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Kaiser Aluminum Corp  (NASDAQ:KALU)
Q1 2019 Earnings Call
April 24, 2019, 1:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Kaiser Aluminum First Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Melinda. You may begin.

Melinda C. Ellsworth -- Vice President, Investor Relations & Corporate Communications

Good afternoon everyone and welcome to Kaiser Aluminum's first quarter 2019 earnings conference call. If you've not seen a copy of our earnings release, please visit our Investor Relations page on the website at kaiseraluminum.com. We've 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 one filed the Company's Annual Report on Form 10-K for the full year ended December 31, 2018. 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've included non-GAAP financial information in our discussion. Reconciliations to the most comparable GAAP financial measures are included in the earnings release and in the appendix of the presentation. Any reference 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 Jack Hockema. Jack?

Jack A. Hockema -- Chief Executive Officer and Chairman

Thanks, Melinda. Welcome to everyone joining us on the call today. Continuing the positive trend from the second half of 2018, we reported strong first quarter results driven by improving aerospace demand and higher value added prices for our non-contract business. The strong sales results were partially offset by approximately $5 million of cost inefficiencies at Trentwood. Compared to the strong run rate in the second half of 2018, value added revenue increased another $11 million and EBITDA increased $5 million despite the cost inefficiency at Trentwood which was related to a combination of unplanned equipment downtime that temporarily interrupted our finishing operations and purchased rolling ingot costs necessitated by planned casting furnace rebuilds. Improved value added pricing was an important driver for our first quarter results as our proactive pricing actions have successfully restored our sales margins to a level consistent with prior experience under similar market conditions.

Turning to Slide 6. In the current business environment, the temporary reduction of Boeing 737 production from 52 per month to 42 per month before ramping up to 57 in September, has introduced uncertainty regarding industry demand for our products. Boeing has indicated a focus on the health of the supply chain during this period of reduced production. In other words, the supply chain is producing at a pace higher than the Boeing build rate. While it is likely that this supply chain restocking while 737 build rates are low could eventually lead to some level of supply chain de-stocking, the impact and timing are uncertain until the 737 MAX is recertified.

Meanwhile, demand for military aircraft continues to grow for the F35 Joint Strike Fighter and the modernized F15 Super Fighter and F/A-18 Super Hornet.

For our automotive applications, underlying demand remains strong. As a reminder, 2019 is a transition year with numerous end of life programs rolling off and a number of new program launches. We expect strong automotive shipments growth in 2020 and 2021 following the transition of programs this year.

Although demand for our non-contract general engineering products remains strong, we allocated a portion of our capacity in the quarter to address strong aerospace demand. This contrasts with 2017 and early 2018 when relatively soft aerospace demand enabled capacity to shift toward non-contract general engineering products.

We continue to incur tariff costs of approximately $200,000 per month while decisions by the Department of Commerce remain pending on specific exclusion requests. If we receive approval for the exclusion requests, we expect to recover approximately $3 million of previously paid tariff costs and eliminate the current $200,000 per month cost.

Moving to Slide 7, and a summary of our outlook for 2019. While facing some uncertainty in aerospace and automotive demand this year, we continue to focus on executing our strategic initiatives, to capture the full efficiency and capacity benefits from the recent Trentwood investments, and to position the Company for expected strong automotive extrusion shipments growth in 2020 and 2021, as we transition from old to new programs.

As we previously discussed, we plan significant maintenance activity and equipment downtime at Trentwood in the second quarter, for casting the hotline and the large plate stretcher. We estimate a one-time EBITDA impact of approximately $15 million in the second quarter, from related operating inefficiencies, maintenance costs and lost production and sales.

While we continue to monitor the 737 MAX situation, at this time, we have no specific information to warrant any change in our full year 2019 outlook, for EBITDA margin above 25% and low to mid single digit percent year-over-year increase in both shipments and value added revenue.

I'll now turn to Neal for additional detail regarding the first quarter results. Neal?

