Kaiser Aluminum Corporation (KALU) Q4 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Kaiser Aluminum Fourth Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. As a reminder, today's program maybe recorded. I would now like to introduce your host for today's program, Melinda Ellsworth, Vice President of Investor Relations and Corporate Communications. Please go ahead.

Thank you. Good afternoon everyone and welcome to Kaiser Aluminum's fourth quarter and full-year 2019 earnings conference call. If you've not seen a copy of our earnings release, please visit the Investor Relations page on our website at kaiseraluminum.com. We have also posted a PDF version of the slide presentation for this call. Joining me on the call today are Chief Executive Officer and Chairman, Jack Hockema; President and Chief Operating Officer, Keith Harvey; Senior Vice President and Chief Financial Officer, Neal West; and Vice President and Chief Accounting Officer, Jennifer Huey. Before we begin, I'd like to refer you to the first two slides of our presentation and remind you that the statements made by management and the information contained in this presentation that constitute forward-looking statements are based on management's 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 to the company's earnings release and reports filed with the Securities and Exchange Commission, including when filed, the company's Annual Report on Form 10-K for the full-year ended December 31, 2019. 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. In addition, we have 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 reference in our discussion today to EBITDA means adjusted EBITDA, which excludes non-run rate items, for which we've posted 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 Jack Hockema. Jack?

Thanks, Melinda. Welcome to everyone joining us on the call today. We reported strong fourth quarter and record second half and full-year 2019 results. These results were achieved despite planned and unplanned downtime at Trentwood in the first half, the impact of the General Motors strike in the second half, and a significant number of automotive model changeovers during the year. Countering the headwinds, aerospace demand was strong driven by restocking in the commercial aerospace supply chain and growing military airframe build. The strong demand provided a supportive market environment for pricing on non-contract aerospace and general engineering products. Turning to Slide 6, and a recap of 2019 results, we achieved a number of important financial milestones, including record value added revenue, record adjusted EBITDA, and record adjusted net income and earnings per share. These milestones were achieved despite approximately $20 million combined EBITDA impact from Trentwood downtime in the first half and the General Motors strike in the second half. In addition, we experienced manufacturing inefficiency and reduced sales from a significant number of automotive model changeovers in 2019. We were proactive to enhance our long-term financial and operational position. Capitalizing on attractive credit markets, we successfully completed two new debt financings that increased liquidity. This enhanced financial flexibility will support our strategic investment initiatives, ensuring our continued financial strength throughout the business any given economic cycles. In addition, we recently finalized a new labor agreement that extends through 2025 for our two largest facilities in Trentwood and at Newark, Ohio. Our continued confidence in the long-term outlook for our business is reflected in our decision to increase the quarterly dividend by 12% up from the 9% increase in early 2019 marking the ninth consecutive year that we have increased our quarterly dividend. Turning to Slide 8. 