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Kaiser Aluminum Corp (KALU -1.24%)
Q3Â 2020 Earnings Call
Oct 22, 2020, 1:00 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Welcome to the Third Quarter 2020 Kaiser Aluminum Earnings Conference Call. My name is John. I'll be your operator for today's call. [Operator Instructions]
And I will now turn the call over to Melinda Ellsworth.
Melinda C. Ellsworth -- Vice President, Investor Relations & Corporate Communications
Good afternoon, everyone, and welcome to Kaiser Aluminum's third quarter and first nine months 2020 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; 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 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-Qs for the quarters ended March 31, 2020 and June 30, 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'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 to 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?
Keith A. Harvey -- President and Chief Executive Officer
Thanks, Melinda, and good morning, everyone. We delivered solid third quarter results driven by a rebound in automotive demand and continued strength in demand for our defense and general engineering applications. Following the onset of COVID, we have continued to aggressively flex cost to align with changes in market conditions. Although demand for our commercial aerospace applications in the third quarter dropped sharply from the strong first half of the year, we continue to reiterate the outlook for the second half of 2020 given in our second quarter earnings call.
Strong execution by our employees enabled us to deliver solid third quarter results in very challenging conditions as we continue to deal with varying market dynamics influenced heavily by the impact of COVID. Total liquidity remained strong at $1 billion. Our capital allocation priorities and our financial guidelines remain unchanged, and we continue to sustain our quarterly dividend.
Let me comment briefly on the end markets. As we noted on our second quarter earnings call, we anticipated the full year decline in demand for our commercial aerospace applications would be reflected in our second half results as the large commercial aircraft manufacturers continue to deal with production interruptions and slowing deliveries as a result of significantly reduced domestic and international air travel.
During the quarter, we quickly moved to lower cost in our aerospace and high strength focus facilities and pivot available capacity to other markets where possible. In addition, we continued working with our customers on modifications to existing declarations. As we have previously noted, we have long-term strategic relationships with our customers, many with multi-year agreements in place that allow both parties to mitigate the short-term impact of changing market conditions and meet agreed upon commitments. The continued strength and demand for our defense applications has partially offset the decline in commercial aerospace, and we have been successful in adjusting capacity and lead times to meet double-digit year-over-year growth in demand for these applications.
Turning to automotive. As we expected, our automotive extrusion shipments and resulting value-added revenue, bounced back strongly in the third quarter to mirror our strong first quarter results as new program launches resumed. These launches and other recently awarded programs are expected to continue to drive growth through 2021 and beyond. With these expected increases in automotive demand, we have recalled virtually all furloughed employees in our automotive focus facilities. We are well positioned to manage the expected longer term growth for these applications with minimal additional investments.
Our general engineering business continues to remain strong despite normal seasonal demand weakness in the second half. Solid service center demand for our Kaiser select products and continued strength in the semiconductor and automotive end market applications drove third quarter results. As I mentioned earlier, our ability to pivot aerospace plate capacity to meet the demand for general engineering applications enabled us to better meet demand and improve lead times for our customers. Pricing for these applications continue to remain stable during the quarter as the industry has responded to changing demand with adjustments to operating levels.
I am pleased with how our employees aggressively addressed cost and managed spending in the quarter given the different dynamics in each of our end markets. While our aerospace and high strength facilities were ramping down to align with lower commercial aerospace demand, the opposite was occurring for those facilities serving automotive and general engineering markets where we were ramping up to meet improving demand.
Despite the challenge in managing our operations with these significant swings in demand, our results reflect our ability to flex our variable cost structure to changing levels in demand in an efficient and effective manner. As business levels improve, we expect increased operating leverage will drive margin improvement as incremental cost will lag volume increases. In addition to strong execution and aggressively managing the impact of the COVID virus in our facilities, our employees are also achieving record safety performance. I'm extremely proud of the work they're doing and the manner in which they're achieving these results.
Turning now to our outlook on aero and high strength on Slide number 7. We see a continued slow recovery for large commercial aerospace applications driven by longer than expected recertification of the 737 MAX, slower recovery in domestic and international air travel and destocking in the supply chain. Destocking also occurred in the business jet supply chain as manufacturers dealt with temporary production delays due to COVID-19 outbreaks in late second quarter and early third quarter. As we reassess the full year outlook for these applications, we anticipate value-added revenue for commercial aerospace will now be down approximately 30% to 35% year-over-year from our record year 2019 versus the 20% to 25% previously anticipated. Demand for our defense applications remained strong and is expected to continue into 2021.
