Kaiser Aluminum Corporation (KALU) Q1 2022 Earnings Report, Transcript and Summary

Good morning. And welcome to the First Quarter 2022 Earnings Conference Call. My name is Zenaira and I will be the operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. I will now turn the call over to Melinda Ellsworth. Melinda, you may begin.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's first quarter 2022 earnings conference call. If you have 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 President and Chief Executive Officer, Keith Harvey; Executive 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 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, 2021. 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. Reconciliations of certain forward-looking non-GAAP financial measures to comparable GAAP financial measures are not provided because certain items required for such reconciliations are outside of our control and/or cannot be reasonably predicted or provided without unreasonable effort. Any references in our discussion today to EBITDA means adjusted EBITDA, which excludes non-run rate items for which we've 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. Good afternoon, everyone. Thank you for joining us in a review of our first quarter 2022 results. Turning to slide 6. Adjusted EBITDA for the first quarter 2022 of $55 million reflected a continued strong demand environment for our general engineering and packaging products and, as expected, steadily increasing demand for our aerospace products, which experienced the highest shipments and value-added revenue we've produced since the second quarter of 2020. Automotive demand remained in neutral, as shipments and value-added revenue remain relatively flat to previous quarters due to the continued shortage of semiconductor chips for North American automotive and light truck production. Value-added revenue per pound improved sequentially across the board in all product categories, as our commercial teams have been successful in passing through rising metal, freight, energy and other costs. Even with the success we've had to date in offsetting these costs, we are continuing to see rising costs in almost all materials and services we utilize. First quarter results reflect approximately $6 million of unusual freight cost incurred at our Trentwood operations, where we experienced higher-than-normal export shipments in the quarter. When ports and rail systems generally utilized to transfer these products experienced significant disruptions during the quarter, we utilized less efficient means of shipping material on an interim basis to meet needed deliveries for our customers. As I noted during our February earnings call, we expected efficiencies to continue to improve at most of our facilities in 2022. These improvements have generally begun to be realized, including at those facilities focused primarily on automotive as they have continued to successfully pivot to servicing the unprecedented general engineering demand. However, as demand for packaging products remains quite strong, lingering supply chain issues regarding the availability and timely delivery of metal and magnesium continue to negatively impact efficiencies at the Warrick operations. We believe the actions we have taken will significantly reduce the impact of these conditions on our business going forward. Integration of the Warrick packaging business continues with completion of our final temporary service agreement with Alcoa expected sometime in the second quarter. Looking at the larger global environment, the company is well positioned. With the exception of aerospace, our markets are heavily North American centric. We have multi-decade relationships with our blue chip customers and have strategic long-term contracts in most of our markets. Our supply base for the most part is well diversified, and we will continue to work to improve these positions. While historically a small percentage of our primary aluminum requirements have been produced in Russia, that small portion of our requirements is now being sourced elsewhere. In addition, we have expanded and qualified other sources to diversify our supply over time to reduce our heavy dependency of mag from one supplier. The company maintains a conservative capital structure. And while we are focused on supporting the strong secular growth anticipated in all of our major markets, we will continue to manage our business as we have in the past, by maintaining strong discipline in our use of capital, continued focus on debt leverage reduction to targeted levels and relentless focus on managing cost. Neal will now discuss the first quarter results in more detail, and I'll follow up afterwards on our outlook for the balance of the year. Neal?