Neal West -- Senior Vice President and Chief Financial Officer

Thanks, Jack. Turning to Slide 9, value added revenue for the first quarter of 2019 increased $16 million or 8% to $218 million dollars on a 2% decline in shipments as compared to the prior-year quarter. Looking at our end markets, value added revenue for our aerospace applications increased approximately 17% from the first quarter of 2018, on a 17% increase in shipments reflecting strong underlying aerospace demand and moderating aerospace supply chain destocking.

Value added revenue for our automotive extrusions declined approximately 15% from the prior-year quarter, on a 4% decrease in shipments. The decline in shipments reflected the winding down of end of life automotive programs, and lower VAR reflects the trends of lower value added mix. Value added revenue for our general engineering applications increased approximately 2% on a 15% decline in shipments compared to the first quarter of 2018. While fully benefiting from the price increases implemented in 2018 and early 2019, as previously mentioned, we reallocated a portion of our heat treat plate capacity from general engineering to aerospace plate to meet the strong aerospace demand.

EBITDA for the first quarter of 2019 of $56 million increased approximately $8 million or 17% compared to the prior-year quarter. The increase in EBITDA reflected higher value added revenue and pricing on non-contract sales, partially offset by the higher costs associated with purchased ingot and unplanned downtime in Trentwood as Jack mentioned in his earlier comments. EBITDA margin in the first quarter of 2019 increased 190 basis points to 25.7% compared to 23.8% in the prior-year quarter.

Now turning to Slide 10. Consolidated operating income as reported for the first quarter 2019 was $43 million, net income was $28 million, and earnings per diluted share was $1.71. These results compare favorably to reported operating income of $37 million, net income of $26 million, and earnings per diluted share of $1.51 in the prior-year quarter. Adjusted for non-cash, non-run rate items, first quarter adjusted operating income increased to $44 million compared to $38 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 earnings per diluted share was $1.85. This compares favorably to the adjusted net income of $27 million and earnings per diluted share of $1.60 in the prior-year quarter.

Our effective tax rate for the quarter was approximately 26% compared to an effective tax rate of 18.6% in the prior year which reflected a few discrete tax benefits. We anticipate our 2019 full year blended federal and state effective tax rate will be in the mid 20% range and our cash tax rate in the low to mid single digits.

Capital investment in first quarter was approximately $14 million and we anticipate full year capital spending to be approximately $80 million to $90 million.

During the first quarter, we returned approximately $29 million of cash to shareholders through dividends and share repurchases. We continue to maintain strong liquidity and financial flexibility. At quarter end, cash and short-term investments totaled $138 million with borrowing availability of approximately $292 million under our revolving credit facility which remains undrawn.

Now I'll turn the call back to Jack.

Jack A. Hockema -- Chief Executive Officer and Chairman

Thanks Neal. Turning to Slide 12, and a summary of our comments today, we delivered strong first quarter results driven by improved aerospace demand and non-contract value added pricing. Although the 737 MAX situation has introduced additional uncertainty to our overall outlook for 2019, we continue to anticipate improved year-over-year results. As we look longer term, we remain well positioned to capitalize on the secular demand growth for our aerospace and automotive applications. In addition, we expect a continued steady improvement in underlying manufacturing cost efficiency to drive additional value for all of our shareholders. Our strong balance sheet and cash flow generation support our growth and capital deployment priorities and provide sustainability through industry cycles.

We will now open the call for questions.

Questions and Answers:

Operator

(Operator Instructions) And our first question is from Jeremy Kliewer from Deutsche Bank. Your line is now open.

Jeremy Kliewer -- Deutsche Bank -- Analyst

Hey, good morning.

Jack A. Hockema -- Chief Executive Officer and Chairman

Good morning.

Jeremy Kliewer -- Deutsche Bank -- Analyst

Looking for a little additional color on some of your industrial pricing, you jumped about 30% year-over-year. And I didn't know, is that due to the product mix or is it more on supply side constraints that it may be switching off to different industries or something along those lines?

