Kaiser Aluminum Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited results. Kaiser manufactures specialty semi-fabricated aluminum products for aerospace/high strength, automotive, general engineering and other industrial markets; it reports one operating segment.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $393.1 million | $332.8 million | $1,196.5 million | $1,044.4 million |
| Operating income | $34.9 million | $41.5 million | $106.7 million | $113.3 million |
| Net income | $21.7 million | $19.9 million | $68.1 million | $60.6 million |
| Diluted EPS | $1.29 | $1.16 | $4.03 | $3.49 |
| Operating margin | 8.9% | 12.5% | 8.9% | 10.8% |
| Operating cash flow | Not separately stated | Not separately stated | $112.5 million | $131.5 million |
Q3 sales increased 18.1%, while operating income declined 15.9%; net income rose 9.0%, helped by a lower effective tax rate (27.3% versus 44.7%). For the first nine months, sales grew 14.6%, operating income fell 5.8%, and net income increased 12.4%. Shipment volume was 158.8 million pounds in Q3, up 6%, and 493.8 million pounds year to date, up 4%. Management’s non-GAAP value-added revenue was $205.0 million for Q3 and $617.8 million year to date, versus $186.5 million and $592.6 million, respectively.
Liquidity, debt and capital allocation
- At September 30, cash and cash equivalents were $94.3 million and short-term investments were $88.4 million. Net availability under the $300 million revolving facility was $292.0 million; total stated liquidity was $474.7 million.
- Long-term debt was $370.2 million, primarily the $375 million of 5.875% senior notes due May 2024. The company had no revolver borrowings and $8.0 million of letters of credit outstanding.
- Nine-month capital expenditures were $53.1 million; management expected approximately $80 million for full-year 2018. Operating cash flow decreased year over year. Financing cash outflows included $31.9 million of share repurchases and $28.5 million of dividends.
- The quarterly dividend was $0.55 per share. In September, the board authorized an additional $100 million for share repurchases; $178.3 million remained available at quarter end.
Material changes and unusual items
- Q3 cost of products sold rose to 82% of sales from 77%. Management cited higher metal costs, an unfavorable $13.7 million impact associated with hedge-accounting adoption, and higher manufacturing, tariff, maintenance and other costs. For the nine months, it cited a $28.7 million hedge-accounting impact.
- ASC 606 revenue adoption changed the timing and balance-sheet presentation of some sales, including $51.0 million of contract assets at quarter end. Reported nine-month net income was $3.6 million higher than it would have been without adoption; operating cash flow was unchanged. Prior-year figures were not restated.
- On September 19, Kaiser acquired Imperial Machine & Tool Co. for $43.3 million net of cash received. The acquisition added additive-manufacturing and machining capabilities; $24.6 million of goodwill was recorded.
- The company completed installation of thin-gauge-plate handling equipment at Trentwood. A planned one-week hot-line and large-stretcher outage was moved from Q4 2018 to mid-2019.
Outlook, commentary and risks
Management maintained its expectation of mid-single-digit growth in 2018 shipments and value-added revenue. It expected continued demand strength in Q4, moderating aerospace supply-chain destocking and normal industrial seasonality. Management described sales margins as improved but still at historical lows and said it would assess further price increases. It expected strong demand across end markets in 2019, but gave no specific 2019 financial forecast.
Key exposures include aerospace and automotive demand cycles, shipment mix, metal-price pass-through timing, energy and alloying-metal prices, tariffs, and customer and supplier concentration. Two customers represented 26% and 15% of Q3 sales; two customers represented 24% and 15% of trade receivables at quarter end. The top five aluminum suppliers provided 83% of primary aluminum supply in Q3.
Environmental remediation accruals were $17.2 million. The filing says costs could reasonably exceed accruals by up to an estimated $11.6 million over the remediation period, and estimates may change as investigations and remediation plans progress. Other pending legal matters were not expected by management to materially affect financial position, results or liquidity. The company also expected lease-accounting adoption in 2019 to have a material financial-statement impact.
Important facts for investors to verify
- Whether shipment growth and planned price increases translate into improved conversion margins, given Q3 and year-to-date operating-margin declines.
- The underlying cash conversion trend, including working-capital movements and the lower year-over-year operating cash flow.
- Integration and performance of Imperial Machine & Tool, and the expected returns from the Trentwood investment program.
- Potential changes to environmental remediation costs and the status of Trentwood groundwater and Newark investigations.
- Customer and supplier concentration, commodity-hedge exposure, and the financial-statement effects of ASC 606, hedge accounting and upcoming lease accounting.