Kaiser Aluminum Corp (KALU) 2011 Q3 法說會逐字稿

Good day and welcome to the Kaiser third-quarter 2011 earnings conference. Today's conference is being recorded. At this time, for opening remarks and introductions I'd like to turn it over to Vice President and treasurer, Ms. Melinda Ellsworth. Please go ahead.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's third-quarter 2011 earnings conference call. If you've not seen a copy of today's earnings release, please visit the investor relations page on our website at kaiseraluminum.com. We've also posted a pdf version of the slide presentation for this call. Joining me on the call today are Chairman, President and Chief Executive Officer, Jack Hockema; Senior Vice President and Chief Financial Officer, Dan Rinkenberger; and Vice President and Chief Accounting Officer, Neal West.

Before we begin, I'd 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 managements current expectations. 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 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 the statement to actual results or changes in the Company's expectations.

In addition, we have included non-GAAP financial information in our discussion. Reconciliations to this most -- the most comparable GAAP financial measures are included in the earnings release and in the appendix of the 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, Melinda, and welcome to everyone joining us on the call today. As I indicated on our last earnings call, third-quarter value-added revenue adjusted EBITDA and margin were similar to the first-half pace as strong aerospace demand offset the impact from normal seasonal weakness. We have a strong order book in aerospace for the fourth quarter and that strong demand is expected to continue in 2012. We're well positioned to meet this growing demand as a result of previous investments in our plate capacity at Trentwood and the expansion of our Alexco aerospace extrusion plant, which is on schedule to be completed by year end. To provide additional support for this increasing demand we recently announced further expansion of our heat treat plate capacity that is scheduled to come on-stream during 2013.

An important achievement in the third quarter involved enhancing our financial flexibility. We amended our revolving credit facility to extend the maturity to 2016, with favorable pricing, terms and conditions and $100 million of additional borrowing capacity. We're very pleased with the total package as it strengthens our already-strong liquidity position and provides additional financial flexibility for the next 5 years.

I'll now turn the call over to Dan to discuss the details for our third-quarter results. Dan?

Thanks, Jack. Slide 5 shows the trend evaluated revenue, which, once again, is net sales minus the hedged cost of alloyed metal. Consistent with our expectations discussed during the second-quarter earnings call, total value-added revenue in the third quarter was similar to the first-half run rate. Looking at value-added revenue by end-market application, as we expected, aerospace and high strength improved approximately 9% in the third quarter compared to the run rate of the first half of the year. Compared to the prior-year quarter aerospace and high strength value-added revenue increased 31% on improved commercial aerospace demand for our products.

Value-added revenue for automotive extrusions in the third quarter was roughly the same as the quarterly average of the first half of the year. However, it's also worth noting that 9-month year-to-date value-added revenue for automotive extrusions increased nearly 20% on higher build rates and the continued ramp-up of new automotum -- automotive aluminum extrusion programs. Third-quarter value-added revenue for general engineering products declined 10% from the quarterly average of the first half of the year, reflecting seasonality and cautionary destocking by many of our service center customers. Further detail on 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. Third-quarter 2011 adjusted consolidated EBITDA of $28 million reflected a slight improvement over the run rate of the first half of the year and a sizable improvement over the third quarter of 2010. We were pleased that in the third quarter, we achieved better metal cost pass-through on spot sales of our higher value-added products, recovering from the metal prices squeeze we experienced earlier in the year. However, during the quarter rapidly changing volume levels in several plants tempered our ability to flex operating costs. Also, in the third quarter we recorded two offsetting adjustments to workers' compensation reserves for approximately $1 million each relating to injuries in prior years. One adjustment reduced expenses in the corporate business unit, and the other increased expenses in fabricated products.

While segment results were affected the impact to adjusted consolidated EBITDA was essentially neutral. Our third-quarter adjusted consolidated EBITDA margin as a percentage of value-added revenue was 17.3%, a slight improvement over the 16.9% average for the first half of the year and a notable improvement over the third quarter of 2010, as stronger value-added revenue and favorable sales mix more than offset higher underlying costs.

