Q3 2020 Kaiser Aluminum Corp Earnings Call

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Welcome to <unk> third quarter 2020, <unk> earnings Conference call. My name is John up your operator for today's call. At this time all participants are in listen only mode. Later, we will conduct a question and answer session during the quarter.

During the question and answer session. If you do have a question press Star then one on your Touchtone phone and then I will turn the call over to Melinda Ellsworth.

Good afternoon, everyone and welcome to Kaiser aluminum third quarter and first nine months Twentytwenty earnings Conference call.

If you have not seen a copy of our earnings release. Please visit the Investor Relations page on our website at Kaiser aluminum Dot com we have.

We have also posted a PDF version of the slide presentation for this call.

Joining me on the call today are president and Chief Executive Officer, Keith Harvey Senior Vice President and Chief Financial Officer, Neal West and Vice President and Chief Accounting Officer, Jennifer Healy.

Before we begin I'd like to refer you to the first three slides of our presentation and remind you that the statements made by management and the information contained in this presentation constitute forward looking statements are based on managements current expectations.

For a summary of specific risk factors that could cause results to differ materially from those expressed in the forward looking statements. Please refer.

Please refer to the company's earnings release, and reports filed with the Securities and Exchange Commission, including the company's annual report on form 10-K for the full year ended December 31, 2019, and form 10-Q for the quarters ended March 31, 2020 and June 32020.

The company undertakes no duty to update any forward looking statements to conform the statement to actual results or changes in the company's expectations ended.

In addition, we've included non-GAAP financial information in our discussion reconciliations to the most comparable GAAP financial measures are included in the earnings release and in the appendix of the presentation any.

Any reference.

To to our discussion today to EBITDA means adjusted EBITDA, which excludes non run rate items for which weve provided reconciliations in the appendix.

At the conclusion of the company's presentation, we will open the call for questions.

I would now like to turn the call over to Keith Harvey Keith Thanks, Melinda and good morning, everyone.

We delivered solid third quarter results driven by a rebound in automotive demand and continued strength and demand for our defense and general engineering applications.

Following the onset of Covance, we have continued to aggressively flux costs to align with changes in market conditions.

Although demand for our commercial aerospace applications in the third quarter dropped sharply from the strong first half of the year. We continue to reiterate the outlook for the second half of 2020, given in our second quarter earnings call.

Strong execution by our employees enabled us to deliver solid third quarter results and very challenging conditions as we continue to deal with varying market dynamics influenced heavily by the impact of Covance.

Total liquidity remains strong at $1 billion, our capital allocation priorities on our financial guidelines remain unchanged and we continue to sustain our quarterly dividend.

Let me comment briefly on the end markets.

As we noted on our second quarter earnings call, we anticipated the full year decline in demand for our commercial aerospace applications would be reflected in our second half results as the large commercial aircraft manufacturers continue to deal with production interruptions and slowing deliveries as a result of Cigna.

Inefficiently reduced domestic and international Air travel.

During the quarter, we quickly moved to lower costs in our aerospace and high strength focus facilities and pivot available capacity to other markets where possible.

In addition, we continued working with our customers on modifications to existing declarations as.

As we have previously noted we have long term strategic relationships with our customers many with multi year agreements in place that allow both parties to mitigate the short term impact of changing market conditions and meet agreed upon commitments.

Continued strength and demand for our defense applications has partially offset the decline in commercial aerospace and we have been successful in adjusting capacity in lead times to meet double digit year over year growth in demand for these applications.

Turning to automotive as we expected our automotive extrusion shipments and resulting value added revenue bounced back strongly in the third quarter to mirror, our strong first quarter results as new program launches resumed.

These launches and other recently awarded programs are expected to continue to drive growth through 2021 and beyond.

With these expected increases in automotive demand, we have recalled virtually all furloughed employees in our automotive focused facilities we are.

We are well positioned to manage the expected longer term growth for these applications with minimal additional investments.

Our general Engineering business continues to remain strong despite normal seasonal demand weakness in the second half.

Solid service center demand for our Kaiser select products and continued strength in the semiconductor and automotive end market applications drove third quarter results as.

As I mentioned earlier, our ability to pivot aerospace plate capacity to meet the demand for general engineering applications enabled us to better meet demand and improved lead times for our customers.

Pricing for these applications continued to remain stable during the quarter as the industry has responded to changing demand with adjustments to operating levels.

I'm pleased with how our employees aggressively address cost and manage spending in the quarter given the different dynamics in each of our end markets.