2019 was a record year for our aerospace shipments and value added revenue. Although the 737 MAX situation will impact our aerospace shipments in 2020, our aerospace order book is bolstered by increased defense spending, and demand for the F35 Joint Strike Fighter, the F/A-18 Super Hornet, and other military applications. For 2020, despite a single-digit percent reduction from the record highs in 2019, we expect 2020 shipments in value added revenue to exceed any previous year other than 2019 for these applications. Turning to Slide 9. As expected 2019 was a difficult year for our automotive applications impacted by the numerous model changeovers and program delays and exacerbated by the unexpected General Motors strike late in the year. In 2020, we expect North American build rates similar to 2019 and we expect double-digit year-over-year growth in our automotive shipments as new programs come on stream. Turning to Slide 10. Strong pricing in 2019 offset lower general engineering shipments driven by reallocation of a portion of our plate capacity to meet our strong aerospace demand and by supply chain destocking for these applications in the second half. In 2020, we expect strong demand driven by semiconductor applications, and relief from the supply chain destocking that suppressed demand in the second half. In addition, reduced aerospace demand related to the 737 MAX will enable increased capacity allocation to our general engineering plate products. We expect the market conditions will continue to support the favorable pricing environment that we experienced in 2019. Turning to Slide 11. Shipments for non-core applications continued to decline in 2019 and we expect a 60% decline in 2020 as we continue to allocate capacity to more strategic extrusion applications. While this is a small portion of our product mix, a 60% decline represents about a 1.5% year-over-year decline in shipments and value-added revenue in total. Moving to Slide 12, and a summary of our 2020 outlook. We expect that the impact from the Boeing 737 MAX situation will be offset by higher military, general engineering and automotive shipments resulting in a low single-digit 2020 year-over-year increase in both shipments and value added revenue. We also expect to achieve record full-year EBITDA with EBITDA margin above 26% with a market environment continuing to support strong value added pricing, along with expected efficiency gains in our automotive operations and at Trentwood. Moving to Slide 13, and our capital spending plans. As we communicated throughout 2019 despite investments that have nearly tripled capacity for heat treat plate, Trentwood has operated at or near capacity since 2004. In 2020, we expect to continue to operate at or near capacity at Trentwood despite the temporary curtailment of 737 MAX builds. While the 737 MAS has short-term demand implications, we expect the result will be pent-up long-term demand for global commercial aerospace applications. In anticipation of strong long-term demand growth for our heat treat plate products, in 2020, we will launch a $375 million multi-year expansion and operational security investment project at Trentwood. The first module in the $375 million project is a new $145 million heavy gauge plate stretcher that will relieve the load on the existing plate stretcher that is operated at production levels far greater than was anticipated in 2005 when we developed a heavy gauge plate initiative at Trentwood. The new stretcher will provide increased capacity, redundancy, efficiency, and operational security for this critical step in our process flow. Timing of other smaller investment modules within the remaining $230 million will depend upon market conditions although we currently expect to complete the full-program by 2025. Expected benefits from the full $375 million project are an approximately 25% increase in aerospace and general engineering heat treat plate production capacity plus enhanced quality, costs, and inventory efficiency. 2020 capital spending of $100 million to $125 million is planned including approximately $40 million spending for the new stretcher plus investments addressing plate processing bottlenecks as well as other quality, efficiency, and sustaining CapEx projects. I'll now turn to Neal to provide additional detail regarding the 2019 results. Neal?