On slide 7 we show key consolidated financial metrics. Consolidated operating income as reported of $6 million in the third quarter reflected $16 million of unfavorable non-run rate items, including $15 million of non-cash mark-to-market losses on metal hedging positions due to declining metal prices during the quarter. Details for non-run rate adjustments to operating income are shown in the appendix on slides 21 and 22. Reported net income for the third quarter was $4 million, or earnings per diluted share of $0.23.

In addition to interest expense of $4 million, the third-quarter net income reflected a $4 million non-cash mark-to-market gain on our convertible debt and related hedging transactions, which we consider to be non-run rate in nature. Adjusting for total non-run rate items, third-quarter net income was $12 million, or adjusted earnings per diluted share of $0.63. Our effective tax rate for the first nine months of 2011 was approximately 34%, and for the third quarter of 2011 was approximately 13%, reflecting the release of a $1 million tax reserve related to the prior year tax position. Our cash tax rate, however, continued to be in the low single-digit percentages as we use our sizable net operating loss carry forwards and other tax attributes.

Slide 8 shows consolidated cash flow for the first nine months of 2011. After funding the Alexco transaction in early January, adjusted consolidated EBITDA of $81 million funded cash requirements for operations and internal growth. The increase in working capital is due to higher underlying metal prices, growth in our operating activity as our end markets continue to improve, and the shift toward a more capital-intensive mix. Our year-to-date capital spending is $23 million. We expect total capital spending for the year will be between $30 million and $40 million as we complete the Alexco expansion, proceed with the Trentwood plate expansion that we announced in August and continued to invest to improve quality and efficiency and eliminate manufacturing bottlenecks. Financing cash outflows included dividends, interest payments, and principal payments on miscellaneous debt items. Total liquidity at September 30, 2011 exceeded $300 million, including cash of $24 million and availability under our recently-amended revolving credit facility of $281 million.

And now I'll turn the call back over to Jack to discuss current industry trends and our outlook. Jack?

Thanks, Dan. During the past few weeks we've been asked for our perspective on the strength of the industrial economy and the implications of a potential double-dip recession in the US industrial economy. On slide 9 we display data for service center aluminum rod and bar shipments and inventory. This inventory is provided by the Metal Service Center Institute and serves as a window to the world for industrial demand trends for our rod and bar products. The graph on the left displays service center shipments for the last 10 years, the impact of the recession of 2001 to 2003 and the current recession beginning in 2008 are clearly illustrated on this graph. The graph on the right displays service center inventories. The destocking and restocking cycles are evident and highlight the significant service center destocking during the current recession.

What conclusions do we draw from these graphs? The most important point is that there is no evidence to this point of a double-dip recession in the general industrial sector. However, the economic recovery is very modest. We believe that most of the demand improvement since the bottom in 2009 is a result of inventories coming into balance in the supply chain beyond service centers. In 2009, service center's destocked their inventories to a very low level. After some modest restocking last year the relentless talk of a possible double-dip recession has led to a round of cautionary destocking by service centers in recent months. If we do experience a double-dip recession, we expect that the impact will be much less severe than in 2009 because the supply chain inventories are already very low. On the other hand, if we begin to experience a sustainable economic recovery, there will be a need to replenish inventories throughout the supply chain.

So what does all this mean for Kaiser? While we believe the likelihood of a double-dip recession is low, if it should occur we believe we are already relatively insulated on the downside. On the other hand if the market recovers, we clearly had great growth opportunities throughout our business with the means to service the growing demand. The recent cautionary destocking of rod and bar inventories by service centers did have a short-term impact on our third-quarter operations in Kalamazoo. While service center shipments to their customers exhibited normal seasonality in the third quarter, significant destocking by the service centers exacerbated the seasonal implications for rod and bar mill demand. This short-term destocking-induced demand slump caused us to substantially reduce Kalamazoo's production output in the third quarter to avoid building excess inventory in our system.

The short-term situation doesn't change our long-term outlook for Kalamazoo. The plant is delivering exceptional product quality that exceeds our very high expectations. This bodes well for our long-term prospects for both general engineering and automotive products at Kalamazoo. The ramp up and throughput is behind our original expectations, which in retrospect were too optimistic for such a sophisticated process. However, we're making steady progress and expect that to continue. In summary, Kalamazoo's output has been less than originally expected in 2011 but we remain extremely optimistic about the long-term outlook for this plant supplying rod and bar products for general engineering and automotive applications.

