Kaiser Aluminum Corporation (KALU) Q1 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by and welcome to the Kaiser Aluminum First Quarter 2020 Earnings 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] I would now like to introduce your host for today’s conference call, Ms. Melinda Ellsworth. You may begin.

Thank you. Good afternoon, everyone and welcome to Kaiser Aluminum’s first quarter 2020 earnings conference call. If you have not seen a copy of today’s 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 would 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 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 the company’s Annual Report on Form 10-K for the full year ended December 31, 2019 and Form 10-Q for the 3 months ended March 31, 2020. 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 have 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. Hope everyone’s in health and safety today, welcome for joining us on the call. While our comments would normally focus on our record first quarter results; today, Keith, Neal, and I will focus on our preparedness and actions addressing the pandemic. Turning to Slide 6, adherence to our longstanding business cycle strategy has prepared us well for unexpected economic adversity. Execution of the strategy depends upon the strong preferred supplier position, ability to quickly flex our variable costs, strong liquidity and conservative leverage. Liquidity and leverage are the most critical features of the business cycle strategy. We focus on maintaining sufficient liquidity to fund our tactical and strategic needs through a severe economic downturn. In every board meeting, we review our 5-year contingency liquidity plan assuming a deep recession to ensure that as we make strategic investments, we have sufficient liquidity to remain strong through the economic cycles. Our guidelines for leverage are designed to provide financial flexibility and access to diverse sources of capital. Turning to Slide 8, in the current situation, the health and safety of our employees is and continues to be our first priority. We are classified as an essential business enabling all of our facilities to continue operations as they comply with social distancing and CDC guidelines. We have implemented steps to protect our employees and visitors to our sites; and where possible, our employees are working remotely. Keith will provide additional color regarding our operations and our procedures to maintain a safe and healthy operating environment in our facilities. With nearly $700 million of liquidity and a 0.7x net debt leverage, we are well positioned to navigate a recession without resorting to survival cost-cutting measures that could compromise our ability to promptly respond to our customers’ needs when the economic recovery begins. Turning to Slide 9, we have taken immediate actions to preserve liquidity. Our first action was to suspend share repurchases in mid-March. We are flexing our variable costs consistent with changing business activity. Within our cost of goods sold, metal costs are 100% variable and more than two-thirds of non-metal costs are variable. Also in April, we began limiting capital spending to sustaining projects, which under normal circumstances, would average approximately $35 million per year. However, with reduced activity level, there is less wear on equipment and the level of sustaining CapEx will decline in line with the reduced activity level. Any investments beyond sustaining projects must meet our standards for preserving a liquidity safety net and conservative leverage. In February, we announced a $375 million multi-year project at Trentwood and indicated that the timing would be subject to market conditions. We will continue to monitor market conditions to decide the timing, including the initial $145 million investment in a new plate stretcher. During the recession, there may be potential acquisitions to consider. We will adhere to the same disciplined approach as in the past employing the same filters we apply in evaluating prior potential acquisitions, must be a business that we understand and be compatible with our existing business, must have a winning strategy and be capable of achieving a defensible competitive position, must have a transaction price consistent with creating long-term shareholder value, and importantly must meet our liquidity safety net and leverage guidelines. Turning to Slide 10 and demonstrating the underlying strength and potential of the business, we had record EBITDA and EBITDA margin in the first quarter following our record results in 2019. While Keith will provide a 2020 outlook on our commercial aerospace and military applications, until there is more clarity surrounding the COVID-19 economy, we will suspend providing a full year 2020 outlook. Now, Keith, and Neal will update you on the current situation and review the first quarter 2020 results. Keith?

