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Noranda Aluminum Holding Corporation (NYSE:NOR)

Q2 2014 Earnings Conference Call

August 11, 2014 04:30 PM ET

Executives

Gail Lehman - General Counsel and CAO

Kip Smith - President and CEO

Dale Boyles - CFO

Analysts

Brett Levy - Jefferies

Timna Tanners - Bank of America

Bob Amenta - JPMorgan Asset Management

Sal Tharani - Goldman Sachs

Swaraj Chowdhury - Dalton Investment

David Olkovetsky - Jefferies

Operator

Welcome to the Noranda Aluminum Holding Corporation Second Quarter 2014 Earnings Conference Call. Hosting the call today from Noranda Aluminum is Kip Smith, President and Chief Executive Officer. He is joined by Dale Boyles, Chief Financial Officer and Gail Lehman, General Counsel and Chief Administrative Officer. Today’s call is being recorded and will be available for replay beginning two hours after the completion of the call.

It is now my pleasure to turn the call over to Gail Lehman.

Gail Lehman

Thank you, operator. Good afternoon, and welcome to today’s conference call. Before we get started, I want to remind listeners that some of our comments during this call constitute forward-looking statements related to future events and expectations. Actual results may differ materially from any of our forward-looking statements.

In our earnings release and in our most recent SEC filings, you can find important factors that could cause actual results to differ materially from those in the forward-looking statements. Except as required by applicable securities laws, we undertake no obligation to publicly update or revise any forward-looking statement.

During the call, we will be using certain non-GAAP financial measures. We have provided a reconciliation of these non-GAAP measures to the comparable GAAP measures in our press release, which is available on the Investor Relations page of our website at www.norandaaluminum.com. We will take questions today after the discussion of our results.

Now, I will turn the call over to our President and CEO, Kip Smith.

Kip Smith

Thank Gail, and welcome to those joining today’s earnings call. We entered the second half of 2014 with positive momentum from a sequential improvement in our operation continuing stable demand for our product and favorable volatility in the aluminum price. During second quarter 2014 we improve the operating reliability of the business focusing on preserving our liquidity and continue to make accretive investment in the business. We saw a stable demand in the second quarter for our key aluminum product and we believe there are attractive growth forecasts for those products.

We’re hearing from our customers that they want us to grow with them. In June the average LME aluminum price for the month reached the highest point since April of 2013. In July stock prices reached levels not seen in nearly two years. We also entered the second half of 2014 poised to transform the cost structure of our company. In 2013 in the first half of 2014 our transformation was hampered by LME prices near historically low levels and unsustainable dollar rate.

These two factors were the primary drivers creating a drain on our liquidity and cash position. As we entered the second half of 2014, the positive volatility and LME aluminum prices is expected to support our results, but this is not enough for us to drive sustainable results. We must and will continue to drive our CORE program and we must achieve rate relief quickly to create a sustainable position for the New Madrid smelter.

Unsustainable power and LME aluminum prices are the two largest threats to our company and are inextricably linked because of their impact on our cash and liquidity. To say this plainly as possible throughout 2013 and into 2014, low aluminum prices and unsustainably high electricity rates are eating away at our liquidity and our balance sheet.

There has been a modest improvement in aluminum prices which we are pleased to say. But as a commodity company we can’t rely on prices to keep us sustainable and we can’t rely on the price of aluminum to make up for the unsustainable price for electricity, our single largest input cost that we are paying. Fortunately, there is an opportunity for the Missouri Public Service Commission to address this unsustainable power rate by approving a rate structure that is supported by consumer groups representing all electricity consumers in the state of Missouri.

We believe this proposed rate structure will provide much needed urgent relief from unsustainable power rates and will support Noranda’s liquidity for the next five years. To put it on the context let's start with our financial highlights, which are listed on slide 3 of this afternoon’s conference call material.

Our net loss excluding special items was $0.10 per share. Total segment profit was $30 million, which was an expected improvement over the first quarter of 2014 given the lack of extreme weather conditions and the improvement in LME aluminum prices during the quarter.

The average realized Midwest transaction price for primarily aluminum was $0.99 per pound in second quarter 2014, $0.04 higher than in first quarter 2014. We reported a $0.84 per pound integrated primary aluminum net cash cut. This is an improvement against the $0.90 per pound from the first quarter which was affected by extreme winter weather. We experienced an $18 million net use of cash during second quarter 2014 and a $47 million net use of cash since December 31, 2013.

Moving to slide 4, you can see graphically that our shipment levels were fairly stable in the second quarter. Primary was down slightly year-over-year and quarter-over-quarter. In that business we saw an unexpected lingering impact in the extreme cold first quarter weather, despite the slightly lower production levels in the second quarter. In the alumina segment we also experienced an operational disruption in the second quarter as hurricane-level weather rain caused a day and half power outage in mid-May. We felt the effects of these disruptions through the early part of June, but that particular issue is behind us.

