Kaiser Aluminum Corp (KALU) 2010 Q2 法說會逐字稿

Good day, everyone, and welcome to the Kaiser Aluminum second quarter 2010 earnings release conference call. Today's call is being recorded. For opening remarks and introductions, I would like to turn the conference over to Melinda Ellsworth.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's second quarter 2010 earnings conference call. If you have not seen a copy of our earnings release, please visit the Investor Relations page on our website at www.kaiseraluminum.com. We have also posted a PDF version of the slide presentation for this call. Joining me today are President, CEO, and Chairman, Jack Hockema; Senior Vice President and Chief Financial Officer Daniel Rinkenberger; 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 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 constitutes forward-looking statements within the meaning of the Private Security 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 second quarter of 2010 and reports filed with the Securities and Exchange Commission, including the Company's Form 10-K for the full-year ended December 31, 2009, and current report on Form 10-Q for the quarter ended March 31, 2010.

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. 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 markets 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 for fluctuations and underlying metal prices. We characterized metal profits and LIFO charges, as non-run-rate items that eventually offset to a great extent over the course of year. Further, presentations, including such terms as net income, operating income before non-rate, or after adjustments, or earnings before interest tax, depreciation and amortization 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 impacted certain material items on the GAAP measure and are not intended to imply such items should be excluded.

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

Thanks. Thanks, Melinda, and good afternoon, everyone. Thank you for joining us for our second quarter 2010 earnings call.

I'm pleased to report that this quarter was the best we've had since the economic downturn began two years ago. Our second quarter results reflected $35 million of adjusted operating income for Fabricated Products, an increase of 30% sequentially, and 75% compared to the prior year quarter. The increase was driven by higher value-added revenue, which increased 8% sequentially on stronger than expected shipments for aerospace, and high-strength applications, and by continued improvement in our manufacturing cost performance. Consistent with our previous updates, we continue to move forward with the start up of our new extrusion plant in Kalamazoo, and the facility remains on schedule to be fully operational late this year.

Dan will now provide highlights regarding the second quarter results. Dan?

Thanks, Jack.

I'll review the quarter's consolidated financial highlights on slide seven. The second quarter continued a trend of improving underlying results. Consolidated operating income before non-run-rate items, increased sequentially to $26 million. That's a 62% increase compared to the first quarter. Higher value-added revenue continued improvement in manufacturing cost efficiencies in our fabricated product segment, and lower corporate expenses drove the favorable results for the quarter. Reported consolidated operating income in the second quarter was negatively impacted by $22 million of non-run-rate items, including a $19 million non-cash mark-to-market loss on aluminum hedging positions due to a decline in metal prices from March 31 to June 30.

As a result of these large non-run-rate items, reported net income for the second quarter was approximately $100,000, or $0.01 of earnings per fully diluted share. Net income excluding non-run-rate items was $13.5 million, or $0.71 per fully diluted share. Net income in the second quarter, also reflected the first full quarter of interest expense on our convertible notes. Interest expense includes both the cash component and the non-cash amortization of the discount, booked upon the issuance of the notes in late March.

Our effective tax rate for the second quarter was higher than usual, reflecting tax provisions that were not affected by our low pre-tax income. However, we anticipate our effective tax rate for the full-year will be in the low 40% range. More importantly, cash taxes will continue to be in the mid-single digit percentages, reflecting our usage of net operating loss carryforwards and other tax attributes, which apply mainly to pre-tax US income.

Slide eight focuses on our Fabricated Products results. As Jack mentioned in his earlier remarks, our Fabricated Products segment reported the best quarterly results in two years. Operating income excluding non-run-rate items increased sequentially to $35 million, reflecting a 30% increase compared to the first quarter, driven by higher value-added revenue and continued cost improvement from ongoing manufacturing efficiencies. The increase in the first quarter in value-added revenue is primarily related to stronger shipments and a richer overall product mix.

In July, we completed the sale of our Greenwood, South Carolina, forging facility to a strategic buyer, Revstone Industries. Fabricated Products recorded a second quarter impairment charge related to these assets of approximately $2 million, which we reflect as a non-run-rate item. We don't anticipate the sale of Greenwood will have any material impact on our ongoing Fabricated Products business. Proceeds from the sale totaled approximately $5 million.

Slide nine provides a summary of the quarterly sales analysis by end market application. Fabricated Products' value-added revenue improved approximately $11 million sequentially on stronger than expected aerospace and high-strength shipments. This increase was partially explained by orders placed with us due to uncertainties surrounding expiring labor agreements at competitor plants.