Thanks, Keith. Good afternoon, everyone. Turning to slide 8. Value-added revenue for the first quarter of 2022 of $370 million increased $199 million or 116% compared to the first quarter of 2021, primarily reflecting the inclusion of our packaging business acquired on March 31, 2021, which contributed $146 million to value-added revenue during the first quarter of 2022. On a sequential basis, value-added revenue increase approximately 17%, reflecting pricing initiatives implemented in the latter part of 2021 to offset the impact of rising metal, freight, energy and other costs to date. Value-added revenue for our aero high strength applications improved to $95 million or 35% on a 26% improvement in shipments from the first quarter of 2021. We continue to see improvements in demand for our commercial aerospace applications, along with the continuing strong demand in business jets and defense applications. On a sequential basis, our first quarter VAR improved $13 million or 16% from the fourth quarter of 2021 on a 7% improvement in shipments, reflecting improving demand and higher price reflecting the pass through of inflationary costs. Our general engineering value-added revenue was up to a record $102 million for the first quarter of 2022, up $31 million or 43% from the first quarter of 2021 on a 23% increase in shipments. The increase in value-added revenue in shipments reflect improvement in pricing and strong demand for our general engineering applications, driven by reshoring, plate used in tooling and semiconductor applications, and the strength in North America general industrial market. First quarter 2022 value added revenue was up $29 million or 40% on a 23% increase in shipments over the fourth quarter of 2021. Automotive value-added revenue was $24 million in the first quarter of 2022, down approximately $4 million on a 14% decrease in shipments. Sequentially, automotive was flat compared to the fourth quarter of 2021 as a result of the continuing semiconductor chip shortages and other supply chain issues impacting the North American automotive production. As previously noted, value-added revenue for our packaging applications was $146 million in the first quarter 2022, increasing $15 million sequentially or 11% compared to the fourth quarter of 2021 on relatively flat shipments, reflecting improvements in pricing to pass through the higher costs. Additional details on value-added revenue and shipments by end market applications can be found in the appendix of this presentation. Moving to slide 9. First quarter 2022 adjusted EBITDA of $55 million increased $18 million or approximately 47% compared to the first quarter of 2021, reflecting the higher value-added revenue as discussed and reflecting operating and overhead costs related to the Warrick acquisition. On a sequential basis, adjusted EBITDA is up $9 million or 20% over the fourth quarter of 2021. Adjusted EBITDA for the first quarter of 2022 compared to the fourth quarter 2021 reflects higher value-added revenue, offset by the $6 million of incremental freight costs as noted earlier by Keith and continuing, but improving, manufacturing inefficiencies at our Warrick operations due to the supply chain and integration distractions. For the first quarter of 2022, we reported a 14.8% EBITDA margin, down from the 21.8% in 1Q of 2021, but up slightly from the 14.5% in the fourth quarter of 2021. Moving to slide 10. Reported operating income for the first quarter of 2022 was $25 million. Adjusting for approximately $2 million of non-run rate items, adjusted operating income was $28 million, up from $24 million in the prior-year quarter, primarily reflecting the change in EBITDA, as previously discussed, offset by an additional $14 million of depreciation and amortization expense predominantly related to the Warwick acquisition. Reported net income for the first quarter of 2022 was $8 million compared to $5 million in the prior-year quarter. Adjusting for non-run rate items, adjusted net income for the first quarter of 2022 was $11 million, which was comparable to the prior-year quarter. As reported earnings per diluted share were $0.51 in the first quarter of 2022 compared to $0.66 in the prior-year quarter. Adjusted earnings per diluted share were $0.66 and $0.64 in the first quarter of 2022 and 2021, respectively. Our effective tax rate for the first quarter of 2022 was 29%. The increase in the expected effective rate was primarily driven by 123-R stock-based compensation. For the full year and long term, we continue to believe our effective tax rate will be in the mid-20% range under the current tax regulations. We anticipate that our cash tax rate will remain in the low-single digits until we consume our federal NOLs of approximately $187 million as of year-end 2021. And as of March 31, 2022, we had $261 million of cash and cash equivalents. On April 7, we completed an amendment to our revolving credit agreement, increasing the commitment of the facility from $375 million to $575 million and extending the maturity to April 2027. Total availability under the amended revolving credit facility was $563 million, providing total liquidity of $824 million. There were no borrowings under the revolving credit facility during the quarter and the facility remains undrawn. And now, I'll turn the call back over to Keith. Keith?