With limited exceptions if we could have produced one more pound of primary aluminum or flat rolled aluminum product, we could have sold it. That’s a good way to the product segment growth information on slide 5.

Extrusion billet is highly co-related to the overall U.S. manufacturing base and approximately two thirds of North American billet consumption is in transportation and building and construction. Consumption growth for aluminum and electrical applications benefits both our primary and collateral products businesses. Of course this product segment supports the new state-of-the-art rod mill that we’re building in New Madrid.

Growth rates for the overall packaging segment are considered to be flat or slightly negative over the forecast period. Noranda’s experience appears better because of our successful long term relationships with leading semi-rigid container manufacturer.

And finally the big news these days is automotive and as the Chairman of the Aluminum Association I can tell you that the growth of aluminum in the automotive space is very exciting.

Noranda has participated in this space for some time through extrusion billet and that’s in the primary segment and automotive HVAC in the flat rolled product space. In new application we’re optimistic about also comes out of New Madrid were foundry alloys are finding their way into high pressured die cast parts. Automotive manufacturers are finding that they are able to achieve a 70% weight reduction layers by using these aluminum alloys and thin valves structural parts that are substitute for high strength steel.

Over the past 12 months we've shipped over 25 million pounds of a licensed alloy named Silafont for use in these applications. The combined takeaway from slide 4 and 5 is that we have opportunities to grow with our current customers and to file the spread of aluminum in the new application. As I've already mentioned the combination of unsustainable power rates and unsustainably low LME aluminum prices have created a drain on our cash and our liquidity throughout 2013 and into 2014.

Recent improvements in aluminum prices are encouraging and we've summarize some of the driving factors on slide 6. We believe that the underlying long term demand fundamentals of the aluminum industry are sound and have been so for some time. But the supply side dynamics are the pieces of puzzle that have plagued aluminum prices. According to HARBOR aluminum LME inventory levels are at 22 months low and there is a growing chorus that the global supply demand balance would be a deficit driven by significant capacity closures including over 3 million metric tons in China.

The improvement in the LME is critical to the resolution of our liquidity constraints. As we transition to our rate design discussion, it is worth noting that both our original rate design proposal and the compromised solution from the PSC were built around an assumption that aluminum prices will improve. Our reduced power rate alone was going to be enough for us to be sustainable, improvement in aluminum prices is also a pre-requisite for us and for our industry.

Turning now to slide seven, let’s talk about the status of our rate design petition with the Missouri Public Service Commission. As you have already know in February we filed the petition with the PSC to reduce the rate New Madrid pays for electricity. In April the PSC agreed to hear our petition and to do so in an expedited timeframe, ultimately establishing an August 6th decision date.

On July 24th the Missouri Office of Public Counsel filed a non-unanimous stipulation agreement which proposed a compromise alternative to our original rate design petition. As appointed background the Missouri Office of Public Counsel or OPC represents the interest of the public and utility customers and proceedings before the PSC.

On July 29th Noranda signed on in support of the OPC's proposed compromise. The OPC proposals supported by the Missouri Industrial Energy Consumers Group, the Missouri Retailers Association and Consumer Counsel of Missouri. We supported the OPC proposal because we believe it is an acceptable outcome in our rate design petition and it is supported by the groups I mentioned earlier who represent all Missouri electricity consumer.

Although the specific rate relief from the OPC proposal is lower in most cases than what we saw, the elements are the same. First it resulted in immediate cost reduction of approximately $30 million or $0.05 lower per pound over the first 12 months versus actual rates for the 12 months ended June 30, 2014. Second because of its 2% cap on general rate increases and its provision related to fuel adjustment charges the OPC proposal limits New Madrid's exposure for future cost increases.

Before I turn the call to Dale, I want to emphasize as we wait for a decision by the Missouri Public Service Commission in our petition for a sustainable electricity rate for the New Madrid aluminum smelter, we continue, while we wait, our intense focus on preserving our liquidity.

Now I'll turn it over to Dale for more detailed discussions second quarter operating results and financial position. Dale?

Dale Boyles

Thanks Kip and good afternoon everyone. Beginning with slide eight of the material we have our trailing 12 months trends on realized Midwest transaction price, primary aluminum net cash cost, revenue and segment profit.

Declining LME prices have certainly had a negative impact on our operating results in the trailing 12 months period presented. Although we saw a modest improvement in LME prices near the end of the second quarter our trailing 12 months comparison we see that the LME portion of our prices continue to slip from $0.81 in the first quarter to $0.80 in the second quarter. Midwest premiums continue to hold above traditional level and you can see that for the trailing 12 months ended in the second quarter the realized Midwest premium increased to $0.14 per pound compared to $0.12 per pound in the first quarter.

