Kaiser Aluminum Corp (KALU) 2009 Q3 法說會逐字稿

Good day and welcome everyone to the Kaiser Aluminum conference call. At this time for opening remarks and introductions I would like to turn the call over to Melinda Ellsworth.

Good afternoon welcome to Kaiser Aluminum third quarter 2009 earnings conference call. If you have not seen a copy of our earnings release, please visit our Investor Relations section 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 Rickenberger and Vice President and Chief Accounting Officer, Neil 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'd like to remind the audience that the information contained in this presentation includes statements based on management's current expectations. Estimates and projections that constitute forward looking statements within the meaning of the Private Litigation Reform Act of 1995. Such statements include statements regarding the Company's 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 third quarter of 2009 and reports filed with the Securities and Exchange Commission, including the Company's form10-k for the full year ending December 31, 2008. All information in this presentation is as of the date of the presentation and the Company undertakes no duty to up date 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 occur from period to period are particularly material to results, impact costs as a result of external market factors and may not recur in future periods if the same level of underlying performance were to occur. These are certainly part of our business and operating environment, but are worthy of being highlighted for the benefit of the users of our financial statements. Management's intent is to significantly neutralize the fabricated products segment from fluctuations and 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 or after adjustments are not intended to be and should not be relied on in lieu of the comparable caption under generally accepted accounting principals to which its reconciled. Such presentations are solely intended to provide greater clarity of the impact of certain material items on the GAAP measure and are not intended to imply such items should be excluded.

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

Thanks and good afternoon everyone. As Melinda mentioned you may follow our discussion by viewing the slide presentation on our website at Kaiseraluminum.com. I will begin with a high level review of the third quarter, turn the call over to Daniel Rinkenberger to review some of the financial details and then I'll share some thoughts on the outlook before we open the call for questions. My comments begin on slide five. In a market environment that continues to be challenging, operating income in the third quarter was consistent with the business outlook that we shared with you during our second quarter earnings call. We had a modest increase in shipments compared to the prior quarter reflecting an increase in the automotive build rates and reduced the destocking by service centers. Our primary emphasis in 2009 has been to improve underlying cost performance to achieve results during the second half of the year, equivalent to our record 2007 baseline, we've made significant progress to date realizing steady improvement each quarter and are on track to achieve our manufacturing cost improve target.

We are continuing to position the Company for improve long-term profitability. The Kalamazoo project is proceeding on schedule, equipment is being installed and tested and hiring and training have begun. We anticipate that billet casting and both extrusion presses will commence production during the first half of 2010. Kalamazoo will be a world class facility and will represent a step change in our cost structure as it becomes fully operational late next year. Despite the challenging market environment, Kaiser Aluminum is well positioned financially and has continued to generate strong cash flow from operations and working capital. We're confident that the investments that we've made in our strategic growth initiatives combined with improved cost performance, strong cash flow, and a solid balance sheet will continue to enhance our competitive and financial position as the market recovers.

I'll now turn the call over to Dan who will go into more detail regarding the third quarter results.

Thanks Jack, the consolidated financial highlights are shown on slide seven. Underlying operating income performance in the third quarter reflected continued weak end user demand and economic conditions consistent with the second quarter. Consolidated operating income excluding nonrun rate items was $13 million for the third quarter, comparable to the second quarter of this year. Nonrun rate items were a positive $30 million in the third quarter, reflecting unrealized mark to market gains on metal derivative positions due to underlying metal prices that increased during the quarter. As we previously discussed, Angelsey fully curtailed its smelting operations on September 30 and it now operates as a remelt and casting facility. We do not anticipate that we will realize our share of Angelsey's earnings through the receipt of dividend payments in the foreseeable future however. As a result, we discontinued equity accounting for Angelsey as of the third quarter. Third quarter operating income before nonrun rate items of approximately $3 million for the primary aluminum segment was related to activities outside of Angelsey including our hedging activities. We expect the primary aluminum segment results in the fourth quarter will reflect a net realized loss of approximately $5 million related to external metal hedge contracts. These hedge contracts were put in place at the time that we determined Angelsey production would no longer provide a natural hedge for the fabricated products firm price customer commitments.

Corporate operating expenses show a significant improvement this year. In addition to lower incentive compensation expense, our underlying cost performance compared to 2008 has improved at a run rate of approximately $4 million annually. And we continue to look for ways to lower our corporate operating expenses. Reported net income was approximately $23 million or $1.14 per diluted share, up slightly from $20 million or $0.97 per diluted share in the second quarter. Adjusting for nonrun rate items, third quarter net income would have been approximately $5.5 million or $0.27 per diluted share. The effective tax rate for the third quarter was approximately 45%. However, the cash income tax rate is expected to remain in the mid-single digits as we apply our significant net operating loss carry forwards and other tax attributes against pretax US income.

