U.S. Markets closed

Edited Transcript of TMST earnings conference call or presentation 26-Oct-18 1:00pm GMT

Q3 2018 TimkenSteel Corp Earnings Call

Canton Oct 30, 2018 (Thomson StreetEvents) -- Edited Transcript of TimkenSteel Corp earnings conference call or presentation Friday, October 26, 2018 at 1:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Kristopher R. Westbrooks

TimkenSteel Corporation - CFO & Executive VP

* Mitchell Byrnes

TimkenSteel Corporation - Senior Manager of IR

* Ward J. Timken

TimkenSteel Corporation - Chairman, CEO & President

================================================================================

Conference Call Participants

================================================================================

* Justin Laurence Bergner

G. Research, LLC - VP

* Michael David Leshock

KeyBanc Capital Markets Inc., Research Division - Associate

* Stephanie L. Yee

JP Morgan Chase & Co, Research Division - Analyst

* Theodore Rudd O'Neill

Litchfield Hills Research, LLC - CEO & Research Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning. My name is Mariamma, and I will be your conference operator today. At this time, I would like to welcome everyone to the TimkenSteel Third Quarter 2018 Earnings Call. (Operator Instructions) I would now like to turn the call over to Mitch Byrnes, Senior Manager of Investor Relations. You may begin your conference.

--------------------------------------------------------------------------------

Mitchell Byrnes, TimkenSteel Corporation - Senior Manager of IR [2]

--------------------------------------------------------------------------------

Great. Thank you. Good morning, everyone, and thank you for joining us. I'm here today with Tim Timken, Chairman, CEO and President; as well as Kris Westbrooks, Executive Vice President and Chief Financial Officer to discuss our third quarter 2018 financial results.

During today's conference call, we may make forward-looking statements as defined by the SEC. These statements relate to our expectations regarding future financial results, plans and business operations among other matters. Our actual results may differ materially from those projected or implied due to a variety of factors, which we described in greater detail in today's press release, supporting information provided in connection with today's call and in our reports filed with the SEC, all of which are available on the www.timkensteel.com website. Where non-GAAP financial information is referenced, we have included reconciliations between such non-GAAP financial information and its GAAP equivalent in the press release and/or supporting information as appropriate.

Today's call is copyrighted by TimkenSteel Corporation, and we prohibit any use, recording or transmission of any portion of the call without our expressed advanced written consent.

With that, now I would like to turn the call over to Tim.

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [3]

--------------------------------------------------------------------------------

Good morning. Thanks, Mitch, and thank you all for joining us. I want to formally welcome our new CFO, Kris Westbrooks. Kris brings a deep financial and accounting experience to the company and a track record of contributing to growing companies. In the one month since he has come on board, he has already made a strong addition to our executive team.

As I look at the big picture of our performance, I see 3 things. First, we outperformed our adjusted EBITDA guidance in the third quarter, which is indicative of the improvements we're driving in product mix and on-time delivery. Second, as we look ahead, it appears the fourth quarter is not going to be as strong as we originally anticipated. We'll see some carryover costs related to a couple of onetime manufacturing issues from the third quarter. Also, our forecast has an assumption around the fourth quarter customer buying that was stronger than usual, but now we are seeing normal seasonality. We believe that the upcoming quarter will be a short-term pause in our favorable trajectory. And third, given the strength of our markets and improving trade environment and a solid strategy, we're looking forward to a strong 2019.

So let's take a look at each one of these 3 time periods. First, the third quarter. We had record safety performance. Employees are working together across the company to challenge the status quo, identify safety risks and remove them. As a result, our safety performance is top quartile in our industry and is on the way to becoming the best in the industry, because as I have often said, the goal is that every one of our employees and contractors goes home safely at the end of each day.

When it comes to our financial results in the third quarter, net income was at the high end of our guidance range and adjusted EBITDA exceeded expectations. We sold a richer mix of products and in fact set a record at our new advanced quench-and-temper facility. Shipments in the third quarter were higher than the same period last year, and we improved delivery performance.

Pricing improved in the third quarter, driven by a more positive trade environment and 7 increases in stock pricings for bars and tubes this year, which affect approximately 30% of our order book. I want to thank our employees for these efforts, their work on price, mix and on-time delivery is enhancing our position as a leader in the special bar quality and seamless mechanical tubing markets and is growing the company.

These actions will continue to be an important focus of the organization and will help drive an even better 2019 and beyond.

Now as I said, the fourth quarter is a little more complicated because we're looking at a convergence of a couple of factors that will affect our performance. In the fourth quarter, we'll be paying for a couple of unusual manufacturing issues that occurred in the third quarter. We unexpectedly had to replace a failed transformer at our Faircrest Steel Plant, and are now in the process of repairing it. We also had a small fire at our Harrison Plant. During the third quarter, we were able to make up most of the days we unexpectedly lost. The costs related to these events will carry over into the fourth quarter.

