Alcoa Corporation
Q2 2007 Earnings Call Transcript

Published: 10 Jul 2007

[Operator:]

Good afternoon, ladies and gentlemen, and welcome to the Alcoa 2007 second quarter earnings conference call. (Operator Instructions) I would now like to turn the call over to the Director of Investor Relations, Mr. Tony Thene. Please proceed, sir.

[Tony Thene:]

Thank you. Good evening, and thank you for attending Alcoa's second quarter 2007 analyst conference. At today's conference, Chuck McLane, Vice President and Chief Financial Officer, will review the second quarter financial results, as well as current and next quarter's anticipated business condition. In addition, Alain Belda, Chairman and CEO, will then give an overview of the current market conditions and recent events. Before I turn it over to Chuck, I would like to remind everyone that the information discussed on this call contains forward-looking statements that involve future events and known and unknown risks and uncertainties, including current expectations regarding Alcoa's future performance and the potential benefits of the combination of Alcoa and Alcan. Actual results may differ materially from those discussed today in our presentation. Additional information concerning factors that may cause actual results to differ can be found in Alcoa's and Alcan's respective filings with the U.S. Securities and Exchange Commission; and in Alcan's case, the Canadian securities regulatory authorities. Lastly, certain portions of this discussion concerning the proposed transaction are addressed in a registration statement which Alcoa has filed with the SEC and the Canadian securities regulatory authorities. We urge you to read the registration statement, because it contains important information. In our discussion today, we have also included some non-GAAP financial measures. You can find our presentation to the most directly comparable GAAP financial measures, calculated in accordance with generally accepted accounting principles, and all related reconciliations on our website at www.Alcoa.com under the invest section. At this point, let me turn it over to Chuck.

[Chuck McLane:]

Thanks, Tony. Good evening, everyone. In the second quarter, we continued to deliver outstanding results, achieving the second-highest earnings in the company’s history. Income from continuing operations was $716 million, or $0.81 per share. Included in our results was a favorable after-tax restructuring adjustment of $21 million, or $0.02 per share. This adjustment was generated as a result of completing the soft alloy extrusion JV with Sapa. The quarterly results also included $0.02 per share in after-tax transaction costs stemming from our outstanding offer from Alcan. As you can see, these offset one another in the quarterly earnings. It is worth noting that the strong results were achieved despite the $36 million or $0.04 per share of curtailment costs at Tennessee and Rockdale. Sequentially, all of our downstream segments improved, and three of four achieved record quarterly earnings. Quarterly revenue of $8.1 billion, an all-time high, was up 2% sequentially and 3.5% higher than the year-ago quarter. Just as a reminder, we completed the JV for soft alloy extrusions on June 1st. Once we did that, those revenues ceased to be included in our consolidated results. Were we to have included those in our consolidated results, our revenues would have been $8.3 billion. Cash from operations was a quarterly record of $1.35 billion, up $650 million from the year-ago quarter, and $822 million sequentially. Debt to capital at 29.4% continues to decline; in fact, this is the lowest level since the fourth quarter of 1999. We have achieved that leverage ratio despite being in the midst of a peak year of capital spending. We continue to exceed the cost of capital with an ROC of 11.8%. Excluding our growth investments, return on capital would stand at 14.7%. With those highlights as a backdrop, let’s move on to the income statement. Cost of goods sold as a percent of sales increased slightly on a sequential basis. Excluding the primary business curtailment and start-up costs, the underlying improvement was driven by productivity. SG&A costs as a percent of sales remained flat at 4.5%, though they included $26 million of transaction costs. Restructuring charges were a credit of $57 million. The main driver was the completion of the Sapa joint venture as the asset valuations were higher than originally anticipated. The corresponding tax rate for the transaction was also higher than originally forecast. The original net impairment that we took last year was therefore reduced accordingly. The net impact to after-tax earnings from restructuring was $21 million, or $0.02 per share. Interest expense increased due to slightly higher debt levels. Let’s move to the next slide and compare the performance against the sequential quarter. This chart illustrates the operational improvement captured in the second quarter. We were able to offset cost inflation and currency impacts with improved mix, volume and productivity, with each of our downstream segments showing improvement sequentially. The three main detractors from profitability on a sequential basis were lower LME pricing, primary curtailment costs and higher start-up costs in Iceland, all of which were either publicly disclosed or readily available. In addition, on a quarterly year-over-year basis, productivity, volume and mix completely offset cost inflation, energy and currency. Now let’s spend some more time on the details and walk through each one of the segments. For the Alumina segment, ATOI increased $16 million, or 6%. This increase was driven by slightly higher pricing and increased shipment volume, but partially offset by a continued weak U.S. dollar. In fact, the Australian dollar and the Brazilian real appreciated approximately 6% in the quarter, which led to a reduction in profit of $14 million sequentially. In addition, costs associated with the first quarter Guinea strike totaled $9 million in the quarter. Production was up 4% sequentially, right in line with the guidance we provided last quarter. In the third quarter, we anticipate a consistent level of production and shipments. Next, let’s move to the Primary segment. Sequentially, Primary Metals ATOI decreased by 8% due to the following

