Kaiser Aluminum Corp (KALU) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Kaiser Aluminum Second Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference may be recorded. I would now like to turn the call over to Ms. Melinda Ellsworth, Vice President, Investor Relations and Corporate Communications. Ma'am, you may begin.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's Second Quarter 2017 Earnings Conference Call. If you've not seen a copy of our current 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; Executive Vice President and Chief Financial Officer, Dan Rinkenberger; and Vice President and Chief Accounting Officer, Neal West.

Before we begin, I'd like to refer you to the first 2 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, 2016. 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 nonrun 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 Jack Hockema. Jack?

Thanks, Melinda. Welcome to everyone joining us on the call today. Our second quarter results exceeded our expectation as Trentwood performed significantly better than anticipated despite project-related equipment outages and operational disruption. Beyond Trentwood's strong performance, our other facilities continued to achieve solid underlying manufacturing efficiency. We also benefited from favorable scrap material prices similar to the first quarter, and overhead and other costs in this quarter were also more favorable than we had anticipated.

In addition to reduced complexity and execution risks at Trentwood, we rescheduled approximately $4 million of major maintenance projects unrelated to the modernization project from the second quarter to the second half.

As anticipated, industry dynamics remained largely unchanged from the first quarter. Despite construction-related throughput constraints at Trentwood and destocking in the commercial aerospace supply chain, total shipments increased 3% year-over-year. Reduced year-over-year aerospace shipments were more than offset by year-over-year growth in shipments for general engineering and automotive applications, driven by strong industrial demand and new automotive program launches.

While shipments improved year-over-year, we experienced a 2% decline in total value-added revenue due to a lower value-added product mix, higher contained metal costs and competitive price pressure. Unusually favorable price spreads for scrap raw material purchases continued from the first quarter and partially offset margin pressure from the lower sales prices. Despite headwinds in the aerospace market and disruption from modernization construction activity at Trentwood, we achieved strong EBITDA and margin comparable to the prior year, demonstrating benefits from our past capital investments as well as our focus on continuous improvement in our manufacturing operations.

In addition, we returned cash to shareholders through share repurchases and dividends of $40 million in the second quarter and $82 million in the first 6 months of the year. The Trentwood modernization project is proceeding as planned, and we expect to complete the heat treat furnace outage and restore normal operations and material flow during the third quarter.

I'll now turn the call over to Dan for additional color regarding the second quarter results and then provide an update on our outlook for the second half and the full year of '17. Dan?

Thanks, Jack. Similar to the first quarter, value-added revenue in the second quarter reflected a lower value-added product mix with fewer aerospace shipments and more automotive bumper and general engineering shipments. Additionally, compressed margins on spot sales of certain products continued from the first quarter into the second quarter.

While total shipments increased 3% year-over-year in both the second quarter and the first half of 2017, value-added revenue declined 2% in the second quarter and 3% in the first half, reflecting the leaner mix and the compressed margins.

Aerospace value-added revenue declined 6% from the prior year second quarter and 7% from the prior year first half due to supply chain destocking of aerospace plate as well as planned project-related equipment outages that temporally constrained our second quarter plate capacity. Additionally, competitive pricing on aerospace spot transactions continued to prevent full pass-through of higher contained metal costs.

Automotive value-added revenue increased 3% compared to both the second quarter and the first half of last year on higher volume, particularly for bumper programs for which shipments nearly doubled. General engineering value-added revenue also continued to show year-over-year improvement, increasing 3% over the second quarter and 5% over the first half of last year. As with some of our aerospace products, continued competitive pricing hindered our ability to pass through higher contained metal costs on some of our higher value-added general engineering products.

On Slide 7, EBITDA for the second quarter of 2017 was $54 million compared to $55 million in the second quarter of last year. Compressed sales margins and a lower value-added product mix resulted in a $6 million adverse sales impact in the second quarter while major maintenance expense exceeded the prior year quarter by $2 million. However, as Jack mentioned, favorable price spreads for scrap purchases continued in the quarter providing a $4 million year-over-year benefit.

Additionally, operating and overhead costs were slightly lower than the prior year quarter. With solid operating performance across our manufacturing platforms, second quarter EBITDA margin was 26.7%, which was higher than any prior quarter.