All right. Thank you, Neal. Turning to slide 12 and looking at the balance of 2022. Aerospace shipments and value-added revenue continued to improve in the first quarter due to strengthening demand from all end customers in defense, business jet and commercial aviation. Shipments increased 7% and value-added revenue increased 16% from fourth quarter of 2021. We continue to anticipate value-added revenue growth of 15% to 20% year-over-year, as discussed in our February call. Our anticipated recovery of the commercial aviation market is on track, and we continue to be well positioned to participate in that recovery. As noted, we incurred significant transportation costs in first quarter due to multiple transportation bottlenecks for export of aerospace products from our Trentwood operation, but the costs associated with these issues have been largely resolved. Turning to slide 13. We had a solid quarter in the general engineering markets to start the year. Value-added revenue increased 40% over our fourth quarter results and 43% over our first quarter 2021 results, which were considered quite strong. And while we always expect seasonality to typically drive stronger results in the first quarter in general engineering, the strength of this market continues to impress. Our teams have done a great job in improving spreads per pound and providing additional capacity to meet the higher demand and we're well positioned in the market with our broad product offerings. While it is uncertain that the markets will maintain the torrid pace experienced in the first quarter for the balance of the year, we now believe value-added revenue growth will conservatively be closer to the high end of the approximately 10% to 20% increase year-over-year 2021 reflected in our prior outlook. Turning to slide 14. Automotive shipments and value-added revenue remained relatively flat sequentially. We continue to expect accelerated improvement for both shipments and value added revenues towards the end of the year, as semiconductor chips become more available, allowing stronger North American automotive and light truck production. In addition, interest in new applications utilizing our extrusion products continues to grow and we are quoting on multiple new programs. The outlook continues to be favorable for secular growth in demand for these applications. We reiterate our outlook on expected shipments and value-added revenue, up 10% to 20% in 2022 versus the prior year. Turning now to slide 15. Our outlook for the packaging business continues to be very strong in terms of demand and secular growth. As we noted during our February earnings call, we anticipate value-added revenue growth of 35% to 40% year-over-year, reflecting the benefit of four full quarters of sales and improving price and mix. We reiterate our outlook for these applications for the balance of the year. In addition, we have continued to successfully secure additional long-term contracts with favorable terms with strategic customers for supplier positions for higher margin products. As we have discussed, ongoing supply chain issues with specific focus on metal supply and magnesium supply have continued to impact our packaging operation. Warrick is a large consumer of magnesium, as a large portion of our production is utilized for coated food tan and beverage lid and tab applications. These products use alloys with relatively high magnesium content as compared to alloys used to fabricate beverage can body applications. Our main supplier, US Mag, declared force majeure in September of 2021 and we have been on allocation below our contracted volumes since that time. We have worked diligently to minimize any impact to our customers from this event, including securing additional magnesium where we could at costs considerably higher than our contracted agreements. To date, we have met all obligations to our customers, and we continue to work all options in order to continue to do so as we pursue the resolution of our issues and concerns with US Mag. Turning now to slide 16. And finally, an update on comments from our February call regarding planned increased major maintenance spending, our large structure outage in third quarter of 2022 and the phase seven expansion project discussed for Trentwood. We expect incremental major maintenance spending in the second quarter versus the first quarter of approximately $8 million to $10 million to support planned projects at several facilities including casting equipment and facility reconditioning. This spending is in line with our outlook given in February for full-year 2022 expected major maintenance spending of approximately $40 million. We are preparing for a multi-week outage at our Trentwood facility beginning in July for reconditioning and upgrades to our heavy gauge stretcher. As previously discussed, this investment is in lieu of a previously planned purchase of a new stretcher announced prior to the pandemic. These actions have been included in previous outlooks and represent no change from previous discussions. With respect to the previously discussed phase seven expansion project at our Trentwood rolling mill, which will increase capacity for aerospace and general engineering plate, no decision has been reached for when this project will launch and no spending is planned at this time. We will continue monitoring market conditions and evaluate appropriate timing to launch this next phase of growth at the Trentwood facility. Now, turning to slide 18 and a summary of today's comments. Our first quarter results reflect continuing strength in our major markets with considerable strength in our packaging and general engineering markets, steadily improving aerospace demand and continued supply chain issues around semiconductor chips for automotive and light truck production. We continue to aggressively address inflationary conditions, as well as continuing supply chain challenges to mitigate higher costs and disruptions in our businesses. We expect EBITDA margins to continue to improve, strengthening through the year and continue to anticipate margins for the full year of 17% to 20%, as operations and efficiencies improve, costs normalize, and commercial conditions further improve. I'll now open up the call to address any questions you may have from our remarks today.