Jack A. Hockema -- Chief Executive Officer and Chairman

Now there's some mix in there, but most of it is just a raw price increases, where our prices had become extremely compressed on non-contract business a year ago in the first quarter and we passed through price increases second quarter last year, we passed through additional price increases January of this year. And so we have our sales margins including covering the additional freight costs that we commented on last year. We now have those sales margins back in that territory that's typical for this kind of business environment.

Jeremy Kliewer -- Deutsche Bank -- Analyst

All right. So we should anticipate those should continue?

Jack A. Hockema -- Chief Executive Officer and Chairman

Yes.

Jeremy Kliewer -- Deutsche Bank -- Analyst

All right. And then if I may on the unplanned downtime at Trentwood. There's about $5 million cost this quarter. But you kept your $15 million headwind for 2Q unchanged. So will there ever be kind of a release of that $5 million, like less CapEx spend in 2019 or beyond?

Jack A. Hockema -- Chief Executive Officer and Chairman

No, the first quarter was completely unrelated to the second quarter. Roughly, a third of that $5 million in the first quarter was related to purchasing rolling ingot, outside purchases of rolling ingot, while we're rebuilding casting furnaces and we have additional casting furnace rebuilds in the second quarter. So there's that impact, but then the bigger impact, roughly two-thirds of it was related to extraordinary costs created by a significant downtime that we had on major handling equipment in our finishing operations, that basically ceased our operations there for several days. And then we -- there was a lot of maintenance cost involved to get back online and then additional overtime costs and lost absorption, as we made up for the lost days of production.

Jeremy Kliewer -- Deutsche Bank -- Analyst

All right. Thank you for the color.

Operator

Thank you. Our next question is from Martin Englert from Jefferies. Your line is now open.

Martin Englert -- Jefferies -- Analyst

Hi, good morning, everyone.

Jack A. Hockema -- Chief Executive Officer and Chairman

Hi, Martin.

Martin Englert -- Jefferies -- Analyst

So you noted no change in the outlook within the release which includes low to mid single digit value added sales growth as well as shipments. But then we saw slightly lower volumes year on year. I imagine some of this could be due to the disruption at Trentwood. And then we should probably expect some lower volumes due to the planned Trentwood outage in 2Q. So reasonable to assume that you're expecting some catch up in the back half of the year to make up for that, right?

Jack A. Hockema -- Chief Executive Officer and Chairman

I don't know if it's catch up but we expect very strong demand in the second half of the year so long as as Boeing sticks to this current plan where they have reduced production for just a few months here before returning to 52 and then a 57 build rate in the third quarter. We're expecting really strong demand, general engineering continues to be strong, we expect automotive is going to improve in the second half, we're suffering now in the early part of the year as Neal mentioned from some of the end of life programs hitting us. But we're ramping up some of the new programs and expect some of that to begin to hit in the second half. So we're expecting once we get past this Trentwood -- major Trentwood outage here in the second quarter, we're expecting strong demand and really strong results in the second half of the year. And that's despite the fact that we had $5 million or so surprise in the first half or first quarter from the downtime and the repurchased ingot here. So we're still -- we're very optimistic here about the second half of the year so long as this Boeing situation gets resolved and recertified relatively promptly.

Martin Englert -- Jefferies -- Analyst

Thanks for all the detail there, that's very helpful. And then when thinking about the guidance here and more so kind of heading into 2Q and the implications. So you provided the $15 million headwind. But how should we think about that so this quarter was $56 million or so adjusted EBITDA, add back you know $5 million or so to that, but should we take like a $60 million EBITDA and then be pulling out about $15 million for a rough run rate for 2Q, given the outage or will there be some positive partial offsets there?