Thanks, Jack. Turning to Slide 15, record value added revenue for the full-year 2019 of $856 million reflected a 3% or $28 million increase from prior-year driven by a strong aerospace order book and strong value added pricing, partially offset by the lower general engineering and automotive shipments. Aerospace/high strength contributed an incremental $56 million in value added revenue reflecting a 12% increase year-over-year and a 10% increase in shipment. Value added revenue for general engineering applications was essentially flat with 2018 on a 12% decrease in shipments as strong value added pricing offset the impact of lower shipments driven primarily by the allocation of general engineering plate capacity to meet strong aerospace demand. Automotive value added revenues declined 20% on a 10% reduction in shipments due to transition from end-of-life programs and delays in new program launches. Value added revenue for other categories was down approximately $5 million or 20% on a 36% reduction in shipment, as we continue to exit non-strategic business and as noted by Jack, redirect a capacity to more strategic applications. Value added revenue for the fourth quarter 2019 was $213 million reflecting similar full-year trends. Value added revenue in quarter also reflected weakening industrial demand and supply chain destocking of our general engineering applications and our automotive business was further impacted by the General Motors strike. Additional detail on value added revenue and shipments by end-market applications can be found on the Appendix of this presentation. Turning to Slide 16. EBITDA for the full-year 2019 was a record $213 million, increasing approximately 4% or $8 million compared to the prior-year. Strong aerospace demand for our products and higher pricing on our non-contract business more than offset the negative impact of approximately $15 million related to Trentwood downtime, approximately $5 million related to the GM strike, and $1 million of costs associated with the ratification of the new USW five-year labor agreement, in addition to other costs and inefficiencies associated with the automotive program transitions. Fourth quarter 2019 EBITDA of $52 million, while comparable to a very strong 2018 fourth quarter, reflected the combined impact of approximately $5 million related to the GM strike and new labor agreement as previously noted. Despite these headwinds, EBITDA margin for the full-year 2019 was 24.9% slightly higher than the 24.7% from the prior-year. Moving on to Slide 17. Reported net income for 2019 was $62 million compared to $92 million for 2018. Adjusted for non-run rate items in both periods, adjusted net income increased approximately 2% to $111 million in 2019 compared to adjusted net income of $109 million in 2018. Reported net income for the full-year 2019 included fourth quarter pre-tax impacts of an approximately $20 million charge related to the early retirement of our 5.875% unsecured senior notes and a non-cash goodwill impairment charge of approximately $25 million related to the 2018 acquisition of Imperial Machine & Tool. For 2019, our effective tax rate was 23%, reflecting our blended federal and state tax rate of approximately 25%, reduced primarily by a Federal R&D tax credit, which was partially offset by an increase in rate for certain executive compensation and state valuation allowance. Long-term, we continue to believe our effective tax rate will be in a mid-20% range. Our cash tax rate for 2019 was in a low single-digits as we continue to utilize our NOLs and other tax credits. Our cash tax rate will remain in the low single-digits until we consume our federal NOLs and available tax credits of approximately $121 million and $13 million respectively. As reported, earnings per diluted share were $3.83 in 2019 and $5.43 in 2018. Adjusted earnings per diluted share were $6.85 and $6.48 for 2019 and 2018 respectively. Reported earnings per diluted share in 2019 reflected $2.14 after-tax impact from the fourth quarter charges previously noted. Turning to Slide 18, and touching briefly on our fourth quarter 2019, VAR of $213 million was up slightly compared to the prior-year quarter, while EBITDA of $52 million was down from the prior-year period, primarily due to the GM strike and costs associated with the new USW labor agreement. The reported net loss and loss per share reflect the early retirement of our senior notes and non-cash goodwill impairment charges as previously discussed. Turning to Slide 19. Adjusted EBITDA of $213 million and approximately $33 million from improved working capital funded all of our other cash requirements during the year including capital investments, interest, dividends, and approximately $44 million of share repurchases. During the fourth quarter 2019, we further strengthened our financial strength and flexibility successfully completing two significant refinancings, a revolving credit facility and senior notes. Our new $375 million senior secured credit facility maturing in 2024 increased the lending commitment by $75 million and provided more favorable pricing and greater flexibility than the previous facility. The new $500 million 4.625% senior notes maturing in 2028 refinanced the $375 million 5.875% senior notes maturing in 2024, providing net proceeds of $100 million. We continue to manage our business and liquidity to support our ongoing growth initiatives and return cash to shareholders through the business and economic cycles. At year-end 2019, total cash and short-term investments of approximately $343 million and more than $353 million of borrowing availability on our revolving credit facility provided total liquidity of $696 million. The facility remains undrawn. Turning to Slide 20. During the year, we continue to allocate capital in a disciplined manner with a focus first on our reinvesting in our business. Capital spending in 2019 was $60 million. As Jack mentioned, in 2020, we will begin to implement our Trentwood expansion plan and we expect capital spending to be $100 million to $125 million primarily related to the investment in new stretcher and in addition to ongoing quality, efficiency, and sustaining capital spending across our platform. Since 2011, we have continued to increase our quarterly dividends each year. And most recently, we announced a 12% increase in our first quarter dividend to $0.67 per share, which was paid in early February 2020. As previously mentioned, we also continue to distribute cash to shareholders through our disciplined share repurchase program. In 2019, we repurchased 445,000 shares of our common stock for $44 million at a weighted average price of $96.18 per share. Approximately $106 million remained available for further share repurchases under our existing board authorization as of year-end 2019. And now I'll turn the call back over to Jack for summary comments. Jack?