Slide eight focuses on the fabricated product results excluding nonrun rate items. As Jack previously mentioned, our third quarter operating income excluding nonrun rate items was consistent with the business outlook we shared in our second quarter earnings call. On a sequential basis, fabricated products operating income of $20 million, before nonrun rate items was essentially flat with the prior quarter, reflecting improved manufacturing efficiencies and underlying cost performance offset by a lower margin product mix and continued pricing pressure especially on general engineering plate products. Year-over-year the decline in third quarter operating income, excluding nonrun rate items, reflects the recessionary impact on shipments and value added pricing. However, this was mitigated in part by significant improvements in manufacturing efficiencies as well as lower energy costs.

Slide nine shows the sales analysis for fabricated product shipments and value added pricing by end use application. We believe this information is helpful to understand the underlying financial performance of our business. Although third quarter shipments for aero space, sheet, coal finish rod and bar and drawn two were comparable to the second quarter, total aero space and the high strength shipments declined sequentially. This overall decline reflected lower third quarter aero space plate shipments as timing of plate orders shifted into the fourth quarter. As such, we expect that higher fourth quarter plate shipments will result in total shipments of aerospace in high strength applications in the last six months of the year to be at a rate similar to the second quarter. Of note, aerospace plate shipments continue at a pace higher than mid-2008, reflecting a base load of contract business made possible by the Trentwood expansion.

Automotive shipments increased sequentially as build rates improved from the very depressed levels of the first half of the year. Shipments of general engineering products also improved as destocking moderated in the third quarter. As a reminder, value-added revenue represents revenue less the hedged cost of aloid metal. Quarterly and annual shipment volumes and value added revenue by end use application for the periods 2007 through year to date 2009 are shown on slide 25 and 26 in the Appendix.

And turning to slide 10, as we have previously discussed, our focus in 2009 has been on working capital improvements and prudent liquidity management to maintain and strengthen our financial position. Year to date, we have generated over $130 million of cash flow from EBITDA and working capital reductions, which have funded major capital investments, quarterly dividends and other obligations, all while improving our overall net cash position by $71 million. We have virtually no debt and fully anticipate cash flow and borrowing availability on our revolver will continue to provide sufficient liquidity for the Company. As we go forward, our priorities for cash remain first, sustaining levels of capital spending, second, strategic growth initiatives including both internal investments and acquisitions, and finally, returning cash to shareholders. Year to date we have returned $15 million in cash to our shareholders through quarterly dividends. We recently announced that our Board declared the next quarterly dividend of $0.24 per share, which will be paid on November 13th to holders of record on October 23rd. Our ongoing financial performance reflects our ability to manage for and through this recessionary environment and we are well positioned financially to capitalize on both growth opportunities as the economy recovers.

And now I'll turn the call back to Jack to provide some additional comments.

Thanks Dan. Turning to slide 12 provides a context for discussion of our outlook for aerospace and high strength applications. We remain bullish on the long term fundamentals for commercial and defense aerospace applications. The order back log for commercial aircraft is robust despite cancellations of orders by airlines and we expect strong build rates to continue. While air frame build rates are strong, we have experienced lower demand for our products this year as a consequence of destocking in the aerospace supply chain, a trend that we expect to continue well into next year. As Dan commented, our fourth quarter aerospace plate shipments will benefit from a shift in orders from the third quarter. We expect that the higher fourth quarter shipments will bring our total shipments for aerospace and high strength applications over the last six months of this year to a rate similar to the second quarter of the year. While destocking has affected our shipments for aerospace applications this year, it is noteworthy that our aerospace plate shipments each quarter has exceeded the mid 2008 pace. Our sales contract provisions have provided a safety net and as market conditions improve we will be in a position to capitalize on the significant upside opportunity provided by the Trentwood expansion.

Slide 13 addresses our outlook for general engineering automotive and industrial applications. Visibility remains limited although we anticipate normal seasonal weakness in the fourth quarter as customers adjust for work schedules that typically reflect holiday shutdowns. As illustrated on slide 27 in the Appendix, while service center destocking continued in the third quarter, the pace of destocking has moderated. Service center inventories are substantially below levels experienced in the 2001 through 2003 recession and we're cautiously optimistic that this destocking cycle for general engineering products is ending. Industry forecasts for automotive builds in the second half suggest a 40% increase from the first half pace but the expected build rate is still substantially below historic rates. New cafe regulations are stimulating increased interest in aluminum extrusions for light weighting 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. Other than continuing downward pressure on general engineering plate, pricing for other products is relatively stable.

