Kaiser Aluminum Corporation

Welcome to the third quarter 2021 earnings conference call. My name is Jenny. I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. During the question and answer session, if you have a question, please press star then 1 on your touchtone phone. I'm going to turn the call over to Melinda Ellsworth. You may begin.

Thank you. Good afternoon, everyone, and welcome to Kaiser Aluminum's third quarter and first nine months 2021 earnings conference call. If you've 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, Executive Vice President and Chief Financial Officer Neil 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 years ended December 31, 2020, and Form 10-Q for the quarters ended March 31, 2021, June 30, 2021, and September 30, 2021. 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. Reconciliations of certain forward-looking non-GAAP financial measures to comparable GAAP measures are not provided because certain items required for such reconciliations are outside of our control and or cannot be reasonably predicted or provided without unreasonable effort. Any reference in our discussion today to EBITDA means adjusted EBITDA, which excludes non-run rate items from 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?

Thanks, Melinda. And thank you for joining us in a review of our third quarter 2021 results. I want to begin by acknowledging and thanking the Kaiser team who continue to execute on our strategies to position us for long-term growth while working safely and diligently during the quarter to meet customer requirements in the face of increasingly dynamic market conditions and a very challenging operating environment. As we discussed during our second quarter earnings call, we entered the third quarter aggressively addressing labor challenges in several of our locations. and working to mitigate the impact of inflationary costs as we prepare to continue to meet improving demand. While demand remained robust during the quarter, adverse conditions impacting operations proved to be even more challenging than we anticipated. In particular, continued challenges in the labor market, rapidly rising material and other inflationary costs, as well as supply chain issues, reduced efficiencies in our facilities, and contributed to results that fell well short of our expectations going into the quarter. We've made significant progress addressing our labor challenges, enabling an increase in output and efficiencies in our operations as of the third quarter. However, we expect these other transitory issues to persist at least through the end of the year. Supply chain disruptions and labor inefficiencies in the quarter accounted for approximately $8 million of negative impact to EBITDA. These headwinds included delayed shipments and plant inefficiencies resulting from the disruptions. Higher per unit costs for raw material, labor, and other manufacturing costs negatively impacted the quarter and additional $5 million. These costs were partially offset by lower GNA incentives and other costs in the quarter by approximately $5 million. Collectively, these costs led to a further EBITDA margin compression of approximately 200 basis points in the third quarter results as compared to the second quarter. We are aggressively passing through these additional costs through price increases where we can in our transactional businesses and through the terms of our supply agreements. While these increases and adjustments provide a pathway to mitigate our exposure to these additional costs, there is generally a lag effect before these higher costs can be reflected in increased prices. Looking now at each of our end markets and turning to slide seven in the presentation, Our aerospace and high-strength shipments in the first half of 2021 were up 31% from the second half of 2020, and we expect shipments will continue to increase in the second half of 2021 compared to the first half of the year. Although we are pleased to see the recovery in the aero and high-strength underway, the challenging operating environment impacted our ability to meet demand in the third quarter. Earlier in the year, we projected our aero and high-strength value-added revenue would be down approximately 5 to 8 percent year-over-year compared to the 2020 results. We now expect value-added revenue for aerospace will be down approximately 10 to 15 percent year-over-year, slightly worse than initially anticipated, or 35 to 40 percent down from our record year in 2019. This slight decline in our projected value-added revenue is attributed primarily to staffing challenges and supply chain issues I previously noted, which created inefficiencies at our facilities and resulted in increased lead times and some shipment delays. Turning to slide eight, with respect to our automotive markets, the expected recovery did not occur in the third quarter due to the continuing global impact of insufficient supply of semiconductor ships. Shipments and value-added revenue for the quarter declined by 17 percent and 15 percent, respectively, from the second quarter. The updated IHS industry forecast for North America vehicle builds has declined from 16.3 million vehicles to 13.0 vehicles for the year due specifically to the chip shortage. While auto value-added revenue is a smaller portion of our overall portfolio, our automotive facilities have been fully staffed for the better part of 2021 in anticipation of meeting previously forecasted strong customer demand. And while we have been able to pivot and divert a good deal of this capacity to meet the strong general engineering demand, the higher staffing levels negatively impacted our manufacturing costs and hampered the efficient operation of those facilities which support the automotive market. Our current outlook for full year 2021 has automotive value added revenue now up 15 to 20% year over year compared to our outlook in the first half of the year when we had anticipated year-over-year growth in our automotive applications of 35% to 45% increase. Although current OEM production has been significantly curtailed, the automotive programs we support remain in place and are moving to the right until our customers return to normal operations. Now turning to slide nine, on a more positive note, General engineering demand continues to be robust, and we are well positioned to continue to capture these opportunities in both long and flat-rolled products. We initially anticipated value-added revenue would be up 10 to 15 percent year-over-year compared to 2020. However, with continued strength in demand, we are now on pace for a greater than 25 percent increase of value-added revenue year-over-year, due to heavy restocking and reassuring of OEM supply chains and strength of our Kaiser Select products. Shipments and value-added revenue were down slightly from the second quarter, due partly to labor inefficiencies at the beginning of the quarter, and larger amount than normal of in-transit material at the end of the quarter, which we could not recognize from an accounting perspective. Demand for these products remain very strong through the entire quarter and is continuing into the fourth quarter. Turning now to slide 10, the addition of packaging to our portfolio with our acquisition of the Warwick rolling mill continues to demonstrate strong strategic growth opportunities beyond what we had anticipated at the time of the acquisition as demand for our packaging products continues to increase. We remain confident in our ability to deliver significant margin expansion and long-term profitability in this business. During the third quarter, however, our performance was negatively impacted by supply chain issues and labor inefficiencies, which resulted in lower planned volume output and higher material and operating costs, representing approximately $9 million of the total cost impact to EBITDA mentioned in my earlier comments. We faced a myriad of challenges in the quarter, including higher staffing and training, unplanned outages at one of our outside converters, two unplanned power outages at the site, and metal supply disruptions from one of our sources. We anticipate some of these supply chain issues will continue into the fourth quarter as we continue to execute countermeasures to mitigate the impact to the business. With continued strength in demand, our outlook for packaging value-added revenue for the full year 2021 currently remains in the $375 to $400 million range. We continue to make good progress integrating Warwick into the company and are on track to exit most of the transition service agreements by the end of 2021 with one or two potential IT-related transition service agreements running into the first quarter of next year. Turning now to slide 11, summarizing our outlook for the fourth quarter, 2021, we anticipate total consolidated value-added revenue will be up in the low single digits from the third quarter results, with adjusted EBITDA margins similar to the third quarter recognizing that continuing uncertainty remains around some material costs and ongoing supply chain disruptions, likely through the balance of the year. Magnesium in particular has recently emerged as a headwind for us in the fourth quarter, and we have included the expected impact of those headwinds in our fourth quarter outlook. However, the situation remains fluid. The recent force majeure declaration from one of the domestic magnesium suppliers due to an equipment failure and worsening industry supply issues with production from China together could further impact our fourth quarter results. We are working with our suppliers to better understand the situation, as well as discussing with our customers potential supply and cost implications associated with these interruptions for the balance of the quarter and potentially beyond the quarter. I'll now turn the call over to Neil to provide more color on our earnings for the quarter, and I'll be back to discuss our outlook for our markets and opportunities later in the presentation.