial strength and flexibility which not only helps us navigate the current market conditions, but also puts us in a better position to capitalize on the eventual economic rebound. Year-to-date cash flow generated from EBITDA and working capital improvements, funded capital investments, quarterly dividends, our contingent VEBA obligation and the repayment of $36 million of revolver borrowings that were outstanding at December 2008. We anticipate cash flow on borrowing availability on our revolver will continue to provide sufficient liquidity to fund operating needs, capital investment requirements and other strategic initiatives.

Also, we continue to maintain our quarterly dividend and returned $10 million in cash to our shareholders year-to-date. And two weeks ago, we announced that our Board declared the next quarterly dividend or $0.24 per share which will be paid on August 17 to holders of record on July 27th. Overall, we think it's notable that in the first half of 2009 during the worst recession in recent history, Kaiser improved its cash position by $51 million while funding a major capital investment and continuing to pay dividends. And now, I'll turn the call back to Jack to provide some additional comments.

Thanks, Dan. Slide 13 provides context for a discussion of our outlook for aerospace and high strength applications. Consistent with our previous outlook, the long-term fundamentals for aerospace and high strength are good. However in the short-term, we're experiencing weakened demand exacerbated by destocking throughout the supply chain, particularly for high value-added products. We expect this trend to continue in the third quarter with shipments similar to the second quarter. Sales contract provisions related to the Trentwood heat treat plate expansion will continue to soften the impact from the cyclical downturn.

Slide 14 addresses the outlook for general engineering, automotive, and industrial applications. While visibility is limited, third quarter shipments for these applications are currently trending on a pace similar to the second quarter. As illustrated on Slide 28 in the appendix, destocking continued in the second quarter, but the pace of destocking was reduced compared to the prior six months.

Service center inventories are at historic lows and we are cautiously optimistic that we've reached the bottom of this destocking cycle for general engineering applications. While 2009 armored demand is not quite as strong as the 2007-2008 peak demand, we expect that our second half armor plate shipments will continue at a strong pace similar to what we experienced during the first half of this year. Industry forecasts for automotive builds in the second half suggest a 50% increase from the anemic first half pace, but builds will be substantially below historic rates. New cafe regulations are stimulating increased interest in aluminum extrusions for lightweighting to improve fuel efficiency and we expect that future growth trends will exceed the historic 5% compound annual growth rate for aluminum extrusion content in vehicles. Pricing is relatively stable for this group of applications except for the continuing downward pressure on general engineering plate.

Slide 15 summarizes today's prepared remarks. The second quarter market environment was challenging, but lower energy costs and improving manufacturing efficiency cushioned the impact from weak market conditions. We continued to strengthen the balance sheet through strong ongoing cash flow generation that we expect to continue for the foreseeable future.

The third quarter market outlook is similar to the second quarter. Destocking is moderating for general engineering applications, and the impact from destocking and products for aerospace applications is cushioned by provisions in our sales contracts for aerospace plate. Our capital investment strategy remains focused on opportunities that enable long-term growth in shareholder value.

The Kalamazoo project is the next significant step in our strategy to be a low cost producer as we strengthen the value stream for rod and bar products and it will provide additional capacity to facilitate profitable sales growth, driven by increasing demand for aluminum extrusions for automotive applications. Despite the higher cost necessary to complete Kalamazoo, we believe that the investment will pay significant long-term dividends to our shareholders due to the sales growth and profit opportunity that it creates. We will now open the call for questions.

Thank you. (Operator Instructions). We'll go first to Tony Rizzuto with Dahlman Rose.

Hi, everybody. Can you hear me all right?

Yes, we can, Tony.

Hi, Tony.

Hi, everyone. I've got a couple questions here. First of all just on the aero and high strength and by the way, the slide presentation was posted after the call began. I'm sure maybe some other people didn't have copies of it in front of them. Just a heads up here. The aero -- the high strength shipments were down more significantly than we expected in the quarter. What is the current status as you guys see it with regard to inventory in the pipeline?

There are two aspects of that. One is the service centers which is the predominant destocking that we saw in the second quarter. We see that situation continuing here in the third quarter and like any destocking situation, is difficult to predict how long it will last. But we predict it's going to last for awhile.

The other aspect is the inventory at the OEMs and that inventory has been building for quite some time. We expect that's going to have some impact. But at this point, our visibility is that the second quarter is pretty much what we expect in the third quarter. It's difficult to look beyond that, but we don't see any real degradation in the fourth quarter at this point from where we were in the second and then what we see for the third quarter.

Jack, do you think the contracts with Boeing -- and in a good market, obviously in a stable market, there's obviously a lot of positives for those. But I'm wondering are these contracts the minimum take or pay volumes, are they contributing do you think to the inventory dislocation in the system?

I do not. I think that the issue that we saw in the second quarter is virtually 100% related to service centers and the typical boom/bust cycle. They build way too much inventory during a boom cycle and then immediately let the air out as soon as things start to turn south. Everything we saw in the second quarter was essentially related to service center management of their inventories.

But your comment about the OEMs though, they've been building for some time. Am I to read from that that they're clearly destocking now and we've not seen any further build there?