Moving to Slide number 8. Strong demand for our automotive extrusions is expected to continue in the fourth quarter with value-added revenue and shipments similar to our strong third quarter results. Build rates for North American vehicles are currently projected to increase approximately 18% from a 12.9 million vehicle production rate in 2020 to over 15.2 million vehicles in 2021. In addition, we expect continued growth in aluminum extrusion content as consumer preference toward larger vehicles and light trucks drive demand.
Moving on to Slide number 9. We see continued strength in demand for our general engineering applications despite second half normal seasonal demand weakness. In addition to strong service center and end market demand, we continue to see the emerging trend for OEMs reestablishing domestic supply chains. Our Kaiser select rod, bar and plate products and our long-term service center partnerships uniquely position us to capitalize on these opportunities as they continue to develop.
On Slide number 10, and a review of our outlook summary. Looking at the balance of the year, we reiterate our outlook for the second half of 2020 as communicated on our second quarter earnings call. We anticipate total value-added revenue in the second half will be down approximately 10% to 15% from the second quarter rate driven by lower aerospace and high strength sales, offset by continued strength in demand for defense, automotive and general engineering applications with EBITDA margin expected to be in the mid-teens. We have reduced cost to align with demand levels across the organization in our operations and in support functions that will provide significant operating leverage as business levels continue to improve.
As discussed in our second quarter earnings call, in addition to capital spending for critical sustaining projects, we resumed spending for other organic investment opportunities to further support automotive growth and enhance efficiencies throughout our operations. We continue to expect capital spending for the full year will be in the approximately $50 million to $60 million.
I will now turn the call over to Neal to discuss the third quarter in more detail. Neal?
Neal West -- Senior Vice President and Chief Financial Officer
Thanks, Keith, and good morning, everyone. Value-added revenue of $154 million in the third quarter 2020 declined approximately $60 million or 28% compared to prior year quarter and 30% lower shipments, primarily driven by the decline in aerospace demand. Aerospace/high strength value-added revenue of $73 million decreased 43% on a 59% decline in shipments compared to the strong demand levels experienced in the prior year quarter.
While demand for defense-related applications remained strong, the impact of COVID-19 on commercial aerospace demand drove the significant decline in shipments. Value-added revenue in the third quarter 2020 reflected the impact of lower volumes, a favorable product mix and approximately $15 million of additional revenue recognition related to modifications to 2020 customers annual declarations under multi-year contracts.
Automotive value-added revenue of $24 million increased approximately 2% compared to the third quarter of 2019 on a 5% increase in shipments, reflecting new program launches that began to ramp up as the auto supply chain return to production following the second quarter 2020 COVID-related shutdowns.
General engineering value-added revenue of $55 million declined approximately 4% on a 5% reduction in shipments, reflecting seasonal demand weaknesses normally experienced in the second half, while pricing continue to remain stable. For the first nine months of 2020, total value-added revenue of $546 million decreased $97 million or 15% on 19% lower shipments. Following a record 2019 and first quarter 2020, the impact of the pandemic on our aerospace/high strength applications drove the majority of the decline compared to prior year period. In addition, the second quarter impact of our automotive applications and our other planned exit of other non-strategic applications further impacted value-added revenue in shipments year-over-year.
Turning to Slide 13. Adjusted EBITDA of $30 million in the third quarter of 2020 decreased $27 million compared to prior year period, reflecting a total sales impact inclusive of the $50 million, as previously noted, and other cost flex with lower demand. EBITDA margin for the third quarter was approximately 20% compared to 26% in the prior year quarter, driven by lower VAR and operating leverage. EBITDA for the first nine months of 2020 $124 million declined $36 million compared to the prior year period with the majority of the impact due to the third quarter 2020 results, as previously discussed. EBITDA margin for the first nine months of 2020 was approximately 23% compared to 25% in the prior year period.
Turning to Slide 14. Reported operating income for the third quarter 2020 was approximately $12 million. Adjusting for $5 million of non-run rate charges, operating income for the third quarter was $17 million compared to $44 million in the prior year quarter. The third quarter 2020 non-run rate charges primarily reflects a $4 million increase -- reserve increase for environmental issues associated with ongoing historical PCB cleanup at our Trentwood facility.
Reported net income for the third quarter 2020 was $400,000 or $0.02 per diluted share. Adjusting for non-run rate items, net income for the third quarter was $5 million compared to $29 million in the prior year quarter. The $5 million adjusted net income reflects the impact of lower operating income and an increase of $6 million of pre-tax interest related to our recent bond offerings. Adjusted earnings per diluted share in the third quarter declined to $0.33 from $1.82 in the prior year period.