Jack A. Hockema -- Chief Executive Officer and Chairman

That sounds like a question from an analyst who's really worked hard on his forecast. So all your rationale makes sense here, we're not going to comment on our second quarter outlook, but basically we're saying -- we're looking -- we're expecting roughly $15 million from a normal run rate kind of operation. You saw what we did in the second half of last year. We had really, really strong results in the second half and even with the $5 million hiccup in the first quarter, we had really, really strong first quarter. So it's pretty obvious that we've got really strong momentum underlying in our business. And clearly, the first quarter would have been a $60 million plus pace and high 20s EBITDA margin. So long as market conditions stay the same and we get through this outage in the second quarter, we're expecting really strong results going forward.

Martin Englert -- Jefferies -- Analyst

Okay. But nothing else to call as far as positive partial offsets that you'd expect in 2Q there, right?

Jack A. Hockema -- Chief Executive Officer and Chairman

No, no. I mean basically, it's -- we lose sales and production here in the second quarter, as we go through the outage. One could say with the Boeing situation, it turned out to be good timing, which is just an accident for us. But no, the second half demand was there, it's really that strong going forward at least under the current situation.

Martin Englert -- Jefferies -- Analyst

Okay. Excellent, thanks for all the added color there and good luck.

Jack A. Hockema -- Chief Executive Officer and Chairman

Thank you.

Operator

(Operator Instructions) And our next question is from Curt Woodworth from Credit Suisse. Your line is now open.

Curt Woodworth -- Credit Suisse -- Analyst

Thanks. Good afternoon, Jack and Melinda.

Jack A. Hockema -- Chief Executive Officer and Chairman

Hi, Curt.

Melinda C. Ellsworth -- Vice President, Investor Relations & Corporate Communications

Hey, Curt.

Curt Woodworth -- Credit Suisse -- Analyst

So first question just on the aerospace dynamic. Can you talk to -- I guess maybe pre the Boeing event, when you had all of your OEM nominations sort of settled in the first quarter, how your aerospace volume nominations looked this year relative to last year? And have you seen any change in spot lead times as a result of the Boeing build rate cut?

Jack A. Hockema -- Chief Executive Officer and Chairman

The nomination for this year is up from last year, which you would anticipate with the build rate increases that they've announced here. We've seen no change in order patterns given the situation. Boeing on their call this morning just reiterated that they're using this period of time to work on the health of the supply chain. As we view it and we see what's happening with orders here and then we've got -- still got despite the cutback to 42, we've got really, really strong pressure on our plants to deliver on the orders that we have on the books here.

Our view is that the destocking situation that we endured for a year-and-a-half, all of 2017 and the first half of 2018, it would appear to us that, that went on for too long. And the supply chain wasn't ready to meet the 52 rate and certainly the 57 rate. And so that's why we still see strong demand in terms of order rate here given the plans to ramp back up to 52 and then 57 in the third quarter. They're working hard on the health of the supply chain. So we think that destocking was too pronounced. They're clearly is restocking here with the supply chain producing at a rate above the 42 that Boeing is building planes at. But that appears to be getting everything back into equilibrium to meet that 57 demand. So long as they get recertified relatively promptly as as they hope to do, we think this should be pretty clear sailing going ahead, if the ramp-up happens as planned here. But we put the caution in here primarily because who knows when with all these government entities involved now who knows when we're gonna get the recertification and what the implications may be for the future, because everything is full go to ramp back up to 52 and 57 here later in the year.

Curt Woodworth -- Credit Suisse -- Analyst

Okay. That's super helpful. And then just where your lead times stand now for your more spot exposed aerospace business?

Jack A. Hockema -- Chief Executive Officer and Chairman

Just as I responded on your prior question, we've really seen no change in our outer outlook at this stage and as we commented on the prior call, a couple of months ago, we basically are fully booked. We've allocated capacity for the remainder of the year to our strategic customers based on their requests and we still stand there. We're basically fully booked Trentwood for the rest of the year and have very strong demand throughout the rest of our aerospace and general engineering operations.