While our aerospace and high strength facilities were ramping down to align with lower commercial aerospace demand. The opposite was occurring for those facilities, serving automotive and general engineering markets, where we were ramping up to meet improving demand.

Despite the challenge in managing our operations with these significant swings in demand our results reflect our ability to flex our variable cost structure to changing levels and demand in an efficient and effective manner.

As business levels improve we expect increased operating leverage will drive margin improvement as incremental cost will lag volume increases.

In addition to strong execution and aggressively managing the impact of the cobot virus in our facilities. Our employees are also achieving record safety performance Onyx.

Im extremely proud of the work they are doing and the manner in which they are achieving these results.

Turning now to our outlook on Aero and high strength on slide number seven.

We see a continued slow recovery for large commercial aerospace applications driven by longer than expected recertification of the 737, Max slower recovery in domestic and international Air travel and Destocking in the supply chain.

Destocking also occurred in the business jets supply chain as manufacturers dealt with temporary production delays due to COVID-19 outbreaks in late second quarter and early third quarter.

As we reassess the full year outlook for these applications, we anticipate value added revenue for commercial aerospace will now be down approximately 30% to 35% year over year from our record year 2019 versus the 20% to 25% previously anticipated.

Demand for our defense applications remains strong and is expected to continue into 2021.

Moving to slide number eight.

Strong demand for our automotive Extrusions is expected to continue in the fourth quarter with value added revenue and shipments similar to our strong third quarter results.

Build rates for North American vehicles are currently projected to increase approximately 18% from a 12.9 million vehicle production rate in 2020 to over 15.2 million vehicles in 2021.

In addition, we expect continued growth in aluminum extrusion content as consumer preference towards larger vehicles and light trucks drive demand.

Moving on to slide number nine we see.

We see continued strength and demand for our general engineering applications. Despite second half normal seasonal demand weakness in.

In addition to strong service center and end market demand, we continue to see the emerging trend for Oems reestablishing domestic supply chains.

Our Kaiser select Rod bar and plate products and our long term service center partnerships uniquely position us to capitalize on these opportunities as they continue to develop.

On slide number 10, and a review of our outlook summary.

Looking at the balance of the year, we reiterate our outlook for the second half of 2020 as communicated on our second quarter earnings call.

We anticipate total value added revenue in the second half will be down approximately 10% to 15% from the second quarter rate driven by lower aerospace and high strength sales.

Offset by continued strength and demand for defense automotive and general engineering applications with EBITDA margin expected to be in the mid teens.

We have reduced costs to align with demand levels across the organization in our operations and support functions that will provide significant operating leverage as business levels continue to improve.

As discussed in our second quarter earnings call. In addition to capital spending for critical sustaining projects, we resumed spending for other organic investment opportunities to further support automotive growth and enhance efficiencies throughout our operations.

We continue to expect capital spending for the full year will be in the approximately $50 million to $60 million.

I'll now turn the call over to Neil to discuss the third quarter in more detail Neil Thanks, Keith and good morning, everyone.

Value added revenue of $154 million in the third quarter, 2020 declined approximately $60 million or 28% compared to prior year quarter, and 30% lower shipments primarily driven by a decline in aerospace demand.

Aerospace high strength value added revenue of $73 million decreased 43% on a 59% decline in shipments compared to the strong demand levels experienced in the prior year quarter.

While demand for defense related applications remained strong the impact the COVID-19, and commercial aerospace demand drove the significant decline in shipments.

Value added revenue in the third quarter 2020 reflected the impact of lower volume a favorite.

A favorable product mix and approximately $15 million of additional revenue recognition related to modifications to 2020 customers annual declarations under multiyear contracts.

Automotive value added revenue of $24 million increase approximately 2% compared to the third quarter 2019 on a 5% increase in shipments, reflecting new program launches that began to ramp up as the global supply chain return production. Following the second quarter 2020 cobot related shutdown.

General engineering value added revenue of $55 million declined approximately 4% on a 5% reduction in shipments reflecting seasonal demand weaknesses normally experienced in the second half while pricing contain continue to remain stable.

For the first nine months of 2020 total value added revenue of $546 million decreased $97 million or 15% on 19% lower shipments by.

Following a record 2019 in first quarter 2020, the impact of the pandemic in our aerospace high strength completions drove the majority of the decline compared to prior year period.

In addition, the second quarter impact of our automotive applications and and our other planned exit of other non strategic applications further impacted value added revenue and shipments year over year.

Turning to slide 13.