Reported operating income for the first nine months of 2020 was $63 million. Adjusting for $22 million of non-run rate charges, operating income was $85 million, down from the $124 million in prior year period. The decline in operating income, as adjusted, primarily reflected the decrease in EBITDA, previously discussed, and approximately $3 million of higher depreciation expense. The $22 million of non-run rate charges in 2020 -- year-to-date, primarily reflects a $12 million restructuring charge for severance and benefit costs reported in the second quarter, and a total of $6 million reserve increases for ongoing environmental cleanup projects.
Reported net income for the first nine months of 2020 was approximately $23 million or $1.44 per diluted share. Adjusting for non-run rate items, net income was $41 million compared to $82 million in the prior year period. Adjusted earnings per diluted share for the first nine months was $2.60 compared to $5.06 for the first nine months of 2019.
The effective tax rate for the quarter was impacted by discrete issues during the period. However, the effective tax rate for the full year 2020 is still projected to be in a low-to-mid-30% range, due primarily to an increase in state tax NOLs, valuations and adjustment for non-deductibility of executive compensation. We expect our 2020 net cash tax to be a cash refund of $11 million related to AMT monetization. Capital spending totaled $5 million in the third quarter and $37 million for the first nine months of 2020. Full year capital spending is expected to be $50 million to $60 million, as Keith previously noted.
During the first nine months of 2020, total cash return to shareholders was approximately $45 million. In addition, we recently announced our quarterly cash dividend of $0.67 per share that will be paid on November 13. Total liquidity on September 30 was $1 billion, comprised of $750 million of cash and cash equivalents and borrowing availability on our undrawn revolving credit facility of approximately $253 million.
Now I'll turn the call back over to Keith for closing comments. Keith?
Keith A. Harvey -- President and Chief Executive Officer
Thanks, Neil. Summarizing our remarks on Slide number 16, we delivered solid third quarter results driven by a strong rebound in automotive demand and continued strength in demand for our defense and general engineering applications despite the impact of the ongoing pandemic, and we have aggressively flexed cost and reallocated capacity to align with the changes in market conditions.
We continue to anticipate total value-added revenue for the second half of 2020 will be down approximately 10% to 15% compared to the second quarter run rate with EBITDA margin in the mid-teens. Total liquidity remained strong at $1 billion. Our capital allocation priorities and our financial guidelines remain unchanged. We are well positioned to continue to navigate challenging market conditions and capitalize on opportunities to further strengthen our prospects for long-term profitable growth.
We will provide more color on our 2021 outlook during our fourth quarter earnings call next February, but we believe that 2020 will be the trough for earnings. Our philosophy has always been to prepare ourselves to navigate through the highly cyclical nature of the end markets we serve. We're confident that we have the levers in place to navigate through this period with our strong customer relations, our broad product offering, solid multi-year agreements, which provide a safety net through challenging market conditions and a very strong balance sheet that allows us to manage our business and capitalize on additional opportunities which may come our way.
With that, I will now open the call for questions.
Questions and Answers:
Operator
Thank you. [Operator Instructions] And our first question is from Curt Woodworth from Credit Suisse.
Curt Woodworth -- Credit Suisse -- Analyst
Thanks. Hey, everyone, and congratulations on a great result this quarter.
Keith A. Harvey -- President and Chief Executive Officer
Hey, good morning, Curt.
Neal West -- Senior Vice President and Chief Financial Officer
Thanks, Curt.
Curt Woodworth -- Credit Suisse -- Analyst
With respect to the aerospace guidance, not totally surprising, but can you comment a little bit more on kind of what drove the change? Is it a function of just continued destocking that -- were there further cuts in the build rate? I know you said the MAX certification was delayed. And maybe it's a little bit too early to think about next year in terms of customer nominations, but do you have any sense of view on how the market could look into the early part of next year or the cadence of the inventory destock, which arguably will take at least another two quarters to work itself out?
Keith A. Harvey -- President and Chief Executive Officer
Sure. Looking at the market, we saw the large airframers begin to show reduced orders rapidly after the end of the second quarter. And so from a destocking perspective, they stopped early on. And so we think that that will shorten the length of a typical destocking period that we experienced. As that relates, we're still looking at the return and we're measuring return as to the strength that we saw in the 2019 time period.
