Kaiser Aluminum Corp (KALU) 2012 Q3 法說會逐字稿

Good day, everyone and welcome to the Kaiser Aluminum third-quarter 2012 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to Melinda Ellsworth. Please go ahead ma'am

Thank you. Good afternoon everyone and welcome to Kaiser Aluminum's third-quarter 2012 earnings conference call. If you have not seen a copy of today's earnings release, please visit the investor relations page of our website www.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; Executive 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 two slides 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 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 annual report on Form 10-K for the full year ended December 31, 2011, and Form 10-Q for the quarterly period ended June 30, 2012. 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 and reconciliations to 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. We were pleased with our third-quarter results that continued the positive momentum from the past few quarters. Similar to the results from the first six months of this year, the third-quarter results reflect strong aerospace and automotive demand and strong pricing on high value added products. The third-quarter results gained additional boost from steadily improving manufacturing cost performance across our platform, especially in the rod and bar value stream at our Kalamazoo and LA facilities and in our heat treat plate processing at Trentwood.

Overall the year-to-date results reflect the early stages of realizing the full benefit from capital investments that we've made to increase capacity, expand our product offering, and improve efficiency and quality. An additional observation for the third quarter is that our value added revenue was similar sequentially to the second quarter, as our general engineering shipments did not exhibit their normal seasonal weakness. However, we anticipate a much more pronounced seasonal impact for the service center applications in the fourth quarter to bring the second-half value added revenue in line with the outlook that we communicated on the prior earnings call, meaning that we expect the second-half value added revenue to be up approximately 10% compared to the same period last year, but down sequentially approximately 5% from the first-half pace. The scenario for planned major maintenance spending is similar to the value added revenue story line. Our third-quarter major maintenance expense was consistent with the run rate of the first half, but we anticipate that significantly higher major maintenance expense in the fourth quarter will bring total planned major maintenance expense for the second half in line with our outlook as expressed on the last earnings call.

Also as we indicated on the last earnings call, with all other things being equal, the combined effect of lower volume and higher planned major maintenance costs would have a negative impact of 3 to 4 percentage points on our second-half EBITDA margin compared to the first half. However, all other things are not equal. We anticipate that improvements in the underlying manufacturing cost performance as demonstrated in the third quarter will largely offset the negative effect of lower volume and higher major maintenance expense, resulting in second-half EBITDA margins similar to the first half.

Turning now to slide 6, our trailing 12 months value added revenue and adjusted EBITDA, EBITDA margin, net income, and earnings per share are all new records. These record results illustrate meaningful progress toward the long-term potential of the existing platform to achieve value added revenue well into the $800 millions and EBITDA margin into the high 20%s. Of course, we also have financial flexibility to make prudent strategic investments both organic and inorganic to further expand our platform and drive additional top line and bottom line growth.

I'll now turn the call over to Dan to provide further insight into our third-quarter results and then I'll provide additional color and context regarding our short-term outlook. Dan?

Thanks, Jack. Going to slide 7, with strong demand for our aerospace and automotive products, our value added revenue in 2012 continued at a higher pace than in 2011. For the third quarter of 2012 value added revenue was 14% higher than the prior year and down only slightly compared to the second quarter and the first-half pace, as we saw some seasonal weakness and lower shipments for only some of our products, but as Jack said, we anticipate more pronounced seasonal weakness in the fourth quarter. As we look at each of our end market applications, aerospace and high-strength value added revenue improved substantially in 2012 relative to 2011 periods, due to strong demand and higher utilization of our aerospace plate capacity additions. Value added revenue was up 14% for the third quarter and 25% in the first nine months over the comparable periods of 2011. Stronger demand drove higher shipments and improved pricing on high value added products. We also benefited from lower contained metal costs that were not passed through on some high value added products.