Thanks, Jack. The health and safety of our employees always is our top priority. However, our focus has been amplified with the onset of the COVID-19 virus. Our businesses are included in the critical manufacturing sector defined by the U.S. Department of Homeland Security and recognized as essential businesses by local and state authorities. We have continued to operate all of our facilities and have initiated a number of actions to best protect our employees and maintain a safe and healthy environment. We have implemented local, state and federal recommendations to reduce the spread of the virus at all of our facilities and continue to monitor recommendations for further actions. We are also working closely with our employees and local unions to stress the importance of following CDC guidelines to mitigate the risk of exposure to COVID-19. In addition, where possible, our employees are working remotely until we return to normal operations, and we have implemented additional health and safety protocols for all outside contractors and service providers required to enter our facilities. A number of our employees have displayed symptoms and have been tested and others have been quarantined or self-isolated since the pandemic began. To-date, we have had no employees test positive for COVID-19. Our employees and their families are concerned for their health, jobs, and financial security. As we flex operations in response to changes in business conditions, we have also taken initiatives to support our furloughed employees. We have revised our policies to provide any employee experiencing a job interruption, 60 days of continued benefits with the company waiving the premiums for the continued coverage. Combined with the enhanced unemployment benefits provided by the CARES Act, we expect our furloughed employees to receive unemployment compensation similar to their regular pay. Moving to our markets and operations, as Jack stated in his opening comments, we have long, deep relationships with our blue-chip customer base and we are working closely with all of them as we deal with the COVID-19 virus and its impact on our markets and the economy. Let me speak to our key markets and current conditions as we see them presently. Our large commercial aerospace segment represents approximately one-third or more of our total value-added revenue under normal circumstances. Our large commercial airframe customers and their customers, the airlines, have been significantly impacted by COVID-19 since late February as airline travel has slowed dramatically. While many of our commercial customers have curtailed operations on a temporary basis, we are working with them closely to meet their raw material needs now and as their operations ramp up. At this time, we anticipate our value-added revenue for commercial aerospace could be approximately 20% to 25% lower this year compared to 2019, reflecting the impact of mutually agreed upon modifications to existing contract declarations. We continue to work in partnership with our customers to address all their needs. We have solid multi-year contracts with these customers; and longer term, we expect the full commitments reflected in the original contract declarations will be met in their entirety. As we have seen through the history of commercial aerospace, we expect that over time passenger traffic will recover and the subsequent growth in aircraft builds will continue. Defense has been and continues to be an important part of our business representing approximately 10% to 15% of our total value-added revenue. We enjoy a strong position on many legacy fighter programs in this market, and most notably, our significant supplier to the F-35 Fighter program. We experienced strong shipments for these programs in Q1, and we expect demand to remain strong for the reminder of the year. Moving to automotive, many of our customers have temporarily suspended operations due to COVID-19 and we are adjusting our automotive operations consistent with these reduced activity levels. We are in close communication with these customers and will have more information on our new product launches once our customers resume operations and redefine their needs for the remainder of the year. While our general engineering shipments were steady through March, recent state and federal mandated shutdowns of all non-essential businesses served by this end market has begun to have a negative impact on our current order rates. Until these mandates are lifted and order rates improve, we will continue to flex cost proportionately while continuing to support our service center customer relationships. Just as important to our strategy and value system of being a preferred supplier to our customers, we are committed to being a preferred customer to our suppliers. We maintained strong working relationships and remained current on all our payments to our suppliers. We have had no supply issues at any of our facilities and our suppliers continue to meet all our needs. Finally, I would like to thank all of our managers, union leaders and employees, who are working together with dedication and loyalty to provide essential services to our customers in a way that reflects the proud history of Kaiser Aluminum. I will now turn it over to Neal to provide an update on our financial condition and a recap of our record first quarter results. Neal?

