Kaiser Aluminum Corp (KALU) 2011 Q2 法說會逐字稿

Good day and welcome to Kaiser Aluminum's second quarter 2011 earnings conference call. Today's call is being recorded. At this time I would like to turn the conference over to Melinda Ellsworth. Please go ahead.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's second quarter 2011 earnings conference call. If you have not seen a copy of today's earnings release, please visit the investor relations page of our website at KaiserAluminum.com. We have also posted a PDF version of the slide presentation for this call.

Joining me today on the call are Chairman, President and Chief Executive Officer Jack Hockema; Senior Vice President, Chief Financial Officer, Dan Rinkenberger; and Vice President, Chief Accounting Officer, Neal West.

Before we begin, I would like to refer you to the first slide of our presentation and remind you that the statements made by management and the information contained in this presentation that constitute forward-looking statements are based on management's current expectations. For a summary of the 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 and reports filed with the Securities and Exchange Commission, including the Company's Form 10-K, for the full year ended December 31, 2010. The Company undertakes no duty to update any forward-looking statements to conform to statements' actual results or changes in the Company's expectations.

In addition, we have included non-GAAP financial information in our discussion. Reconciliations to the most comparable GAAP financial measures are included in the earnings release and in the appendix of this presentation. At the conclusion of the Company's presentation, we will open the call for questions. I would now like to turn the call over to Jack Hockema. Jack?

Thanks, Belinda, and welcome to everyone joining us on the call today. As indicated during our first-quarter earnings call, second-quarter value-added revenue for our aerospace, automotive and general engineering applications was similar to the first quarter. We also realized higher value-added revenue from our custom industrial products compared to the first quarter. In addition, we benefited from improving operating efficiencies and recovery of a significant portion of the metal price margin squeeze that impacted first-quarter results. These were all contributing factors leading to improved EBITDA and margins in the second quarter.

We are pleased with the progress we've made in the quarter, and we continue to be very optimistic about our prospects for growth as we look to the future. We have a strong aerospace order book and are well positioned to meet the growing demand with previous investments in plate capacity and with the recently announced expansion of our Alexco aerospace extrusion facility. I will provide additional perspective on our outlook, but will now turn the call over to Dan to provide details on the second quarter.

Slide 5 shows the trend of value-added revenue. Consistent with the expectations we discussed during our last quarterly earnings call, total value-added revenue in the second quarter was similar to the first quarter with steady demand in shipments across all end market applications. Custom industrial products also showed sequential quarterly improvement, nudging total value-added revenue slightly higher in the second quarter.

In addition to reviewing sequential information, we believe it is helpful to analyze our results over six-month periods to smooth out the choppy nature of quarterly data. With this view, the first quarter -- our first six months of 2011 reflected solid improvement with total value-added revenue increasing about 11% compared to the first half of 2010. Looking at the 2011 first-half value-added revenue by end market application, aerospace and high-strength improved approximately 19% compared to the first half of 2010, primarily reflecting the benefit of additional sales from the Kaiser-Alexco hard alloy extrusion facility, as well as higher volumes of other products.

The Alexco acquisition is performing well, and with further opportunities for growth in hard alloy extrusions, we recently announced an expansion of the Alexco facility.

Value-added revenue for automotive extrusions in the first six months of 2011 also improved more than 20% as compared to the first half of 2010 on significantly stronger shipments as build rates improved over last year and new automotive aluminum extrusion programs continued to ramp up.

Next, general engineering was roughly flat with the first half of 2010 as the benefit of slightly higher volume was offset by the negative impact of the metal price squeeze we experienced over the last couple of quarters on general engineering plate. Further detail and value-added revenue by sales application can be found in the appendix on slides 19 and 20.

Slide 6 shows the adjusted consolidated EBITDA trend. On a sequential basis, adjusted consolidated EBITDA improved in the second quarter to $30 million, an improvement of $7 million or more than 30% over the first quarter. This reflected the impact of higher value-added revenue, improving manufacturing efficiencies and better pass-through of metal costs on flat sales of our higher value-added products.

For the first half of 2011, adjusted consolidated EBITDA of $53 million was a 6% improvement over the first half of 2010 as the impact of stronger value-added revenue during the first half of the year was partially offset by higher energy and currency costs and an increase in operating and overhead costs to support higher demand.

Slide 7 shows key consolidated financial metrics. Adjusted consolidated operating income, excluding non-run rate items, increased to $24 million in the second quarter of 2011 compared sequentially to $17 million in the first quarter. This was reflecting the impact of slightly higher value-added revenue, improving manufacturing efficiencies and better pass-through of metal costs, as we had previously mentioned.