The value added revenue for automotive extrusions also showed improvement over 2011 with the third quarter and the first nine months of 2012 increasing 11% and 15% respectively compared to the prior-year periods, primarily reflecting improved pricing on some of our automotive products. We did see, however, a slight decline from the third quarter on value added revenue for automotive, consistent with our expectation of normal seasonal weakness in the second half of the year. Due to model changeovers our year over year shipments in pounds have lagged year over year in North American build rate increases, but as new programs with Kaiser extrusions launch, we anticipate our volumes will improve with both build rates and content increases. General engineering showed year over year improvement with value added revenue for the third quarter and first nine months, up approximately 25% and 13% respectively compared to the 2011 periods. And relative to the second quarter, third-quarter value added revenue improved 6%.

In addition to higher volumes, improvements reflected stronger pricing on higher value added products and lower contained metal costs. Despite these improvements, demand remains weak in the slowly growing North American industrial economy and we anticipate especially pronounced seasonal weakness for service center applications in the fourth quarter. You can find more detail on value added revenue in the appendix on slides 21 and 22. Trends for adjusted consolidated EBITDA on slide 8 show a step change improvement in 2012 compared to the 2011 levels. Third-quarter adjusted consolidated EBITDA of $48 million was a 71% improvement over the prior year. For the first nine months of 2012 adjusted consolidated EBITDA was $138 million, a 70% improvement over the prior-year period. Stronger shipments in most product categories, a more favorable pricing environment, greater operating leverage, and better underlying cost performance all served to drive this improvement.

On a sequential basis adjusted consolidated EBITDA improved $2 million in the third quarter on virtually the same value added revenue as the second quarter. An EBITDA margin as a percent of value added revenue grew to 26% in the third quarter as we saw sustainable improvements in our underlying cost performance, particularly at our Trentwood facility and in our soft LA rod and bar value stream which includes our Kalamazoo and Los Angeles extrusion facilities. While major maintenance in the third quarter was similar to the levels of the first half of 2012, we are planning higher major maintenance activity in the fourth quarter. As we have mentioned before, major maintenance expense tends to be incurred unevenly throughout the year and therefore can have a noticeable impact on EBITDA margins from quarter to quarter. Reviewing longer periods removes the quarterly variation to show a more meaningful trend. For example, on a trailing 12 month basis we have continued to set new records each quarter this year for adjusted consolidated EBITDA and EBITDA margin, which for the 12 months ending on September 30 were $168 million and 23% respectively. This further supports our view that in normal market conditions our existing platform has the potential for annual value added revenue well beyond $800 million, and EBITDA margins in the high 20% range.

On slide 9 we showed key consolidated financial metrics. Consolidated operating income as reported was $56 million in the third quarter and $142 million for the first nine months of 2012. These included non-run rate gains which are detailed in the appendix on slides 23 and 24. Adjusting for the non-run rate items, consolidated operating income was $41 million for the third quarter and $118 million for the first nine months of 2012, reflecting approximately a 90% improvement over the comparable 2011 periods. This was driven by an improved pricing environment, stronger shipments across most in these categories, greater operating leverage, and improved underlying cost performance.

Reported net income for the third quarter was $29 million, or earnings per diluted share of $1.51. Adjusting for non-run rate items, third-quarter net income was $20 million or adjusted earnings per diluted share of $1.02, showing a significant improvement from the prior year. Our effective tax rate was approximately 38% as of the end of September. However, given our sizable net operating loss carry-forwards and other tax attributes our cash tax rate remains in the low-single digits. Cash from operations in the first nine months of 2012 of $107 million continued to more than fund capital spending, cash interest, and dividends. And our strong financial flexibility keeps us well positioned to continue to invest in value-creating organic and acquisition opportunities. And now Jack will discuss industry trends and our business outlook. Jack?

Thanks, Dan. Turning to slide 10 and our outlook for aerospace and high-strength applications we continue to be very bullish regarding both the short-term and long-term prospects for our aerospace and high-strength applications. For the fourth quarter we expect value added revenue for these applications to be similar to the third quarter as we anticipate the continuing strength in aerospace plate demand will offset seasonally weak service center order patterns in our other aerospace products. All indications for 2013 aerospace demand are very positive and we have expect that our order book will fully utilize our heat treat plate capacity including the Phase 4 expansion next year. Looking beyond 2013 we remain optimistic as we anticipate that the large order backlog for airframes will drive steadily increasing build rates throughout the remainder of the decade, and we will continue to monitor market and customer needs to determine if and when additional heat treat plate capacity will be required beyond Phase 4 that will be online by the end of this year.

