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Edited Transcript of KALU earnings conference call or presentation 21-Feb-19 6:00pm GMT

Q4 2018 Kaiser Aluminum Corp Earnings Call

FOOTHILL RANCH Feb 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Kaiser Aluminum Corp earnings conference call or presentation Thursday, February 21, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel J. Rinkenberger

Kaiser Aluminum Corporation - Executive VP & CFO

* Jack A. Hockema

Kaiser Aluminum Corporation - Chairman & CEO

* Melinda C. Ellsworth

Kaiser Aluminum Corporation - VP of IR & Corporate Communications

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Conference Call Participants

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* Edward James Marshall

Sidoti & Company, LLC - Senior Equity Research Analyst

* Jeremy David Kliewer

Deutsche Bank AG, Research Division - Research Associate

* Joshua Ward Sullivan

Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst

* Martin John Englert

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Kaiser Aluminum Fourth Quarter Full Year 2018 Earnings Conference Call. (Operator Instructions)

It is now my pleasure to introduce Vice President Investor Relations and Corporate Communications, Melinda Ellsworth. Please go ahead.

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Melinda C. Ellsworth, Kaiser Aluminum Corporation - VP of IR & Corporate Communications [2]

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Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's fourth quarter and full year 2018 earnings conference call. If you've not seen a copy of today's earnings release, please visit the Investor Relations page on our website at kaiseraluminum.com. We have also posted a PDF version of the slide presentation for this call.

Joining me on the call today are Chief Executive Officer and Chairman, Jack Hockema; President and Chief Operating Officer, Keith Harvey; 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, when 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 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 have 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?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [3]

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Thanks, Melinda. Welcome to everyone joining us on the call today. We reported strong results for the fourth quarter, the second half and the full year of 2018, consistent with our initial outlook and despite headwinds from aerospace supply chain destocking and high-contained metal, freight and tariff costs.

Before getting into the results, I'd like to reflect quickly on our end markets. Commercial airframe builds were another new record in 2018 and supply chain destocking began to moderate in the second half, further accelerating aerospace demand growth. Aluminum extrusion content continued to increase on solid North American automotive builds and demand for general engineering and industrial product remained strong throughout the year, with normal second-half seasonality.

Turning to Slide 6 and a recap of 2018 results. We achieved a number of important milestones, including record shipments, record value-added revenue, near-record adjusted EBITDA and record adjusted net income and adjusted earnings per share. In addition, consistent with our capital allocation priorities, we continued to invest in our platform with $74 million of capital expenditures for efficiency, quality, capacity, and operational security projects. Invested $43 million to acquire Imperial Machine and Tool, a leader in multi-material additive manufacturing and machining technologies. And returned approximately $100 million to shareholders through share repurchases and dividends. In addition, in early 2018, we raised our quarterly dividend of 10%. And in early 2019, for the eighth consecutive year, we increased it an additional 9%. 2018 results were excellent, especially considering the headwinds. Without the $3 million of tariff costs, EBITDA also would've been a record in addition to all of the other record results. However, we're often asked by investors why EBITDA and EBITDA margin hasn't improved since the record year in 2016. The answer is simple. While our 2016 results were bolstered by tailwinds from strong aerospace demand and low-contained metal costs, 2018 was the reverse scenario, with headwinds from aerospace destocking and high metal and freight costs.

These changed conditions created a $49 million price squeeze in 2018 compared to 2016. This large price deficit, in combination with the headwind from aerospace destocking, masked substantial underlying EBITDA growth driven by increased sales volumes, operating leverage, manufacturing cost efficiency and favorable spreads on scrap purchases in 2018, in combination, more than offset the $49 million headwinds compared to 2016. We took action to address the price squeeze with price increases on certain noncontract shipments last year. And early this year, with improving value-added prices and continuing sales growth and manufacturing efficiency improvements, we're well positioned to realize strong EBITDA growth that has been masked by the price squeeze and aerospace destocking.

Turning to Slide 9. We enter 2019 with strong momentum. As aerospace destocking began to moderate and price increases took effect in the second half, we reported record results. We expect continuing strong aerospace demand as commercial aerospace and F-35 Joint Strike Fighter build rates grow and supply chain destocking further moderates.