[Alain Belda:]

Well, thank you, Chuck and good evening, everyone. I am certainly pleased with another strong quarter. We achieved the second-highest quarterly earnings in the company's history, the highest quarterly revenue in the company's history, the highest quarterly cash from operations in the company's history and improved earnings and margin in all our downstream businesses. On a half-year basis, we have established all-time records for revenue, net income, earnings per share and cash from operations. We are well on our way to another record year of financial performance. Now, I'd like to give you an update on the alumina market, and then close with a quick update on the many activities within Alcoa. But first, let me review our safety results. For those of you who may be new to this quarterly report, we always start with our safety numbers. Safety is one of our key substantial metrics and is a good leading indicator of how we run our businesses. For the second quarter 2007, our lost work day rate was 0.07, and our total recordable rate 1.12. Year to date, we have 306 locations that have not had a lost workday incident. That is 87% of the total Alcoa locations worldwide. This is benchmark performance for a global industrial company. Superior performance in this area of safety is not just the right thing to do, it also has a positive financial impact. Between 2001 and 2006, our cost for worker comp claims decreased from about 15% due to the reduction of severe claims. That reduction is worth more than $4 million per year. Now, let's get into current market conditions. On the demand side, China remains the major driver of growth. We project a consumption increase of 34% year over year. This is 60% higher physical consumption than the U.S. and 43% higher than Europe. Rapid urbanization is driving a tremendous demand in markets such as building and construction, consumer durables and high voltage transmission lines. For the other regions of the world, we see the following

[Operator:]

Our first question comes from Kuni Chen - Banc of America Securities.

[Kuni Chen:]

Thanks and good afternoon. I want to ask about the upstream project pipeline with the potential merger with Alcan. Do you envision the pipeline changing substantially if Alcan and Alcoa merge? Phrased differently, do you think the organic growth potential of the combined company will be any different than if the two companies are separate?

[Alain Belda:]

No, I think the organic opportunities for the new company are the same. The opportunities continue to be in aerospace, transportation, marine, building and construction, all the same fields, and packaging.

[Kuni Chen:]

So the growth potential is the same, whether it's a combined company or whether they are separate?

[Alain Belda:]

The areas of opportunity are the same. The ability to do the right investment, if you're talking about upstream. On upstream, the opportunities are also to improve the risks that are inherent to the choices that we have to make as we look for energy around the world and decide where we're going to invest. Every plant is a major capital expenditure, they cost over $2 billion. The political risk of every decision is different. So I think it permits us to optimize investment decisions, location decisions and also permits us to choose to expand on brownfield opportunities rather than greenfield opportunities.

[Kuni Chen:]

Thank you.

[Operator:]

Your next question comes from Rob Clifford - ABN Amro.

[Rob Clifford:]

Good afternoon. Along a similar vein, I wanted to explore the enhanced capacity for growth point that you talked about in the merger, along with your debt to capital guidelines of 30% to 35%. Now, with the large cash component, it will exceed that, certainly our numbers, pretty easily. Does that mean that you will curtail organic growth if you're successful in the Alcan deal to bring yourself back to that 30% to 35% rapidly, or would you scale down to that over a number of years?

[Chuck McLane:]

I think we've said from the beginning that once the transaction is consummated, that we will definitely go above that target range of 30% to 35%. If you looked at our pipeline right now in something that gets started we've got projects that are going on that are in our pipeline, but no new ones in a very short timeframe of two to three years. So I don't think it's going to inhibit us. We already understand the leverage ratio that we are dealing with, but there's also a strong set of cash flows that are coming, especially those projects that are currently in progress, that will start to generate cash flows next year and the year after.

[Operator:]

Your next question comes from David Martin - Deutsche Bank.

[David Martin:]

Thank you. Chuck, I wanted to come back to your comments about the fasteners business. There's been a lot of press and trade reports about yours as well as the industry's inability to supply fasteners to Boeing. Can you give us a little perspective on the issue, and maybe some numbers around the growth in that business for you?