During the second quarter, we chose to reduce complexity and execution risks at our Trentwood facility by rescheduling major maintenance that was not critical or required to be completed in conjunction with the hotline and heat treat furnace upgrades. We believe this contributed to the Trentwood team's efficient execution of equipment upgrades and enabled favorable sales and cost performance that we initially did not expect during the quarter.

The rescheduled major maintenance projects totaling $4 million are now planned for the second half of the year.

EBITDA in the first half of 2017 of $108 million was $2 million lower than the prior year, reflecting a $14 million adverse sales impact, largely offset by a $6 million benefit from favorable price spreads for scrap purchases and $6 million of favorable operating and overhead costs. EBITDA margin in the first half of 2017 was 26.6%, slightly higher than the 26.4% EBITDA margin in the first half of last year.

Turning to Slide 8. Operating income as reported for the second quarter of 2017 was $11 million. This was net of $33 million of noncash, nonrun rate losses. Adjusted for the nonrun rate losses, operating income for the second quarter was $44 million compared to $46 million in the prior year's second quarter. The $2 million decline reflected the $1 million reduction in EBITDA that I just covered as well as a $1 million increase in depreciation expense.

For the first half of 2017, operating income as reported was $71 million. Adjusting for $18 million of noncash, nonrun rate losses, however, first half 2017 operating income was $89 million, down slightly from $92 million in the prior year period, reflecting a $2 million reduction in EBITDA and a $1 million increase in depreciation expense. Nonrun rate losses for both the second quarter and the first half of 2017 included an $18 million impairment of goodwill associated with our January 2011 acquisition of Alexco. The impairment reflected our updated assessment of market conditions for hard alloy aerospace extruded shapes.

Nonrun rate losses for the second quarter also included $12 million of noncash mark-to-market losses on our commodity hedge positions.

Reported net income for the second quarter of 2017 was $5 million or $0.27 per diluted share and for the first half of 2017 was $41 million or $2.34 per diluted share. Adjusting for nonrun rate items, net income was $25 million for the second quarter and $52 million for the first half or adjusted earnings per diluted share of $1.47 for the quarter and $2.99 for the first half.

Our effective tax rate was 32% for the second quarter and 34% for the first half of 2017, but our cash taxes continue to be low as we use our net operating loss carryforwards.

Capital spending totaled $25 million in the second quarter and $40 million for the first half of 2017. We expect capital spending for the full year will be approximately $80 million, which is more than twice our level of depreciation. A significant portion of our 2017 spending is related to the Trentwood modernization project.

Additionally, during the first half of 2017, as Jack mentioned, we returned $82 million of cash to shareholders in the form of share repurchases and dividends. At June 30, cash and short-term investments totaled approximately $233 million and borrowing availability on our revolving credit facility was approximately $287 million.

And now I'll turn the call back over to Jack to discuss our outlook and business market trends.

Yes. Thanks, Dan. We continue to expect destocking in the commercial aerospace supply chain through the remainder of 2017. Despite the destocking and constraints on capacity from our planned equipment outages at Trentwood, we continue to expect full year 2017 shipments similar to 2016 for our aerospace applications. Although we expect most of the aerospace destocking to be resolved by the end of the year, we now expect isolated instances of inventory overhang to linger into 2018. However, we continue to anticipate strong demand growth for aerospace applications in both 2018 and 2019 driven by commercial, military and other aircraft applications.

For automotive extrusion applications, while the 2017 North American build rate forecast has decreased slightly since our last call, the build forecast is unchanged for larger vehicles that represent a significant portion of our automotive mix. Shipments for our new bumper programs are ramping up as expected, and our outlook for 2017 automotive shipments and value-added revenue are unchanged. We continue to expect double-digit year-over-year growth in shipments and mid-single digits value-added revenue growth as demand growth is concentrated in lower value-added parts.

Turning to Slide 10. We experienced destocking for general engineering applications in the second quarter following restocking in the first quarter. Supply chain inventories appear to be in equilibrium, and underlying industrial demand remained strong. Our current lead times at Trentwood are 14 weeks for general engineering plate and 10 weeks for high-strength alloys. The longer lead time for general engineering plate is related to working around the planned outage just completed for the light gauge heat treat furnace.