Slide 14 summarizes today's prepared remarks. While the third quarter market environment was challenging, the improvements that we have made in our manufacturing efficiency have cushioned the impact of weak market conditions. It is also encouraging that our shipments have stabilized over the past six months. The fourth quarter market outlook is similar to the prior six months. We anticipate that the impact from normal seasonal weakness will be offset by aerospace plate shipments that have shifted from the third quarter to the fourth quarter and we expect that fourth quarter fabricated product shipments at a pace similar to the prior six months. We're encouraged that our shipments level has stabilized over the past several months and we are very optimistic regarding our long-term prospects. The fundamentals for commercial and defense aerospace applications are excellent. Our capital investment strategy remains focused on opportunities that enable long-term growth and shareholder value. The full benefit of our Trentwood expansion has yet to be realized due to soft market conditions, and Kalamazoo, once completed next year, is the next step in our strategy to enhance the position as the low cost producer. In addition Kalamazoo will provide capacity to facilitate profitable automotive sales growth driven by increasing demand for aluminum extrusion to achieve more fuel efficient vehicles.

The past 12 months have reinforced our confidence that our business model has positioned us well to navigate market cycles and provides the financial strength to capitalize on new opportunities as the market recovers. We will now open the call for questions.

(Operator Instructions). And we'll take our first question from Tony Rizzuto with Dahlman Rose.

Hi folks are you?

Good Tony.

I have got a couple of questions here and I was wondering if you could give us a sense of the inventory levels, not at the service centers, but at the customers on the aero side, number one and I have got a couple of other questions too.

Well really the situation in aero is pretty much unchanged from what we have been discussing in the last six months or so. The big frame air manufacturers are sitting on substantial inventories that were built in anticipation of A380 and Boeing 787 builds. And in my remarks I said we see this destocking trend and it relates specifically to plates continuing well into next year. In our other aerospace and high strength applications, a lot of that goes through service centers and we have a lot less visibility. We're continuing to see destocking there but we don't have a good sense of how much longer that will continue.

Jack, was the timing of the orders that have been shifted in the fourth quarter was that mainly because of Boeing and Air Bus taking the minimums on their contracts and maybe wanting a little bit more of tonnage in 4Q?.

Not really, its spread across a number of customers larger airframe manufacturers, but a lot of other people that use plate -- and it really is just a function of quarter to quarter timing. When we look at the last nine months of the year and put that altogether we expect shipments are pretty much going to be at that $33 million per quarter pace plus or minus. It is just timing of shipments and that occasionally happens.

Okay and I was wondering if you could maybe give us an idea of where Trentwood is operating today. More and more of the companies seem to be talking about operating rates. I was wondering if you could share that with us, maybe a little bit more of granularity about the operating rate at Trentwood?

Well, I don't specifically know how to characterize that. But we're certainly not at capacity. Because we have added capacity. But in my remarks I commented that if you look at each quarter this year for aerospace plate which is the big factor that I think you're referring to, our aerospace plate shipments actually exceeded the rate that we had in the middle of last year. And you will recall middle of last year we were running at red line capacity for heat treat plate. So the current levels of aerospace plate production are essentially at the same level as what our capacity was before the phase three capacity came on in the fourth quarter, if all that made sense.

I'm going to have to look back and kind of -- and configure that. But it is helpful, I appreciate that. And the final question I have right now is obviously your financial condition is in great shape. You have done a good job in managing a very challenging cycle. Your thoughts on M&A here, has the cycle progressed enough to maybe where you're feeling more comfortable perhaps to maybe take a look -- a harder look at maybe some opportunities that might be out there?

I would agree with the characterization as more comfortable, but I wouldn't characterize that as we got anything really hot that we're working on right now. My biggest concern regarding M&A is getting to the point that sellers as well as us as an acquirer have a consistent view long-term. And I'm not confident at this term that sellers have adjusted to the new paradigm, here.

I see they still feel their assets are too much for you for your liking?

I feel that we're converging, but I don't see that we're there yet.

Seems like you have the ability to wait it out, so to speak?