For our automotive applications, similar to other end markets, underlying demand remains strong. However, 2019 will be a transition year with numerous end-of-life programs rolling off and a number of new program launches. Demand for our general engineering products also remains strong. However, we temper our optimism in this market due to the uncertainty surrounding global economic weakness and ongoing trade negotiations. One clear recurring theme is that demand remains strong in all of our end markets and the current market environment continues to be favorable. As we noted during our October earnings call, we continue to monitor market conditions to determine timing for further price increases. In January and February, we successfully implemented additional price increases on certain noncontract general engineering and aerospace products. Late in the fourth quarter, we received approval for our Bellwood facility to operate as a Foreign Trade Zone, which mitigates more than 50% of the tariff cost otherwise incurred on internal cross-border transactions. While decisions by the Department of Commerce are still pending on specific product exclusion requests, we continue to incur tariff costs of approximately $200,000 per month. If the exclusion requests are approved, we expect to recover approximately $2.5 million of previously paid tariff cost and eliminate the current $200,000 per month cost.

Turning to Slide 10. In our aerospace and high strength applications, consistent with our 2018 initial outlook, our shipments grew approximately 7% and value-added revenue increased approximately 6% year-over-year as commercial airframe build rates increased and supply chain destocking began to moderate late in the year. We expect growing builds and additional moderation in commercial aerospace destocking in 2019. In addition, defense spending from U.S. allies bolsters growing demand for the F-35 Joint Strike Fighter, the F/A-18 Super Hornet and other military applications.

Turning to Slide 9 (sic) [Slide 11]. While our shipments for automotive applications increased 3% year-over-year in 2018, our value-added revenue was down approximately 1% as mix continues to migrate to lower value-added applications. In 2019, we expect North American build rates to be similar to, but down slightly, from 2018. As previously mentioned, 2019 will be a transition year for our automotive applications as we have numerous new product launches and many existing programs reaching end-of-life. New program launches are inherently unpredictable as there are a multitude of other suppliers and processes for the automotive manufacturers to qualify, in addition to the uncertainty of market sentiment and customer acceptance of the new vehicles. As such, we have uncertainty regarding our automotive shipments and value-added revenue in 2019.

Turning to Slide 12, and our shipments for general engineering in 2018 were up 1% year-over-year and value-added revenue was up 8% due to a rich product mix and improved pricing. In 2019, while we remain cautious due to the uncertainty around global trade negotiations and economic conditions, we expect continuing strong demand and value-added pricing for these applications.

Moving to Slide 13 and a summary of our outlook for 2019. We expect strong demand across our end markets to support a low to mid-single-digit percent increase in both shipments and value-added revenue year-over-year. Value-added prices will benefit from additional price increases in January and February. Ongoing tariff costs will be approximately $200,000 per month in 2019, while we await a decision on our exclusion request. We expect continued improvement in underlying manufacturing cost efficiency at Trentwood as we implement practice changes to capture the full efficiency and capacity benefits from the recent Trentwood investments. However, we expect some efficiency challenges in our automotive operations with the demand uncertainty and transition of products. We also planned significant maintenance activity at Trentwood for casting the hotline and the large plate stretcher in the second quarter. After reviewing our past experiences with similar planned outages, we estimate a onetime EBITDA impact of approximately $15 million from the combination of operating inefficiencies, maintenance costs and lost production and lost sales. We expect EBITDA margin to increase to above 25% in 2019, with increased sales, operating leverage and pricing more than offsetting the expected drag of more than 150 basis points from the maintenance outage at Trentwood. Capital spending of $80 million to $90 million is planned in 2019 for quality efficiency, capacity, and operational security projects.

I'll now turn to Dan to provide additional detail regarding 2018 results. Dan?