Turning to Slide 11 and a summary of our outlook for the full year of 2017. Our sales outlook for aerospace, auto and general engineering applications is unchanged. Project-related inefficiencies will continue at Trentwood in the third quarter. We expect to restore normal operations and material flows by the end of the quarter and to begin realizing the quality cost and capacity benefits from this work later in the year. As demand strengthens and we fully implement the improved practices and capacity expansion, these benefits will continue to grow in 2018 and beyond. As mentioned in my earlier remarks, we made a decision during the second quarter to reschedule certain major maintenance projects to the second half of the year. As a consequence, approximately $4 million of planned major maintenance spending has been shifted from the second quarter to the second half of the year. Reflecting the seasonality of our business, we typically experience reduced sales and EBITDA in the second half compared to the first half. This year, we expect a pattern very similar to 2016, although the scheduled major maintenance expenses will cause additional drag on the second half compared to the prior year.

Turning to Slide 12 and a summary of our comments today. As expected, second quarter results were negatively impacted by construction-related activities at Trentwood, aerospace supply chain destocking and reduced sales margins. However, we had strong operational performance, and scrap raw material prices continued to be unusually favorable. As a result, we improved year-over-year EBITDA margin for both the second quarter and the first 6 months of the year.

In the second half, we expect normal seasonality, unusually high planned major maintenance expense and restoration of normal operations and material flows at Trentwood by the fourth quarter. Longer term, our strong balance sheet and cash flow generation will support continued investments in organic and inorganic growth and return of cash to shareholders. We will now open the call for questions.

(Operator Instructions) And our first question comes from the line of Edward Marshall with Sidoti & Company.

So I guess, Jack, in Q1, you talked about major maintenance running at about $5 million to $7 million higher than 1Q. Obviously, there's been some change with the rescheduling here. I know the hotline you said was done, and the furnace is partially done, on its way in 3Q. So kind of maybe you can parse that $4 million kind of how does that work into that $5 million to $7 million as it relates to the first quarter.

Sure. The -- I don't remember, the $5 million to $7 million, I think we're probably talking the first half year-over-year. Yes. But anyway, basically, we shifted $4 million of planned major maintenance not related to the modernization project, shifted that from the second quarter into the second half of the year. In terms of the modernization project, we had the major equipment outages in the second quarter on the hotline, a little more than a week on the hotline and several weeks on the light gauge heat treat furnace. The light gauge heat treat furnace just started up late last week, so we're beginning to ramp it up and the big sheet -- new sheer that we put in place also began to ramp up early this week. So we're through the major outages now, and we're in the early ramp-up phases on the major equipment installations that we made. But in terms of how it affects EBITDA, the only real effect from our outlook that we gave on the last call is we've moved roughly $4 million of unrelated to modernization major maintenance projects from the second quarter into the second half.

Got it. And is there any way you can kind of talk second half over second half or first half over second half as to the maintenance costs on...

Well -- yes, we didn't expect it was going to be that way this year with all the planned maintenance that we had in the first half, but now that we've moved it to the second half, as we said in our outlook, we're expecting that the second half this year compared to the first half this year is going to be a very similar pattern to what we saw last year with the exception that we've got even $4 million of additional major maintenance loaded into the second half. So we're going to have an even more increased major maintenance spending in the second half this year than we had last year.

Got it. And you're seeing yields, I guess, or at least the initial yields off the furnace and maybe even the sheer, probably too early to tell, but are they meeting kind of expectations at this stage -- or at this early stage?

Yes, but we're only days into it, so we haven't even finished the first inning yet.

Yes. And you gave some commentary on the general engineering and the heavy -- or the heat-treated plate. Based on lead times today, where were they a year ago?

I think we were 30 weeks or so.

We were 15, 20.

15, 20 weeks a year ago.

15, 20, so it's come down significantly, okay. And you'd mentioned the scrap versus primary and the benefit in Q1, just to refresh my -- that's about $1 million to $2 million benefit, right, in Q1, I think, it was.

Well, I think Dan said, this quarter over prior year was $3 million or $4 million.

$4 million in the quarter compared to last year, so -- I can't remember what the first quarter was offhand so I'll do a quick research here.