This is the first time in 11 quarters that a trailing 12 months realized Midwest transaction price has improved sequentially. This is also the first time in four quarters the trailing 12 month total segment profit has improved sequentially reflecting the results of our core productivity program and a modest improvement of aluminum prices.

Let’s move to the components of segment profit for the second quarter of 2014. Please turn to slide nine. We reported over $30 million of total segment profit this quarter consisting of nearly $22 million from our integrated upstream business, $15 million from our flat-rolled product segment, thus $6 million of corporate cost. Our second quarter total segment profit has improved sequentially by $20 million and year-over-year by over $5 million. I'll go into some of the details in a moment, but I think it’s particularly noteworthy the improvement came from the integrated upstream business, flat-rolled products business and corporate all of the businesses have pulled together to improve our operating results.

Turning to slide 10, our upstream results for the product of 143 million pounds of total primary aluminum shipment at a net margin of $0.15 per pound. The average realized Midwest transaction price rose $0.04 per pound sequentially from $0.95 to $0.99 on higher Midwest premium price. Our net cash cost decreased by $0.06 per pound driven by the absence of extreme winter weather conditions from the first quarter but there are a number by other puts and takes as you’ll see in the next page.

Turning to slide 11, at the top of the chart you will see the bridge of net cash cost with segment profit from the first quarter to the second quarter. Let’s start with net cash cost in the top chart.

Excluding the first quarter operational impact from extreme winter weather conditions in the aluminum primary segment we have $0.82 per pound as starting point.

Seasonal peak power rate at New Madrid added $0.04 per pound during the quarter. Remember that peak power rate kick in at New Madrid from June through September.

Absent any changes from our rate design petition we would expect net cash cost in the third quarter to be $0.08 per pound higher than in the second quarter, reflecting the full impact of seasonal peak power rates.

One of the features of our rate design petition and a feature that’s included in the compromised proposal proposed by the office of public counsel is that we would pay the same rate throughout the year with no seasonal peak power surcharge. The new rate design would improve the earnings volatility going forward, but we won’t know what the actual impact will be until the proposed rate design is approved and the effective date is known.

A day and a half power outage at Gramercy also added $0.04 per pound for a net cash cost. The negative impact from this disruption was more than offset by a $0.02 benefit from LME linked aluminum prices on sales to third party. Improved prices for input such as natural gas and benefit costs which were lower in Q2 after having spiked in Q1.

The segment profit bridge at the bottom of the chart follows cash cost bridge so there is not a lot to add sequentially. Modestly higher LME aluminum prices in higher Midwest premium contributed $10 million to our sequential quarter segment profit improvement.

Turning to slide 12, you will see two similar bridges comparing net cash cost and segment profit for the first half of 2014 for the same period in 2013. Taking these two charts together you will see a couple of comments in. First, LME prices have been lower in the first half of 2014 than they were in the same period 2013, with a negative impact of over $11 million. Second, natural gas sales prices have been higher in the first half of this year compared to 2013 which were partially offset by a lower raw material input cost. Our core productivity results and all other costs improved almost $7 million in the first half of 2014 versus last year.

Now let’s walk through how segment profit reconciled to net income excluding special items. Please see slide 13 in the deck. We had over $2 million of additional expense this quarter from the difference between LIFO and FIFO inventory valuation compared to a $2 million benefit in the first quarter. However, the second quarter amount was comparable to last year. Besides LIFO cost, other recurring non-cash cost were approximately $3 million up slightly from first quarter and comparable to last year.

These are items such as non-cash pension, accretion, and stock compensation expense. Depreciation and amortization expenses totaled $22 million while interest expense was $13 million both at comparable level to the first quarter. The combination of those items brings us to a pre-tax loss of $10 million in the second quarter of 2014. Our after tax loss excluding special items was $7 million in the second quarter or $0.10 per share.

Now let’s turn to our second quarter cash and financial management results. Slide 14, will dispatch from the end of the first quarter 2014 to the end of the second quarter 2014. Cash provides by operating activities was $2 million in the second quarter compared to nearly $17 million in the second quarter of 2013. The principal causes for this difference were a semiannual interest payment on the 11% fixed note on June 2014, and the fact that we built working capital in second quarter.

Our first semiannual interest payment on the notes was Q4 2013. During the second quarter we invested a total of $18 million in capital expenditures for sustaining the growth project, compared to $20 million in 2013. Of the $18 million invested in the quarter approximately $12 million was for sustaining capital and $6 million was for growth capital.

For the trailing 12 months we’ve invested $61 million in capital of which $48 million has been sustaining capital. This amount is in line with the $50 million to $60 million of sustaining capital expectations to 2014 that we communicated in our February earnings call.

Second quarter growth capital spending was almost exclusively related to the construction of a new state-of-the-art rod mill at the New Madrid facility. Year-to-date through June 30, 2014 the company has spent $11 million on the rod mill. Although we expected to finance the rod mill for the project specific financing, to date we have not obtained the financing because of the pending decision of New Madrid's power rate.