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Daniel J. Rinkenberger, Kaiser Aluminum Corporation - Executive VP & CFO [4]

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Thanks, Jack. As Jack mentioned, strong demand across all end users supported shipment growth of 4% in 2018, leading to record shipments of 652 million pounds. Those strong shipments drove us to record value-added revenue of $828 million, which was a 5% year-over-year improvement. Value-added pricing improved over the course of the year after difficultly recovering high-contained metal costs early in the year. Market conditions finally allowed us to lead price increases into the second quarter that we fully benefited from in the last half of the year. Aerospace value-added revenue improved 6% year-over-year on a 7% increase in shipments. Continued growth in underlying demand, moderation in aerospace supply chain destocking late in the year and incremental capacity from recent investments at our Trentwood rolling mill led to record aerospace shipments for the fourth quarter, second half and the full year of 2018. Automotive applications' value-added revenue declined 1% in 2017 despite a 3% increase in shipments, reflecting a lower value-added product mix weighted more towards crash management systems. General engineering value-added revenue for the full year improved 8% to a record $233 million on a 1% increase in shipments, which reflected a higher value-added mix and improved year-over-year pricing.

Turning to Slide 16. EBITDA of $205 million in 2018 was a $6 million improvement over the prior year and just shy of our record EBITDA of $207 million in 2016. Solid underlying demand across all our end users led to favorable volume and mix-related impact of $21 million compared to the prior year. This was partially offset by a combined $14 million adverse impact related to pricing and tariffs. At the start of 2018, our sales margins had compressed to unprecedented levels due to a spike in underlying metal prices and a significant increase in freight expense due to new regulations restricting the trucking industry. Eventually, market conditions in the second quarter allowed us to realize sizable price increases that improved our sales margins, especially in the last half of the year as we realized their full effect. Nevertheless, the net year-over-year pricing impact was an adverse $11 million.

While our pricing structure generally allows us to pass through tariffs as a component of underlying metal price, in the second half of the year, we incurred approximately $3 million of tariff expense on cross-border shipments within our internal supply chain. We have already taken action to reduce this exposure going forward to approximately $200,000 per month, and we are awaiting decisions from the government on exclusion requests that could further reduce this exposure. Additionally, higher overhead and benefit costs were largely offset by manufacturing efficiency improvements at our Trentwood facility. We expect further cost structure improvement as we continue to reap the benefits of our recent investments at Trentwood. Our EBITDA margin of 24.7% for the year was slightly below the record 25.4% set in 2016 and 25.3% achieved in 2017.

Moving on to Slide 17. Reported net income for 2018 was $92 million, up from $45 million in 2017. Both years included a number of nonrun rate charges, including incremental income tax expense in 2017 of approximately $37 million related to the revaluation of our deferred tax assets under the new tax law. Adjusting for nonrun rate items in both periods, adjusted net income was $109 million in 2018, a 24% improvement from $88 million in 2017. The reduction in the corporate tax rate explains virtually all of the increase in adjusted net income as our effective tax rate declined to 24% in 2018 from 38% in the prior year. Adjusted net income of $109 million was a record for the company and represented a compound annual growth rate of 15% since 2014. But even without the benefit of lower -- of the lower tax rate, adjusted net income in 2018 would've been a record $89 million, representing a compound annual growth rate of 9% since 2014. We estimate our blended federal and state statutory tax rate will continue to be in the mid-20% range. However, our cash tax rate should remain in the low single digits until we use all of our federal net operating loss carryforwards, or NOLs. At year-end 2018, we had $118 million of NOLs remaining to apply to future pretax income.

Moving on to Slide 18. As reported, earnings per diluted share were $5.43 in 2018 and $2.63 in 2017.

Adjusting for nonrun rate items in both periods, including the incremental tax charge in 2017, adjusted earnings per diluted share increased to a record $6.48 in 2018 from $5.09 in 2017. The reduction in the tax rate explains $1.15 of the $1.39 per share increase, with most of the remaining $0.24 per share improvement attributable to the reduction in the number of outstanding shares. While the compound annual growth rate for adjusted net income since 2014 was 15%, the continued reduction in our number of outstanding shares due to our share repurchase program boosted the compound annual growth rate for adjusted EPS to 18%.

And moving on to Slide 19, I'll touch briefly on the fourth quarter. Total value-added revenue for the fourth quarter increased 8% to $210 million on 4% higher shipments compared to the prior year. Aerospace value-added revenue increased 11% in the fourth quarter on a 14% year-over-year increase in shipments, reflecting improved underlying demand growth, moderating supply chain destocking and incremental capacity at Trentwood. Automotive value-added revenue decreased 6% to $27 million and shipments decreased 1% as the mix shift to lower value-added programs continued. While general engineering shipments declined 6%, value-added revenue increased 10% to $55 million, reflecting improved pricing. Adjusted consolidated EBITDA of $55 million in the fourth quarter increased 6 -- $7 million compared to the prior year, driven by favorable sales impact, partially offset by higher freight cost and tariffs. Adjusted EBITDA as a percentage of value-added revenue increased to 26% in the fourth quarter compared to 24.6% in the prior year.