Yes, we do have the ability to wait it out. As you know we're never going to do a knee jerk reaction, we're going to be very prudent in making investments. But we still think we're a good acquirer and we think there are going to be making opportunities. At some point we're going to get to where we have a common view of value.

Now going through this down turn, this economic challenge, have you changed your thought process on where that M&A is likely to be? Are you still thinking that there are opportunities to add more heat treat capacity in the plate side or are you seeing other opportunities perhaps that may be taking greater .

I'm not sure what your reference is to heat treat plate capacity, but let me just speak a minute to the heat treat plate capacity. You may recall a couple of years ago when we announced phase three, we took a long time looking at the market before we made that move to validate for ourselves that there really was demand in the marketplace to justify that expansion. We still believe that we'll use that expansion but we certainly don't believe that additional capacity at least in the next few years is required beyond the industry capacity that exists today. In terms of our priorities as a Company, as you know we're very focused on what we characterize as demanding applications. And the most demanding applications are those high-strength aerospace and high-strength type applications. So that is where we would look for first is for bolt ons and other opportunities in that particular area. That doesn't preclude making moves in the industrial and general engineering sector where again we see opportunities in automotive for example or in the general engineering type products. Where again it is a demanding application where we can establish a sustainable defensible competitive position. So it is really similar to the business that we're in. Those kinds of products and applications and there are bolt-ons out there and other companies that we eventually think will be a good fit.

Thanks Jack, I appreciate all of your in sights.

Thanks Tony.

Thank you and we'll take our next question from with Lloyd O'Carroll from Davenport & Company.

On the Kalamazoo -- well what is the date that you expect the shipping on a commercial basis -- the -- rod and bar to service centers?

I think we'll probably start to see some production out of there during the second quarter. But in terms of a meaningful impact that investors would see in the numbers we think it is going to be late next year before that kind of impact is involved. We're going to be bringing up a lot of new equipment, new employees and shaking things out. So before we see the big step change in terms of performance we're looking at late next year.

Okay. And when would you be ready to off-load any volume out of London into that plant, presumably after you get the service center markets taken care of.

That's exactly right, Lloyd. We'll really move product from London into Kalamazoo as is dictated by the need to free up capacity at London. And then the second aspect we'll be looking at obviously is when Kalamazoo is ready to digest some of that automotive business once they're up and stabilized on the service center business.

Okay, you told us last time about the 25 million over-run. Is there an opportunity to do better than that?

We've made no change in our outlook there. It is pretty much stable from what we discussed three months ago.

Okay, thank you.

Okay thanks Lloyd.

Thank you. We'll take our next question from Mark Parr with KeyBanc Capital Markets.

Good afternoon, I guess it is still morning where you guys are.

Yes, it is, but we prevent we're back east except for the weather.

Well you know you wouldn't mind it too bad here in Cleveland today. It is actually pretty nice for a change. But first of all I really think you shouldn't let Tony ask all the good questions.

He was quick on the trigger today.

He definitely was. I'm curious, there is two things that really kind of intrigue me. This aerospace as it sorts itself out, you guys are definitely in a good position. And I think that will certainly accrue to your and the shareholders business. But I just wonder on the Kalamazoo project and the Trentwood project, what do you think is the potential for growth and value-add revenue per pound over the next several years? And I'm talking about basically pricing or enhancing value overall, which would give you a larger value-add per pound.

Well the -- let me speak to Kalamazoo first of all. The kind of products that -- will go with the market in rod and bar. As we said when we announced Kalamazoo it was not a market share project it was a cost reduction project. And we continue to view it that way. But the incremental growth from a Kalamazoo standpoint is the capacity that it provides for automotive products. And those products typically are more demanding products, meaning higher value added products than our standard rod and bar products. So some of the market growth that we see coming there would have a small impact on improving the value added per pound and total value added dollars.

In terms of the Trentwood and the aerospace, I think that more relates -- the growth other than what would happen in terms of other normal market growth would be additional projects that we might pursue that enhance the value of the products that we supply through the supply chain. So there could be things that we would do like additional machining or aspects like that that could add value to the products. And we continue to look for opportunities such as those and there could be some bolt on acquisitions that would occur that would have a similar impact, if that addresses the thrust of your question.

I think that is really helpful. And just to follow on with that if I could, as the Kalamazoo project kind of winds down, I mean is there -- is there any -- what sort of strategic discussions or what sort of things should we be thinking about as kind of the next several steps where you're going to be taking the business? I mean you certainly have mentioned in a general sense with external opportunities, is there any opportunity that would be major that would come on in a discussion as in 2010 or 2011?