Turning to slide 11 and our automotive applications, while the full-year North American industry automotive build forecast is expected to be up approximately 15% compared to 2011, the second-half industry build rate is expected to exhibit seasonal weakness and be down approximately 7% from the first-half build. As a reflection of the seasonal reduction in industry build rate, we anticipate that our second-half automotive value added revenue will be down 5% to 10% from the first half. There are two offsetting factors embedded in this outlook; model changeovers on certain bumpers and structural programs depressed our first-half volume, but new programs are launching in the second half, boosting our shipments for these applications. On the other hand, the strengthening currency exchange rate for the US dollar compared to the euro has had a negative effect on exports of our ABS blocks for European applications. As we look further ahead to next year we anticipate that industry build rates will grow a small amount from this year, but we anticipate that our automotive value added net revenue growth will substantially exceed the industry build rate growth as we continue to benefit from growing content as a result of automotive platforms adding aluminum applications for increased fuel efficiency.

Slide 12 addresses our outlook for general engineering applications. As is typically the case, the outlook for these applications is clouded with uncertainty related to year-end order patterns from service centers, and this year that uncertainty is exacerbated by the elections and the year-end fiscal cliff. Based on the unusually strong third-quarter service center demand and feedback from our service center customers, we anticipate a significant seasonal impact for general engineering applications in the fourth quarter and expect value added revenue for these applications to be down sequentially approximately 15% to 20% compared to the third quarter.

Turning to slide 13 and a summary of our short-term outlook, we anticipate that significant year-end seasonal weakness in orders from the service centers will result in a sequential decline in our overall value added revenue to 5% to 10% below the third quarter. With less operating leverage and significant planned major maintenance spending in the fourth quarter we anticipate that our adjusted fourth-quarter EBITDA margin will be in the low 20%s. Despite our expectation for strong headwinds from the seasonal weakness and the higher planned major maintenance spending in the fourth quarter, we still expect that our fourth-quarter results will compare favorably to a very strong fourth quarter last year, and we expect that despite less operating leverage and higher planned major maintenance expense our second-half 2012 EBITDA margin will be comparable to the record 23.7% margin in the first half of 2012. Looking ahead to 2013, while there is still significant uncertainty surrounding the US economy, we expect to enter next year with very strong momentum from 2012. We foresee continuing growth in aerospace and automotive demand, and with increasing operating leverage and improving underlying cost performance, we anticipate that adjusted EBITDA margin next year will continue to improve from the record 23% pace achieved over the last 12 months.

Slide 14 summarizes our remarks today. Our record quarterly nine-month and last-12 months sales and earnings results are evidence that we are in the early stages toward realizing the significant potential of our existing platform. While we expect seasonal weakness in the fourth quarter, we expect to enter next year with strong momentum from the record 2012 results. We're optimistic about our prospects in 2013 based on strong underlying demand growth for our aerospace and automotive applications, our expanded capacity that we have created to meet this demand, and the steady and sustainable improvement evident in our underlying manufacturing cost performance. Longer term, we're very well positioned with financial flexibility and additional capital efficient investment opportunities to benefit from the long-term demand growth expected from these very attractive markets. We will now open the call for questions.

(Operator Instructions)

Tony Rizzuto, Dahlman Rose.

I've just got a couple questions. By the way, congratulations on all the progress and seeing it in your numbers is just -- it's very exciting and you're welcome. My first question, I just want to make sure I understand your guidance correctly, because it seems a little bit different in some of the statements that were made. I think, Dan, you talked about that the second-half EBITDA margins would be similar to the first half and the first half averaging 26%, a little bit above that. And then in slide 13 the fourth-quarter EBITDA margin in the low 20%s and I just wanted to make sure I'm thinking about this correctly. That's my first question I've got. I've got a couple others, too.