We expect to spend approximately $28 million in the rod mill during the second half of 2014 including approximately $13 million upon delivery of the rod production line in September. We ended the quarter with $33 million of cash. This represents an $18 million net use of cash during the second quarter and a $47 million net use of cash since December 31, 2013.

We ended the quarter with a $146 million of availability under our ABL facility. Combined, there is $179 million of total liquidity at the end of the second quarter. This represents a $12 million reduction in total liquidity from March 31, 2014 and $17 million reduction from December 31, 2013. Other items of note include our ABL facility was undrawn at the quarter end except for outstanding undrawn letters of credit.

Although we ended the quarter with no outstanding borrowing, during June borrowed and repaid approximately $19 million in the ABL to support our operating investing activity. Additional borrowings totaling $19 million were necessary in July and August, $14 million of which have been repaid through today.

Finally, we are committed to improving our operational reliability, maintaining a healthy balance sheet and preserving our liquidity in the second half of 2014.

With that I’ll turn it back over to Kip.

Kip Smith

Thanks Dale. We entered the second half of 2014 with positive momentum with the sequential improvement in our operations, continuing stable demand for our products, and favorable volatility in the LME aluminum price. We also entered the second half of 2014 poised to continue to transform the cost structure of our company.

We haven’t been sitting around waiting for aluminum prices to improve, in fact in the first half of 2013 we recognized that lower LME price environment demanded a response, so we initiated and executed prudent actions to improve our operating results and preserve our liquidity. We set out to transform our company during the trial to commodity cycle because we believe that’s what great commodity companies do.

We establish the 2014 to 2015 CORE program with a $225 million productivity target, a target approximately 60% larger than our proceeding three year program. And in the second quarter our results of $21.8 million exceeded our expectation.

We installed a strict capital expenditure process to help preserve our liquidity. We also reduced our regulatory quarterly dividend by 75% and we completed a company-wide work force production cutting our total work force by 10% generating annual savings totaling $15 million per year. The actions we took in response to market conditions demonstrated our commitment to taking prudent actions to mitigate the impact of low aluminum prices and to transform our company’s cost structure.

One cost that we’ve not been able to reduce however is the price of electricity at New Madrid. Excluding electricity cost the New Madrid smelter produces a pound of aluminum today more efficiently and for less cost than in 2008. However since 2008, our electricity rates have increased $44 million to the point where they eliminate the effect of all the productivity gains at New Madrid combined since 2008. Because of these increases the power rate for New Madrid is the second highest of the nine smelters remaining in the United States.

We had the act so we went to the Public Service Commission because it has the competencies and capacity to make decisions exactly like this one and there is an urgent meeting to address this unsustainable rate. The PSC also in the best position to quickly remedy that urgent need.

History tells us that no aluminum smelter can survive without a sustainable power rate. We trust the PSC will make the appropriate decision with respect to the OPC’s proposed rate structure and protect New Madrid from the consequences that have come to other smelters unable to remedy unsustainable power rate.

And that concludes our prepared remarks for today. Eric I’ll turn the call over to you for questions.

Question-and-Answer Session

Operator

Thank you Mr. Smith. We will now open the call to questions. (Operator Instructions) And our first question comes from Brett Levy of Jefferies. Please go ahead.

Brett Levy - Jefferies

Good progress to date. Can I ask on the rod mill investment here, can you slow that down a little bit until the rate case is decided? And can you sort of give us a rough sense, we have seen some articles talking about independent interviews with some of the commissioners who would be voting, and they independently gave some negative commentary. To talk a little bit about the rate case, and then your ability to slow down spending on something that obviously will be affected by this decision.

Kip Smith

Hey, good morning Brett, thank you very much for your question. Let me start a little bit by commenting on the rate case.

First, you will note that we did sign on to a unanimous stipulation that was presented by the Office of Public Counsel. We did that really for two very, very important reasons.

The first is that we believe that it is an adequate address when you look at a five year term to support our liquidity because we made it very clear in our original ask as well in the stipulation that was presented, that improvement in the LME over the cycle was going to be needed, and since the LME has moved we felt that that would actually be a thoughtful compromise and equally important is the breadth of support that we have for this stipulation.

Now you always hear the disclaimer and it's always appropriate to have out there that past success is no demonstrator or guarantee of future success. We have been in this process before. I personally have been involved in four rate cases now. And in three of those four rate cases, we have a non-unanimous stipulation and agreement. And in two of those three, we -- the rate design was approved completely by the Public Service Commission and in the third, the majority and in fact there was one change that that resulted in a small rate impact to Noranda but we felt that substantially all that we asked for we got and so at the -- what we needed, we got in. So we know this process, we believe in it and actually trust in it. And so having that broad base of consumer support in the past has really supported getting the stipulations approved and our strategy was to gain that type of support again by going through the Public Service Commission process. And so we did so and that’s where we are right now with that particular stipulation and I can go any more detail on the stipulation that you might like.