Yes, but it's -- order of magnitude, it's the same thing. And it just -- when I put my thumb in the air and compare it to what we think are typical benefits from scrap, we're running roughly $3 million a quarter in the first half better than what we were running -- than what we typically would run.

Just to be clear, though, this is a strategic choice, correct? Or is there...

Well, no. It's really 2 factors. First of all, a lot of credit goes to our operations because they put a lot of focus on improving our buying as well as improving our scrap utilization. So we've gotten a permanent improvement in our raw material costs because of actions implemented in our operations. That said, we're working with a favorable market environment. And I said on the first quarter -- the call for the first quarter, it was unusually favorable in the first quarter. We didn't expect it to continue. It was similar in the second quarter. We don't expect it to continue, but we're hopeful that it continues into the year. And frankly, in the first half, it's been a big benefit to tailwind that's help us offset, as Dan mentioned, offset a lot of the price erosion that we've seen on our heat treat plate products.

And our next question comes from the line of Jorge Beristain with Deutsche Bank.

Just following up on the same topic. You had guided toward a sequentially weaker 2Q margins, adjusted margins, because you had thought that 1Q was not repeatable. It's been repeated again, and now you're again guiding to lower adjusted EBITDA margins going forward. But can you just clarify what exactly drove the difference in those adjusted EBITDA margins being about 600 to 700 basis points higher quarter-on-quarter than you had expected?

Yes, yes. So the -- if you just take the major maintenance, you got $4 million of major maintenance, which is 200 basis points, so there's 1/3 of it. And if you take the scrap profits running $3 million to $4 million better than what our outlook was, you've got another close to 200 basis points. Trentwood performed much better than we expected. We thought they'd have a lot more inefficiency related to the significant activity going on at the plant, and they did a marvelous job in the second quarter, not only managing the projects, they were really big projects, bringing those on line but also managing operations, working around all the disruption. And beyond that, we had really strong performance in all of our other plants. So we had just exceptionally strong operating performance throughout all of our facilities. And beyond that, we got a small additional boost from lower-than-expected overhead and some other miscellaneous costs that are lumpy quarter-to-quarter.

Right. So I'm trying to dissect the lumpy stuff from the nonrecurring stuff, but it sounds like of the stuff that you just walked through, you're kind of -- part of it is that deferred maintenance. That's just going to be a 200 basis point headwind in the coming quarter. But a lot of the other stuff I'm not clear if that's going to be unwound.

Okay. Well, first of all, the major maintenance may not all be in the third quarter. We said -- I said we moved it to the second half. So some will be in the third quarter, some in the fourth quarter. The scrap discounts, it's difficult to predict. We didn't think it would be there in the second quarter after the first quarter. We're not anticipating it in the third quarter, but it's too soon to know. The scrap markets are very volatile and can change on a minute's notice. So we really don't know if those 175 to 200 -- or 150 to 200 basis points will be there. In terms of operating efficiency, the summer is always tough in our plants. We have more vacations, a lot of senior people out. And we have high heat in -- especially in our extrusion operations, and we always have less volume. And the combination always has some drag on efficiency. But we expect that Trentwood, while they're still fighting through the ramp up, they're not going to have near the inefficiency we think that we experienced in the second quarter. So all in all, we think our efficiency should be relatively similar in the third quarter to what we saw in the first half. And who knows how some of those other costs fall, they just bounce around quarter-to-quarter.

And our next question comes from the line of Novid Rassouli with Cowen & Company.

So back to -- sticking with the trend of maintenance here. So does the slower maintenance schedule imply that you're going more slowly because market conditions are likely to stay softer for longer? Or what was the impetus behind that?

Actually, it was a decision made at the plant. Keith and I were up there early in the quarter, and they were showing us all the great work they were doing prepping for the construction and all that. But after we left, they took a look at their whole situation and determined that some of what they were planning to do in the second quarter wasn't urgent. And to reduce the amount of distraction that they were going to have with everything they had on their plate in the second quarter, they just made a decision to move some of that to the third and fourth quarter, which we believe was a prudent decision, but that was a local decision, just them looking at their situation.

Okay. And of the $2 million spend in the second quarter versus the $4 million left for the rest of the year, is there a portion of the maintenance whether the $2 million or the $4 million that has a greater impact on production and volume inefficiencies? For instance, I guess, you have to shut anything down with respect to the $2 million this quarter, that you will need to shut down for the $4 million. Or if you could just help us understand that.