I don't know what they've done in terms of builds. On Boeing's call, they talked about the billions of dollars they have in inventory, not just related to aluminum. My view of the issue for the big two, it's really a function of them needing less of all materials and products that they use because of the continuing delays on the A380 and the continuing delays on the 787. Those have been, we're going to deliver tomorrow and tomorrow hasn't come for several years here. They have too much in the pipeline .

Similarly, then from the Boeing standpoint, it was exacerbated last fall when they had the strike that lasted for several weeks. In many cases, they continued to bring in materials because they want to keep their suppliers strong and in position to respond as they begin building planes again after they started up from the strike. Our view is nothing has really changed substantially over the past few months from the Airbus and Boeing standpoint. They've had quite a bit of inventory in their system for quite some time, given the delays that they've had in their programs and have been looking at what they do about those inventories over the longer

It's interesting though when I look at the engine manufacturers who would almost appear to me to be in a little bit of disbelief when they look at the aircraft manufacturers because the engine builders are seeming to cut back further but not yet as much as much as -- it seems like the aircraft manufacturers are not cutting back as much. It almost seems like somebody doesn't -- some of those guys don't believe the Boeings and Airbuses of the world. How do you come out on that?

I don't know what you mean by believing the Boeings and the Airbuses of the world, but neither Boeing nor Airbus is forecasting a major reduction in builds. The third party that we rely on that's completely unbiased is Airline Monitor. They just issued their latest forecast and they are showing builds up in 2010 compared to 2009, and up again in 2011. For Boeing and Airbus, they don't show a decline in builds until 2013 and 2013 is substantially higher than the 2008 level. In terms of builds, we're still seeing on a situation where there's a huge backlog for both Boeing and Airbus.

There's a lot of noise out there about order rates that were essentially net orders are zero or slightly positive this year. But if you look at the huge backlog of orders that were built over the last four or five years, that's really a non-event. And Boeing and Airbus in our view have both been much more disciplined in this cycle in not responding to that huge order rate over the past five years and running their production up to excessive levels that's gotten them in trouble in the past. My view is this cycle by the OEMs has been much more disciplined than any previous cycle where we're seeing normal behaviors in the service center where they grossly overstocked and now we're seeing destocking.

Just one final question before I let somebody else. How important is the Boeing 737 to your overall heat treat business? Could you put that into proper perspective for me?

It's very important. All of the news is what's going on with the 787 and the A380. But the single -- the A320 and the 737 are the backbone of both of those big manufacturers and represent the predominant portion of demand. It's extremely important for us and for all of the suppliers of aluminum products.

Thanks, Jack. I appreciate your insights.

Sure, Tony.

(Operator Instructions). We'll go next to Mark Parr with Keybanc Capital Markets.

Hi, Jack.

Hi, Mark.

How are you guys doing?

Hi, Mark.

Good.

I was wondering if you could make some comments about metal spreads. They had been under some pressure. Just wonder if that's abating or if you could comment -- give some color on where you see metal spreads moving in the second half of the year?

Our spreads are our value-added revenue which you can see from the charts and the data that we've put out here -- have really been pretty steady other than mix changes. The only place where we've seen much degradation in terms of the value-added over metal is in the general engineering plate, the 6061 plate. That continued in the second quarter and we expect we're going to see that continue to some extent in the third quarter, but other than those products our pricing has been relatively consistent.

Okay. I know the Kalamazoo facility appears to be on track. Are there any -- do you still think that's going to be coming in with the budgetary levels that you originally anticipated? Or how is the cost of that coming in relative to plan?

I actually made comments in my opening remarks here, Mark that --

I apologize.

Yes. That's fine. We're running roughly $25 million over the original forecast. That's a combination of two items, the building modifications for the building that we selected is roughly half of the overrun and the rest of it is just the project engineers on the front end underestimated some of the auxiliary equipment.

However, there's a silver lining. As we evaluated manufacturing strategies over the past couple of years since we launched that project, we've expanded our scope of what we intend to do with that facility. We're going to use the excess capacity that was already built in from that operation to fund the significant growth that we expect to see in automotive extrusions. While the investment is higher, we expect the long-term returns that we'll get from that facility will be higher than what we anticipated when we launched the project.

Okay. Terrific. Thanks for that and good luck in the second half.

Okay. Thanks.

With no further questions in the queue, I'd like to turn the conference back over to Mr. Jack Hockema for any closing additional remarks.

Okay. Thank you. Despite ongoing challenges presented by the weak global economy, our long-term business fundamentals remain positive and strong cash flow generation is expected to continue. We continue to invest in strategic projects, such as the world class extrusion plant in Kalamazoo, to improve our long-term growth and profitability. Our experience over the past nine months reinforces our confidence that Kaiser is well-positioned to manage through these challenging market cycles and that we have the financial and competitive strength to capitalize on new opportunities as the market recovers. Thanks for joining us on the call today and we look forward to updating you again on our third quarter call.

That does conclude today's presentation. A replay will be available on the KaiserAluminum.com website. We thank you for your participation.