But that’s where we are. There was a decision date announced of August 6th. That date has obviously passed and there has not yet been an indication of when this will be back on the Public Service Commission’s agenda, but for us this is an urgent -- this really is an urgent issue and it is our hope that this will be back on their agenda swiftly and we will get decision equally swiftly.

We have given and I'll just make final comment, that we believe that in addition to this broad based consumer support we have given the Public Service Commission a substantial amount of expert testimony, a substantial amount of expert testimony and we believe that, that testimony is a strong foundation for a favorable outcome in this particular case.

And on the rod mill Dale said it and I'll say it again. We are passionately focused on our liquidity and have been. That’s -- I mean we have a very, very specific program on maintaining our liquidity. So we have a very good understanding of our capital expenditures were going and if we got into a position in the second half where we needed to manage our liquidity, then there are definitely options for us to mitigate that spending on the rod mill.

Brett Levy - Jefferies

And then as you look into the current quarter, can you sort of defend the idea that you're going to see Midwest premiums in the zip code that you’ve been seeing recently?

Kip Smith

We will go back to our -- I am going to allow -- I'm going to ask Mr. Boyles to add a little commentary here as well. But I'm going to go back to our closely held belief that we’ve actually shared before that we believe that for both the LME price and the Midwest premium, the most -- there are so many different factors that we see affecting these things and you can see the volatility that’s occurring because of the supply side of the equation. But we do believe that the fundamental demand -- trend line driver is fundamental demand. And if you look at the fundamental demand in the United States, especially with the GDP related items and of course there's lot of enthusiasm with what’s happening in automotive with the body sheets and what the Ford announced. But what we're seeing right now with our Silafont product is the ability to make the market to have production introduction and expansion in this market because of our ability to simplify parts, to take multiple parts in pressure casting operation, make one part out of many. And so we saw in the second quarter, saw a fundamental demand. And if you ascribe to our theory that -- that’s the fundamental trend line driver for the Midwest, that’s -- you have to expect to see a change in demand in the third quarter to see a change in the, immaterial change in the Midwest. We can see some short-term volatility but again that's just the way view things? Dale?

Dale Boyles

Not really anything to add there other than we'd really like to see those premiums stay where they are. We really don’t forecast where there will be for the rest of the year, but it looks the supply demand fundamentals are there continuing to support those higher Midwest premium.

Operator

(Operator Instructions). Our next question comes from Timna Tanners from Bank of America. Please go ahead.

Timna Tanners - Bank of America

I wanted to follow up on some of the guidance that you had given in the past for the full year and to see if you could comment on sticking to that. I would assume, if you haven't said anything different. Downstream volumes seem a little light, given the run rate. So we are just particularly interested in that, just because you had said 367 million to 371 million pounds, and you're looking like you are trending ahead of that. And then also wondering about the primary aluminum shipments guidance that you've given in the past.

Kip Smith

Yes, Timna, thanks for the question. We certainly have some issues around the first quarter with weather impacting, getting some shipments out and building our inventories, which has impacted our liquidities using the working capital. So business has been good. Our demand is good in our flat-rolled business. Typically we were built inventories earlier in the year, but I think we came into this year a little too low and our inventory level, the $4 demand that we’re seeing and we continue to see that into this quarter as well. So from a primary shipment standpoint, similar, got a little behind in the first quarter because of all the weather and we’ve chasing it into the second quarter, but at this point given those issues we reiterate our expectations on our first quarter call back in April and at this point we really don’t have anything to change on those expectations, specially until we hear a decision on the power rate.

Timna Tanners - Bank of America

Okay, and I hate to harp on the power rate, but as outsiders we aren't experts on how these decisions are made. How do we think about -- and I understand fully that you're speaking to an audience broader than us, we equity analysts, but how do we think about framing a timeframe for a decision on this? Is there any range of outcomes that you can help us with? You had been quite adamant on your expectations last time and now there is a compromise. Do you expect further negotiations? Do you expect something sooner rather than later? Anything else that you can provide would be helpful.

Kip Smith

Timna, the first I think on -- I was just thinking on word to take some am going to -- start at the end about the further negotiations, we’ve signed on to a stipulation that had representatives, especially having it being presented by the Office of Public Counsel, whose job is to represent the public and the consumers, the electricity buyers, and so when you have them and the Missouri Industrial Energy Consumers the largest, the major players for manufacturing in the state and then the Missouri retailers and the Consumer Council of Missouri, we believe that’s the right level of support to have. It is very, very broad based.