Consolidated operating income as reported of $15 million in the second quarter reflected $9 million of unfavorable non-run rate items. Details for non-run rate adjustments to operating income are shown in the appendix on slides 21 and 22.

Reported net income for the second quarter was $5 million, or $0.24 of earnings per diluted share, reflecting interest expense of $4 million and a non-run rate mark-to-market loss of $4 million on our convertible debt and related hedging transactions.

Mark-to-market gains and losses on the convertible debt and related derivatives are non-run rate in nature, and we have highlighted the impact of these non-run rate gains and losses for the last five quarters in the reconciliation of reported earnings per share to adjusted earnings per share on slide 23 of the appendix. Adjusting for total non-run rate items, second-quarter net income was $12 million, or $0.63 of earnings per diluted share. Our effective tax rate for the second quarter of 2011 was approximately 40%. However, our cash tax rate continued to be in the low single-digit percentages as we utilize our sizable net operating loss carry-forwards and other tax attributes.

Slide 8 shows consolidated cash flow for the first six months of 2011. After funding the Alexco transaction in early January, adjusted consolidated EBITDA has funded all cash requirements for operations, growth and financing. The increase in working capital is due to both an increase in metal prices as well as the growth in our operating activity as our end markets continue to improve. Capital spending was $14 million in the first half of the year. We continue to expect capital spending for the full year will be between $35 million and $45 million as we invest to sustain operations, improve quality and efficiency and remove manufacturing bottlenecks at several of our facilities.

Total liquidity at June 30, 2011 exceeded $250 million, including cash of $60 million and availability under our revolving credit facility of $192 million. Now I will turn the call back over to Jack to discuss current industry trends and our overall outlook. Jack?

Thanks, Dan. Turning to slide 9, we remain very optimistic about the long-term prospects for aerospace applications. We expect robust long-term aerospace demand growth for our products, driven by steadily increasing build rates, larger airframes and conversions to monolithic design. Over the past few quarters, we have gained greater visibility into the aerospace plate inventory situation. Our conversations with airframe manufacturers have indicated that their emphases have shifted from concerns about plate inventory overhang to a focus on rate readiness in anticipation of increasing build rates over the next several years.

As I previously mentioned, our order book for aerospace applications in the second half is very strong and all indications are that this strength will continue in 2012. Our current outlook for the second half is that value-added revenue for these applications will be 5% to 10% higher than the first half, despite normal downward pressure from seasonal weakness.

Turning to slide 10 and our general engineering and automotive applications, we continued to experience slowly improving underlying demand and the benefit from automotive growth. As Dan mentioned, our value-added revenue for automotive extrusions improved more than 20% year-over-year in the first half. This is attributable to both increasing aluminum extrusion content and higher build rates.

Looking to the second half, we expect that normal seasonal weakness for these applications will be similar to last year with a decline in shipments of approximately 10% compared to the first half of the year.

Turning to slide 11 and a summary of the outlook, overall we expect that our second-half value-added revenue will be similar to the first half as the strong order book for aerospace applications is expected to offset the typical seasonal weakness that we experience across all applications in the second half of the year. We also anticipate margin benefit in the second half from improving operating efficiencies at Kalamazoo and other facilities and from further recovery of the margin squeeze caused by rising aluminum and alloying costs. These benefits will be partially offset by higher major maintenance project expense in the second half.

Taking all factors into consideration, we anticipate that EBITDA margin in the second half will show some improvement compared to the 17% margin in the first half.

Turning to slide 12 and summarizing our remarks today, our second-quarter results were driven by improving operating efficiencies and recovery from the metal price margin squeeze that impacted first-quarter results. Our positive outlook for the second half reflects our strong aerospace order book which will offset normal seasonal weakness with a net result of significant improvement compared to the second half of last year.

Longer term, we are very well positioned in attractive, growing markets with stronger demand, and the benefit from our organic and acquisition investments yet to be fully realized, our long-term earnings potential remains strong. As evidenced by the recently announced expansion of our Alexco aluminum extrusion plant, we have additional opportunities for growth. We expect capital spending of approximately $40 million this year and anticipate a similar level in the future.

In addition, we will continue to consider complementary acquisitions consistent with last year's Alexco and Nichols Wire transactions.

We will now open the call for questions.

(Operator instructions) Edward Marshall, Sidoti & Company.

You talked about inventories within the channel -- plate. This is more likely an update from last quarter, but the shift to rate readiness that you talk about -- can you kind of go into more details? Because you kind of talked about the differences that you saw within your own demand as well as the demand that was in the supply chain. Can you talk about the differences and if those have changed since you last updated us?