On Slide 20, you can see our cash declined approximately $70 million from 2018 as discretionary cash outflows for share repurchases and the acquisition of Imperial Machine and Tool consumed over $100 million. Adjusted EBITDA of $205 million funded all other cash requirements during the year, including sizable capital investments, working capital needs, and interest and dividend payments. We continue to maintain financial strength and flexibility with total cash and short-term investments of approximately $162 million at year-end and additional liquidity provided by more than $290 million of borrowing availability on our revolving credit facility. The facility remains undrawn and it matures in December 2020.

On Slide 21, we continue to allocate capital in a disciplined manner, with a focus first on reinvesting in our business. Capital spending in 2018 was $74 million, and we expect $80 million to $90 million of capital spending in 2019. Over a longer time frame from 2007 to 2018, our organic investment totaled over $750 million, which was more than double our depreciation expense over the same period. Acquisition investment over the same period totaled over $140 million, including our acquisition in 2018 of Imperial Machine and Tool. In addition to investing in our business, we have provided cash returns to shareholders through quarterly dividends and our share repurchase program, having distributed over $700 million to shareholders since we initiated quarterly dividends in 2007. We have continuously paid a quarterly dividend since then and raised it every year since 2011, most recently with a 9% increase for the first quarter 2019 dividend. We also distributed cash to shareholders in a disciplined manner through our share repurchase program. In 2018, we purchased over 600,000 shares of our common stock for $61 million at a weighted average price of $100 per share. Approximately $149 million remained available for further share repurchases under our board authorization as of year-end 2018. And one last thing from me before Jack wraps things up. We provided a concise recap of our 2019 financial outlook on Slide 22.

Jack, you have some summary comments then.

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [5]

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Thanks, Dan. Turning to Slide 24 and a summary of our comments. Despite formidable headwinds in 2018, we achieved record shipments, value-added revenue, adjusted net income and EPS and near-record EBITDA during the year. While 2019 will present challenges, we expect that growing demand for our aerospace products combined with improved noncontract pricing will drive record results. As we look longer term, we remain well positioned in attractive served markets to capitalize on the secular demand growth for our aerospace and automotive applications. In addition, we expect to continue steady improvement in underlying manufacturing cost efficiency to further drive value for all of our stakeholders. Our strong balance sheet and cash flow generation will support our growth and capital deployment priorities, and provide sustainability through industry cycles.

We'll now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Jeremy Kliewer with Deutsche Bank.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [2]

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You guys have been very consistent on stating that aerospace plate destocking is ongoing and now it's been moderating over the past couple of quarters. One of your largest partners or customers, Reliance, earlier stated that the plate market is very tight. So I'm wondering if you could provide a little bit more insight as to which of your aerospace products are actually tight versus others that still have some room to do some moderated destocking.

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [3]

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There were several parts to that question, but let me just speak from an overview standpoint. Demand for plate products is very strong in both aerospace and general engineering. And all of the production for those products goes across the same fundamental equipment, goes through the hotline and goes through the same heat treat furnaces. The destocking situation began to moderate late in the -- in 2018. We see it moderating further in 2019, however, there will be destocking continuing in 2019. So in terms of segregating what the impact is, frankly, we're seeing strong demand across the board. Strong demand for all of our aerospace products, and that's not just plate. Reliance may have made some comments about plate. But we have the same situation with our drawn tube, our aerospace shapes, extrusions, cold-finished rod bar. It's really across the board, really, really strong demand. And the same thing for general engineering products across the board, not just plate, but also our long products. So we're in a really good period right now with really strong demand across the board.

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Jeremy David Kliewer, Deutsche Bank AG, Research Division - Research Associate [4]

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Good to hear. And then on your capital allocation. You guys have done a lot of share repurchases lately, and you really picked it up in the fourth quarter as it appeared that your share price kind of sold off there. So how should we think about that moving forward now that your share price is close to your all-time highs?