Thanks, Neal. Turning to Slide 22 and a summary of our comments today. Despite headwinds, we achieved record shipments, value added revenue, adjusted EBITDA, adjusted net income and adjusted earnings per share in 2019. In 2020, we expect year-over-year shipments and value added revenue growth despite the Boeing 737 MAX production curtailment and we expect to achieve record EBITDA margin. As we look longer-term, we expect continued secular demand growth for our aerospace and automotive applications and we're launching a multi-year $375 million expansion program at Trentwood to be prepared to address long-term customer needs. In addition, we expect to continue steady improvement in underlying manufacturing cost efficiency to further drive value for all of our stakeholders. Our strong balance sheet and cash flow generation will support our growth and capital deployment priorities and provide sustainability through industry cycles. We will now open the call for questions.

[Operator Instructions]. Our first question comes from the line of Matt Korn from Goldman Sachs. Your question please.

Great to hear the optimism regarding next year with everything going on, great to hear. Let me ask this, we always appreciate how you articulate the expected effects from things like the $15 million from Trentwood, $5 million from GM. Now even if there end up being some moving pieces, are you able to quantify given all we've heard from Boeing and the other suppliers and emerging consensus out there in build rates? What you would expect to be the year-over-year drag on VAR or EBITDA from the MAX as you look at things today?

No. We're not going to go to that level of detail. What we said is that we had record shipments and value added revenue from aerospace last year. And we expect to be down single-digits this year, but it's still going to be the second or the second strongest year better than any other year that we've had since 2019. So it's single-digits in aero and total.

Got it, all right. And then, when we look through your deck on Slide 8, the bump in volumes there in aero and high-strength stands out, all the much more relative to history. Is there any particular product type that really took off over the year? And then you continue to highlight the military demand as a main tailwind? Could you -- would you break out what did that market particularly represent in terms of your volumes or VAR?

Yes, I'm going to let Keith Harvey address that question.

Yes, thank you. Well, quite frankly, we saw stronger increase on all of our aerospace related products last year. Definitely in our plate products out of the Trentwood rolling mill, but also in our extruded hard alloy shapes business from our Alexco operation. And then in our hard alloy business overall, we saw really good indications as you saw on the numbers here year-over-year in 2019.

All right, great. And then just last from me, are we effectively through all the speed bumps on the changeovers in the automotive platform?

I'll let Keith address that, I'm tired of being wrong.

Well, as Jack articulated all of last year, we had an interesting year with regard to new programs and old programs, stopping with new programs launching. But as you heard in the discussion earlier, we expect a very strong year and with multiple launches planned throughout 2020 for automotive, we've got really strong indication throughout the whole year. We also had some programs that were slow to launch as we discussed last year, those started late 2019. And we're starting to see the impact of those as they begin their ramps in early 2020.

Thank you. Our next question comes from the line of Martin Englert from Jefferies. Your question please.

When thinking about the aero and high-strength volumes throughout 2020 given some of the longer lead time nominations, would it be a scenario wherein we should expect some continued volume growth maybe during the first half of the year then a decline year-on-year over the second half? Or is your guidance for single-digit declines expected to trend quarterly throughout the full-year?

Well, we actually expect fairly strong shipments in Q1. The discussions with Boeing regarding the 737 were taking place all of the second half of last year and early part of this year. We have a clear runway of what the expected shipments now will be in what period of time and so you would expect to see some of that alter and change throughout the year. However along with the Boeing, we also have picked-up, as Jack mentioned, on the -- on our military side of the business. So we're seeing that ramp-up beginning early on. And then of course, that's all been bolstered by the strong demand we've also noticed in our general engineering plate.