Yes. The three months feels like three years ago, at this point. But at that point, we had a pretty clear picture of what our situation was, but we have had a lot of additional discussions, particularly with the OEMs over the past three months. And there has been considerable news. There was the Paris Air Show and a lot of other news. And everything from a macro standpoint that you read in the industry points to higher and higher build rates. It's pretty clear that both Airbus and Boeing are committed to going to at least a monthly rate of 42 builds of single aisles at both operations, and both of them now are talking about ramping up future production even beyond that 42 rate.

So everything in the last three months has become more bullish in terms of long-term builds over the next few years for the OEM manufacturers.

The other part of this is that, while we had some intuition on this three months ago, as we have had discussions it has become pretty clear to us that with them looking at these significant ramp-ups and builds, their vision is changing to what is their rate readiness throughout the entire supply chain, not just metal. And we think that -- we are pretty confident there's a feeling there that these inventories that they have today are going to be required, at least this level of inventory, required to support their future production.

So that's really the change in tone, is that, with additional elaboration and discussion with the OEMs, we are feeling much more confident and much more bullish that this thing really has legs in terms of the end of the de-stocking.

So, to be clear, is there a change in the actual inventories that are out there, or the timing, maybe, of that recovery? What are you kind of alluding to?

What I am saying is that, for the past two years their entire focus has been on reducing their inventory. And when we talk to them now, there's no real discussion of reducing inventory. There's more a sense that, as they look forward, these kind of inventories are going to be required for the very high build rates that they anticipate over the next few years. So it's really just a change in their attitude where, two years ago, it was everybody thinking how can we get some cash out of this inventory, and now it's how can we get enough materials and supplies to build our airplanes for the future.

So are you committing to -- kind of supply and demand balance has been achieved, I guess, is kind of what you're saying at this point.

What I'm suggesting is that I'm pretty confident that the de-stocking phase is over, at least in the OEM supply chain.

Okay. When you talk to the margin benefit that you're going to see kind of second half to first half, can you quantify the relief that you're going to see either from both the squeeze that you saw from pricing and then the benefit that you'll see from the roll-on of the Kalamazoo facility as that continues to ramp up?

Yes. Well, I won't quantify those, but those are positives. We expect that we're going to have better costs and we expect that we're going to have better margins, a little bit better margins as we move into the second half. We did recover some of the margin squeeze there in the second quarter, just not all of it.

But the big offset -- and there was a lot of this in the second half results last year as well; I refrained from saying that our major maintenance spending is seasonal. But typically, the spending is much higher in the second half of the year than the first half of the year, for the same reason that our volume is down, and that is that there is available time on the equipment, and so our plants use that time to work on it.

So a significant portion of the underlying benefit we are going to get that's long-term from margins -- from selling price margins and from operating efficiencies is going to be offset in the next six months with these high major maintenance expenses. That being said, we think we will do better than the 17%, that we will be in the high teens in terms of the margin for the second half.

Can you -- looking backwards into the first half, can you quantify the absolute value of the squeeze that you saw from pricing, for the first six months first?

Yes. We can do the math here, but I can say the numbers. I believe in the last call, we said that the squeeze was, order of magnitude, $3 million. So $3 million on $160 million, roughly, of value-added revenue is roughly 2 points of margin. So the first quarter was roughly 2 points of margin, and we got more than half of that back in the second quarter, so say the second quarter was a point or so below what would be a typical margin. And we expect to have all that back in the second half and be back to normal recession pricing. We do not expect to be back to normal pricing; we are still recession levels. But at least we're back to recession-level pricing, where we weren't in the first quarter.

And you talk about the benefit that you would see from Kalamazoo, and you qualified it on prior calls of about -- I think it was $15 million for 2000. Can walk me through, exactly, what percentages of which maybe you've achieved thus far? Is it half of it?

I won't go into that level of granularity. Let me just say about Kalamazoo, that it's -- at this point, I wouldn't put a 15 on it. I would put more like 10 to 15 for the year. There's still a lot of uncertainty as we go through a start-up, but it's starting up slower than we expected. But that has been particularly in the first half. We expect the second half is going to be better, and a lot of what we say about operating efficiencies in the second half is attributable to what we expect out of Kalamazoo, and more loaded to the fourth quarter than the third quarter.

But for the year as a whole, I'd say it's going to be in that 10 to 15 range. But, again, coming back, there are a lot of moving parts inside the margin. You try to get down to the granularity -- I'll come back to my point. We had roughly 17% margin in the first half and we expect we will get a nice lift from selling price margins and a lift from operating efficiencies in the second half. But there's a significant offset with much higher major maintenance spending.

