Kaiser Aluminum Corporation — Q3 2017 Form 10-Q
Business context and period. Kaiser produces specialty semi-fabricated aluminum products for aerospace and high strength, automotive, general engineering, and other industrial markets. This filing covers the quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods. The company operates one reportable segment, Fabricated Products.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $332.8 million | $320.6 million | $1,044.4 million | $998.7 million |
| Operating income | $39.8 million | $29.8 million | $110.7 million | $132.5 million |
| Net income | $19.9 million | $14.9 million | $60.6 million | $67.2 million |
| Diluted EPS | $1.16 | $0.82 | $3.49 | $3.70 |
| Operating margin | 12.0% | 9.3% | 10.6% | 13.3% |
- Revenue and shipments: Q3 sales rose 4%, reflecting 1% higher shipments and 3% higher average realized prices. Nine-month sales rose 5%, with shipments up 2% and average realized prices up 2%. Higher metal prices contributed to sales growth, while value-added revenue per pound declined 5% in both comparison periods.
- End-market mix: Q3 Aero/HS shipments fell 4%, while Automotive Extrusions rose 8% and GE shipments rose 2%. For the first nine months, Aero/HS shipments declined 4%; Automotive Extrusions and GE shipments each increased 7%. Competitive pricing and a less favorable value-added product mix pressured margins.
- Cash flow: Nine-month operating cash flow was $131.5 million, versus $107.4 million. Capital expenditures were $56.1 million, compared with $57.4 million. Cash, cash equivalents, and restricted cash totaled $87.1 million at period-end.
- Liquidity and debt: Cash and cash equivalents were $73.9 million and short-term investments were $191.4 million. Total stated liquidity, including $286.6 million of net revolver availability, was $551.9 million. No revolver borrowings were outstanding. Long-term debt was $369.4 million, principally the $375 million 5.875% senior notes due 2024.
- Margins and segment results: Fabricated Products operating income was $53.7 million in Q3 and $149.9 million for nine months. Excluding management’s non-run-rate items, segment income was $45.0 million in Q3 versus $47.0 million, and $158.5 million for nine months versus $165.1 million.
Material changes and notable items
- Q3 reported operating income improved year over year, aided in part by a $10.8 million unrealized derivative gain, compared with a $2.0 million gain in Q3 2016. For nine months, operating income declined; results included an $18.4 million non-cash goodwill impairment in 2017, while 2016 included a $4.9 million inventory write-down.
- The goodwill impairment related to the Chandler, Arizona extrusion facility. Management cited reduced wide-body aircraft build rates, persistently low business-jet production, and substitution of composites, titanium, or plate for hard-alloy extrusions.
- Q3 income tax expense was $16.1 million, with a 44.7% effective rate, including a $2.5 million deferred tax liability related to Canadian subsidiary earnings no longer considered indefinitely reinvested. The nine-month effective rate was 37.8%.
- The company repurchased 806,307 shares for $64.9 million during the first nine months, paid $26.4 million in dividends and equivalents, and declared a further $0.50-per-share dividend after quarter-end.
Outlook, risks, and contingencies
- Management lowered its 2017 Aero/HS shipment outlook: it now expects shipments below 2016, citing constraints and a slower-than-anticipated ramp-up of new equipment and automated controls at Trentwood. Automotive Extrusions and GE outlooks were unchanged; double-digit year-over-year Automotive Extrusions shipment growth was expected, with mid-single-digit value-added revenue growth.
- Management expected aerospace supply-chain destocking and lower sales margins to remain headwinds through year-end, while anticipating solid Aero/HS demand growth in 2018 and 2019. It expects the Trentwood modernization to support efficiency, quality, and capacity; the multi-year investment is $150 million, with approximately half spent by September 30. Full-year 2017 capital spending was expected to be approximately $80 million.
- The company said available liquidity and operating cash generation should fund working capital, planned capital spending, debt service, and other needs for at least 12 months, subject to operating performance and broader economic conditions. No numerical earnings or revenue guidance was provided.
- Environmental accruals were $16.9 million. The company said reasonably possible additional undiscounted costs could reach $12.2 million over the remediation period; estimates may change as investigations, feasibility studies, and regulatory reviews progress. Trentwood remediation may continue for 30 or more years.
- Customer and supplier concentration is notable: two customers represented 27% and 11% of Q3 segment sales; the top five aluminum suppliers provided 86% of primary aluminum supply in Q3. Other risks include aerospace and automotive demand cycles, competitive pricing, metal and energy prices, production ramp-up, labor agreements, and environmental obligations.
- ASC 606 adoption was planned for 2018 and will move much of Aero/HS and a substantial portion of Automotive Extrusions revenue to recognition over time. Management was still assessing the dollar impact. Lease accounting adoption in 2019 was expected to materially affect the financial statements.
Important facts for investors to verify
- Whether Trentwood equipment and automation ramp-up met expectations and whether Aero/HS shipments recovered as projected.
- Whether price competition, product mix, and value-added revenue per pound continued to constrain profitability.
- How much of reported operating income reflected unrealized derivative gains, the goodwill impairment, and other non-run-rate items.
- Progress, cost estimates, and regulatory approvals for environmental remediation, particularly at Trentwood and Newark.
- Customer and supplier concentration, liquidity availability, capital-spending execution, and the timing and impact of ASC 606 adoption.