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Edited Transcript of CENX earnings conference call or presentation 1-Aug-18 9:00pm GMT

Q2 2018 Century Aluminum Co Earnings Call

Monterey Aug 3, 2018 (Thomson StreetEvents) -- Edited Transcript of Century Aluminum Co earnings conference call or presentation Wednesday, August 1, 2018 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael A. Bless

Century Aluminum Company - President, CEO & Director

* Michelle M. Harrison

Century Aluminum Company - Interim Principal Accounting Officer, Senior VP of Finance & Treasurer

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Conference Call Participants

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* David Francis Gagliano

BMO Capital Markets Equity Research - Co-Head of Metals and Mining Research and Metals and Mining Analyst

* Jeremy David Kliewer

Deutsche Bank AG, Research Division - Research Associate

* John Charles Tumazos

John Tumazos Very Independent Research, LLC - President and CEO

* Lucas Nathaniel Pipes

B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst

* Peter A. Trpkovski

Century Aluminum Company - Finance Manager

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by and welcome to the second quarter 2018 earnings call. (Operator Instructions) As a reminder, today's call is being recorded.

I would now like to turn the conference over to our host, Peter Trpkovski. Please go ahead, sir.

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Peter A. Trpkovski, Century Aluminum Company - Finance Manager [2]

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Thank you very much, Carey. Good afternoon, everyone, and welcome to the conference call. I'm joined today by Mike Bless, Century's President and Chief Executive Officer; Craig Conti, Executive Vice President and Chief Financial Officer; and Shelly Harrison, Senior Vice President of Finance and Treasurer. After our prepared comments, we'll take your questions. As a reminder, today's presentation is available on our website at www.CenturyAluminum.com. We use our website as a means of disclosing material information about the company and for complying with Regulation FD.

Turning to Slide 2 of today's presentation. Please take a moment to review the cautionary statement shown here with respect to forward-looking statements and non-GAAP financial measures contained in today's discussion.

With that, I'll hand the call to Mike.

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [3]

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Thanks very much, Pete, and thanks as always for all of you for joining us this afternoon. As Pete said, we're joined here in the room by Craig Conti, our new CFO. We're delighted to have him here. He's got a fantastic background, great experience at ITW, and before that at GE. He's going to add huge value, here. We're quite confident, and we're looking forward to working with him. It truly is Craig's day 3 here, so we're going to give him a break and let him stay in listen-only mode for this call. But obviously, you'll all, I'm confident, enjoy working with him and you'll be hearing plenty from him in the months and obviously quarters to come.

Okay. We can turn to Slide 4, please. I'll give you a quick rundown of the last couple months. We think we had a really good quarter in the second quarter. Financial results, if you had a chance to have a quick look, came in consistent with our expectations, and Shelly will deconstruct the numbers for you in just a minute. All the plants have been stable, with strong and consistent production metrics, and given the complexity of the capacity restart projects that are in full swing, the stability of the operations are even more important than they normally are. And I'll give you an update on the Hawesville restart program in just a minute.

Pete will give you some detail on the industry environment, but in a nutshell the picture remains good, both in respect of demand growth and the growing global deficit. We see this at present and continuing for the foreseeable future.

The alumina price, as we talked to you about last time, did come down significantly over the last couple months. As you'll recall, it peaked at almost $700 a metric ton after the sanctions on Rusal were announced, and then it slid back to the mid-$400s before recently rising again to over $500 a tonne. We remain quite confident in the consensus view that the fundamental value of alumina is somewhere in the mid-$300s. That's especially with metal, kind of where it is right now, in the low-$2,000s.

We further believe there should be continued downward pressure over the next couple years, especially in the Atlantic region. That's obviously due to recent capacity additions in Jamaica -- we've talked about all this -- and those coming in the next year or so in the Persian Gulf. That said, significant overhang does remain, and we and others believe once it's cleared up the price will swiftly revert to its norms. Obviously, I'm talking about the continuing curtailment of half of the world's largest aluminum refinery, in Brazil, as you all know.

As we discussed with you a couple months ago, we believe the physical market had quickly and effectively adjusted to alternate supply lines, at least over the reasonably short- and mid-term. The majority owner of the refinery says it's continuing to work with the Brazilian authorities, and several times over the last couple months the consensus of market participants has been that an agreement to allow a restart is imminent.

We believe it's simply not productive to speculate at this point, but are very confident the parties will figure out a solution during the reasonably near term.