We continue to believe as well as our end customers at this time that that's going to take about two to four years to get back to that 2019 record level. Now that doesn't mean that we won't see a gradual recovery start happening over the next, hopefully, sooner than later, but perhaps, a couple of years or one year or so forth. So we're monitoring that very closely, discussions continue with all involved. These things that I mentioned in our discussion points earlier are the things that we're waiting on. We're waiting for recertification of the MAX. We think that's going to be one little hurdle that we're going to get past that will start to give us more visibility as to how fast this will come back. And then I think as things progress, obviously, we're looking for a public to be comfortable with returning to travel, that's going to continue to drive demand, and we think ultimately, we'll recover. When those things start to happen is how fast we will get back on this.
Now with regard to how we are looking at how the world looks over those next few years. As we mentioned, we are very pleased with the strong multi-year agreements we have in place. And we think that that -- those are going to give us a safety net with which to navigate until that time period when destocking has ended and we are back on recovery with more sales with large airframes.
Curt Woodworth -- Credit Suisse -- Analyst
Okay. That makes sense. And then with respect to general drill, clearly some pretty strong success that we see in the common alloy market on the anti-dumping outcome to the 18 countries. Have you seen any shift in buying behavior with respect to that? We had heard that some servicers had engaged in a little bit of a pre-buy to get ahead of that. And is pricing now starting to recover more or how would you kind of characterize the broader industrial market right now?
Keith A. Harvey -- President and Chief Executive Officer
Yeah. I think, what we're seeing with the stronger activity in general engineering in some of the other markets that I specifically outlined there, I think that's helping over all the conditions with pricing that we're seeing. That strong demand and with other markets starting to come up and really with the industry managing with their capacity availability that tends to raise all boats. And so typically if you go back to the '08, '09 period and more of that typical recession, we saw price degradation begin to happen. And hopefully with this strong occurrence other than some of the challenges in some of the key markets, hopefully, we're going to see some stability continue to reign here on the pricing on all fronts. So add activity is raising all boats, Curt.
Curt Woodworth -- Credit Suisse -- Analyst
Okay, great. And then just one final one. Maybe it's a little bit difficult to kind of talk about this now, but in terms of like the future for Kaiser, you have the incredible balance sheet, you have a lot of optionality with respect to some of the interesting secular things going on in the market. From an M&A perspective, are you looking to become more active? I mean, there is a couple of assets that are pretty decent quality assets available in the market now I believe for sale. Do you have any kind of vision for how the portfolio could look maybe not next year, but in the next three to four years?
Keith A. Harvey -- President and Chief Executive Officer
Well, you mentioned it. What we have is the ability to be able to react if something comes along that matches our filter and our capital allocation strategy. We've always focused on organic growth first. But inorganic, as long as it fits certain guidelines and conditions, as we've stated many times, we're always first on the call list as a preferred buyer. That should continue with the current environment. And as we've stated, if we find something that's additive to our business, that we understand, it's got a defensible good strong position, we understand the culture, if it's something that can provide that long-term shareholder value and we can stay within our leverage and liability guidelines, we are in a position to be able to pull the trigger. And -- but we're going to remain disciplined in that approach. So as long as we can check the boxes on those filters, we're in a good place to be able to do one of those if they come along.
Curt Woodworth -- Credit Suisse -- Analyst
Great. Thank you very much. Stay well.
Keith A. Harvey -- President and Chief Executive Officer
Thank you. You as well.
Operator
Our next question is from Josh Sullivan from The Benchmark Company.
Josh Sullivan -- Benchmark Co. -- Analyst
Hey, good afternoon.
Keith A. Harvey -- President and Chief Executive Officer
Hi, Josh.
Josh Sullivan -- Benchmark Co. -- Analyst
Can you just talk a little bit about the conversations you've had with aerospace customers, those modifications you mentioned in the prepared remarks? Can you just help us understand some of the parameters around those conversations? Is pricing part of that conversation? And maybe what the timelines you're talking about some of those modifications?
Keith A. Harvey -- President and Chief Executive Officer
Sure. Well, listen, without really getting into the balance of our agreements, which we wouldn't do, but many of our contracts have provisions in place for cost recovery, margin protection, volume, product mix, a number of things. And when it's determined that those provisions can't be met, it could -- it creates a contractual obligation. During the quarter, it was determined that several of those would not meet the provisions in the contract and that triggered the obligation that was recorded, and Neal spoke at detail too.
So we -- if you think through that from a Kaiser Aluminum perspective, that's really how we approach. We've always stated we approach things in understanding the markets, because even though it hasn't demonstrated as such, the aerospace market has always been a cyclical market. And so we always plan for those downturns. Our approach to long-term agreements reflects that philosophy, and you can see that those are in place. It happened to trigger in for 2020. And again, those same agreements are in place for multi-years with many of our customers.
Josh Sullivan -- Benchmark Co. -- Analyst
I mean is there any reason to think that it could be triggered in 2021 at this point or do you think that '20 was the low point and...