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Daniel J. Rinkenberger, Kaiser Aluminum Corporation - Executive VP & CFO [5]

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Well, our program is designed, as we said many times before, that we would -- so that we will buy more at lower prices and fewer shares at the higher prices. That's been the consistent way we bought for the entire duration of our program, going back 4, 5 years. So I think it would just be a similar kind of expectation. We would not probably buy as many in the current price environment than we would if we -- that we saw in the fourth quarter.

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Operator [6]

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And our next question comes from the line of Martin Englert with Jefferies.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [7]

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So following the Trentwood outage, do you anticipate any incremental capacity from debottlenecking on any of this work that you're planning in 2Q here?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [8]

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No. It's -- this is fundamental maintenance in casting. It's a rebuild of a major casting, our largest casting complex at Trentwood. It's major work on the big reversing mill, but just typical maintenance work, just restoring the equipment to a good condition. And the same with our stretcher, our large plate stretcher has had significantly more volume go through it than we anticipated back 10 years ago when we installed that equipment. And this is routine maintenance just to go in and replace some of the parts that are showing wear and tear after 10 years of -- or 12 years of really, really high volume going through there.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [9]

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Okay. And what's the exact timing during 2Q? Or dates that you have blocked off, where you start and anticipate completing this?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [10]

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I'm not going to go to the specific dates, but it's during May and June.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [11]

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Okay. Okay. And then maybe if you could just talk about the lead times for aero heat treat plate. And if you have any excess availability for 2019?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [12]

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Yes. Actually, we basically are booked in 2019. Booked doesn't mean that we have orders for all of 2019. So lead time has become a bit of an anomaly in the current conditions. We have partnerships with a number of customers and so we have capacity blocks for those specific customers. But at this point, there's really not room for drop-in business from customers other than those who are our long-standing partners.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [13]

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Okay. So fair to say that it's largely blocked off or on allocation or allocated for your long-term contractual customers for 2019, correct?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [14]

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Yes, we don't like to use that word allocation. But yes, -- but we've blocked capacity for our strategic partners.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [15]

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Okay, that's helpful. And broadly, what are you seeing from commercial aero customers regarding their materials requirements for 2019? I imagine they probably came back to mid or late last year. Would then ask as far as the volumes and how does that look?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [16]

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It varies by customer. But I'll go back to the general comments. We're seeing increasing demand overall and it's a combination of commercial and military demand. But we do know from what we hear from certain customers in terms of what their take will be, that there still is an element of destocking that's perpetuated through 2019, and who knows where it will go after that.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [17]

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Okay. And is this destocking that's occurring, is that more at the OEM level? Just inventories of plate products and/or finished pieces or parts that's occurring there? Or is it somewhere else in the supply chain?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [18]

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No, it's definitely at the OEM level and it continues to have the same genesis, which is the changing outlook for some of the widebodies, in particular, there's been a lot of news about the A380. But changes in forecast builds for some of the widebodies that have created some of the overstocking and now the destocking.

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Operator [19]

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

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [20]

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Just digging into the 2019 as a transition year for automotive. You've talked about that before. But is there any way to quantify the number of programs rolling off versus the number of ramping up? And maybe what the cadence looks like throughout the year?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [21]

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Yes. It's -- in terms of quantity, I mean, it's not in the teens, but it's approaching that level. So it's a number of programs on both sides. And frankly, in terms of timing, I wish I knew. No one knows. And that's why we've put so much uncertainty on this. There's just so many variables involved. A lot of the times, in fact, similar to what we saw in the second half was actually some end-of-life programs that ended sooner than we expected. And there be more of that or some of the end-of-life may extend to be on what we're currently anticipating. And then we've put narrative in the earnings release and in my comments here about the uncertainty in a launch. There are so many variables involved with numerous suppliers, with the processes, internal to the OEMs if they launch a new model. And then the question whether the dog's going to eat the dog food, so once they launch the vehicle.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [22]

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Got it. Got it. And then on the CapEx outlook for $80 million to $90 million. I know you mentioned some priorities in the prepared remarks there. But what do you see as the most valuable projects in there going forward?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [23]