[Chuck McLane:]

Well, I can tell you that as you are aware, the backlog is significant and the deliveries are beyond anybody's estimates for this year. Certainly what came out of the Paris Airshow was beyond the expectations as well. Fasteners are one of the things that have been listed as something of a supply chain issue to deal with. I can tell you that we're working with our customers on a day-by-day basis to fulfill all of their requirements, and we have capacity that is being increased in certain locations in order to help meet those demands. But without getting to a specific number for you on growth, I would just as soon stay away from that.

[Operator:]

Your next question comes from John Tumazos - John Tumazos Independent Research.

[John Tumazos:]

Good afternoon. If for the September and December quarters the exchange rates and energy prices and outlooks were exactly as today and exactly as you described, how much higher would your cost per unit be on average in the third and fourth quarters?

[Chuck McLane:]

From an exchange rate standpoint?

[John Tumazos:]

Exchange rates, energy prices and outlook as you've described. Use a range, if it simplifies anything, Chuck.

[Chuck McLane:]

Well, energy really has a lot to do with us, as you are probably aware, on rain in the third quarter. That's why we list it as a seasonal cost to us. So you tell me how much rain is going to fall, and I'll tell you how much the cost is going to go up. But on the exchange rate side -- look, it changes quarter to quarter, but I will give you a rule of thumb. If you've got a 1% change in the value of the dollar to our other major currencies, it's about $0.02 a share. Will that vacillate from quarter to quarter? It may, but it's a good rule of thumb for us.

[Operator:]

Your next question comes from Greg Barnes - TD Newcrest.

[Greg Barnes:]

I was wondering if you can give us any clarification on what the next steps are for the European competition authorities and what timing might look like?

[Alain Belda:]

Well, this is the way it goes. You are going to have to submit the application once they comment on the draft application we made. I'm sure they are going to be working with the US DoJ as they normally do and this process will follow the normal process like you've seen many of those before. It just continues to go on, and we will answer the questions. There's nothing new here.

[Greg Barnes:]

Do you have a timeframe on when their comments could come back to you on the draft?

[Alain Belda:]

No, no, we don't have a timeframe.

[Operator:]

Your next question comes from Rob Clifford - ABN Amro.

[Rob Clifford:]

If you could give us an update on Iceland, you mentioned before the massive capital costs in putting in greenfield smelters and political risks. I just wonder if you could outline some of the things you've learned about securing power and what has gone on there, and how that is progressing in terms of the ramp-up?

[Chuck McLane:]

Securing the power, we are perfectly satisfied with the situation in Iceland from a hydro standpoint and a power standpoint. Some of the costs that we incurred were higher construction costs that most everyone else has been incurring during the ramp-up stage of that smelter being built. But I can tell you, even with pretty conservative metal prices and the capital costs that we have, where they are placed on the cash cost curve and what kind of return we will earn over the long term, we're still totally satisfied with.

[Rob Clifford:]

So the power has come on stream as you expected?

[Chuck McLane:]

No. The power is not coming on stream. I thought you were referring to cost of the hydro project. It is a delay. We're working on temporary power right now and we're working with the authorities there that run the power project to get it up into a permanent situation as quickly as possible. We think that's going to be building up during the fourth quarter, and we still anticipate that next year we will get the full capacity out of that facility.

[Rob Clifford:]

So was the delay just due to slow construction or technical problems with the power side of the project?

[Chuck McLane:]

It was some problems in actually the tunnels being built and the extra concrete that had to be put up to support the tunnels.

[Operator:]

Your next question comes from Tony Rizzuto - Bear Stearns.

[Tony Rizzuto:]

Thank you very much. With regard to the European regulatory environment, would you be prepared to divest ESWA if required to do so?

[Chuck McLane:]

We will have to decide what we divest as we get the questions, Tony. We are not prepared to start negotiating or talking about that at this point in time.

[Tony Rizzuto:]

As a follow up, if I may, on Russia you mentioned improved performance. Could you quantify what that may have been in terms of the numbers, give us a little detail on that in the quarter?

[Chuck McLane:]

Well, if you looked at the reconciliations that we have, Tony, you would see that Russia, China, in Bohai and Kunshan had a loss of about $30 million last quarter, and it and down to about $15 million this quarter. You can assume most of that improvement was Russia.

[Tony Rizzuto:]

It sounds like you are ahead of plan to possibly get to breakeven by end of year. It sounds like you might be a little ahead of target on that?

[Chuck McLane:]

No, that's still our plan.

[Operator:]

At this time, we have no more questions in queue. I would now like to turn the call back over to Mr. Thene. Please proceed, sir.

[Tony Thene:]

Thank you for attending the call tonight. That now ends the second quarter 2007 analyst call. Thank you.