Turning to slide 10, we continue to be bullish regarding automotive applications for our London, Ontario, and Kalamazoo plants. As Dan mentioned, our year-to-date value-added revenue for custom automotive extrusions has improved nearly 20% year over year. This growth is attributable to both increasing aluminum extrusion content and higher build rates trends that we expect to continue for several years. In the short term we expect that value-added revenue for the fourth quarter for general engineering and automotive applications will exhibit seasonality similar to what we experienced last year.

Turning to slide 11, the long-term prospects for aerospace applications remain quite strong. Accordingly, we continue to expect robust long-term aerospace demand growth for our products, driven by steadily-increasing build rates, larger airframes, and continued conversion to monolithic design. We expect fourth-quarter value-added revenue for these applications will be similar to the results that we saw in the third quarter, once again reflecting a healthy second-half order rate that will offset normal seasonal weakness. And again, as I mentioned in my opening remarks, we expect this strong aerospace demand will continue in 2012.

Turning to slide 12, and our near-term outlook, we've always -- we always have reduced visibility in the fourth quarter due to year-end uncertainty. With that caveat, we expect that our total value-added revenue and consolidated adjusted EBITDA margin in the fourth quarter will be similar to the third quarter, as of the strong order book for aerospace applications is expected to offset the typical seasonal weakness we see across our other end market segments.

Summarizing our remarks for today, our third-quarter results demonstrated strong underlying aerospace demand and with that continuing we expect that the fourth quarter will be similar to the third quarter. Longer term we are very well-positioned in attractive growing aerospace and automotive markets. With stronger demand and the benefit from our organic investments and acquisitions yet to be fully realized we believe we have excellent long-term earnings potential. Further, as evidenced by the recently-announced expansions of heat treat plate capacity at Trentwood and aerospace extrusion capacity at Alexco we have additional opportunities for growth. We expect that these opportunities will support capital spending of $40 million to $50 million per year over the next few years. And in addition, we will continue to consider complementary acquisitions.

We will now open the call for questions.

Thank you. (Operator Instructions). And we'll take our first question from Edward Marshall with Sidoti & Co.

Good morning and good afternoon. I wanted to spend some time if I could on -- and talk about the value-added revenue and in particular per segment. And as I look at what -- some of your prepared remarks and the MSCI data and the hedges and we can see there in your hedging activity and it's confirming what's going on in the LME pricing of aluminum then I look in your appendix and value-add revenue was up across the board for every one of your businesses. And I know they're somewhat disconnected to LME, but can you talk about maybe your outlook for pricing and was it driven by the mix of customers? What was really driving the pricing and is it sustainable?

Ed, which pricing are you talking about? You're talking about the value-added revenue per pound in the applications?

Correct. Yes, (inaudible) exactly.

Well, other than Dan's mention of resolving the margin squeeze our pricing's been relatively consistent through the year and we expect it to continue to be relatively consistent. So the bulk of what you're seeing in terms of fluctuation in the dollars per pound is a function of mix.

Okay.

And it's not just customer mix. Each one of those buckets includes a wide variety of applications that have a wide variety of prices per pound.

And am I correct that the LME is somewhat of a guidepost, but it's somewhat disconnected from your value-add revenue per pound, as well?

Well, our goal is to be totally disconnected.

Right, okay. And then inventories I saw ticked up a little bit. Is there some seasonal nature in the third quarter here, or is there something else I should be aware of> Are you building inventories?

No. The inventory -- part of it wa -- I mentioned the destocking, which caught us a little bit flat footed, and we curtailed operations at Kalamazoo, frankly, to keep from building to much inventory. But most of it is a function of just building for the very strong demand that we see coming at us in the future.

Do you expect to make up that working capital drawdown by the -- in the fourth quarter, or should it take up to the first of the year?

I'm not sure that we're going to have a significant drawdown of working capital. There may be some in the fourth quarter but as Jack said, we're building to a level we think is appropriate for the future demand.