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Well, in terms of value, they're all valuable or we wouldn't be doing them. Those that create efficiency or quality or capacity have good solid returns. The ones that are operational security are critical to maintaining our position and keeping our equipment in good operating conditions. So it's really important. And frankly, we're seeing a migration to more operational security than what we've had in the past. We still look at roughly 75% of depreciation as our long-term operational security level, but we'll probably be a little bit above that in the 2019 period and maybe more than that in 2020. We've got some significant programs coming up that we'll talk about more later, as we get those well defined. But some pretty significant investments that are primarily operational security, but they'll also have efficiency and capacity benefits.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [24]

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And then just one last one on the price increases here for '19. Do you think that the benefit will follow the cadence as it did in '18? Or has there been any change in the customer's willingness to absorb the new price increases here?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [25]

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Well, we passed through price increases on certain aerospace and general engineering products in January and February. Those were successful. As we've said all along, we continue to monitor market conditions and whether that means more price increases as we go through the year or not, we'll just see what those conditions are. We're not in complete control of this. We have competitors and we have customers. And so we monitor the total market conditions. And typically, we're the ones taking the lead, but we're doing it based on our market intelligence of when and if we think is the right time for additional price increases.

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Operator [26]

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

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [27]

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So I wanted to pick up on price again. You -- when you started in 2018, you had a minor increase. And then second quarter, you called, for what you characterized as significant. As we kind of look at the new price -- round of price increases and maybe some more to come, looking at the umbrella of kind of new competitive dynamics around -- maybe around tariffs and so forth and using that umbrella to push some price. I'm curious, could you give a sense of kind of the order of magnitude of some of these increases that are coming through, either quantify or qualitatively kind of talk about maybe some of the increase?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [28]

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Sure. You've opened the door for me to talk about my favorite chart which no one's mentioned so far, which is the 2016 to 2018 bridge that shows the magnitude of the pricing impact, almost $50 million. People ask us, "Why is your EBITDA flat for 2 years?" Well, we've been hit with $50 million of price reductions in 2018 versus where we were in 2016. Where we are now after the increases in the second quarter last year and the increases in January and February, we're roughly midway between the pricing that we had in 2016 and the pricing that we had for the full year of 2018. What's normal, we don't know yet. But we think normal prices should still be above where we are today, whether the market will bear that, time will tell.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [29]

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Got it. And any sense for contract business. I know that these price increases have really been targeted toward spot. But as you think about maybe some of your contract business and what's up for renewal, either 2019 or beyond, kind of any sense that you may be able to push some prices through to the contract side?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [30]

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Yes. Those big customers are pretty friendly, so yes. So I'm not sure but it will be easy sledding.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [31]

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If I look at your EBITDA outlook, and I just want a point of clarification. The greater than 25%, first, that's a good number. But my sense is that's not adjusted for 2 things, the $2.5 million recapture of the recharacterization of the tariffs and then the $15 million from Trentwood. So if I adjust and look at the normalized number, that rate well exceeds 26%. First, is that accurate from a...

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [32]

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Yes.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [33]

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Yes, okay.

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [34]

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Yes. Yes, I put -- you are correct in that the tariffs are -- at this point, we're assuming that we're not getting relief on the tariffs, even though we think we have a really, really strong case. Don't know why we don't have a decision yet, but we expect to get one sometime relatively soon. But that's embedded in our outlook. The bigger piece though is the $15 million at Trentwood, and if you just do simple math on that, that's 150 to 200 basis points. And it affects -- and I tried to stress it in my voice when I was going through that in my prepared remarks. But that's a combination of cost, but it's also lost sales opportunity. So our value-added revenue would increase and our shipments would increase more than we're saying now did we not have this onetime impact of the outage at Trentwood. And we'd be looking at an outlook on margin probably 150 to couple of hundred basis points better than what we suggest here.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [35]

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Got it. And so if I look at the buckets of volumes and spreads over scrap, deficiencies in manufacturing and price, I guess, two questions there. One, what would be the most significant driver to that EBITDA walk? And then secondly, what would you probably most worried about or the riskiest elements of those buckets?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [36]