Tony, just a couple of corrections in there. The first-half EBITDA margin was I believe 23.7%, and in both Dan's comments and my comments we said we expected that the second half would be similar to that. The second half included a 26% in the third quarter and we said somewhere in the low 20%s probably in the fourth quarter. You put those together, that averages out the second half to roughly the same place as we were in the first half plus or minus 1 point or so.

Okay.

And we put a lot of numbers in there and a lot of statements. I understand how it could be confusing, but hopefully that clarifies it.

Okay. Just wanted to verify that and then a lot of comments from both you and Dan about -- and in the press release about the early stages of operational efficiencies and sustainable improvement. It is very exciting and would I be off base if I thought about margins for 2013 that could climb up to a range of maybe 28% to 30%? Would that be unfair or unreasonable?

What we said is that we expect margin improvement as we move into next year from the operating leverage. I don't know that we'd put a specific number in there, but high 20% is -- I don't think we'll be seeing numbers like that or predicting numbers like that for next year.

Okay, okay. I was wondering if you could -- I know it's very early but if you could give us a little bit of preliminary color on expectations for major maintenance in 2013. I know it's going to be determined by the prospects for Phase 5, et cetera, and how you size up the markets' end demand for your products but I was wondering if you could maybe address it a little bit just to help us frame it a little bit for 2013.

Actually I think 2013, I don't remember the exact number at this point, but 2013 major maintenance will not be significantly higher than this year. It probably might even be a little bit lower. I think 2011 and 2012 as we look at our history and the forecast going forward, 2011 and 2012 actually are a little bit higher than what would be a norm for major maintenance, but from your standpoint at this point until we give you more color, I'd just assume it's going to be similar to what we've been seeing in '11 and '12.

Okay. That's very helpful. The final question I have is just there's been some mixed commentary out in the marketplace about lead times and I understand lead times have come in a little bit for aeroheat treat, still a very tight market, though. But I was wondering if you guys could address a little bit and provide us with your thoughts about what you see coming into the market that may be of incremental supply that has maybe been put in place this year and as it might affect over the next maybe one or two years, that type of thing?

In terms of first-tier legitimate suppliers of aerospace plate?

Absolutely, yes.

The only expansions that we're aware of are Kaiser's Phase 4. And just looking at it from our standpoint as we've said pretty consistently here, we have a very strong order book in the fourth quarter and we expect to fully utilize the Phase 4 expansion that comes on the end of this year, fully utilize that next year.

Excellent. Thanks very much, Jack.

Dave Katz, JPMorgan.

I was hoping that we could just come back to aerospace. Would you be able to go into any impact that you saw from the Consilium labor action?

We frankly didn't see much impact from Consilium, and I'll just go back to my comment. We have a very strong order book for aerospace plate in the fourth quarter and in my comments we said we expect fourth quarter similar to the third quarter for aerospace, with plate offsetting weakness in service center shipments for other aerospace products that we supply. And we have a full order book, expect to fully utilize Phase 4 next year.

And with the order book remaining full throughout the third quarter and presumably into the fourth quarter, the value added on aero and HS went down from the second to third quarter. Is that just due to product mix?

Yes. Yes. We have -- it's impact on product mix normally.

Okay. And --

Just to clarify that to some degree, within our aerospace portfolio we've said this on several times over the years that actually plate is one of our lower value added revenue per pound products. So when plate is an increasing component of that, it's actually a mix impact that drops the value added revenue for that grouping.

Okay. And then finally coming back to Tony's question on CapEx, I know you guys in the past have indicated that a more normal maintenance spend would be something like $60 million per year, but it looks like you've been running thus far at $10 million per year. Why is that? Not $10 million per year, pardon me, $10 million per quarter.

Yes. Well, our sustaining capital spending we've always said is in the mid-teens, $15 million or so plus or minus and what we've said is that over the next five years or so we would expect that we'll be investing in the $50 million to $60 million range going forward.

Okay.