Moving on to the metal price, as you know, it's moved around a bit, again after sanctions were announced it rose quickly to $2,700, give or take. And after that short-term pressure was relieved, it reverted back to around $2,300, and it kind of stayed in that range, within a reasonably tight range, for a period of time.

As you know, it's recently come off by as much as 10%. This has been obviously wholly in concert with the selloff of risk assets in general. If you've had a look, aluminum has actually performed better than most, if not all, of the other base metals.

Obviously, the tariffs have been a subject of significant attention and commentary, and that's -- given everything that's out there, I'll just give you a quick update now, and then I'm happy to take all your questions.

We've seen a very limited number of country exemptions, and these have been modest in nature, as you've seen. We just need to point out the plain facts here: that tariffs have simply accomplished the administration's goals. If you take a step back and remember what they talked about they wanted to accomplish, there were 2 main parts of it. The first was creating the conditions to support the restart of U.S. primary aluminum capacity. That's been accomplished. Once all the announced restarts are back online, U.S. production will be up 60%.

Secondly, they wanted to ensure that the industry, with the other advantages it has, is competitive over the longer term. Obviously, this is so the U.S. can maintain some amount of indigenous supply in primary aluminum.

We do continue to hear some tired and misleading arguments about the U.S. industry, and thus I think it's just helpful to take a pause here and restate some facts. Those of you who know the industry of course, know that power is -- the power cost is the most significant differentiator of a smelter's competitiveness. Independent data have now shown consistently, for the last couple of years, that U.S. power cost to smelters are better than, obviously lower than, the world median. We know this to be true of our Kentucky plants, both plants in Kentucky, and we know this to be true of the market power we purchase for 75% of Mount Holly's requirements. Here, the administration's policies have also been very helpful in providing environment for the long-term competitiveness of the U.S. fuel and electric power markets.

Some people also talk about the age of U.S. smelting technology, and of course, this is important. But they fail to mention, again, those of you who follow the sector know this -- what they fail to mention is that power usage in U.S. plants is only about 10% less efficient than more modern smelters, and that this is more than offset by the favorable U.S. power price. They also don't mention the value of the proximity to customers in the most vibrant [downstream] market in the world.

The bottom line, the tariffs are having their intended effect, and that's to allow the U.S. industry to reinvest for long-term competitiveness. And bottom line, this industry absolutely can be competitive over the long term. Of course, as long as the world's excess state-supported supply isn't allowed to flood this country under the market.

So in that context, we're moving along to restart the idle capacity at Hawesville, as I said. We began energizing the cells in the first of the 3 curtailed potlines in June, project on track. This one, the first line here, as we've described to you before, is reasonably straightforward. These cells haven't been touched since we've curtailed the 3 lines in the third quarter 2015, and thus they don't require significant rebuilding. We continue to believe that this first of the 3 lines will be fully producing by the end of the third quarter.

We're also deep in the rebuild process of the other 2 curtailed lines. As again, as we've told you, we had been regularly cannibalizing these lines as cells in the 2 currently producing lines normally fail. Thus nearly all the cells in these last 2 lines require a rebuild, that's over 200 pots. So quite a significant effort. This part of the project is also proceeding on schedule, and we intend to begin restarting these lines during the fourth quarter and we continue to believe the plan will be fully operational by early 2019.

The most significant risk -- it won't surprise you, the most significant risk to the schedule remains our ability to hire enough qualified potline operators. As you all know, the manufacturing economy has really strengthened across the country, and that's no different in western Kentucky.

As a reminder, we've talked to you about this, we've been evaluating an upgraded cell technology, and the 5 test cells that we've had online have now performed for 6 months. Actually, it's probably 7 months now, at levels above the modeled metrics. And thus, we've made the decision to move forward with the technology upgrade. We do intend to break this project up into 2 pieces. There's really 3 reasons.

First is, we want to mitigate any remaining technical risk. We think that's very low given the performance of the test cells and the longevity. Number two, we want to spread the investment over a longer period of time. And most importantly, what we want to make sure is that we're able to focus on the rebuild and restart activities over the next 9 months. We want to get these last 3 lines, or last 2 lines after the third quarter, back up and running, and we don't want to risk spreading ourselves too thin.