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Well, the big issue is price. I mean, if you go back to that -- the EBITDA walk slide, it's a huge number. Embedded in that volume mix cost bar that we show is operating leverage, is manufacturing efficiency. But it also includes, in contrast to the price squeeze we have on our sales, we have benefited from -- and rich spreads on our scrap purchases, and that's roughly 25% to 30% of the price impact year-over-year. So favorable scrap purchase prices helped us offset the unfavorable selling prices that we had going forward. We are hopeful that we maintain those scrap spreads, although they are at unusual highs, but they've persisted there for a sustained period of time. So we're hopeful that we're able to hang on to those scrap spreads. But beyond that, it's just continuing to whittle away at the operating leverage we get from our sales growth and just steady day-to-day improvements in our manufacturing cost efficiency.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [37]

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Great. And then the final one for me is really just a follow-up on Martin's question earlier. We talk about kind of the aerospace supply chain and how they're preparing and where they've come from. Now as I look forward, there's a pretty big aircraft coming out relatively soon, I guess, first flight's coming and ultimately delivery. Do you think that the supply chain is adjusting for that as of yet? Or is that a late 2019, early 2020 event that might be coming down the pipe and ultimately higher demand for you?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [38]

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Well, I think it's built into -- as I commented to Martin, I think it's built into the destocking that we're seeing continue in 2019. That's already -- whether it's embedded all of the A380 cutbacks or not, I don't know, but it certainly has considered a significant cutback in the A380. And where we go from there, I mean, the flip side of that there is, they still have more seats that they need to put in the air. So if they're not building the A380, that means they're building a lot more single house in some of the widebodies. So we're still seeing strong underlying demand growth, but we continue to have this anomaly that no one likes, including us, which is these destocking and restocking cycles. But unfortunately, that's just the nature of the business.

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Edward James Marshall, Sidoti & Company, LLC - Senior Equity Research Analyst [39]

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Right. You were looking at it from the opposite direction. I'm looking at the 777X. I guess I was trying not to say the aircraft out loud. But the 777X?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [40]

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Yes. Yes. Yes, but it's the same situation. So they may have to pair back some inventories for one model but that'll result in increased builds on other models. So it just -- it keeps moving around. And that's why for them, their builds continue to increase in a nice straight line, but for us, because of the long supply chain, we get things ramping up and ramping down and it creates a lot more volatility in our shipments.

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Operator [41]

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And our next question comes from the line of Martin Englert with Jefferies.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [42]

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Any idea, in today's dollars, how much it may cost to build a facility like Trentwood?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [43]

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We've not done a detailed analysis of that. We've looked at a new rolling mill for other products and other purposes, but it would be well north of $1 billion.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [44]

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Okay. Pretty significant. And when you -- you've focused a lot on shareholder returns with the dividend and buybacks as well as internal growth and other initiatives with the CapEx there. How are you thinking about inorganic growth looking forward here?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [45]

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Remains the same. We're very confident that our business model in the core businesses that we're in will continue, and I stress, continue to generate very strong returns for our shareholders as we have for the past 10 years. And we frankly look out 10-years plus with our board. And the board and the management remain confident that we can deliver strong returns over the long term without inorganic growth. That said, we continue to look for inorganic growth opportunities, complementary acquisitions in businesses that we understand that most importantly will create value for our shareholders. And we're not going to chase some of the outrageous prices that some of our peers have paid for assets that -- at levels we wouldn't pay.

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Martin John Englert, Jefferies LLC, Research Division - Equity Analyst [46]

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Do you have any broad framework about how you think about reasonable purchase prices versus unreasonable? Like are you thinking about like a through cycle forward-looking EBITDA generation and some multiple on that, excluding or including synergies?

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [47]

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No. We actually -- we'll talk about EBITDA multiples. But the reality is, we'll -- when we look at an acquisition opportunity, we do a long-term forecast and do a discounted rate of return on it and make our decisions on a discounted rate of return compared to cost of capital, and factor in what kind of a risk premium would we need for this particular asset.

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Operator [48]

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And that concludes today's question-and-answer portion. Now I will turn the call back over to CEO, Jack Hockema, for closing remarks.

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Jack A. Hockema, Kaiser Aluminum Corporation - Chairman & CEO [49]

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Thanks, everyone, for joining us on the call today. And we look forward to another update on our first quarter in April. Thank you.

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Operator [50]

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