Adjusted EBITDA of $30 million in the third quarter of 2020 decreased $27 million compared the prior year period, reflecting the total sales impact inclusive of the $50 million as previously noted and other cost flex with lower demand.

EBITDA margin for the third quarter was approximately 20% compared to 26% in the prior year quarter, driven by lower var and operating leverage.

EBITDA for the first nine months of 2020 of $124 million declined $36 million compared to prior year period.

With the majority of the impact due to the third quarter 2020 results as previously discussed.

EBITDA margin for the first nine months of 2020 was approximately 23% compared to 25% in the prior year period.

Turning to slide 14.

Reported operating income for the third quarter 2020 was approximately $12 million.

Adjusting for $5 million of non run rate charges operating income for the third quarter was $17 million compared to $44 million in the prior year quarter.

The third quarter 2020, non run rate charges, primarily reflect a $4 million increase reserve increase for environmental issues associated with ongoing historical PCB cleanup at our Trentwood facility.

Reported net income for the third quarter, 2020 was $400000 or two cents per diluted share Ajay.

Adjusting for non run rate items net income for the third quarter was $5 million compared to $29 million in the prior year quarter. The.

The $5 million adjusted net income reflects the impact of lower operating income and an increase of $6 million or pre tax interest related to our recent bond offerings.

Adjusted earnings per diluted share in the third quarter declined to 33 cents from $1.82 cents in the prior year period.

Reported operating income for the first nine months of 2020 was $63 million.

Adjusting for $22 million and non run rate charges operating income was $85 million down from the $124 million in prior year period.

The decline in operating income as adjusted primarily reflected the decrease in EBITDA previously discussed and approximately $3 million of higher depreciation expense.

The $22 million of non run rate charges and 20 funding year to date, primarily reflects a $12 million restructuring charge for severance and benefit costs reported in the second quarter and a total of $6 million reserve increases for ongoing environmental cleanup projects.

Reported net income for the first nine months of 2020 was approximately $23 million or $1.44 cents per diluted share.

Adjusting for non run rate items, net income of $41 million compared to $82 million in the prior year period.

Adjusted earnings per diluted share for the first nine months was $2.60 compared as $5.06 for the first nine months of 2019.

The effective tax rate for the quarter was impacted by discrete issues. During the period. However, the effective tax rate for the full year 2020 still projected to be in the low to mid 30% range due primarily to an increase in state tax on oil valuation and adjustment for non deductibility of executive compensation.

We expect our 2020 net cash tax to be a cash refund of $11 million related to AMC monetization.

Capital spending totaled $5 million in the third quarter and $37 million for the first nine months of 2020.

Fully full year capital expected spending is expected to be $50 million to $60 million as Keith previously noted.

During the first nine months of 2020 total cash return to shareholders was approximately $45 million. In addition, we recently announced our quarterly cash dividend of 67 cents per share that will be paid on November 13.

Total liquidity on September Thirtyth was $1 billion comprised of $750 million of cash and cash equivalents and borrowing availability on our undrawn revolving credit facility of approximately $253 million.

Now I'll turn the call back over to Keith for closing comments.

Thanks Neil.

Summary, summarizing our remarks on slide number 16.

We delivered solid third quarter results driven by a strong rebound in automotive demand and continued strength and demand for our defense and general engineering applications.

Despite the impact of the ongoing pandemic and we have aggressively flex cost and reallocated capacity to align with the changes in market conditions.

We continue to anticipate total value added revenue for the second half of 2020 will be down approximately 10% to 15% compared to the second quarter, Rob run rate with EBITDA margin in the mid teens.

Total liquidity remains strong at $1 billion.

Our capital allocation priorities and our financial guidelines remain unchanged.

We are well positioned to continue to navigate challenging market conditions and capitalize on opportunities to further strengthen our prospects for long term profitable growth.

We will provide more color on our 2021 outlook during our fourth quarter earnings call next February but we believe that 2020 will be the trough for earnings.

Our philosophy has always been to prepare ourselves to navigate through the highly cyclical nature of the end markets we serve.

We're confident that we have the levers in place to navigate through this period with our strong customer relations our broad product offering.

Solid multiyear agreements, which provide a safety net through challenging market conditions and a very strong balance sheet that allows us to manage our business and capitalize on additional opportunities, which may come our way.

With that I will now open the call for questions.

Thank you we'll now begin the question and answer session. If you do have a question press Star then one on your Touchtone phone if you wish to be removed from the queue. Please press the pound sign or the hash key.

Delay before the first question is announced if you are using a speaker phone you may need to pick up the handset first before pressing the numbers once you.