Thanks, Keith. Turning to Slide 15, as Jack discussed, our business cycle strategy and planning process always includes a severe recession stress test of our liquidity under a variety of scenarios to focus on sufficient liquidity to fund our operations, interest, taxes, regular dividends and both sustaining and strategic capital investments. As of March 31, our balance sheet remains strong with the current net debt leverage of 0.7 with approximately $346 million of cash and short-term securities. In addition, our $375 million revolving credit facility had approximately $342 million of borrowing availability for our total liquidity of $688 million as of quarter end. As of March 31, our revolving credit facility was undrawn and currently remains undrawn. As a reminder in November 2019, we replaced a previously existing revolving credit facility with a new $375 million senior secured revolving credit facility with the maturity date of October 2024. In addition, we issued $500 million of unsecured 4 5/8 senior notes with maturity dates of March 2028. Both our revolving credit facility and unsecured notes have covenants that allow us to operate our business with limited restrictions and significant flexibility. We currently do not anticipate any material change in our working capital requirements and our accounts receivables are supported by our strong customer base. In addition, we have ample credit lines with highly rated hedge counterparties. With financial strength and flexibility, we have continued to address the pandemic economy while also positioning for an economic rebound and potential opportunities that enhance our strong competitive position. Turning to Slide 16, value-added revenue for the first quarter of 2020 was approximately $217 million, down approximately 1% compared to the first quarter of 2019 on a 4% decline in shipments driven primarily by a planned exit of other non-strategic applications and lower automotive shipments as customers began suspending operations late in the quarter. Looking at our end markets, value-added revenue for our aerospace applications increased approximately 4% or $5 million from the first quarter of 2019 on a 1% decrease in shipments reflecting favorable pricing and a strong aerospace mix. Value-added revenue for our automotive extrusions declined approximately 7% or $2 million from the prior year quarter on a 5% decrease in shipments. The decline in shipments and related VAR reflect the impact of automotive customers temporarily suspending operations due to the COVID-19 pandemic. Value-added revenue and shipments for our general engineering applications was essentially flat with the first quarter of 2019. Value-added revenue for our other applications decreased approximately 71% or $5 million compared to the prior year quarter on a 64% decrease in shipments reflecting our planned exit from these non-strategic applications. EBITDA for the first quarter 2020 was a record $59 million, an increase of approximately $3 million or 6% compared to the prior year first quarter. EBITDA margin of first quarter 2020 was also a record of 27.4% compared to 25.7% in the prior year quarter. The 170 basis point improvement was driven by 160 basis points due to favorable price and mix and 10 basis points achieved from lower net costs. Now, turning to Slide 17, consolidated operating income as reported for the first quarter 2020 was $46 million, net income was $29 million and earnings per diluted share was $1.81. These results compare favorably for the reported operating income of $43 million, net income of $28 million and earnings per diluted share of $1.71 in the prior year quarter. Adjusted for non-cash, non-run rate items, first quarter adjusted operating income increased to $46 million compared to $44 million in the prior year quarter reflecting the items previously noted that drove the year-over-year improvement in EBITDA in addition to approximately $1 million of additional depreciation expense. Adjusted net income for the first quarter was $30 million and adjusted earnings per diluted share was $1.90, which is comparable to the adjusted net income of $30 million and adjusted earnings per diluted share of $1.85 in the prior year quarter. Our effective tax rate for the quarter was approximately 25% compared to an effective tax rate of 26% in the prior year quarter. We anticipate our 2020 full year blended federal and state effective tax rate will be in a bit 20% range. In addition, as we continue to review the full impact of the CARES Act, we anticipate we will be able to monetize our remaining AMT credits for a cash tax credit in 2020. While capital investments in the first quarter was approximately $21 million. As we focus on preserving liquidity at this time, our capital spending will be limited to critical sustaining projects until we gain more clarity on the post-pandemic economy. During the first quarter, we returned approximately $24 million of cash to shareholders through dividends and share repurchases. As noted previously by Jack in response to the current economic environment, we have suspended our share repurchase program. And now, I will turn the call back to Jack.

Thanks, Neal. As Keith mentioned, commercial aerospace applications represent one-third of our – approximately one-third of our total value-added revenue and demand is ultimately driven by air passenger travel. Turning to Slide 19, in the history of airline travel, the current crisis is one of many over the past 60 years. In previous cases, despite the thought that maybe its different this time, travel returned to the long-term growth trend within a short time after the crisis. While this is a challenging time for the airlines, we expect that once again air travel will be restored to the long-term growth trend after a period of adjustment. Turning to Slide 20 and the commercial airframe order backlog, the industry has enjoyed a large and growing backlog since 2005. What we don’t often reference is that for decades prior to 2005 a much smaller backlog was normal. While it’s difficult to predict to what orders and build rates will be during and after the pandemic, the current 8-year backlog could decline more than 50% and still be in line with the long history prior to 2005. We are often asked for perspective to be gained from the great recession. Turning to Slide 21, the graph illustrates annual shipments from 2005 to 2019 for each of our major market segments. In 2009, our total shipments declined 23% from 2008 and it took 2 more years until 2011 to return to the prior peak. Kaiser’s aerospace and high strength shipments declined only 8% in 2009 from the prior year, while commercial airframe builds actually increased in 2009, the lower shipments were a result of supply chain destocking. Kaiser’s general engineering shipments declined 27% year-over-year in 2009 driven by weakening industrial demand and by reduced orders for armor plate as the Iraq war was winding down. Industry demand was further impacted by de-stocking in the long supply chain. Our automotive extrusion shipments in 2009 declined 28% from prior year driven by a 32% decline in build rates. And our shipments of highly cyclic non-strategic applications declined 37% in 2009. During that period of time, our non-strategic applications represented approximately 17% of our mix and have since declined to less than 1% of our current mix. Another frequently asked question is how Kaiser is prepared today compared to 2009? Turning to Slide 22, while our mix of strategic applications is similar as I just mentioned, the highly cyclic non-strategic applications have essentially been eliminated from the current mix. When the 2009 recession began, Kaiser was only 2.5 half years removed from a long 4.5 year corporate restructuring process. Today, Kaiser has greater liquidity and access to diverse sources of capital. Our customer partnerships are also much stronger based on our long track record of excellent customer satisfaction and development of our highly differentiated Kaiser select products, which provide industry leading performance attributes. While we were well-prepared to navigate the great recession in 2009, we are even better positioned today. Back then, we successfully flexed our variable cost, continued the regular dividend and proceeded with building our new Kalamazoo extrusion facility, a major strategic investment at the time that upon completion significantly enhanced our competitive strength. As I noted earlier, we are taking similar initiatives today aggressively preserving liquidity to navigate the downturn while positioning to be ready to address the challenges and opportunities of an economic recovery. Turning to Slide 23 and a summary of our remarks today, the health and safety of our employees is and continues to be our top priority as we confronted challenges presented by COVID-19. In the first quarter, we achieved record results, continuing the momentum from our record 2019 results. We have suspended our overall outlook for 2020 pending more clarity on COVID-19. We are well-prepared to address this economic adversity with a strong liquidity safety net, low debt leverage and access to capital and we are taking actions to navigate the recession and to be well positioned for the opportunities and challenges of an economic recovery. We expect to have attractive investment opportunities beyond the sustaining projects and as always we will adhere to our guidelines for liquidity and leverage as we continued to evaluate all value-creating investments. We will now open the call for questions.