General engineering shipments for the second quarter declined 7% sequentially. We saw unusually large shipments in March followed by weaker April shipments, indicating that the quarterly decline was largely due to timing of deliveries, rather than a change in demand or inventory stocking activity among our customers. Our richer overall sales mix, with higher aerospace and high-strength shipments and lower general engineering shipments, drove improvements in the average value-added revenue per pound.

And now, I'll turn the call back over to Jack to discuss the outlook for our end markets and opportunities for Kaiser. Jack?

Thanks, Dan.

Slide 11 reiterates our positive long-term view for commercial aerospace, as industry news from the recent Farnborough Airshow reinforced our very positive outlook. Boeing and Airbus have both announced plans to increase build rates, and both have indicated that they do not expect to re-design single aisle frames until the mid 2020s. Airline Monitor has incorporated this information into an updated forecast that anticipates industry record aircraft builds throughout the remainder of the decade. These developments enhance our already bullish long-term outlook for aerospace applications.

Slide 12 illustrates recent trends for Kaiser shipments and value-added revenue for aerospace and high strength applications. While the long-term demand outlook is very strong and the short term demand is effected by destocking, as large air program manufacturers work through their inventory overhang. We expect that destocking by airframe manufacturers will begin to abate in 2011 as build rates ramp up. In the very near term, our outlook for third quarter shipments and value-added revenue for these applications is similar to the first half pace.

Slide 13 addresses our outlook for general engineering and automotive applications. Service center inventories for our general engineering products have stabilized and are at historic low levels. While there is some evidence of modest restocking by service centers, we don't anticipate meaningful restocking until real demand begins to rebound and service centers become more confident in the sustainability of demand. In the third quarter, we expect market dynamics similar to the first half, but we anticipate that normal seasonal weakness will curtail volume. Seasonality for these applications typically reduces third quarter shipments approximately 10% compared to the first half run rate.

Slide 14 profiles our improving EBITDA and value-added revenue trends for the past five quarters. As mentioned on the preceding slides, we expect that market dynamics will be similar to the first half. But the third quarter volume and value-added revenue for general engineering and automotive applications will reflect normal seasonal weakness compared to the first half run rate. We also anticipate major maintenance costs, approximately $4 million higher during the quarter than the average quarterly rate during the first six months of this year.

While we've yet to see evidence of a robust economic recovery, we are very optimistic about the Company's near term and long-term prospects. The long-term fundamentals for aerospace application are excellent, and the full benefit from our Trentwood expansion has been realized. Our new Kalamazoo facility is an important next step in advancing our competitive cost position. And it will provide capacity and cost-efficient sourcing for expected sales growth related to growing use of aluminum extrusions in automotive applications.

We've also made significant investments at several other fabricated product facilities, and these investments will provide earnings leverage as the economy recovers and the aerospace and automotive markets grow. These investments have further strengthened our platform for growth, and we anticipate additional organic and acquisition investment opportunities in the future. With attractive markets and a strong financial and competitive profile, Kaiser is well positioned for profitable long-term growth.

We will now open the call for questions.

(Operator Instructions).

We'll go first to Timna Tanners with UBS.

Yes, hi, good afternoon.

Hi, Timna

Hi, Timna.

You guys ran through some of that a little bit fast, so I apologize if I ask something that you've just explained. But I was kind of intrigued by the comments about some of the benefit in the second quarter, as a function of some of your peers that may have had labor agreements expiring. Can you try to describe that a little more, maybe quantify it possible?

Timna, order of magnitude, we estimate it may be a 1 million to 2 million pounds, and it's not unusual, frankly. In this case, there were two major plate mills that were in negotiation that had simultaneous contract expirations. And so, whenever there is a situation like that, it's not unusual for some customers to put some contingency orders on other mills, like ours, where our labor agreement was settled earlier in the year, and we're working on a five year labor agreement.

I thought I saw that at least one of those was resolved. I mean how do we think about that going forward? Is that not repeatable?

I think they've both been resolved. Alright, great. I know that you've been talking about some concern that destocking would minimize or reduce your value-added revenue, but then you had a very strong added performance. So can you just describe what happened, maybe in the quarter to support that? Well, if you look at the value added revenue per pound by application, it was pretty consistent. Aerospace and high strength, the $1.87 a pound was very consistent with where we had been for the prior two quarters. And the $0.83, in the general engineering and automotive, while it's higher than the first quarter, it's on track with where we've been running in the second half of last year.

Most of that is mix related. We had high rod and bar shipments in the first quarter, compared to the second quarter. And so that was pretty much mix related. So, really the value added revenue is very much a reflection of product mix here for the past few quarters.

Okay, and that's the sustainable then, with the exception of kind of the seasonal impact that you might have described?

Again, I think the best way to look at it is in those two buckets that we provide. We think that aerospace and high strength has settled in this $1.87 plus or minus range. And the general engineering and automotive applications have settled in the low 80s there. It could bounce around a little bit with mix. It's pretty stable right now.