So what we're doing first, is we're now rebuilding all the cells with an upgraded cell lining. We will realize some immediate benefits from that, through more efficient power usage and higher metal output. And at a later time, we'll introduce a new anode bed design. This will require some reworking of our anode rodding shop, and at that point in time we'll derive additional benefit in cell performance. Again, the thesis here is to mitigate risk by ensuring we can focus on what we need to get done right now, is to get those metal units back. That's where the money is, as fast as practical.

I do want to flip to Slide 5, please. Just the next page, if that makes sense, just to give you a quick summary of the spending for the full project. So if you have a look here, as I've said, the 3 potlines we're rebuilding now, in aggregate again through early 2019, $50 million for those 3 lines. And then as we've told you, there's some capital projects that go along with that, and then adding in that first phase of the technology upgrade about which I just spoke. That's $25 million in aggregate. So that first phase of the Hawesville project does have a total budget of $75 million. Again, we'll spend that through the first quarter of 2019 to get the plant to full production.

And again, to that full budget, Shelly will give you some detail on what we actually spent in the second quarter, and what we expect to spend in the next couple quarters.

We have not yet decided a schedule for the remainder of the project. If you asked right now, it's likely to begin somewhere into the late part of 2019, early 2020. Again, as I said, this will include the rebuild of the 2 potlines that are currently producing. They will clearly be at the end of their life by that point in time, and that'll require ach of those being taken down for a period of time for the cells to be rebuilt. There's some remaining capital projects and then importantly, the second phase of the technology upgrade. So in aggregate, that'll be an additional $75 million in spending, $45 million for the rebuild of the 2 lines and $30 million for the capital projects. Most of that is attending to the technology upgrade, principally the work in our rodding shop.

Okay, if we can just ask you to go back, one page back, to Page 4, we'll just hit a couple of additional topics before passing you off to Pete.

At Sebree, we have begun restarting cells after the power equipment failure on the last day of May. As you recall, that resulted unfortunately in the curtailment of one of the 3 potlines at the plant. We're on schedule there for the line to be returned to full production no later than the end of the third quarter, and Shelly will give you some detail on the restart spending and on the lost profit during the second quarter as well as what we expect for each of those items during the third quarter.

Last topic here, turning to Mount Holly, those of you who follow this situation know that the electric power environment in the state of South Carolina remains really, really complex. There was legislation passed at the end of June, for example, causing rate reductions on Santee Cooper's partner in the failed nuclear projects. It also provided for a bunch of other power market reforms. Some of this, we understand, is subject already to litigation. Santee Cooper's largest customer has already sued to prevent Santee from recovering any portion of the failed nuclear costs under their contract together.

The legislature created, near the end of June this happened, a committee to make recommendations concerning the future of Santee, and that committee includes both legislators and the governor himself. And lastly, Santee Cooper continues to be run with an interim CEO and an acting Board chair, so that just gives you a flavor of the complexity of the situation.

We do remain absolutely convinced that a solution exists that's going to allow for the entire plant to run at some point in time, hopefully sooner rather than later. But given the complexity of the situation, at this point, our immediate focus is to preserve the current production level for 2019, while we continue to explore all the options to enable the restart of the second potline.

And with that, I will hand it over to Pete.

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Peter A. Trpkovski, Century Aluminum Company - Finance Manager [4]

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Thanks, Mike. If we can move on to Slide 6, please. I'll give you a quick update on the state of the global market. The cash LME price averaged $2,260 per tonne in Q2, which reflects a 5% increase over Q1. The LME price on a 2-month lagged basis was up quarter-over-quarter 2%, and averaged [$2,100 per tonne]. As Mike discussed, the metal prices come off by approximately 10% over the past couple months, similar with the rest of the base metal complex. Aluminum prices have averaged approximately $2,100 per tonne for the month of July, and are currently sitting right around $2,035 per tonne.

In the second quarter, regional premiums average approximately $0.217 per pound in the U.S., up 50% quarter-over-quarter, and approximately $200 per tonne in Europe, a 20% increase from prior quarter. However, spot premiums are down slightly to around $0.2075 in the U.S., and $160 per tonne in Europe.

In the second quarter of 2018, global aluminum demand grew at a rate of 5% as compared to the year-ago quarter. We saw 6% year-over-year demand growth from China, and 3% growth in Europe and North America. Global production growth was mostly flat in Q2 for the same period last year. China production was down 2%, while the world ex-China was up 2%. As a result, in Q2 the global aluminum market recorded a deficit of approximately 1.5 million tonnes, and we continue to see a drawdown of inventories globally. While most industry experts predict some slowing in Chinese demand growth in Q3, demand growth globally is predicted to remain strong, resulting in a continued supply deficit globally. We therefore expect a continued destocking of global inventories, which should be positive for long-term price levels.