[Operator Instructions] Our first question comes from Curt Woodworth with Credit Suisse.

Yes. Hey, Jack and everyone. How are you?

Good. Good morning.

Happy to hear that no one tested positive for COVID. On the aerospace outlook, could you just frame some of the parameters around the VAR potentially being down 20% to 25%, given the start to the year that would imply potentially down 30% to 40% in the back half of the year? And just kind of want to get a sense for what are you assuming for build rates? Are you assuming any destocking into that number as well? That’s my first question.

Well, let me say first, you didn’t get 30% or 40% from us, you got that somewhere else, because the only outlook we gave was that our total aerospace and high-strength would be down single digits, I believe, for the year. So, that was the only outlook that we gave. And Keith is talking specifically to just the commercial aerospace portion of the aerospace and high strength. And I will let Keith elaborate on the outlook.

Yes, good morning, Curt. We – the large commercial aerospace is the largest component of our total aero and high-strength total VAR, value-added revenue. The other components which we also look at are in the regional jets, business jets, and military applications. And we also have a subset of the – which is included in industrial and those are generally in high-strength structural components for auto and GE. So, we have a lot of these products that go into other than the large commercial airframe. That’s why we pulled out large commercial, it was because it’s such a large segment and it’s heavily identified with Boeing and Airbus.

Right. Sorry, I should have been more clear. Within the commercial piece of that, can you provide any color in terms of the assumptions on build rates that underlie just the commercial OE aspect of the guide?

Well, Keith and his team are heavily engaged with our major strategic customers in this case on a day-by-day basis. We are always heavily engaged, but things are changing dramatically. So, this is based on conversations with our major customers. And as he just said, that’s roughly one-third, actually a little – slightly higher than one-third of our total value-added revenue. And we expect based on extensive discussions with our customers that, that value-added revenue year-over-year will be down roughly 20% to 25%.

Right, okay. And then in terms of the inventory situation, can you talk to how you feel about that? I mean, I recall from I think early ‘17 to mid-to-late ‘18 we went through this sort of lengthy destocking process which I think at that time was very functional around the wide-body build rate cuts. Now, this is obviously much more pronounced. Do you have any sense of how the supply chain is sort of handling this? Would you expect significant de-stocking in the interim?

Well, let me just restate what we have said in the past, and I will let Keith give additional color, because again he is really close to all this. We did say that there was de-stocking in ‘17 and ‘18. We said at the time that we felt it was overdone and in fact it was. And that created two really, really strong orders in the second half of the year because the supply chain got stretched way too thin. So, we felt we were pretty close to equilibrium or maybe even still thin coming into this year, but then I will turn it over to Keith here.

Yes. And so, as Jack stated we are speaking daily and have been speaking daily with our customers in this area really since the beginning of the year. Some of our customers have experienced other things that they are working on, Boeing for instance on the 737 MAX as they are looking and remain focused to bring that platform back online, but we have generally looked at this and we have included with them. We have got mutual declarations that we have discussed, and our outlook includes those discussions which also include what their needs may be, their inventory situation, and all, so that’s inclusive of our comments on our outlook.

Okay. And then just one last one, on capital spending and free cash flow, could you quantify what the AMT credit could be and then how quickly can you flex capital spending down, and any update on, if you can, maybe what a good estimate for this year for CapEx would be? Thank you very much.