Once again, if you have a question press star one on your Touchtone phone.

And our first question is from Curt Woodworth.

Woodworth from credit Suisse.

Thanks, Hi, everyone and congratulations on a great result, this quarter.

Hey, good morning, Curt expert.

With respect to the aerospace guidance.

No not not totally surprising but can you.

Can you comment a little bit more on kind of what drove the change.

The function of just continued destocking that whether further cuts in the build rate I know you said Max certification was delayed and maybe a little bit too early to think about next year in terms of customer nominations, but do you have any sense of.

You know view on how the market could look into the early part of next year or the cadence of the inventory destock, which.

Arguably will take at least another two quarters to work itself out.

Sure.

Right.

In looking at the market, we solve the large airframers begin to show reduced orders rapidly. After the end of the second quarter and so from a de stocking perspective. They stopped early on and so we think that that will shorten the length of a typical destocking peers.

With that we we experience.

As that relates we're still looking at the return and we're measuring return as to the strength that we saw in the 2019 time period, we continue to believe that as well as our our end customers at this time that thats going to take about two to four years to get back to that 2019.

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Now that doesn't mean that that we won't see a gradual recovery start happening over the next hope.

Hopefully sooner than later, but perhaps a couple of years or one year or so forth. So were monitoring that very closely discussions continue.

With all involved as these things that I mentioned in the in our in our.

Discussion points earlier are the things that were waiting on we're waiting for recertification of the Max we think thats going to be one one little hurdle that we are going to get past that will start to give us more visibility as to how fast. This will come back and then I think as things progress obviously, we're looking for.

A a public to be comfortable with returning to travel that's going to continue to drive demand and we think ultimately will recover.

When those things start to happen is how fast we'll get back on this now with regard to how we're we're looking at how the world looks over those next few years as we mentioned we were very pleased with the strong multi year agreements we have in place and we think that that those.

We are going to give us a safety net with which to navigate until that time period. When does stocking has ended and we're back on recovery with more sales with the large airframes.

Okay that makes sense and then with respect to general drill.

You know clearly some some pretty strong success at least in the common alloy market on the anti dumping outcomes 18 countries have you seen any shift in.

Buying behavior with respect to that we had heard that some servicers.

Engage in a little bit of a pre buy to get out of bed and its pricing now starting to recover more how would you kind of characterize the.

The broader industrial market right now.

Yes, I think I think that what we're seeing with the stronger activity in general engineering and some of the other markets that are specifically outlined there I think thats, helping helping over all the conditions with pricing that we're seeing that strong demand and with others.

Market, starting to come up and really with the industry managing.

If there are capacity availability that tends to raise all boats and so.

Typically the feedback go back to the old way to nine period in more of the that typical recession, we saw price degradation begin to happen and hopefully with this strong occurrence other than some of the challenges in some of the key markets.

Hopefully, we're going to see some stability continue to rain here on the pricing on all fronts. So add activity is raising all boats Kurt.

Okay, Great and then just just one final one.

Maybe maybe a little bit difficult part about this now but in terms of like the future pizer, yet the incredible balance sheet.

I had a lot of lot of Optionality with respect to some.

Some of the interesting secular things going on in the market.

From an M&A perspective or are you looking to become more active I mean, there's a couple of assets that are.

Pretty quick you did all the assets available in the market now I believe for sale.

Do you have any kind of vision for how the portfolio could look maybe not next year, but in the next three to four years.

Well.

You mentioned that what we have is the ability to to to be able to react if something comes along that matches, our filter and our capital allocation strategy. We've always focused on on organic growth first but inorganic.

As long as it fits certain guidelines and conditions.

As we've stated many times, we're we're always first on the call list as a preferred buyer.

That should continue with the current environment.

And as we've stated if we find something that's additive to our business.

Now that we understand it's got a defensible good strong position.

We understand the culture, if it's something that can provide that long term shareholder value and we can stay within our our leverage and and liability guidelines.

We were in a position to be able to pull the trigger and that but we're going to.

But we're going to remain disciplined in that approach so as long as we can check the boxes on those.

On those filters.

We're in a good place to be able to to to do one of those if they come along.

Great. Thank you very much stay well.

Thank you as well.

Our next question is from Josh Sullivan from the benchmark company.

Hi, good afternoon.

Hi, Josh.

Can you just talk a little bit about the conversations you've had with aerospace customers. Those modifications you mentioned in the prepared remarks, you just help us understand some of the parameters around those conversations.

His pricing part of that conversation conversation and maybe what the timelines you're talking about some of those modifications share.