Keith A. Harvey -- President and Chief Executive Officer
It's a great question, Josh. Not necessarily in a position to answer that at this time. But what gives us comfort in being able to understand what our future looks like is understanding that with these agreements there is a safety net at certain conditions. And so we're able to pull on those. If the market were to get worse, we're able to pull on those heavier and hopefully the markets will return quicker than what has been anticipated or communicated to date.
Josh Sullivan -- Benchmark Co. -- Analyst
Got it. And then just switching over to general engineering, can you give us any granular detail on the reshoring impact? What products gives you confidence that reshoring is really driving some of that strength?
Keith A. Harvey -- President and Chief Executive Officer
Well, we're seeing, obviously, and you heard in our last earnings call, lot of -- there was a lot of disruption in the supply chain with folks that had a supply chain that perhaps spanned over some oceans of water. A lot of disruption there. And then as they come back to really look at the availability and the products that we have, these markets had gotten pretty hot in a lot of the key areas; semiconductor is one, the automotive, we talked about. We don't talk a lot, but munitions, space programs and all that. And we're able to provide a very good product in a very good lead time. These days lead time is pretty key. In a lot of our product lines we're half the lead times that perhaps some of the imports can offer, and that resonates. That resonates for long-term supply positions and we're just seeing a move in that direction.
We happen to have more capacity available to meet that demand and help shore those things up. And I think the overall condition is really just supporting this -- our position here with capacity and looking at security of supply chain. So I think that's going to continue strongly into '21. We've had some really good wins to date in that area and we continue to talk to others about long-term agreements.
Josh Sullivan -- Benchmark Co. -- Analyst
And then just one on the automotive strength into 2021. I mean, do you think you're going to be more focused on a couple of these large new product launches that are coming through or do you think it's a little more broad-based?
Keith A. Harvey -- President and Chief Executive Officer
It's pretty broad for us, Josh. We have multiple launches that are executing this year. We have a number of launches planned for -- excuse me, this year and next year. I stated in the last call, we also were recipients of a couple of really nice new contracts, new awards, which are actually being implemented and were implemented, becoming implemented in the third quarter. So we're seeing significant activity right now. We've anticipated this for a long time. We've put millions and millions in place for -- and expectation for these markets to move off. We had a really good recovery, albeit second quarter for the COVID-related. The first and the third quarter has been very strong, as we would have expected. And we just see that just getting hotter for next year. So it's a really good outlook for automotive from our perspective and a lot of opportunities on new programs across the spectrum on all the products we're offering.
Josh Sullivan -- Benchmark Co. -- Analyst
Got it. Thanks for your time.
Keith A. Harvey -- President and Chief Executive Officer
Thanks a lot.
Operator
And we have a question again from Curt Woodworth from Credit Suisse.
Curt Woodworth -- Credit Suisse -- Analyst
Yeah, hi. Just wanted to follow-up on Josh's question. Within the extrusions market in terms of the sort of the secular trend in lightweighting and aluminum taking -- aluminum generally taking share, typically I would think on the new platform, you've got three to four years of visibility ahead of that given redesign and the timing around that. Would you say that you still feel pretty comfortable that that secular trend has momentum into 2022, 2023? Is bidding activity still pretty good for those products or do you think we're getting closer to a point of maturation?
Keith A. Harvey -- President and Chief Executive Officer
No, I think it's very good. When we quote on programs, we're generally out two or three years, three or four years in some cases on some of these platforms. So the businesses that we're quoting on are out in that timeframe, and we've seen no fall-off in increasing demand for lightweighted aluminum extrusions. So we think that's -- this thing has legs and we're continuing to be very well positioned to take advantage of it.
Curt Woodworth -- Credit Suisse -- Analyst
That's great. Thanks. Thanks for your time.
Keith A. Harvey -- President and Chief Executive Officer
Thanks, Curt.
Operator
And we have no further questions at this time. I will turn it back over to Keith Harvey for closing remarks.
Keith A. Harvey -- President and Chief Executive Officer
All right. Well, thank you very much for joining us on the call today. We look forward to updating you during our fourth quarter 2020 conference call in February. Have a good day.
Operator
[Operator Closing Remarks]
Duration: 35 minutes
Call participants:
Melinda C. Ellsworth -- Vice President, Investor Relations & Corporate Communications
Keith A. Harvey -- President and Chief Executive Officer
Neal West -- Senior Vice President and Chief Financial Officer
Curt Woodworth -- Credit Suisse -- Analyst
Josh Sullivan -- Benchmark Co. -- Analyst
