Alcoa Inc. (AA)

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Alcoa Inc. (AA)

Q3 2010 Earnings Call Transcript

October 7, 2010 5:00 pm ET

Executives

Matthew Garth – Director, IR

Chuck McLane – EVP and CFO

Klaus Kleinfeld – Chairman and CEO

Analysts

Curt Woodworth – Macquarie

Brian Yu – Citi

Mark Liinamaa – Morgan Stanley

Jorge Beristain – Deutsche Bank

Sal Tharani – Goldman Sachs

David Gagliano – Credit Suisse

Charles Bradford – Affiliated Research Group

Tony Rizzuto – Dahlman Rose

John Redstone – Desjardins

Paretosh Misra – Morgan Stanley

Carly Mattson – Goldman Sachs

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Alcoa earnings conference call. My name is Derik and I will be your operator for today. At this time, all participants are in a listen-only more. At the end of the conference, we will be facilitating a question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I’d now like to turn the conference over to Mr. Matthew Garth, Director of Investor Relations. You may proceed.

Matthew Garth

Thanks, Derik. Good afternoon, and welcome to Alcoa’s third quarter earnings conference call. I’m joined by Chuck McLane, Executive Vice President and CFO; and Klaus Kleinfeld, Chairman and CEO. After comments by Chuck and Klaus, we will take your questions.

Before we begin, I would like to remind you that today’s discussion will contain forward-looking statements related to future events and expectations. You can find factors that could cause the company’s actual results to differ materially from these projections listed in today’s press release and on our most recent SEC filings.

In addition, we have included some non-GAAP financial measures in our discussion. Reconciliations to the most comparable GAAP financial measures can be found in today’s press release, in the appendix to today’s presentation, and on our website at www.alcoa.com under the Invest section. Any reference in our discussion today to EBITDA means adjusted EBITDA, for which we have provided calculations and reconciliations in the appendix.

Now I’d like to turn it over to Chuck.

Chuck McLane

Okay. Thanks, Matt. Let me really appreciate everyone joining us today. As many of you know, during this quarter we encountered several operational challenges, which we attacked and resolved on a rapid basis. We restarted our Avilés smelter, maintained high aspect levels of São Luís, despite the loss of a ship unloader and have almost completely recovered from a fire at our Tennessee operations.

In a phase of a typically weak quarter, our midstream segment increased shipments and revenue and maintained margins, while our downstream segment increased revenues and achieved a record high EBITDA margin. From a liquidity standpoint, cash from operations and free cash flow improved, debt was reduced, and our leverage ratio was down 270 basis points.

Now let’s move on to the next slide and I’ll highlight the financial results for the quarter. Income from continuing operations in the quarter was $61 million or $0.06 per share, which included restructuring and other special items totaling $35 million or $0.03 per share. A decline in aluminum prices combined with unfavorable currency movements more than offset the continuing benefits of our cash sustainability initiatives and higher volumes. Despite the decline in prices, revenues were higher as a majority of our end markets continued to strengthen.

Adjusted EBITDA totaled $602 million, and our continued focus on cash helped to generate free cash flow of $176 million. We strengthened our balance sheet, reducing debt by $491 million and extending our maturity profile by roughly one year to a successful tender offer in new debt issue. These actions helped to reduce debt-to-capital to 35.7%. Lastly, liquidity remained strong with cash on hand of $843 million.

Now let’s review our revenue change by market. Revenues in many of our markets improved sequentially. Aerospace continues to rise as destocking activity nears completion and volumes rise in the investment castings business. Expanding relationships with customers in North America and Russia drove packaging sales higher, while commercial transportation continues to benefit from increased global economic activity and building and construction continues to expand its customer base.

Let’s move on to the income statement. Third-party revenues rose 2% on higher third-party shipments in the upstream business and improved demand in most of our end markets. COGS as a percent of sales stood at 83.5%, up 2.3 percentage points from last quarter due to a decline in aluminum prices, adverse currency impacts, and higher cost at São Luís.

Lastly, our effective tax rate for the quarter was a negative 82%. For your reference, we’ve attached an appendix to help gauge you through the tax rate, including the discrete items in the quarter. Our operational year-to-date rate, excluding these items, is 32%. Going forward, we would expect our operational rate to remain at that level. However, we will continue to experience swings in the rate given the volatility of the profit drivers within each taxing jurisdiction.

The next slide provides you with an overview of the restructuring of special items in the quarter and their location in financial statements. Let me briefly review each one. Discrete tax items totaled $38 million in the quarter and were largely comprised of a favorable tax ruling in a foreign jurisdiction, which allows us to carry forward net operating losses.

As we shared with you last month, the failure of our ship unloader at our São Luís facility resulted in higher cost, totaling $23 million in the quarter. In June of 2010, the area surrounding our smelter in Avilés, Spain, suffered severe flooding, which forced the temporarily idling of the facility. We’ve performed significant repair work, and the smelter began to ramp up operations in August. As a result of the flooding, we sustained charges in unfavorable impacts of $13 million, net of insurance recoveries, primarily representing higher cost in lost volumes.

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