Curt Woodworth -- Credit Suisse -- Analyst

Okay. That's helpful. And then I guess in terms of framing the MAX issue, can you help investors understand a little bit of exactly what the magnitude of the impact could be in the sense that like how -- like what percent of aeroplate demand would be just from that one plane. You know just -- because I think it's hard for investors to understand kind of the scope of really what it means.

Jack A. Hockema -- Chief Executive Officer and Chairman

It's not a huge number, the 52 to the 42. I mean in terms of percent of total aerospace demand, I mean you still have Airbus going at their rate, you have a lot of wide bodies being produced, and as we mentioned in our comments, we're seeing some nice growth in the military applications as well. So it's not a big hole there, but obviously if they back off and stay at 42 for a long time, or have to back off from 42, that'll start to have a bigger and bigger impact.

Curt Woodworth -- Credit Suisse -- Analyst

Okay, great. Appreciate it.

Operator

Thank you. Our next question is from Josh Sullivan from Seaport Global. Your line is now open.

Josh Sullivan -- Seaport Global -- Analyst

Hey, good morning.

Jack A. Hockema -- Chief Executive Officer and Chairman

Hi Josh.

Josh Sullivan -- Seaport Global -- Analyst

I mean, it sounds like you're (inaudible) essentially what Boeing has communicated here, which makes sense. But if we do see some destocking on the 737 front, what are the thoughts about transitioning demand back from the general engineering side? It sounds like you had given up some of that general engineering capacity for aerospace. But how would that work in the reverse direction. I mean do you think the market could support that?

Jack A. Hockema -- Chief Executive Officer and Chairman

Yes. I mean, at this stage demand is strong. The question is how big is that breadbox. But certainly, there's flexibility to move back and forth between general engineering or really between non-contract business. Our first priority we must fulfill our contractual commitments to our -- based on our long-term contracts. And that's why we ask for declarations a year ahead of time, so that we can then work around, what our contractual commitments are to our major long-term customers.

And so if there is a change in that outlook, it will be a similar situation to what we did If you go back and look at 2017 and first half of 2018, you'll see really strong general engineering shipments and that was with strong general engineering demand and with a pretty significant destocking situation in the entire aerospace supply chain. So there is flexibility. Can you turn it on a dime? No, but over a period of months, you have a -- there's flexibility there. The bigger impact would be, if it's a major reduction in total demand, then it starts to shorten lead times and weaken overall demand and there could be longer term pricing implications. But we're a long way from anything like that.

Josh Sullivan -- Seaport Global -- Analyst

Got it. And then just on the auto extrusion content transition here. Yeah, I mean, the automotive penetration of aluminum, it's gone on a couple of years here, have there been any changes in the duration or the terms of the contracts with the OEMs, just as that -- as that matures with some of these newer platforms?

Jack A. Hockema -- Chief Executive Officer and Chairman

No, it's basically business as usual there. And I mean, there's no change from the last 30 years, every -- new contract there's tremendous pressure on pricing. But we've been dealing with that for decades. So it's pretty much business as usual.

Josh Sullivan -- Seaport Global -- Analyst

Okay. Thank you.

Operator

Thank you. Our next question is from Jeremy Kliewer from Deutsche Bank. Your line is now open.

Jeremy Kliewer -- Deutsche Bank -- Analyst

Yeah, had a follow-up on the extrusions side. Where I guess, are you seeing particular areas of strength or particular areas of weakness?

Jack A. Hockema -- Chief Executive Officer and Chairman

Are you -- you're talking extrusions in general?

Jeremy Kliewer -- Deutsche Bank -- Analyst

No auto extrusions, so like --

Jack A. Hockema -- Chief Executive Officer and Chairman

Auto extrusions?

Jeremy Kliewer -- Deutsche Bank -- Analyst

Yes.

Jack A. Hockema -- Chief Executive Officer and Chairman

Well,, it's the the macro situation, you've got the shift in the OEMs shifting from too less sedan production and even more larger vehicle production and that trend obviously continues, GM and Chrysler have made those announcements as well as Ford that they're going to make that change in terms of the mix of vehicles that they're building. So that continues to go forward. There's really no change from that long-term trend other than it accelerating.