So that deal is in and it’s submitted and so we’ll be expecting a decision on that particular stipulation. So there won’t be -- we’re not anticipating additional negotiation stipulation. Now, it’s always in the purview. It is in the purview of the Public Service Commission where they can change this stipulation and make modification to it or not approve it all. But the strategy that we chose is one that we’re familiar with and that we’ve had success with and again, we can’t -- it doesn’t predict future success but it has been the pattern that we’ve seen.

As far as the timing goes, that’s entirely up to the Public Service Commission at this moment. There is no indication of when this will be back on the agenda, but not necessarily a surprise. That -- a notification of this thing on the agenda could happen any day and so they do have these agenda meetings very routinely. It’s not every one segment they’re quire routine. So it’s our hope that we will be on one of these agenda meetings very soon.

Operator

Our next question comes from Bob Amenta of JPMorgan Asset Management. Please go ahead.

Bob Amenta - JPMorgan Asset Management

A couple of questions. One is just a brief clarification, it sounds like or look likes the weather impact last quarter it was 49, it looks like you’ve adjusted that down to only 11.3 for the first quarter now, is that right?

Kip Smith

That just excludes the natural gas impact, the price increase in the usage of natural gas that was the direct impact on the primary and aluminum businesses.

Bob Amenta - JPMorgan Asset Management

And if said this I missed it, on the CapEx assuming no unfavorable ruling where you have to readjust your timing, what is the remainder of this year CapEx spend, 30 so far this year and then any thoughts on '15, what you might be spending next year?

Kip Smith

I think if you look back at our expectations on capital spending this year, we talked about the range $50 million to $60 million on sustaining capital and another $30 million to $40 million growth capital this year primarily the rod mill. And at this point we’re looking in all that spend this year and we’re starting to develop our plans for '15 but we really haven’t gotten too far ahead ourselves yet to 2015 at this point that we can really talk about it yet.

Bob Amenta - JPMorgan Asset Management

Okay, but the $50 million to $60 million, that maintenance would -- no reason to think that part of it would be any different next year? The maintenance assumption?

Kip Smith

Not at this point. Too early this point, too early to tell.

Operator

Our next question comes from Sal Tharani from Goldman Sachs. Please go ahead.

Sal Tharani - Goldman Sachs

Kip, can you give us some idea of modeling your upstream businesses, how your bauxite and alumina contracts are set up, how do you transfer internally? Because bauxite prices globally have gone up, but it looks like you had a lower pricing, and then alumina prices have held up well -- sorry, have not moved -- aluminum prices have moved up. I’m just wondering, how should we think about how you transfer internally and how you sell outside for modeling as these prices more in the spot market?

Kip Smith

Sal, let me start with this if you have got some specific other clarification I’d be happy to see if we can answer those as well. Our alumina price, we had great success with the index to the alumina and in our most recent round of contract negotiations. We continued with that particular approach and we’ve been public about that. So the movement in the price for us in alumina externally is something that [indiscernible] LME. Bauxite is a different story, we are in that through a market price mechanism and so as the market price of bauxite now moves and we would expect it to move although both of those indices will have a bit of a lag with them.

So that may help explain the movement that you’re seeing in our numbers. Were there other questions that might be helpful in that regard in terms of that. Our internal transport prices we just work very hard to make sure those are marketplaces where we're not subsidizing any kind of irrational non-market behavior.

Dale Boyles

Yes, the bauxite true-up in the second quarter, those prices are adjusted every six months based on the market prices. So that’s why you saw accumulative catch up in the second quarter. It’s a midyear check every year, mid and end of the year.

I might as well, if you’re looking at modeling, look at Slide 10 of our deck and then really look at it from integrated upstream business the total count shift versus the net margin being the difference obviously between our cost and what the realized Midwest transaction price is.

Sal Tharani - Goldman Sachs

Okay. And alumina is indexed to LME or the all-in price of aluminum?

Kip Smith

LME

Operator

Our next question comes from Swaraj Chowdhury from Dalton Investments. Please go ahead.

Swaraj Chowdhury - Dalton Investment

Good afternoon. My question is about liquidity. So although it looks like the EBITDA has improved, I see two things. One is that the volume looks a little light and liquidity is also a little tight, compared to first quarter. And you said that there could be some cash costs add just meant to that kind of $0.08 in the third quarter. So I'd like to know, how are you going to manage liquidity with $33 million cash on the balance sheet?

Kip Smith

Well, as we said, our goal is to preserve our liquidity. So the EBITDA improvement is certainly it seems the modest improvement in the LME price and we continue to really execute our core productivity program and that drives a lot of improvement in our segment profit overall. If you look at year-over-year I think the number was somewhere around -- I don’t have it right in front of me, actually that’s a big part of the improvement there. But as I said earlier with the winter weather we got behind building our working capital on inventory.