Yes, well, I don't know what your $2 million is unless you're looking something quarter-over-quarter.

Second quarter over second quarter.

Yes, yes. But disregard that. That's a -- major maintenance is lumpy quarter-to-quarter and half-to-half. When we look at the first 6 months of the year, our major maintenance spending was actually slightly higher this first half than it was prior year, but relatively the same as the prior year. And now we're looking at a second half other than the $4 million that's relatively comparable to the second half last year, which almost always is much higher than the first half. Plus we moved this other $4 million into the second half. So year-over-year, we're going to be $4 million or $5 million higher for the total year than we were last year. And most of that is lumped into the second half of the year, if that clarifies it.

Okay. And then lastly, just on general engineering shipments. You'd said restocking in Q1, destocking in 2Q. So is there a kind of reasonable level of shipments to expect going forward closer to 2Q? If you could just help us with that moving forward, and that's it for me.

No, it will have the normal seasonality. So you've got the high first quarter, the lower second quarter. And typically, those are the 2 strongest quarters of the year. And we'll see lower shipments in the third quarter and then probably significantly lower in the fourth quarter is the typical pattern.

And our next question comes from the line of Josh Sullivan with Seaport Global.

Just with the completion of the Trentwood efficiency investments here around the corner, has there been any changes to your long-term targets for EBITDA, I believe, in the upper 20s?

No, we're not going to go beyond that, Josh, good try. We're still looking at well over 900 in terms of value-added revenue potential and high 20s of EBITDA margin. And our outlook for the result of the investment we'd said we'd get 5% to 10% increase in capacity just listening to the guys at the plant. They're really, really optimistic about what they're going to get out of these improvements that they've made. But the other thing we're going to get is a step change, important step change in cost and quality on our light gauge plate. And that's going to position us much better in the marketplace plus give us significant cost efficiencies over and above the efficiencies we'll get through the whole operation from the upgrades we made on the hotline. So we're really optimistic, and the plant is exceptionally optimistic about what this all is going to mean once we get a few quarters down the road.

Okay, I had to try. And then just on aerospace destocking, can you give us a sense of where inventory is right now? Are levels consistent with current OEM build rates? Or are they adjusted for any additional rate reduction such as with the A380 or any other aircraft at this point?

Well, we're -- I mean, this year, the destocking is relatively constant through the whole year, and that's typically how it goes. It's a full year phenomenon. I think the A380 and some of the other adjustments are responsible for the comment that we made where we've revised our outlook that we're going to see modest destocking continuing into 2018. But we expect much less severe restock -- destocking in '18 compared to '17. And then with increased real demand as total builds are ramping up, we're still very bullish about increased demand in 2018 and 2019.

Okay. And then just one last one. On that lingering comment, I mean, is that Q1 or the first half? How far do you think that lingers...

It will affect the full year of 2018.

And our next question comes from the line of Piyush Sood with Morgan Stanley.

First, a follow-up on the inventory overhang in 2018. Anything you'd say to help us quantify the impact of that drag? Let's say, like it's 1/10 of what the kind of drag you're seeing this year, or anything that helps us kind of run some numbers through our model? And second, is it more on the long product side, flat product side? Any color you can provide?

The -- in terms of impact, we did not reiterate our outlook for '18 and '19 where we had set up 10% both years. We will be updating that perhaps on the next call, certainly by the February call. I expect that we'll be less than 10% year-over-year growth when we look at demand growth for '18 versus '17. But still, strong, strong growth. How it relates to flat rolled versus some of the long products, it's more contained in the flat rolled, but there is some metal mold destocking throughout some of the rest of the products as well.

Okay. That's helpful. And a question on Section 232 since we hear so much about it these days. Wondering how much of your aluminum is sourced from outside of North America?

The predominant portion is outside of North America.

Acquisition.

Yes, the purchases are outside of North America, more than inside.

And I'm showing no further questions at this time. I would now like to turn the call back to Jack Hockema for closing remarks.

Okay. Thanks, everyone, for joining us on the call. We look forward to updating you again on our third quarter call in October. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.