We said before we don't see anything of the magnitude of the $250 million that we have invested over the past few years. But in the context that I was discussing where we look at product line extensions and those types of projects, there could be tens of millions of projects that could be on the horizon by the end of 2010.

So it is more like rounding out. You have got these two new horses and you're going to kind of round out around them and try to maximize the value proposition.

It is not just those two horses we have very good aspects in aerospace and high strength and beyond Trentwood. Places like Chandler and in Jackson, Tennessee that also offer -- and Newark, Ohio that also offer opportunity for product line extensions in that high value added arena.

And Jack just a couple of quick house keeping questions. The $5 million hit in the primary aluminum business is that going to be considered a run rate or a nonrun rate item?

It will not be stripped out as a nonrun rate. Although I would not expect you would see that as an ongoing basis every quarter into the future.

And then lastly just for clarification it sounded like your aerospace shipments for the fourth quarter, you had indicated that if you took 3Q and 4Q combined and divide them by two, it would be about the run rate of the second quarter, is that right?

Yes.

Thanks very much and congratulations on your progress.

Thanks Mark.

Thanks.

(Operator Instructions). We'll take our next question from Timna Tanners with UBS.

It is actually PT Luther stepping in for Timna today. How are you? Most of my questions have been addressed. If just want to get a little more color if you could maybe on general engineering and the volumes balance that you saw in Q3 you characterized partly automotive and partly destocking. Can you kind of give us a sense of which had the larger impact if you think this is a sign that destocking is in fact coming to an end?

If we look percentage-wise, the impact of automotive it just -- automotive shipments change quarter over quarter was substantial because of a big bump in build rates, compared to where we were running in the first half. But if you look at total volume, the impact from general engineering was slightly more. But there was a pretty significant impact from both of those. The destocking -- and I doubt that I had time to get clear back in the Appendix there, but if you get a chance to look at it, I think it was slide 27 in the Appendix that shows the rod and bar data, the destocking did decline substantially in the third quarter, but it still was pretty significant, which frankly surprised us. There was virtually no destocking in August. And we were about to break out the party hats. And then there was huge destocking again in September and brought the inventories down to unbelievably low levels. So there still is room for some improvement here in terms of destocking as we go forward. And frankly that is one of the sources of optimism, a little source of optimism for 2010 versus 2009. There just can't be much more of this destocking left it has to have run its course in general engineering. As well as the supply chain beyond service center, I mean when we looked at the third quarter, service center shipments, their shipments to their customers were at the lowest rate that we've seen during the recession here. So we expect that we're going to see their customers' inventories rung out too. So hopefully we're going to start to see some up-tick just because the supply chain comes into balance here.

Thanks that is helpful. So it is probably fair to think that pricing could start to stabilize in the segment?

Frankly our pricing has been pretty stable other than what you see for mixed changes. And the other impact has been on general engineering plate. That is one product where we have seen steady erosion during the last nine to twelve months. But that was coming from what were very historically high pricing that lasted for four our five years. So we still have reasonable prices there by historical standards. They're just not as high as they were back in the 2007, 2008 time frame.

Got you, thanks. And then final question is on if you have any sort of preliminary outlook on 2010 capital expenditures as Kalamazoo is wiping down, do you winding down, do you think it will go into 2010?

So there's some carry over that will happen in 2010, PT, so beyond that and I think essentially we have that data in the 10-Q, I want to say it is in the territory of $15 million $20 million. And I think Neil is checking on that right now. Other than that we'll have ongoing sustaining capital and that is normally in the $12 million to $15 million range. And we'll probably have other some other projects, although small, that will determine our good growth initiatives.

Right, thanks very much guys.

And Neil tells me I was on point about $15 million to $20 million.

Thank you and that concludes the question and answer session today. At this time I would like to turn the call back over to Jack Hockema for additional remarks.

Thanks very much, despite the challenges by the weak global economy, our long term business fundamentals remain positive and we are encouraged that our shipments have stabilized. Our experience over the past 12 months reinforces that Kaiser is well positioned to navigate the market cycles, and that we have the financial and competitive strength to capitalize on new opportunities as the market recovers. We continue to invest in strategic projects such as the world class extrusion plan in Kalamazoo to improve our long-term growth and profitability and the full benefit of our Trentwood expansion has yet to be realized due to the soft market conditions. Thanks again for joining the call today, look forward to updating you again on our year end 2009 call.

Thank you ladies and gentlemen this does conclude today's presentation, we appreciate your participation, you may now disconnect.