And with that, I'll hand it back to Mike.

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [5]

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Thanks, Pete. If you could turn to Page 7 please, a couple quick comments on the operations, as we normally provide.

As you can see, safety performance was mixed this quarter. First, and most importantly, we were really pleased with the safety results at Hawesville. As I've said a couple times, it's a large and complex project, the rebuilds and the restarts. From the very beginning, management and the union have worked extraordinarily well together to ensure that safety remains the absolute priority here, and thus far the results have been really gratifying.

As I said, we've got months of really heavy activity left, but we're quite proud of what the team has accomplished thus far, and we're very confident they can maintain their focus and their excellent performance.

At Grundartangi you can see a reasonably-steady safety environment. The other 2 plants performed below our expectations this past quarter. That's very uncharacteristic at Sebree. They've had a fantastic run the last couple years on safety performance. We've already seen much improvement over the last couple months, so we're assuming that was an aberration over the quarter, during the second quarter.

At Mount Holly, we're concerned that the ongoing uncertainty with regard to the power contract is getting in the way of the plant's historical excellent safety focus, and we're watching that situation very closely.

Moving down to production, no surprises here. At Hawesville you see the beginning of some incremental volume coming from the cells that we began restarting in the middle of June. Obviously, you see the loss of the single potline at the end of May at Sebree, and good stability at the other plants as we would expect.

Moving down to production metrics, or KPIs, stable across the plants. We need to reiterate that this really doesn't happen without significant and focused effort, every single day, and just to emphasize one more time how important it is at times like this, of industry volatility, with a lot else going on inside the company.

Conversion cost, lastly, there's a lot going on here due to the restart projects at the Kentucky plants as well as raw material costs, so let me just give you a couple comments to put all this in context. First at Hawesville, carbon and power costs in aggregate account for a little more than half of that increase there, and the power cost is up simply due to the normal seasonal pricing being a little higher from the summer weather. We see that every summer. The rest of the increase, just over half of that is due directly to the restart project. You obviously have to start adding in labor before the production comes back fully, and so that'll start to reverse itself when the plant is back to full capacity towards the end of this year, into next year.

Moving on to Sebree, that entire increase is due to the impact of the potline loss. Same concept, there. You've got a fixed cost -- remember, these data are all measuring per-metric-tonne changes. So you've got the same impact. They've got your fixed costs, spread across a lower production volume, nothing more. We've also got some temporary labor in the plant to help with the restart project, process get done as quickly as possible.

Mount Holly, good performance there as you see. Power costs have actually been down due to a favorable natural gas price and labor and other costs down as well, so good cost management at Mount Holly during the quarter.

And at Grundartangi, actually very good performance there. If you look at power and carbon together, they account for more than 100% of that change that you see there. And of course, power is up solely due to the higher LME price. As you know, we pay on reference. We pay for our power on reference to the LME price in Iceland. These increases were offset by good performance in controllable areas, and the most notable of these was a reduction in pot reline cost, as the stability of the Grundartangi operation has yielded a lower number of cell failures.

And with that, I will hand it over to Shelly.

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Michelle M. Harrison, Century Aluminum Company - Interim Principal Accounting Officer, Senior VP of Finance & Treasurer [6]

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Thanks, Mike. Let's turn to Slide 8 and I'll walk you through the high-level results for the second quarter.

On a consolidated basis, global shipments were down about 4% quarter-over-quarter, primarily due to the equipment failure at Sebree that Mike mentioned. While shipments were down, realized prices were up more than 8% as a result of higher-lagged LME prices and regional premiums.

Looking at operating results, adjusted EBITDA was $54 million this quarter, and we had adjusted net income of $0.32 per share. In Q2, adjusting items include $8.5 million related to the Sebree equipment failure and $3 million for expenses related to the Hawesville restart.

So let me give you a little more background on these 2 items. For Sebree, we expensed $1.5 million in Q2 for costs to prepare the line for restart. We also had reduced production of approximately 6,000 tonnes in the quarter, which translates to about $7 million in lost profit and fixed costs.