So we’ve been chasing it through the first and second quarter and you’d expect some of that to turn later in the second half of this year. So that’s where we are from a liquidity stand point. Obviously we’re going to do everything to manage that process as tightly as we can.

Swaraj Chowdhury - Dalton Investment

And the rod mill, you won’t take any, you won’t spend any additional money until you get a rate decision from PSC. Is that correct?

Kip Smith

I’m sorry I couldn’t quite understand your question. We won’t spend any money on the rod mill is that?

Swaraj Chowdhury - Dalton Investment

Yes, yes I’m asking that if you -- any additional capital expenditure on the rod mill from this month onward would it depend on -- I mean you will wait for the MPSC rate decision. Is that correct or you will go ahead with your expansion, with the project?

Kip Smith

Presuming that the decision happens sooner or rather than later, we will continue to uphold pattern of spending whether it becomes clear either that we have a decision that is not in our favor or one that is not forthcoming in a timely fashion, that at that point in time we will take the best steps to mitigate our spending. So it will depend upon the circumstances. Rod mill is very, very important to us but if it looks like we're either delayed or the outcome will be negative, then we will have to mitigate our spending up to and including suspending the spending until we get an answer. Or get financing, which so far we have not done because of the pending rate case.

Operator

Our next question comes from Brian MacArthur of UBS. Please go ahead.

Brian MacArthur - UBS

Good afternoon. I just want to go back to the rate case and what the -- you commit the spend of certain amount of the money at the smelter assuming you win this case of $35 million per year. Can that $35 million be used for like value add products, rod mill, does that all counter, is that sustaining or what is that -- obviously your $35 million, assuming five years $175 million. Does it have to be done each year, can it be spread out? How does that part of the equation actually work?

Kip Smith

Sure. And thank you very much for that question. This is capital expenditure and it’s probably defined as basically all the capital we spend. So it’s the growth capital it’s also our sustaining capital. We really do expect to spend that amount of money. We do have maintenance needs other growth opportunities in Missouri. So while it’s expected to be ratable, we really do need to spend $35 million a year. We are given credit for spending ahead. So if we were to spend $50 million in the first year, we would have a bit of a buffer if there was another year. That’s only the reason we’ve got ahead of our spending far enough but we didn’t need the spending, then we would have that flexibility. But as part of what -- this would be a big commitment by the State of Missouri to us and we are very comfortable making a big commitment back. That's is a lot of money. And if -- but we want to keep that plant healthy all around. So getting the rate release creates a sustainable rate that will drive the health of that business and along with everything else that we will do. So continued success with our core program where we had a never another very nice quarter for core. The continued investment in that plant and equipment, growth of the rod mill which is a really big deal for us there, that’s a wonderful piece of equipment that does exactly what we want all of our major capital subjects to do. We want them to provide growth while we’re reducing our cost to produce. So all those things for us, these are commitments that we’re actually pleased to make an exchange for the support for our business health through the rate.

Brian MacArthur - UBS

So just following up too with the rod mill, obviously you can create value add, get a better price but then you also talked about the initial rate going up from $34.44 megawatt hour. Effectively, can I think of it as you commit that capital, you're going to get a higher premium and that offsets the increase in the -- from the initial rate going forward, if everything works out well, so you get a margin expansion there?

Kip Smith

What happens with the rate is right now, when you look at our all-in rate including the FAC, we spending about $42.80 actually. Now that $42.80, about a $1.50 is milling charge that we have to pay to another provider. So that takes it down about $41.30. And you take about $3.50 bucks out for the fuel adjustment. So first half fuel adjustment charges goes when you should think over every dollar as kind of $4.2 million worth of rate relief. And so you get that $3.57 and then the delta between the $3.44 and where you end up when you take about $3.5 to lay from $41.30 gets you to the remaining number. So we’re actually going to see quite a nice improvement in our liquidity. We're going to see quite a nice improvement in our ability to generate cash from our primary products, which will impact our liquidity positively. And then we just have to be really, really good at our productivity program because our original ask -- and we still believe in our data, our original ask at $30 was one that we felt really allowed us to bear the brunt of the whole cycle because you can get some pretty tough times in the cycle. But it looks like that we’re seeing some volatility -- the positive volatility and possibly even a trend line in this upward price, if that happens then this rate we think will really help us and the combination of those two things. Whether that trend happens or not, this rate will really help but we really did contemplate improvement in the LME and both of these proposals and again for us in the industry -- it's just the whole industry needs -- this is good for all the industry.

Brian MacArthur - UBS

Okay, and just one more question. The 2% cap, is that -- just technically, is that with or without the fuel adjustment when you talk about that 2% cap on any general rate increase. Because obviously, in the 30 -- the fuel cap of 3.5% was at a point in time.

Kip Smith

Exactly, what happens is that’s the cap on the base rate.

Brian MacArthur - UBS

Okay.

Kip Smith

And so it’s strictly on that.