Okay, and then one final one -- (Multiple speakers). I'm sorry, is there more?

No, it has been stable for several quarters here. Okay, got you.

And final one for me, just to get a updated thought process if you could on uses of cash, given the cash raise that you had, and how you're thinking about things?

Well it's similar to what we've said all along. That our priorities for first are good investments, organic investments, and then complementary acquisitions. And then beyond that, if we have excess cash beyond what we think is investable, obviously, we are paying the regular dividend, but we would look at additional dividends and or stock repurchases to utilize any excess cash. But at this point, we remain optimistic that we're going to have continuation of good internal investment opportunities. We think we'll be in the $30 million plus or minus range, plus or minus $10 million on average, as we go forward in terms of investment. It's not the $60 million pace we've been on. We think we'll continue to be optimistic that we will have some good, complementary, bolt-on type acquisition as we go forward.

That's CapEx that you're talking about, with the $30 million plus or minus the $10 million?

Yes exactly.

Thanks a lot.

(Operator Instructions).

We'll go next to Mark Parr with Keybanc Capital Markets

Hi, good morning.

Good morning Mark.

Good morning, Mark.

Congratulations, nice -- very nice result.

Thanks.

I saw that number and went -- whoa. It's good stuff. I was wondering if you could give a little more color on the cost improvement that you realized in the second quarter? And how we should look at cost programs over the back half of 2010 and how we ought to think about cost, as Kalamazoo and some of the other investments are fully commissioned heading into 2011. If you could quantify any of that, it would be really helpful.

From a cost performance standpoint, we've had good steady improvement over the last three or four quarter quarters. Although the second quarter, just from a raw efficiency standpoint, WAS relatively consistent, it was a little bit better than the sec -- than the first quarter. But pretty much consistent with the first quarter.

Okay.

But if you go back in time, and Mark, I can't remember how closely you were tracking us. But 2007 was a really good year for us. It was record cost performance. And it was cap on about seven or eight years very consistent cost performance improvement. 2008 the wheels kind of came off and as we was doing phase three in Trentwood, and were red-lining some other plants, and had some investments in several plants. And we reported in 2008, that our cost performance actually tailed off $25 million, in order of magnitude from 2007. And then as we went into 2009, especially in the first half the year, we had a lot of inefficiencies, ramping our cost down to the new cost level, and then pretty much stabilized, and starting improve starting third quarter last year. First half of this yea, we're performing back at a rate similar to where we were back in 2007.

So we're back to that record cost performance, and that's despite some cost inefficiencies related to the start up at Kalamazoo. So we're very encouraged with where we are now. If we took Kalamazoo out, we would be running better than where we were in that record performance back in 2007, even at this very low level, comparatively low level of activity. As we go forward, let me just put a point on Kalamazoo, the second quarter at Kalamazoo, the start-up drag was about the same as first quarter. So we've got a pretty consistent baseline here, in the first half the year.

We think we'll start see a little bit of improvement, as we move into the second half. The third quarter still is pretty much a wild card because we're still in the wild west, in terms of the start up phase. But by the fourth quarter should really start to settle done. And then, as we get into next year, we expect to see real benefits from Kalamazoo. And we've said, order of magnitude, at normal volume level, that's Kalamazoo is worth low to mid 20s, so that's cost reductions. Essentially, all of it is cost reduction versus our old value streams. Maybe not that much compared to some of the value streams we are using now, but we'd expect to see some real cost improvement in the teens certainly next year, compared to this year just as Kalamazoo starts to kick in. Okay?

Okay. That's helpful thanks very much for that color. I guess, again, regarding the third quarter, it sounds as if you got a little bit of an extra bump in value add revenue out of aerospace in the second quarter, because of these labor -- perception of potential labor disruptions. And so that's something that would create perhaps a bit of downdraft in the second half on aerospace. And you're getting a normal seasonal situation in the general engineering and automotive side. Is that fair? Look for some sequential reduction in both of those areas in the things in the third quarter?

I'd rather look at it -- quarters there is still a lot of volatility in our business in just three month buckets. I'd rather look at it as six month buckets. And if you look at it that way, we think that aerospace is going to be very similar to that first half pace, the 40 million pounds plus or minus, in terms of shipments with the similar value added revenue per pound. And then the general engineering ran at a 71 million-pound shipment pace in the first half of the year. And we said, it's hard to predict what seasonalities is going to be, although July was pretty weak. So we think we're gong to see normal seasonality, which is we said, is order magnitude typically 10% plus or minus a few points. So we're probably looking mid 60s plus or minus in terms of shipments from an aerospace -- err, an automotive and general engineering standpoint.