Yes. So, Neal in his comments said we spent $21 million CapEx in the first quarter. I said in my comments and we have said this for a long time that sustaining CapEx is roughly 75% on the average of depreciation, which would be roughly $35 million a year or in this case starting April 1, roughly $9 million per quarter, and I double underscore average on that basis. And we can flex that capital spending quickly. Keith has moved aggressively to put a cap on capital spending. The way I have characterized it when we are talking to investors is right now this is a battlefield. We are in a foxhole in this battlefield is covered with smoke. So right now, we are hunkered down in our foxhole and we are waiting for the smoke to clear, then we will decide where we go. But you can assume going forward although there may be some carryover from the first quarter, then we should be operating at $9 million, let’s say for the rest of the year $27 million or less as we go forward for the rest of the year.

And then -- in regards to your question on the AMT credits, as we go through the CARES Act, we are now looking at that to be in the area of $5 million to $10 million for this year.

Great. I really appreciate it. Stay well.

Yes. Thanks, Curt.

Our next question comes from Josh Sullivan with the Benchmark Company.

Hey, good morning.

Hey, Josh.

Just expanding on the variable cost there, can you talk a little bit about just what you are flexing there outside of CapEx? Anyway to help us understand the fixed cost to maybe utilization piece of that equation versus how much variable cost flex you are able to execute in the model?

Well, for the first time, you can mark this down as a historic day because we have been asked several thousand times over the past few years about our variable cost, but we are going to put some clarity on that today. So what I said in the prepared remarks is that when you look at COGS, the metal portion of COGS as everyone knows is 100% variable for us. The non-metal portion of COGS roughly actually more than two-thirds of the non-metal portion of COGS is variable. And we can flex that pretty quickly. There is always a tail when you start to flex or chasing volume down and then there is a tail of things like benefits and other costs, materials on order, those kinds of things, but it should stabilize relatively quickly after a month or two as soon as volume stabilizes. So, we did it during 2009. We chased it down. And then we get the opposite effect when we start to get to the economic recovery we start flexing back up. Again, there will be a tail. So we will actually get the benefit back when the economic recovery comes.

Got it. I really appreciate that. And then just as far as the defense business, are you seeing defense customers step into the void? Is there any pickup in ordering either to take advantage of the supply or just to support the industrial base?

Well, hi, Josh, it’s Keith. We are seeing a rise in defense orders. The programs that I mentioned earlier continue unabated and good strong outlook in front of those multi-year continued growth still being anticipated. There is also a segment in ours with munitions and other things that we cover, but we are seeing that order rate pickup quite frankly since the beginning of the year. I will say it’s not since the COVID-19, but at the beginning of the year, we are seeing a large pickup, yes.

[Technical Difficulty]

Josh, you are breaking up. Excuse me, Josh, you are breaking up. Can you try to ask the question again? We didn’t hear it.

[Technical Difficulty]

I am sorry. All I heard was preferred supplier.

Yes, we need to – you need to lean out the window there, Josh, and get a stronger signal so we can hear the question. Are you there?

Hey, it looks like his line got disconnected.

Well, okay, we lost Josh. Keith, he was asking about preferred supplier, why don’t you elaborate on that a little bit?

This has been a time, we have spent decades with our large customers, these close relationships. We have talked often about our performance metrics, our supply position, our – the performance of our products. We are really seeing a good strong dialog with these customers on our outlook. We are considered strategic with all of our major customers and the dialog has been continued even though a lot of that dialog has been what Josh just tried to work with is vis-à-vis working from home. So I would say that we are as close to these customers as they are. They are seeing a lot of smoke on the battlefield as well. And I think we are all working towards just as soon as we have clarity to being able to give a little better picture going forward.

And I am not showing any further questions on the phone lines at this time.

Okay. Well, let me wrap up with one final comment here. Just for those of you who didn’t follow all this, I will do a little bit of the algebra for you. We didn’t give an outlook here. But if you put together Keith’s two outlooks, he commented on the commercial aerospace and the military applications, which combined represent about 45% to 50% of our value-added revenue. And if you do the algebra on those that turns out to be roughly a 15% to 20% downturn in value-added revenue year-over-year on roughly half of our business with the remaining half, automotive and general industrial yet to be determined, but that’s the best outlook that we have now. We think we are very well prepared for this, but you never know. This could be a black swan event or severe black swan, so we are just hunkered down as we said and waiting for the smoke to clear and we are ready to move as soon as the smoke clears. Thanks for joining us on the call today and we look forward to updating everyone on our second quarter call in July. Thank you.

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day.