Okay. So maybe the cadences we still see aero/high-strength volumes positive year-on-year throughout the first quarter here, but then we start to see that declines in second through fourth quarter and equating to single-digit declines year-on-year?

Well, it's tough to give it by quarter at this point with the ramp-up of the military, along with some of the impacts we've worked. We're working with Boeing as to the schedule and how they want the releases. So at this time that granularity I really don't have but full-year we're anticipating the single-digit lower than 2019.

Okay. And one of the things that key concerns here is in the past when there's been some changes with aero plate demand, it's often resulted in some delayed impact and then subsequent channel destocking. And such that we saw with the mix shift from wide-body to narrow body, what's your sense that the MAX curtailment results in some inventory destocking down the road here or perhaps the guidance is already accounting for that and you're adjusting your shipments to account for today?

This is Jack again. Clearly and we said this on the last call because when they curtailed the Boeing production late last year, the shipments continued at a strong pace. And that's what generated the restocking and the record aerospace shipments last year. So there has to be some destocking in the supply chain but Boeing as they've stated publicly many, many times, they're really aware of the importance of the supply chain here and are making certain that they don't damage the supply chain. So while we may see less than real demand at some point when they really begin to ramp-up, we don't expect that we're going to see severe implications.

Okay. So it sounds like its largely accounted for in your volume guidance here for the year, correct?

Yes.

Okay. Understood. And then maybe I know you don't want to get too much into quarterly's but in some prior quarters, you helped us framed up expected EBITDA on par better or worse than the prior-quarter, or the prior-year, any detail that you can provide around that?

No, no detail, but just as Keith said, we're expecting a pretty positive first quarter.

Okay. Excellent. I appreciate the detail and congratulations on the record results in light of all the headwinds.

Thanks.

Thank you. Our next question comes from the line of Curt Woodworth from Credit Suisse. Your question please. Curt, you might have your phone on mute. Curt, we're still not hearing you. Seems to have dropped. [Operator Instructions]. Our next question comes from the line of Josh Sullivan from Benchmark Company. Your question please.

I believe you had a longer-term strategy program in effect. I want to see your kind of Kaiser 2025 or something along those lines. Just curious how does clearly large commitment fits into that longer-term outlook? I know what you're thinking Kaiser looks like in the future. It could hit a lot of success reinvesting in Trentwood. But just curious if the investment includes any changes in that strategic outlook?

Yes, you broke up a little bit there.

Talking [indiscernible] we talked about vision, how do things [indiscernible] project in terms of that, any change in strategy?

Yes, there is no change in strategy. We've talked about this for the past couple of calls, where we looked out earlier last year, looked out 20 and 30 years and really pushed ourselves and our team got innovative and came up with some really creative ideas that we think give us brown site expansion opportunities to satisfy demand 20 and 30 years out. So this $375 million expansion program is really just the first tranche of that. We've got plans well beyond what now this becomes like a Phase 7. We got plans well beyond Phase 7 to continue to grow over the next two or three decades with the marketplace.

Got it. And then just on the stretcher investments specifically, how should we think of that feathering into operations over the next year or so, what kind of margin contribution should we think about or reduced maintenance?

Well, it won't be on stream until 2022. By itself, it won't have a major margin impact. It gives us some efficiency and some quality benefits. But the primary attributes of this particular investment, our operational security number one because the preponderance of our plate, both general engineering and aerospace goes through one stretcher today. So having the redundancy of two stretchers is important for operational security purposes. And then the second stretcher is a component, there won't be another stretcher needed in the next 20 or 30 years. So it gives us capacity for long-term growth this one major investment.

All right, thank you.

Also, this is Keith. I might note that the stretcher that we're going to install also gives us some additional capability. It's roughly a 33% more increase on pulling force than our current stretcher. So we expect that to open us up to some more opportunity with our customer base.

Thank you. This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Jack Hockema for any further remarks.

Okay. Thanks everyone for joining us on the call and we look forward to updating you during our first quarter call in April. Thank you.

Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.