For Q3, we estimate they will lose an additional 12,000 tonnes of production, which will translate to a P&L impact of $10 million to $15 million. As a reminder, we expect to fully recover all of these losses from our insurance policies, less our deductible of $7 million. However, the insurance proceeds and associated P&L benefit will probably lag the actual loss by a couple quarters. We'll continue to call out the P&L impact of this loss as well as future insurance proceeds as adjusting items in the coming quarters.

For Hawesville, in Q2 we expensed about $3 million related to the restart of the curtailed lines. As we mentioned on our last call, we're capitalizing most of the spending associated with the restart, and I'll talk about those costs when we get to the cash flow slide.

Turning to liquidity, our cash balance decreased by $7 million, primarily as a result of a build in inventory which I'll talk about in a couple slides. Availability under our revolving credit facilities was up by $26 million in Q2, as a result of an amendment to our U.S. line, increasing the revolver limit to $175 million. That facility was also extended by 3 years, and now matures in 2023.

Okay, let's go to Slide 9 and I can walk you through our Q-to-Q bridge of adjusted EBITDA. During Q2, we generated $54 million of EBITDA as compared to $22 million in Q1. The $32 million increase was driven by higher realized LME prices and regional premiums. On a lagged basis, the LME was up $40 a tonne, and the U.S. Midwest premium was up $178 a tonne. These 2 items increased Q2 EBITDA by $27 million.

Second quarter results also benefited by $8 million from lower raw material pricing, which was primarily related to lower realized alumina costs. The alumina improvement is a bit less than we anticipated on our last earnings call due to timing of deliveries, which can impact our average lag in pricing.

Looking ahead to Q3. The lagged LME is up another $40 a tonne, and the lagged U.S. Midwest premium is up about $75 a tonne. These 2 items translate to an improvement of about $10 million in EBITDA.

Offsetting this, however, is the increase in lagged alumina prices. For Q3, we expect higher realized alumina prices to decrease EBITDA by $35 million to $45 million. So as a result of higher realized selling prices, and higher alumina costs, we expect to see a net decrease in Q3 EBITDA of $25 million to $35 million.

Okay, let's turn to Slide 10. We'll take a quick look at cash flow. We started the quarter at $131 million in cash and ended June with $124 million. During the quarter, we made the semi-annual interest payment on our bonds of just over $9 million. We also had $9 million in capitalized costs associated with the Hawesville restart, and we spent $6 million for non-restart CapEx. We also made a significant investment in working capital during the second quarter, primarily as a result of increased inventories. The majority of the increase related to alumina inventories driven by higher prices and volumes on hand. We also had some buildup of materials in anticipation of the restarts at Hawesville and Sebree.

As Mike mentioned, we expect to spend around $75 million for the restart of the 3 curtailed lines at Hawesville, the vast majority of which will be in 2018. This includes the $12 million we spent in Q2, taking into account both the capitalized and expensed amounts. For Q3, we expect to spend $35 million to $40 million on the restart, and in Q4 that should be around $25 million.

And with that, I'll hand it back over to Mike.

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [7]

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Thanks, Shelly, and as usual we thank all of you for joining us this afternoon. I think Pete, we should just get right to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Jeremy Kliewer from Deutsche Bank.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [2]

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You guys have a strong balance sheet and you have been for the past year or so under 1x net debt-to-EBITDA. I was going to see if you could provide some insight as potential uses of cash, other than at Hawesville, which is going to use the majority of that over the next 3, 4 quarters?

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [3]

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Yes, so you've answered at least short-term, Jeremy, the question that that Hawesville restart will take up. And again, as you of all people know, everyone on this call also knows, that the cash flow is going to be variable based on commodities prices, and will be tempered, I guess is one word one might use, until the alumina price reverts to where it belongs as far as we're concerned, and many people, most people are concerned. So you know, until that happens, the focus is going to be on Hawesville. As I told you, as we've told you, we are looking at some other projects to improve the company's product mix, and production. We've been for some time looking at an investment to enable us to produce more value-added products, a significant quantum change in value-added products at our plant in Iceland. As you know, only about 1/6 of that production today is value-added products, and the rest is standard-grade ingots. So that's something at which we're looking. And then, as we've talked about over the quarters, to the extent we were to see -- because we do agree that the balance sheet, given the earnings power of the company with commodities, especially alumina at normalized levels, is strong. At that point in time, we would look hard at the return of capital to share owners, which we believe is the first call on cash against which we measure any investment.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [4]

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And then just to follow up, as Hawesville, what type of energy savings are you guys seeing with the new technology there?