[Operator Instructions]. And our first question comes from Emily Chieng from Goldman Sachs.

My first question is just around some of the changes that you're seeing in the value-added revenue on a dollar per pound basis. And we've seen a little bit of a step change in improvement here, specifically on the aero and high strength side and the packaging side. And maybe let's start with the aero and high strength piece of it. It looks like the $2.09 per pound is higher than what you've been able to achieve, even in the past. So, first question, I guess, is really curious what's driving that? Or if that's just function of a mix shift in the volumes there?

The change that we're seeing really across the board on all of our products reflects the focus that we've had on ensuring that we pass through these costs as effectively as we can. It also demonstrates some improvement in the demand area, but which we're able to push through some additional price increases as well as some improvement on our mix. Whether or not that $2.09 will continue beyond the first quarter, not necessarily sure we'll be at that same level. But certainly in that same area, we've demonstrated very good success in passing through these costs and improving demand. So, I'm hopeful that we're going to be continuing to see these improvements continue throughout the year, especially as we continue to incur additional cost through the system.

Maybe shifting gears to Warwick and it seems like there are still a couple of supply chain impacts that are impacting that facility there. But maybe can you discuss what actions have been taken to mitigate some of these? And is there a line of sight or a date which we should think about in which these issues should be over by then?

Well, we've called this out to the last two or three quarters. And quite frankly, I am tired of speaking to all those issues. We are making headway. We're making headway with our hot metal supplier, Alcoa. In the past, the rolling mill and the smelter were owned by the same person. And when you have two separate owners, there are expectations on performance that perhaps weren't there in the past. So, we've had a lot of dialogue and a lot of focus on actions to improve that performance from the smelter to the operations, so that we get timely delivery of materials that don't negatively impact the efficiency of the operations. That's truly what we've done there. So, we've taken some significant actions in the first quarter. We expect to see some improved results from that, beginning in the second quarter going forward. With regards to our issue with the supply of mag, we've been very frustrated in this area. We're now in our seventh month where we were dealt with our major supplier for force majeure to the point we filed a complaint last week in the federal court in New York. The issues around the US Mag and their force majeure, there are three issues we have. One is whether or not US Mag was entitled to declare force majeure. The other was a failure to maintain a safety stock according to our contractual agreements. And then finally, US Mag's conduct since declaring force majeure has been very frustrating for us for the lack of communication and follow through on performance. And so, we're going to take those additional measures. Now, I have spoken in the past about actions that we have taken to minimize those, and those are being put into effect. Regardless of our outcome and the position with US Mag, a few of the things that we have done in that area, we have diversified our supply base. That's taken a little bit of time, given the global scenarios that are in place today, but we have diversified that supply position and we think that'll improve over time. And the other steps that we've taken, Emily, have been going back to our customers and changing out the timing of which we have ability to recoup these costs. And I would remind everyone, we do have provisions in our contracts that will allow us to recoup these higher costs, and we are doing so. But that has an impact later. Right now, we're dealing with those costs at hand. So I'm very pleased with the actions we've taken to reduce the impact on a quarterly basis of those costs. However, these costs are going to continue to be focused, and we're going to ramp up our performance, our actions there to finalize where we are here and move forward.

If I am able to squeeze in one more just on the margin environment there, the value-added revenue margin expectation of 17% to 20% for the full year. I know the first quarter margins were a little below that, that 17% range, but what do we need to see for you guys to reach that target margin environment? Is it a resolution of some of the challenges that were experienced in Trentwood? Or is it just steadily improving end market demand and the orders in aerospace industry? I'll leave it at that.