Sure well listen.

Without really getting into the value of our agreements, which we wouldn't do but.

Many of our contracts have provisions in place for cost recovery per acre.

Francis margin protection volume product mix none.

A number of things and when it's determined that those provisions can't be Matt it could it creates a contractual obligation.

During the quarter. It was determined that the several those would not meet the provisions in the contract and that triggered the obligation that that was recorded and Neil spoke at detail too. So.

We if you think through that from a Kaiser aluminum perspective, that's really how we approach. We've always stated we approach things.

In understanding the markets, even though it hasnt demonstrated as such the aerospace market has always been a cyclical market and and so we always plan for those downturns our approach to long term agreements reflects that philosophy and and you can see that those are in place.

It it happened to trigger in.

In and for 2020 and again those those same agreements are in place for multi years with many of our customers.

Is there any reason to think that it could be triggered in 2021 at this point or do you think that Tony was the low point and.

Well I think if you look at it.

It's a great question Josh.

Not necessarily in a position to answer that at this time.

But what gives us.

Comfort in being able to understand what our future looks like is understanding that with these agreements. There is a safety net at certain at certain conditions and so we're able to pull on those if the market were to get worse, we're able to pull on those the heavier if and hopefully the markets will return core.

Occur than than what has been anticipated or communicated today.

To date.

Got it.

And then just switching over to general engineering.

Can you give us any granular detail on on the re shoring impact.

Products gives you confidence that re shoring is really driving some of that strength.

Well the.

We're seeing a lot obviously and you heard in our last earnings call. The lot of there was a lot of disruption in the supply chain with folks that had a supply chain that perhaps spanned over some motions of water.

A lot of disruption there.

And then as they come back to to really look at the availability and the products that we have.

These markets have had gotten pretty hot and a lot of the key areas semiconductors won the automotive we've talked about.

Don't talk a lot, but munitions space programs and all that and we're able to provide a very good product.

Very good lead time these days lead times pretty key in a lot of our product lines were were half the lead times that perhaps some of the the the imports can offer and that resonates that resonates for long term supply positions.

And and we're just seeing a move in that direction, we happened to have more capacity available to meet that demand and help shore those things up and I think the the overall condition is really just supporting this.

Our position here with capacity in the us and looking at security of supply chain. So I think thats going to continue strongly into 21, we've had some really good wins.

To date in that area and we continue to.

To talk to others about long term agreements.

And then just one on the automotive strength.

And just 2021 I mean do you think you are going to be more focused on a couple of these large new product launches that are coming through or or do you think it's a little more broad based.

It's pretty broad for us Josh we have multiple launches that are executing this year, we have a number of launches planned for the skewed this year and next year.

I stated in the last call. We also were recipients of a couple of really nice new contracts, New awards, which are actually being implemented at were implemented becoming implemented in the third quarter. So we're seeing significant activity right now we've anticipated this for a long time.

We've put millions and millions in place for in and and expectation for these markets to move off.

We had a really good recovery, albeit second quarter for for the covered related the first in the third quarter has been very strong as we would have expected and we just see that just getting hotter for next year. So it's a really good outlook for automotive from our perspective and and a lot of.

Opportunities on new programs across the spectrum on all the products we're offering.

Got it thanks for that.

Thanks, a lot.

I had a question again from Curt Woodworth from credit Suisse.

Yes, hi, just to follow up on John.

Johnson <unk> Johnson's question within the Extrusions market in terms of the.

Sort of the secular trend and light weighting and aluminum take.

Although generally taking share it typically I think on the new platform Youve got three to four years that visibility ahead of that given redesign and the timing around that would you say that you still feel pretty comfortable that that secular trend has momentum into two.

2022, 2023 is bidding activity still.

Pretty good for those products or do you think we're getting closer to a point of maturation.

No I think it's it's a very good one week when we quote on programs were generally out the two or three years three or four years in some cases on some of these platforms. So the businesses that we're quoting on our our out in that timeframe and we've seen no fall off in increasing.

Demand for the per lightweight aluminum extrusions.

So we think Thats. This thing has legs and we are continued to be.

Very well positioned to take advantage of it.

That's great. Thanks, Thanks for your time.

Thanks Kurt.

And we have no further questions at this time I will turn it back over to Keith Harvey for closing remarks.

All right well. Thank you very much for joining us on the call today, we look forward to updating you during our fourth quarter 2020 conference call in February have a good day.

Thank you, ladies and gentlemen that concludes today's call. Thank you for participating and you may now disconnect.

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