So in the second half, we think we're going to be in the high teens, probably better than 17% but still somewhere in that high teens.

Okay, great, thank you very much.

Tony Rizzuto, Dahlman Rose.

Thanks very much for taking my questions here. I've got a couple of them. Jack, I was wondering if you could maybe quantify what the magnitude of the major maintenance expenses might be in the second half, first?

I won't quantify it, but it's a few points of margin.

Okay. And I presume that it does include Trentwood, of course.

(inaudible)

So you are also, I would presume, building some inventory ahead of that?

Well, it's spending. I don't know that we are anticipating any major down time that will affect our production. It's just equipment is more available because of seasonal weakness, and you have the holidays, when we may have reduced schedules over holidays and fourth of July week. A lot of it falls in the third quarter, July-August, or a lot of it falls in over the Thanksgiving holidays and the Christmas holidays. But we don't think it will affect our throughput; it's just more expense, where we are repairing and rebuilding parts, normal rebuilds of furnaces, those kinds of things.

Okay, another question I have is one of the things we have been seeing across our coverage that we have is the rising raw materials and other input pressures. And obviously, you alluded to this -- you know, higher energy and currency and other factors. And I'm wondering to what extent is this also likely to impede performance in future quarters?

Yes, go ahead, Dan.

We did see some changes and increases this year in energy and currency. They weren't huge. But again, I think that that's well factored into the way Jack described our margins. We think we'll nonetheless be improving in the last half of the year to be in the high teens.

On the metal price and the alloy costs, that's a story of whether we are able to pass it through in the first half of the year. I think that, also as Jack said, we expect to see that improved in the last part of the year, too.

Understood. And I was wondering -- you guys -- I don't think you've broken out the terms. Obviously, the $83 million purchase price -- but have you broken out what kind of the trailing 12 months revenues and EBITDA might have been for Alexco?

We are reporting in the Qs the amount of the current-year earnings and revenues, as well as comparison to what the prior-year adjusted would be.

Okay, all right, that would be very helpful. I appreciate that. And just back to the aero story -- the heat treat story, and it's so fantastic to hear you talking about the de-stocking being over. And I know it's been a long, long period of going through this process. I was wondering where prices are today in terms of base prices relative to where we were in the last really good part of the cycle?

Good question. I'll give a two-part answer. The first part is that the bulk, or a significant portion of what we supply in aerospace is on contract, long-term contracts, 5- to 7-year contracts, typically. And even when those contracts get renewed, usually there's not a sea change in pricing one way or the other. So there's relatively stable pricing on a significant portion of the mix.

On the other portion of the mix, which is non-contract, and that's -- and some of the service center business is backed by OEM contracts, but some of the service center business is spot business. And that is a portion, less so in plate, but more so in sheet and extrusions, than non-contract business. Those prices are much lower than where they were at the prior peak.

So we have seen significant price deterioration in the spot portion of the business. And back to my comment, I was primarily talking about general engineering spot prices being at recession levels. But the same is true to an extent about the aerospace spot business as well. And it's really a major contrast if we look at where we were in that 2007-2008 period, where it was a barn burner and there were prices there that we had never experienced before and I don't know that we'll ever get back to those, although, hopefully, we start to get back in that range.

So I would characterize it, Tony, that they have bottomed out at this point. And we are encouraged by what we were able to accomplish in the second quarter on spot prices on these higher value-added products. But, again, we are just getting back to what I characterize as recession-level pricing. And we are hopeful that as this increased demand or the inventory overhang, whichever way we play it, as that gets resolved here, that we will start to see some pricing ability, enhanced pricing ability as we move forward.

Thanks for that color, Jack. And the one final question I have is, in terms of CapEx, if you have any thoughts that you could share with us from a 2012 standpoint, obviously excluding any acquisitions, but just from a CapEx standpoint. Obviously, your spending from your plants and all the modernization work and Trentwood and Kalamazoo is behind you, but just wanted to get a feel for that.

Yes, Tony, we -- and it was in the prepared remarks there, but we expect that we will be in that $40 million range again in 2012. So it's not that 80 level that we averaged over the prior five years, but it's also a far cry from the $15 million that we characterize as sustaining. We've still got a lot of good opportunities, and we think we can sustain internally about a $40 million pace, at least for the next couple of years, and probably beyond that.

Thanks, Jack. Listen, congrats on all the hard work, and it looks like it's going to come to fruition. Thank you.

(Operator instructions) Mark Parr, KeyBanc.