Brian MacArthur - UBS

Right, so that's without the $1.50 and the $3.50 down on that. That's my base for the differential, and then I put my fuel surcharge and work it back up over time.

Kip Smith

Yes, yes and then our fuel surcharge, gradually it’s over time. Surcharge is nothing and then ultimately within five years you’re are back at the whole nonfuel adjustment charge, but that five year period is essential to us. That is a nice window of stability for our power rate. It allows us to reinvest in New Madrid, and it give us a platform from which to look out what happened five years out as well and how can we continue a program of globally competitive sustainable rates. So obviously we support this. We think it’s an appropriate rate for this point in time and we would be very grateful for this kind of support from the State of Missouri. The only thing I would add is this obviously still needs approval. It's still got to be approved.

Brian MacArthur - UBS

I get that.

Kip Smith

That’s entirely up to the Public Service commission, when we get that there.

Operator

Our next question comes from David Olkovetsky of Jefferies. Please go ahead.

David Olkovetsky – Jefferies

Can you just talk a little bit about the rod mill investment? What is the kind of timeframe you are looking for in terms of payback on an EBITDA, less CapEx, basis?

Kip Smith

Yes, we really haven’t disclosed that kind of information on the payback period. It’s really about rolling with our customers, customers who really want this rod mill and so we need to do this to support them and that was one of the key drivers. Also there are other rod mills that we have. They are older and don’t have all the safety features. There is a lot of safety concerns around the new having the better safety mechanisms built into the new rod mill, because there's many facets of the rod mill that we looked at not just purely from an IRR stand point or returning standpoint.

David Olkovetsky – Jefferies

So Dale, just to clarify, this is a positive ROIC project, correct?

Kip Smith

Absolutely. It really lowers our costs over the going forward periods if you think about the older mills, technology not there so, it will see a nice increase there from a lower cost standpoint going forward.

David Olkovetsky – Jefferies

And what's the total amount that you guys are investing in that?

Kip Smith

Its approximately $45 million.

David Olkovetsky – Jefferies

$45 million. Great, thank you. And then, with respect to the CORE savings program, you guys are talking about $225 million, or I guess it's a little lower now, given the new slightly higher pricing you are looking for of $34 and change for the electricity. Just walk us through the other aspects of it, of getting from the $140 million to the, I guess now, $205 million. The $15 million workforce reduction, when are we going to start to see that in the numbers, and the $20 million of, I guess I'll say other that you describe in your slides from a couple quarters ago?

Kip Smith

David, thanks for that question. On CORE, we did have success when you look at the first half over bridging from the first half of 2013 to the first half of 2014, our segment profit. We had almost $7 million of core productivity there. If this new rate design is approved as we talked about in the joint proposal, that would decrease that, but it doesn’t change our overall total program of $225 million. We will find in as we always do we’ve to find and have additional projects that we can add to that total portfolio. So, there would not be a decrease down to $205 million or whatever. It would stay at the $225 million. We can make that up, we’ve got plenty of time over the next couple of years to bridge that gap.

David Olkovetsky – Jefferies

So Dale, sorry, I just want to clarify a little bit, if I could. Just with respect to the work force reduction, you talked about $15 million. When does that start to hit the P&L? When do your cost go down by $15 million on a run rate basis?

Kip Smith

It’s started January 1, 2014

David Olkovetsky – Jefferies

Okay. So, then, if I look at your cash costs, I don't see a major decrease in cash costs. In fact, it looks like it was $0.90 for the first quarter, $0.84 for the second quarter of this year. Last year, it was $0.81/$0.83. I realize that in 1Q ‘14, there was a little bit of an impact from weather-related stuff, but that’s still significantly higher year-over-year. So we are talking about all these CORE savings, and yet I'm seeing costs increasing. Help me understand why that is?

Kip Smith

Okay. If you look at the bride on Page 12, you will see it. There it was in that productivity number of $7 million. We just don’t breakout the headcount savings separately and just think of the $15 million roughly spread over the entire year. So when you are around $3 million and 145 million pound shift, it's probably about $0.01 or so. So sometimes you just can’t breakout every detail. But that's built into the CORE productivity program overall. So we had other additional Core savings in that period of time that's in that that number as well.

Operator

At this time, I am showing now further questions in the queue. I will turn the call back over to Mr. Smith for any closing remarks.

Kip Smith

Thank you and thanks everyone for taking the time to hear our story this afternoon. We're deeply appreciative of your time, your commitment, your time and your interest in investment in our Company. So thank you all very much. We sure appreciate it.

Operator

Ladies and gentlemen, this concludes today’s teleconference. Thank you for your interest in Noranda. You may disconnect your lines at this time.

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Source: Noranda Aluminum Holding's (NOR) CEO Kip Smith on Q2 2014 Results - Earnings Call Transcript
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