And that's capital spending and I don't know if we need to clarify again that major maintenance, as we discussed, is something that hits our expenses in the period in which they're incurred. That's separate from capital spending, and importantly it's also separate from what we call a sustaining capital spending.

Okay. Understood. Thank you very much.

Timna Tanners, Bank of America Merrill Lynch.

Our big question is this, and I'm sure that there's a limited amount you may want to talk about it, but your balance sheet looks beyond fantastic. So given that, what can you tell us about organic growth, just any more detail? Obviously you discussed it as an option. It seems to me we know that we're finally seeing Kalamazoo come through. We've got Phase 4 almost behind us in Trentwood. So what's the next -- what can you give us a preview of in terms of your next organic focus? And what you might be looking at just notionally regarding acquisitions?

In terms of organic investments we still have opportunity for capital efficient organic investments at Trentwood. We've already identified that we've defined Phases 5, 6 and 7 going forward and those would represent fairly significant capital investments if you put them all together.

We also anticipate that we'll be making investments for our automotive growth. So those is really aerospace and automotive that would be investments for top line growth, but we also have significant organic investment opportunities to continue to improve the cost and efficiency of our platform, specifically at Trentwood which is typically where we end up with big dollars, but also in other corners of our platform. So it's really a combination of good capital efficient opportunities for top line and for bottom line coming from cost improvement-type projects.

From an acquisition standpoint, as we said when we raised the money several months ago, we continue to be optimistic that there will be good solid complementary bolt-on type acquisitions in our future and we continue to have that optimism, but we're going to be prudent as we pursue those.

Okay, great. Is the $200 million destined for acquisitions? Or is that something that could be absorbed with the expansion in Spokane?

It depends, but we see significant, significant organic investment opportunities as well as we expect that we'll have good acquisition opportunities.

Got you, all right, thanks, look forward to hearing what they are.

Edward Marshall, Sidoti & Company.

The question I had was, I think I heard you say that there were lower material costs that weren't passed through to the customer in the quarter. I'm curious if you could quantify and perhaps the margin as a percent of value add revenue between that savings and say the manufacturing improvement that you put in place previously?

Well, that comment really isn't specific to the quarter. The underlying metal cost has been relatively low most of this year. So -- and we really began getting some benefit from lower contained metal costs already in the fourth quarter of last year. So we had very high contained metal costs first nine months or so or certainly the first six months of 2011. Then it began to level off and even start to come down third quarter of last year and that created some price increases.

You'll remember going back to the first quarter of 2011 we had a pretty significant price compression on our high value added, but we got price appreciation that recovered that by the middle or by the third quarter or so. And then as metal prices have regressed we've been able to hold those prices. So we've really been enjoying that additional spread for three to four quarters here.

Do you have a time line as to when that might reverse itself based on the way the contracts are laid out and timing wise?

It has nothing to do with contracts. Contracts are metal neutral. So that really only applies to spot business on high value added products. And our intent would be as metal prices go up, because the value added revenue's really established here in our opinion, our intent would be to try to pass that through.

Excellent. Thanks, guys.

(Operator Instructions)

Steve Levenson, Stifel.

In relation to the Phase 4 expansion, will the output on aerospace be able to carry you through the currently planned build rates through 2014, or will you need phase 5 to get up to that level?

We're still monitoring that in terms of what it means beyond 2013. At this point we're confident about 2013, but no outlook beyond 2013 at this point.

Okay, thanks. And is there an optimization? Is there a potential to get higher yields? I know you talked about cost performance. Is that the other side of the cost performance?

Well, whenever we do an expansion project, we also look hard for methods and means to make ourselves more cost efficient and improve our quality, and that's true in Phase 4 as well. And in future phases that also will be the case. But going back to my answer to Timna when she asked about organic investments, even if we don't pull the trigger on phases 5, 6, or 7 and I anticipate at some point that we will, but even if we don't, we'll still have substantial investment opportunities to continue to improve the efficiency of our platform.

Got it. Thank you very much.

Phil Gibbs, KeyBanc Capital Markets.