Hi, this is [Phil] sitting in for mark. How are you? I have a question on the EBITDA margins, EBITDA over VAR. I know that you said that value-added revenues are likely to be similar to the first half. Now, with efficiencies from Kalamazoo, are you expecting that, you know, call it 24% level to expand or stay solid? I wasn't sure how to read that.

Are you using 24% as a fab margin?

I am using --

Because all the conversation we've had so far has been about the total Company margin, which --

Yes, Jack, I'm using the 32 over the 160.

Yes, so you are using fab?

Yes.

Well, let me go back, because it should be the same basic discussion. For the corporate, we averaged 17% in the first half and we think we will get a lift from selling prices, the margin squeeze. And we think we will get a lift from operating efficiencies with Kalamazoo certainly being a big part of the improvements in operating efficiencies. But we will have a significant offset to those with much higher major maintenance spending in the second half of the year. Same phenomenon occurred last year; we had a 5-point drop in margin from first half to second half last year, with a lot of that caused by major maintenance.

So a lot of improvement that we are getting in underlying prices and efficiencies will be offset by the major maintenance. That's why I've been saying consistently here through the call that while we were 17% in the first half, we will be better with underlying, we are still going to be in the high teens, we think, in terms of margin. We'll get another point or two or maybe 3. But that's about all there is, we think. There may be more than that, but at this point that's the way it looks.

Can you help me bridge or support what I would say Reliance has been saying on their calls relative to the strength and I would just say the general engineering type market? They are saying a lot of price increases went through in the second quarter, not only in plate but in sheet, and they see that as one of the stronger parts of their business in the industrial side. Is that what you are referring to is starting to bleed more into the second half as far as the pricing is concerned?

Yes. I didn't listen to the Reliance call, although I got a few reports on what Dave or Greg -- I don't know if it was Dave or Greg who was making those comments. I wouldn't characterize it as the kind of strength that has been reported to me that Dave and Greg were talking about. But, certainly, we are seeing improving strength here, and that goes back to the comment I made in response to Tony's question.

We had relatively good success recovering the margin squeeze. And you remember on the first quarter I quite a bit of angst that we were really getting squeezed there and we weren't having much success getting the prices to pick up. We had good success in getting the prices back up to normal recession levels here in the second quarter.

We think that the groundswell is building in terms of these supply-demand relationships that should benefit us in terms of pricing, but we are not seeing that on the supplier side yet to the magnitude that has been reported to me that Dave and Greg said. But I think we will be seeing improving ability to pass through prices, if that wasn't too vague.

Okay, and it looks like $25 million or so of CapEx allocated to the back half. How much of that would be related to -- call it your maintenance spend? I know you have to do typical maintenance in this business on the front end. How much is related to growth?

I'd say it has been, order of magnitude, $40 million this year. Dan said $35 million to $45 million, and I'd just use $40 million. And we say that $15 million is normal sustaining level. So it's that same basic relationship of $25 million to $15 million. What's that, 60%-40% kind of a ratio. And I don't know that it's any different in the second half versus the first half. We've got the Alexco expansion, and there's capital going into that. We've got other debottlenecking and other projects. So we haven't really broken it down as to which is which.

And just lastly here, what are your thoughts on -- call it further acquisitions? Are you looking for more product extensions, more tuck-ins, something for the aerospace or energy? Anything to diversify product forums? Just curious about your thoughts. And that's all I have.

Well, we are very pleased with the Alexco and the Nichols acquisitions. And so first part is similar types of bolt-ons or tuck-ins, as you characterize those. But we do look at additional product line extensions. So it really is a function of what's actionable, but we have a big inventory of prospects that we monitor and look at, and then some come over the transom that we hadn't even considered that we look at as well.

So I wouldn't narrow the field so much, other than saying that we really like the Alexco and the Nichols wire model, and wherever we can find something similar to those, whether they are product line extensions or if they fit right in the core of what we are doing, we will do those.

Tim Hayes, Davenport & Co.

Just one question on the -- you mentioned the inventory of the aluminum plate being in better balance for the OEMs. Does that hold true also through the service vendors?

I couldn't say, Tim. I'm not sure where the service centers stand in terms of their inventories, but I can tell you that the reports that I'm getting back from my folks in the field is that there's a definite change in tone from the service centers as they talk about what they expect their needs to be in 2012. I'd even go so far as to call it a sea change.

So I don't know where they are in terms of their inventories, but the sense I get is it's almost unanimous across the board of service centers being a lot more aggressive to us talking about how much material they want to buy next year compared to this year.

Very good, thank you.

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

Okay, thanks, everyone, for joining us on the call today and we look forward to updating you on our third quarter call in October. Thank you very much.

This concludes today's conference. We appreciate your participation.