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [5]

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That's a great question. So based on again, divided into -- let me answer the question, once the project is done, i.e., we'll call it the Phase 1 technology improvements which as I said, are more modest than the Phase 2. Phase 1 being the new cell lining design, and Phase 2 being the new anode and anode stub and yoke, the materials that hold the anode to the cell design. So when we get through all that, it's going to be upwards of 10% which is a significant improvement, and it's one of the things, again, going back to the tariffs that the administration has said from the beginning was their hope that this would accomplish would be not just bringing capacity back on for the sake of bringing it back on, but investing in these assets so that they can be more competitive over the long term. So that's the modeled answer to your question, and thus far in the test cells, that's what we're seeing at the very least.

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Operator [6]

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And now to the line of Lucas Pipes from B. Riley.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [7]

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Maybe to follow up on that last point, a quick just clarification? When you said upwards of 10% improvement, is that on the electricity cost at Hawesville, or did I miss something?

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [8]

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No, no, no. Not the cost, the cost doesn't change. We obviously are a buyer of power in the wholesale market. So what I'm talking about here, is what in the industry is -- in layperson's terms, power efficiency. So unit of input of electric power required to make one kilogram or one metric tonne of electricity. It's a standard measure in the primary aluminum industry.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [9]

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Got it. So we should think about, once those improvements are completed, you will consume 10% less electricity?

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [10]

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Correct.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [11]

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And then obviously there's been a tremendous amount of volatility in the aluminum market, and I wondered if this has altered, maybe in the short term, your purchasing activity? And hopefully of course, this volatility and elevated alumina prices will subside and return to more normalized prices in reasonably short order. But anyway, I would appreciate your perspective about managing that risk and that exposure.

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [12]

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Thank you very much. So just before answering your question, I'll pile on and agree with the statement at the end of your question. If you look at all the fundamentals, you look at industry balances, supply and demand, capacity coming on as we've said, the implicit cost of refining bauxite into alumina, etc., etc., etc., there's been no fundamental changes in the macroeconomics of the alumina market over the last year. All that's happened, of course, is these major disruptions. As you recall, just winding up the Wayback Machine, way back in commodities I suppose is 6 months ago. Alumina was trading as we expected it, in the low-to-mid $300s. I think Pete, it came down to $330? And then of course, the excursion in Brazil occurred, and that was compounded sometime later of course by the sanctions on Rusal. And so nothing has changed since back in January from a fundamental basis, so we remain convinced that the market will revert to where it belongs once these temporary things are settled. Now to answer your question, it's a tough one. Obviously, you need safety stock in a smelter. Standard industry practice is anywhere from Shelly, 20 days, to maybe 30 days of alumina on hand. In the U.S., frankly, we've been carrying a little bit more than that to mitigate. I'm sure you've read in just the general press, the severe problems that the Army Corps of Engineers has been having with lock and dam 52 and 53 on the Ohio River. And so until that replacement is fully up and functioning, scheduled I believe still for the third quarter of next year, 2019, you have to mitigate that risk. Because the one thing you can't do is to let an aluminum smelter drive alumina. That's catastrophic. And so that's been a push a little bit the other way. So an answer to your question is, in the U.S. at least, with the Kentucky plants, we just have -- the risk-reward trade is just wrong there to run those stocks down. At the other plants, to your perceptive point, we are running a little bit leaner than we would normally do from a units, volume standpoint. But as Shelly said, the real driver in that alumina balance that you see on the face of the balance sheet, is the price. And as we've discussed many times, you see the impact of alumina pricing roll through our cost of goods sales, and thus through our profitability, on a lagged basis because of course of A, our FIFO accounting, and B, the fact that we pay for our alumina on a lag-month basis. But you see the impact on our cash, and thus our balance sheet, immediately, as soon as we pay for the alumina. So it's a bit complex.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [13]

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That's helpful. Maybe one other one, here? Just in terms of capital allocation, one option would be from a longer-term perspective, so different from the question before which focused more on the immediate term here, but from a longer-term perspective, you could argue vertical integration might be a solution. Are you spending much time thinking about that, or is it -- are you really just happy with where you sit in the value chain? And you mentioned the earlier question, returning capital to shareholders is a priority. So how do you balance those factors? I appreciate your perspective.