The impact that we had at Trentwood reduced our margins a couple of hundred basis points, if you will, roll back in that $6 million of costs that we had there, Emily. So, I think it was maybe artificially lower in the quarter than what we had expected. But to get at the bigger point, the issue with us here is we're seeing really strong demand and the ability to move cost and perhaps even spreads up higher in all of our businesses .The answer on our on our EBITDA margin performance really revolves around the cost, the cost piece, especially that we're experiencing at the Warrick operation. So, with those actions that I outlined to you on your earlier question, I have a strong belief that our margins will return back on the path that we have outlined. And certainly, the top line growth and what we're experiencing with customers demonstrate that we have the capability to do so. And if we can normalize some of these costs that we've been experiencing, I really think that we're back on track with where we've outlined to the market.

Our next question comes from Josh Sullivan from Benchmark.

In aerospace, what are you seeing as far as OEMs pulsing demand through the supply chain? Are those pulses in excess of current build rates yet?

I think there's still a good bit of material. I think there's some destocking that's continuing right now, Josh. But we're starting to see that come to an end. We're getting good pull from the large commercial aviation folks, and that's a positive sign. That's been the missing link that we've been waiting to incur. Even though we've been recovering on quarterly shipments in aerospace, a good bit of that has been driven by defense and the business jets that we talked about in previous quarters. That continues. That's good news. But the real good news is we're starting to see some of that pull coming from the large OEMs. We were initially concerned that other supply chain issues, not materials related to aluminum, but things like perhaps titanium or others may have a bearing on that pull. We're not experiencing that. And our OEM customers are quite frankly relatively comfortable with where they are with the positioning. I think what they're looking at right now is that expected build rates back in the 2023, 2024 timeframe, they want to ensure that the supply base is strong enough, good strength and position to support those higher rates when we get to that period. And that's what we're all working towards. We're seeing really good pull, not just for the first four, but we're starting to see that open up as expected for the balance of the year. So, I think we're on that that road to recovery. We're still dealing with some of these things like the Ukrainian crisis and some of the other things, and I'm sure they'll have little blips in the road. But our customers are beginning to talk about the recovery, and we're starting to see orders begin to support those higher rates.

just on the defense side of that, do you think the international demand for the JSF is going to fill the gap between what the OEM has announced for production rates versus what the US DoD has requested in the 2023 budget?

Absolutely do. And I'm not sure, but I think the hold that was put into the program may be there to allow for continued growth for JSF for the NATO partners. We saw two or three major program commitments moving over to support the JSF. We had Canada, was the most recent, that came over in favor of the F-35. So, we believe that that's going to continue to be enhanced. We also think other things on the defense spectrum that we cover, like munitions and other things, we expect to see fairly strong demand result from that as well. So, I think defense is going to become a growing opportunity from a demand perspective.

Just lastly, on general engineering, is this pricing sustainable? I know you indicated that these are some pretty high levels, but just curious how much of it you think is transitory versus what's really structural?

Well, it's an interesting time, Josh. Again, demand is unprecedented. We actually have the capacities to meet this demand. We saw stronger demand in the 2019 time level. But aero was so strong at the time, we weren't able to secure all that we're seeing now. A number of factors that are going on in the world and whether or not those continue. We believe that reshoring is one of those that is becoming a more permanent fact as it relates to the North American market. And that's going to drive some significant long-term growth. Now, I will say, whether or not we continue to see – and I use the word torrid in my comments for a reason. In my history, I've never seen it this strong. I've never seen the opportunities and the pricing environment be the way that it is. I believe, over time, that from the conservativeness that we take into account, not sure that those types of prices will maintain the longtime, but for now that demand is real. We're not seeing inventory levels at our service center customers really go beyond more than what they had normally in this time. So, there's no big build of restocking that's taking place. So, for the most part, this is true demand that we're meeting, which is a good thing. And so, we're going to continue to service. We're well positioned. We've got the broadest product offering in the industry. And all of those strings are being pulled right now. So, I think this has legs for a good period of time. Whether or not it continues at that pace, we'll have to let a few things unfold to really understand the environment. But it's really good right now. We're taking advantage of it.

We have no further questions at this time. I would like to turn the call over to Mr. Keith Harvey for closing remarks.

Okay. Well, thank you very much for joining us today. And I look forward to updating you during our second quarter 2022 earnings call in July. Everyone, have a great day and thank you.

Thank you. And thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.