Okay, excellent. Thanks, guys.

We'll take the next question from Steve Levinson with Stifel Nicolaus.

Thanks. Good morning, everybody.

Good morning, Steve.

Forgive me, this is the first call with you for me so I have a couple questions that maybe you can help me with.

Certainly.

But do what's customary. In terms of backlog, I don't know if you report the number but if you could that'd be great. If you can't, can you give a percentage change from year to year?

We don't report backlog, and frankly, backlog is not a very meaningful number for us, Steve. Most of our business is very, very short lead time. In the general engineering it's a matter of days, and I mean just a few days in general. In some of the aerospace products the lead times are a little bit longer, but we're really just talking a matter of days or a few weeks worth of backlog.

Okay. In that case is there percentage difference in the orders you might let us know about?

Well, again, just most of this is very short term, especially in general engineering and automotive. It really gets to the demand drivers that we talked about. So if we take it sector by sector what's happening is we have very robust demand in aerospace, as was evidenced in the value-added revenue that we reported in the third quarter, up from the first half and up substantially from the second half of last year and we expect that that's going to continue. So we're seeing very, very strong aerospace demand, much stronger than what it was a year ago.

In automotive, in Dan's remarks he commented that we were up 20% year over year. That's a function of build rates being up roughly 10%, and our content being up making up the difference, and we see that continuing. We expect that next year that auto builds are going to be up another 10% or so, and we expect that we'll have very strong content, as well, going into next year. And in general engineering there's virtually no visibility there. There's the real demand, which is pretty much flat year over year, and then there are the vagaries of restocking and destocking cycles. The destocking bit us some in the third quarter. Hopefully the service centers have ratcheted their inventories down to a low level. They're really low here, again, at the end of the third quarter. But that's just a function of how the general economy behaves.

As we indicated in the prepared remarks, we don't see evidence of a double-dip recession, even though the news cycle keeps reporting that ones on the horizon. We just don't see that so we expect we're going to see pretty steady demand going forward, and we think that the destocking is over. Again, knock on wood. We hope we'll see real demand going forward and maybe even a little bit of restocking.

Got it, thanks. One other one on the new engines for the re-engined models of the narrowbody planes, 730 Max and A320 NEO, do you see think you'll see something similar to what you saw on 747-8 with conversion of certain parts to monolithic parts, do you think you could see that same sort of percentage increase in aluminum used to manufacture of the airframe?

I don't think we'll see the same step change that we saw going from the 747-400 to the dash 8 because that was really going from the conventional fabrication technique to virtually all monolithic design for the plate requirements. The single aisles already have had a significant gravitation to monolithic design, so in terms of that step change a big additional conversion to monolithic, we don't expect to see that. At this point, it's too soon to tell what other design ramifications we'll have on demand there. But we don't think it's going to be substantial one way or the other.

Okay, thanks, last one. Are you getting any inquiries about the use of aluminum lithium alloys and if you can make plate out of that material?

Well, the aluminum lithium is beginning to gain some traction on the -- especially on the A350, the new Airbus design coming out. From our standpoint, we're not as far along as some of our competition in terms of aluminum lithium; however we do have aluminum lithium capabilities. But the real view is as aluminum lithium goes on the aircraft that's just more aluminum plate demand, so that's a good thing for the industry regardless of who has the aluminum on the airframe.

Got it. Thank you very much.

(Operator Instructions). At this time we'll take the next question from Tim Hayes with Davenport & Company.

Hello, everyone.

Morning, Tim.

A few questions. In the third quarter was there any margin benefit from the fall, the decline in aluminum prices? In Q1 we saw a mar -- bit of the margin pinch when they rose sharply, I was wondering if there was any reverse of that in Q3?

There was a little bit, Tim, and that was helpful. As Dan mentioned in his remarks that we pretty much recovered the squeeze that we had in the first quarter and certainly the falling prices helped some with that, recovering that squeeze.

But just recovering, not going beyond recovery into having an actual benefit?

Yes, there was a little bit of benefits, but not huge.

Okay. And with Kalamazoo, the last guidance range for EBITDA for the year was in the range of $10 million to $15 million. Do you have a new ran -- a new number for that?