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [14]

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Great question. So we would like to grow, and it's our intent to grow, and vertical integration for us, we don't call it that here. But we'll use your term, vertical integration, to us is backwards-looking, back into the supply chain, not forward. So bauxite and alumina is something that we look at a lot, and we believe that we wouldn't wish to be 100% covered, i.e., have 100% -- I'll use a term again that we don't use here -- captive alumina production versus our smelting means. But we do think there's a balance somewhere between where we are now, and being 100% covered. To answer your -- perhaps that was part of your question. To answer the other part, we don't see the utility at this point in time in considering downstream investment. It's a very different competency in terms of the operations talent that you need, and that's really how we produce value here is through squeezing these operations and the talent that we have in the operations. It's just so different, one is a manufacturing business downstream. One is an electrochemical process business, upstream, that we do of course, reduction in. So we just don't see the value add there that our company and our management team would bring, and I guess my personal experience is that it just -- I've seen a lot of companies and management teams destroy investor, share owners' value by that kind of integration in places that they had no business in going. And so the standard on that, if you will, the risk-adjusted return, cost of capital, whatever fancy term one would want to use, that we would apply to that kind of investment would be much, much higher than an investment in our wheelhouse, i.e., smelting and backwards. Because ultimately, we do have to compare it to returning cash to share owners. That's the default, as far as we're concerned.

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Operator [15]

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(Operator Instructions) And now it's the line of David Gagliano from BMO Capital Markets.

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David Francis Gagliano, BMO Capital Markets Equity Research - Co-Head of Metals and Mining Research and Metals and Mining Analyst [16]

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I just had a quick clarification. Shelly, you said $10 million to $15 million in the third quarter for the, I believe that's for Sebree, right? Is that incremental to 2Q, or is that total?

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Michelle M. Harrison, Century Aluminum Company - Interim Principal Accounting Officer, Senior VP of Finance & Treasurer [17]

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Yes, so that is incremental. So in Q2 we had the $7 million of lost profit and fixed cost, and Q3 it'll be additional $10 million to $15 million, and we will call that out as an adjusting item again next quarter.

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [18]

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So it's pretty simple, let's take the midpoint, or take the high end to do the math, just to use a point. So 8 is what we realized, quote-unquote, in Q2. Let's say it's 15, Shelly, in Q3, that's 23. So we would get a check for the insurers for $16 million, depending on the timing, perhaps late this year, swapping in for some of it early next year. Might not all be in the same month or quarter, right?

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Michelle M. Harrison, Century Aluminum Company - Interim Principal Accounting Officer, Senior VP of Finance & Treasurer [19]

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Right. Yes.

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [20]

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And so we'll adjust all that out for you, obviously, when we receive those insurance proceeds we'll show you that. We will, quote-unquote, adjust that out so you can see as if we hadn't received it.

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David Francis Gagliano, BMO Capital Markets Equity Research - Co-Head of Metals and Mining Research and Metals and Mining Analyst [21]

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Okay, that's helpful. And I got on a little late, so I apologize if you covered this, but regarding the restart at Hawesville and the tightness in the alumina market, is there any change in the commentary regarding the ability to procure alumina?

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [22]

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No, that's a good question, and no, you didn't miss that, David. We didn't cover that. What I would say is we're looking at it closely, just in terms of cash flow liquidity, what-not. The aluminum market as we all know right now, is not for the faint of heart, but we do have confidence within the reasonably foreseeable future it'll get itself sorted out. No, procurement of ore, of alumina, hasn't been the issue. As I said, I did say earlier in my comments, perhaps you missed it, is that the market did reasonably quickly after the second hammer fell, that was the Rusal sanctions. The market did sort out alternate supply lines, reasonably quickly and reasonably well. So it's a price issue, pure and simple.

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David Francis Gagliano, BMO Capital Markets Equity Research - Co-Head of Metals and Mining Research and Metals and Mining Analyst [23]

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One last question. You mentioned $75 million for Phase 2. Is that all capitalized, or is any of that expensed?

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [24]

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Most of it, David, will be capitalized at this point in time. At least the [capital] portion of it, the capital projects and the technology upgrade. The $40 million line rebuild, we're studying the right accounting of that in the future. As you know, we studied quite comprehensively the right treatment for the rebuild of the 3 lines that have been down, and the accounting treatment there is pretty straightforward. You sort of treat it as if you're building it for the first time, just in layperson's terms. For the 2 lines that are currently producing, the cash we're pretty clear on the budget. So to us, cash is what principally matters. But as to whether that effort will be expensed or capitalized, I wouldn't want to conclude right now. That'll take some additional work over the next couple months.