Just a question on potential uses of capital going forward. I think acquisitions were discussed already, but when do you think about at this point in time in raising your dividend? It seems like your cost performance has improved to a point where it should be sustainably lower. When do we think about potentially raising that?

We obviously discuss that with the Board every quarter. We have a Board meeting here in December and I don't know when we'll actually announce for the first quarter, but that certainly is something that will be on the agenda for discussion at the next Board meeting.

Okay. And what should we think about as far as incremental impacts of the maintenance outages that you'll be taking in the fourth quarter?

We don't see that that will have any meaningful effect on our operations. Most of the things that we'll be doing in the fourth quarter are typical furnace rebuilds, and again part of the reason that they fall so much in the fourth quarter is because we typically see a big seasonal decline in demand. So we have the equipment hours available to do the major maintenance in the fourth quarter without really affecting operations.

Okay. And just the last one, if I could. The general engineering business, is there any reason in your mind that that business is relatively stable in the third quarter versus the first half from a volume perspective that you would have thought it would have had to come in?

That's a good question, Phil, because the reports I was getting from the field in July were that the end of the world was coming and that we were really going to get creamed in general engineering in the third quarter and obviously that didn't happen. We think we're going to get creamed in the fourth quarter. So the second half's going to end up pretty much where we thought it would be.

My analysis is that I think a lot of the fourth quarter actually got pulled into the third quarter for whatever reason and I frankly don't know that reason. But what we're hearing from all of our service center customers is that they're hammering on inventories right now and their order patterns are very weak here in the fourth quarter which is not unusual. The fourth quarter is almost always weak in terms of service center demand. Just so I guess it's going to be a little bit more so this year, but I think part of that's because the third quarter didn't demonstrate its normal seasonality. So I think it's just lumpiness here and that's why we look as Dan said in his comments more at six-month buckets rather than three months. There's just a lot of noise and volatility quarter to quarter.

Can -- one more, if I could. I just was curious in the aerospace business as far as end market applications. Where do you see the differences and the plate versus some of the tubing products? And some of the bar that may come out of Alexco and are there different drivers to those two different dynamics?

About the only difference in driver that's actually a good question that will cause me to contemplate here for a moment. But the key demand drivers are basically the same. The big demand driver is commercial aerospace for all of those applications, be it plate, sheet, aerospace extrusions, or aerospace tubing, and then a secondary demand driver is defense aircraft applications because again virtually everything that we do there's a minor sliver there. But the preponderance goes into airframes, either commercial airframes or defense airframes.

The biggest difference between plate and the other aerospace products is that while some of our plate goes through service centers, the preponderance of plate is on contracts with the big OEMs, whereas the sheet to a lesser extent but especially the extrusions, the rod and bar, and the tubing is very heavily weighted toward going through service centers. And again back to just the phenomenon and I frankly can't explain it, but when we're dealing directly with the OEMs, the order patterns are much more consistent than they are when we're dealing with the service centers. So we see a lot more volatility in the order pattern for those products that are more service center intensive, even though they're driven by the same end uses. It's really just the fact that the pipeline is longer, the supply chain is longer, and we get more volatility, especially with what goes through service centers.

So in aerospace, then, is it reasonable to assume that the first quarter will likely have the benefit of some sort of restock phenomenon or seasonal phenomenon from the service centers? And then also have the added benefit of the Phase 4 on top of whatever you're going to see in the fourth quarter?

Certainly we think that the plate will see that. I'll wait until we get closer to the first quarter to predict what the service centers are going to do. My track record for predicting what they do is not very good.

Fair enough. Thanks. Good luck.

And it appears there are no further questions. I'll turn the conference back over to Jack Hockema for any additional or closing comments.

Okay. Well, thanks, everyone for joining us on the call. We're pleased with the third quarter. We're going to have a little bit of a rough patch here we think in the fourth quarter, but that really is just adjusting we think for the third quarter, strong second half, a really strong 2012 and we're really, really optimistic about 2013. With that we look forward to updating you again on our fourth-quarter call which will now be in February. Thank you, everyone.

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