Yes, it's going to be in the single digits this year. The destocking, as I said, we actually curtailed production for a couple of weeks in the third quarter at Kalamazoo so we got the combination of a weaker market and the ramp up has been slower than anticipated.

Okay. And then final question, was there any maintenance that was pulled into Q3 that maybe was more than what you had figured on three months ago given the soft patch with the customers that I think -- we were assuming that maintenance in the quarter was maybe $4 million to $5 million of maintenance expense, is that a good number or was it maybe more than that?

Well, we're not going to get granular on that but our major maintenance in the third quarter was pretty much what we expected. It was higher than the first half run rate, but we expect we'll have higher major maintenance in the fourth quarter than we had in the third quarter.

Okay. But the maintenance in Q3 was what you had figured it would be three months ago?

Exactly. Yes, we didn't pull anything more forward into the third quarter.

Okay. Thank you.

Thank you. And the next question comes from Mark Parr with KeyBanc.

Hey, thanks very much.

Yes, Mark.

Hi, Mark

How you guys doing today?

Good.

Good. I had a couple of questions. First, related to the value-added pricing in industrial and custom automotive, is that pricing that you've got now sustainable? It looks like the margin squeeze you had earlier in the year may have been recovered by now.

You're talking on automotive, Mark?

Yes.

(Inaudible).

Oh, okay. Well, on automotive, virtually all of that is contract business so we don't get squeezed there. General engineering, as Dan mentioned, we've recovered that margin squeeze so we think that we've got pricing that is sustainable. I would characterize pricing levels now as relatively normal for this phase of the cycle, which is still in a recessionary phase of the cycle. But yes, we think those are sustainable and if we can get some stronger demand here in the general engineering or the general industrial sector, we would expect to see some price -- improved pricing as we go forward but we're not there yet.

All right. So I'm just -- just as a follow on to that, I'm just curious if -- because earlier in the year you had indicated that the GE part of the market is really where you could really get some very aggressive profit recovery and I'm just wondering if you're seeing lead time start to stretch out in this market. Can you talk a little bit about what capacity utilization may look like right now for that piece of the business and what you would expect over the near term?

That's really the chart that we talked about. It shows the rod and bar but we're seeing a similar situation in the general engineering plate side. We really have not seen any appreciable improvement in demand. It's really -- we go through restocking and the destocking quarter to quarter and just normal seasonality. But the industrial economy, while it's not declining into a double dip, we certainly haven't seen any real strength of there. So it's pretty much a flat market in terms of general engineering.

Okay. All right. Thank you very much. I will get back into queue.

Okay. (laughter) Thanks, Mark.

I've got 17 things going on here. (laughter)

And we'll take the next question from Tim Hayes with Davenport & Co.

One follow up. On the shipments for aerospace and high strength in Q3 came in at 49 million pounds, is that pretty much the limit that you can do, say, in 2012, or until you get the incremental expansion project in place by 2013? Or is there still upside with your current configuration that the 49 could be higher come 2012?

Well, again, shipments are misleading, which is why we talk about value-added revenue because there are a lot of product in that bucket that we call aerospace. There's plate in there and we've got a very strong order rate in plate but we're expanding our extrusion facility so it will have more capacity as we move into next year. We're not running at capacity at this point in our draw and tube operation, and we certainly saw seasonality in our cold finish operations in the third quarter. So there's upside for value-added revenue as we move into 2012 versus that third quarter pace.

What about in terms of capacity on the plate side? Are you there at this point or is there more upside for 2012 on the plate products?

Yes, I don't think the shipments were at capacity in the third quarter. I frankly haven't looked the shipments that closely, but we've still got room to grow their in 2012, I believe.

Thank you.

And once again, it is star one to ask a question at this time. Once again, that is star one. That concludes today's question-and-answer session. Mr. Hockema, at this time I'll turn it back over to you for any additional or closing remarks.

Okay. Thanks, everyone, for joining us on the call today and we look forward to updating you again on our fourth-quarter and the full-year 2011 call in February. Thank you.

That does conclude today's conference. Thank you for your participation.