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Operator [25]

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Now to the line of John Tumazos from John Tumazos Independent Research.

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John Charles Tumazos, John Tumazos Very Independent Research, LLC - President and CEO [26]

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How do you expect the Chinese pollution restrictions to work this winter? They restarted all their steel output and more, but their aluminum output appears to be about the same, maybe a little less this year.

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [27]

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Good question, John. We're watching that closely. You may have seen some of the data that we're getting more and more data. This is kind of, we're in the belly of the beast right now looking forward to that season, so maybe you're seeing a lot of the same data as are we. Some fresh information last week, people running around counting noses or smelters and refineries in this case. We think at this point in time, and it's really difficult to predict at this point in time -- as you've seen, the government has on all of these industries, not just ours and steel, all the so-called polluting industries I think is the term as it translates into English, from Mandarin into English, has really been clamping down. And so we do see when you look at last year, at least some consistency with last year, in both smelting and refining. But John, I wouldn't want to call it, and I certainly wouldn't want to behave in the marketplace consistent with a strong opinion because it's just -- it's too volatile, and it's too difficult to tell at this point in time. There's too much else sort of up in the air. I know that sounds like skirting around the question, perhaps it is, but it's an honest answer.

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John Charles Tumazos, John Tumazos Very Independent Research, LLC - President and CEO [28]

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No, we have the same problems in all the markets we study.

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Operator [29]

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Now to the line of Jeremy Kliewer from Deutsche Bank.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [30]

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Sorry for a follow-up question, here. In your prepared comments you stated you guys are trying to plan

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Holly and out past the year end, kind of cutoff for your electrical supply. So can you just confirm that, if it does go into 2019, would it be on that same 75% market rates? Or do you guys still have to work that out with Santee Cooper, or how's that work going forward?

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [31]

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The latter. Still have to work that out. The current contract expires on the 31st of December, and so that needs to be worked out. Good question.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [32]

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Okay, so I guess if your contract negotiations are ongoing, would you still give that 60-day heads-up notice, or how…

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [33]

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Now you're fast-forwarding. Let's see. We're on 1 August right now, you're fast-forwarding to 1 November. So you're fast-forwarding 3 months, and a lot's going to happen between now and then. I wouldn't want to predict. It'll be -- again, this will sound like skirting the question, Jeremy. It'll be facts and circumstances at the time. If it feels like we're close to something that makes sense, i.e., something consistent with where we've been, I certainly wouldn't want to do that. There's a lot of implications in doing that. The 2 constituencies I care the most about are our employees and our customers, and so those are the constituencies that you're thinking about when you make a decision like that. But I'm going to be reasonably optimistic that we'll sort it out before the first of November.

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Operator [34]

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Now to the line of Lucas Pipes from B. Riley.

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Lucas Nathaniel Pipes, B. Riley FBR, Inc., Research Division - Senior VP & Equity Analyst [35]

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I wanted to ask you a little bit about the tariff situation, and it appears that there's some background negotiations, just picking up headlines from the press in regards to the tariffs and our allies. And I wondered if you have a perspective on that, and if hypothetically Europe or Canada would be excluded? What do you think would be the impact to the Midwest premium?

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [36]

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I'll give you a direct answer on the second part of your question in just a second. On the first part, we don't know. We don't know any more than anybody else does. We read the press, we talk to the same folks in Washington to whom everybody else talks. It seems like those negotiations are ongoing. Obviously, there was some, it looked like positive developments with the E.U., that's just last week, now. So who knows? On the second part of your question, we believe there'd be no impact, because we're quite confident, very confident as we said in the past, that if there are any further additional country exemptions granted, that they'll come with quotas that really bite, that the net impact of all that will be that there'll be enough, a significant amount of imports that are still subject to the quotas, that they'll have no impact on the Midwest. And that's what you've seen the administration from the highest levels, both the White House and the trade experts, and responsible persons, say very directly over and over. So that's why we have such confidence there.

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Operator [37]

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Thank you. We have no one else in queue, please continue.

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Michael A. Bless, Century Aluminum Company - President, CEO & Director [38]

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We very much appreciate your time and interest, and look forward to speaking with you in a couple months, if not before. Take care.

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Operator [39]

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Thank you, and ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.