Okay, that's really helpful. Thanks a lot.

Okay.

(Operator Instructions).

We'll go next to Tim Hayes with Davenport and Company.

Hello everyone. Hi, Tim.

Hi, Tim.

First question, on the general engineering, just wanted to see what in that category is doing well, and what's may be not doing well. I was a little surprised that the volume ticked down from Q1. Truck trailer are certainly doing a lot better. Sort of can you give some color on the end markets that are driving that slight -- sequential decrease?

Sure be happy to. General engineering, there's very little to no influence from truck and truck trailer. It's virtually all service center business, and it's driven by industrial economy. In the first quarter, we had unusually high shipments of rod and bar. It was really a strong first quarter and if you go back to our comment in the quarter, I did comment on the last call, that we were a little concerned about the second quarter because our March shipments had been so heavy, that we were a little concerned that the first quarter may have stolen some shipment from the second quarter. And in fact, that is what happened.

It's not really related to true demand. It's more just shift in product shipments, a matter of a few weeks probably from April, back into March. Some of that was probably related to the rising aluminum prices then. We probably had some customers pull ahead orders to try to take advantage of lower metal prices in the first quarter compared to what were developing in the second. So that's all a long explanation of saying, that we really didn't see much change in real market dynamics from the first quarter to second quarter. It's more a matter of timing of the shipments, right at the end of the quarter, into the first -- and the beginning of the second, rather than any real change in market dynamics. If that answer it for you Tim.

Yes, that helps. So the truck and truck trailer, that's in all other category?

Yes, that's in all other. We really de-emphasized those products in our mix, so they are a tiny sliver of what we do today.

And then finally back, on the heat treat plate for aerospace. If you were to exclude the one to two million pound benefit that you got from the competitors having some issues there, if you exclude that amount, where are you in terms -- are you mostly still at minimums with customers that have contracts? Or are you starting to come off those minimums, as the build rates are being pulled forward by the life of Boeing and Airbus?

Well, I wouldn't say we're at minimums, but what we think is the low point, not necessarily right now. But I think we hit the low point, from an airframe manufacturer, the big OEMs is going to be the low point this year. We're very optimistic, that we are going to see destocking begin to recede and abate as we move into 2011. And every quarter, we become increasingly bullish about the outlook for 2012. Think it's still difficult to predict what 2011 looks like. But we're just beginning to put together our updated five year forecast and we're in the second or third iteration, and every call I get from the marketing people is even more bullish about 2012. So 2011 is still volatile, just because of the inventory uncertainty. We're confident that is going to be better than this year, but we think this thing is going to be roaring for us by 2012.

Okay then, final question on the sort of emerging billet shortage, just to refresh our memory. Do you cast all your billet needs, and then if so do you have any competitors that in certain niche extrusions, that do not cast their own billet, that maybe you pick up a little share around the edge, if they fall short of getting their own billet supplies?

We do cast our own billet,virtually all of our own billet, in fact, all of our own billet. It is a rare circumstance when we go outside. In fact we are billet long, and actually sell some billet on the open market. I'm not aware of us picking up any business because of billet shortages affecting our major competitors. They're big enough, that I think they've got relationships with suppliers where they've been able to cover their needs. If they haven't, it's nothing reached up to me saying that there was any benefit to us, so this tight billet supply in the marketplace.

Okay, thank you.

Okay.

(Operator Instructions).

We'll go next to [Grace Hosek] with Franklin Templeton.

Hi, how are you?

Hi, Grace.

I had a question about cash flow. What looks like -- all your non-run rate items, non-cash in nature? What I'm trying to get at, is what looks like a fairly strong sequential increase in earnings. If I did in the math right, you certainly didn't have a sequential increase in cash flow. It looks like the cash flow was actually down in the quarter, even before working capital items, it is looks like it was about flat.

Well, most of our cash -- non-run-rate items are non-cash. There's a few that are -- have a cash element to them, but they are very small. And the biggest impact are the mark-to-market items which are all non-cash. And cash flow -- through the quarter we do have the capital spending program that continues with Kalamazoo. So that would be a consumption of the cash. Ongoing things that we have are dividends, interest is the first time -- we actually haven't had a cash payment yet on interest. Only things that's really going to be impacting is probably going to be the working capital.

I was actually looking at it before capital expenditures.

There's probably a build in inventory that you will see, when you look at the detail.

Okay. Alright thank you.

With no other questions in queue I like to turn the conference over to Jack Hockema, for any additional or closing comments.

Okay, thanks, Laurie. Thanks for joining us on the call today, and we look forward to updating you again on our third quarter 2010 conference call in October. Thank you.

And that does conclude today's conference call. Thank you for your participation.