Jeremy Kliewer -- Deutsche Bank -- Analyst

But you're not seeing anything that's caught you by surprise. I mean you warned of the first half weakness on the model kind of ramp down before the new models ramp up but there's nothing that's out of whack there?

Jack A. Hockema -- Chief Executive Officer and Chairman

Yeah. There's no surprise because as we said on the last call, we have no idea how it's going to pan out this year. So we can't be surprised. So it just happened. Yes, some of the end of life came a little bit faster than we anticipated. But again, it's just a normal transition year. You don't know when they're -- how they're finally going to ramp down a vehicle because they don't know exactly how it's going to sell when they're taking out a service and then the flip side when they have a new model they're introducing, it's a question of whether the dog is going to eat the dog food here. So they have their forecasts in terms of how many they're going to sell but then reality hits when they go out there and start to sell them.

Jeremy Kliewer -- Deutsche Bank -- Analyst

Okay. Thank you and good luck.

Operator

Thank you. Our next question is from Piyush Sood from Morgan Stanley. Your line is now open.

Piyush Sood -- Morgan Stanley -- Analyst

Hey guys, good morning. The question around capital allocation. As you look through this year assuming the economy holds up, Boeing's orders normalize, your costs will likely fall further into next year, your automotive shipments will pick up further, so next year appears to be shaping pretty well. So just wondering how you're thinking about capital allocation going forward, not really for this year but a little beyond. Would you be looking to increase investor returns or would you be setting it up for some kind of growth?

Jack A. Hockema -- Chief Executive Officer and Chairman

Our capital allocation priorities have been consistent for more than a decade here. So as we've said on prior calls, we expect to be making organic investments in this $80 million plus territory for the next few years here. We continue to look for a good attractive inorganic organic growth opportunities with the same thing we'll only do them if we can do it a business that we understand and create long-term shareholder value. And then we go to our regular dividends and last is share repurchases. So there's nothing really on the horizon at this stage that would change or shift the priorities among those four areas.

Piyush Sood -- Morgan Stanley -- Analyst

Okay. Thank you. And one more, looking at the historical VAR per pound for aerospace, looks like the 1.86 level in 1Q brings you back to those historical levels. So just want to understand that if there is probably some more upside to it, once the Boeing situation resolves itself, or do you think, this is the level where you wanted it to be and it's finally climbed back up to that point?

Jack A. Hockema -- Chief Executive Officer and Chairman

The value added revenue per pound, there's such a significant component of the aerospace that is contract business. And then, the products within that everyone focuses on plate, but we've got a wide variety of products in there that have value added revenue per pound ranging from a couple of dollars up to $8 or $9 a pound. So there's a big mix component in there, there's also a component of what's happening with the non-contract business, where pricing actually has improved. But in terms of predicting what the value added revenue per pound is, it's really -- there are just too many variables in there. I mean, we have our forecasts, but it just depends on how the order base unfolds.

Piyush Sood -- Morgan Stanley -- Analyst

All right. Thanks so much and all the best.

Operator

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Jack Hockema for closing remarks.

Jack A. Hockema -- Chief Executive Officer and Chairman

Thanks everyone for joining us on the call today. And we look forward to an update on the second quarter, coming up here in July. Thank you.

Operator

Ladies and gentlemen. Thank you for your participation in today's conference. This concludes the program, you may now disconnect.

Duration: 31 minutes

Call participants:

Melinda C. Ellsworth -- Vice President, Investor Relations & Corporate Communications

Jack A. Hockema -- Chief Executive Officer and Chairman

Neal West -- Senior Vice President and Chief Financial Officer

Jeremy Kliewer -- Deutsche Bank -- Analyst

Martin Englert -- Jefferies -- Analyst

Curt Woodworth -- Credit Suisse -- Analyst

Josh Sullivan -- Seaport Global -- Analyst

Piyush Sood -- Morgan Stanley -- Analyst

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