The second issue is our shipment forecast through the end of the year. Although we anticipated consistent demand in the fourth quarter, we now believe that we'll see normal seasonality. We foresee customers managing their inventories as year-end approaches. In particular, we expect a handful of distributors to be adjusting inventory by pulling back on orders in the quarter. So on the surface, our fourth quarter guidance may not be as high as originally anticipated, but this is a one quarter issue, and we intend to be back on our positive trajectory going forward.

Looking ahead, we anticipate strong performance in 2019, with continued improvements in price, mix and volume of products we sell. In fact, we are preparing for an uptick in the business after the first of the year by running hard in our operations through the end of this year. We are also in the midst of pricing discussions with most of our customers, and those talks are going well.

About 70% of our customers have pricing agreements and the majority of those are in discussion now to be completed by the end of the year. As a result, we'll begin 2019 with improved pricing.

On the cost side, we'll be controlling spending and identifying new continuous improvement opportunities to offset inflation with a little help from continued favorability in the cost of scrap and alloys. With the strength of our markets and a positive trade environment, combined with improved pricing, product mix and delivery performance, we're positioned to capture additional business in 2019.

The mining outlook is amongst the strongest in the industrial sector. General industrial growth is expected to be greater than 5% next year. The automotive market remains strong, and we anticipate automotive makers maintain a production level to align inventory with demand. Energy also is looking positive, particularly in the drilled but uncompleted wells, which have rebounded all-time highs and are expected to remain strong through 2019. And finally, distribution remains solid.

So markets are looking good, and we remain focused on our strategy to improve performance of the base business and grow the company. Now Kris is going to take you through more details on the numbers, and then we'll take your questions. Kris?

--------------------------------------------------------------------------------

Kristopher R. Westbrooks, TimkenSteel Corporation - CFO & Executive VP [4]

--------------------------------------------------------------------------------

Thanks, Tim. Good morning, everyone. Since joining the company in late September, I have had an opportunity to speak with many of our employees and visit our facilities. I'm extremely excited about the future. I look forward to meeting with more of our shareholders, business partners and analysts soon. Now turning to our financial results.

Our third quarter of 2018 net income was $1.4 million or $0.03 per diluted share, and came in at the top end of our guidance range. This compares to a loss of $5.9 million or a negative $0.13 per diluted share in the third quarter of last year. Adjusted EBITDA was $26.5 million in the third quarter of 2018, above both the guidance range of $15 million to $25 million and the prior year quarter of $18.8 million.

As Tim said, our markets remain stable, product mix has improved, and we've been successful in securing pricing improvements that are expected to fully benefit our 2019 financial results.

Our shipments totaled 295,500 tons in the quarter and were 2% higher than the same period last year. This year-over-year improvement was driven by stronger demand within our industrial, energy and mobile end markets. Shipments to the energy market increased 51% compared to the same quarter a year ago, as the oil and gas industry has recovered well. We expect fourth quarter energy shipments to be around the same as the third quarter of 2018. Industrial shipments were 13% higher than the same quarter last year. Strong demand for bearing and power transmission applications continues, and we benefited from an increased demand in the overall industrial market.

Going into the fourth quarter, general economic sentiment remains positive in most industrial market sectors, but we anticipate normal seasonality will impact the quarter as customers balance inventories in advance of year-end. Mobile shipments were 3% higher than the third quarter of 2017, and market mix continued to improve. The 2018 projected North America light vehicle production of 17.1 million units, remains strong. For the fourth quarter of 2018, we expect mobile shipments to be similar to the third quarter with normal seasonality.

Net sales for the third quarter were $410 million, with base sales of $303 million and surcharges of $107 million. Base sales per ton were 14% higher than the third quarter of last year, reflective of improved product mix and higher prices. Gross profit for the third quarter was $25 million, which included $13 million of expenses from the scheduled annual plant maintenance. Melt utilization was 62% during the third quarter of 2018, which fell below our 68% melt utilization rate during our previous shutdown period, held in the fourth quarter of last year. This decrease in utilization was primarily related to downtime due to the 2 manufacturing issues that Tim mentioned.

SG&A expenses for the quarter remained well controlled at $24 million or 6% of net sales. For the third quarter of 2018, operating cash flow was a source of $2 million and capital expenditures were $9 million. We expect our full year capital spending to be approximately $40 million.

Our available liquidity continues to be sufficient with $179 million as of September 30, 2018. Additionally, during the third quarter, we repaid $5 million on our revolving credit facility. Looking ahead to the fourth quarter of 2018, we expect to see modest price improvement from actions already initiated with the full benefit being realized in 2019. Fourth quarter shipments are expected to be similar to the same quarter last year with normal seasonality as customers balance inventories.

Higher manufacturing costs and lower melt utilization in the third quarter will have an unfavorable impact on fourth quarter cost of sales by roughly $10 million, as the inventory is sold. In addition, consumables inflation continued to be a headwind. As a result, we expect the fourth quarter adjusted EBITDA range to be between $15 million and $25 million. As the year comes to an end, we plan to maximize our production output to position the company for a strong 2019, while controlling our cost. Mariamma, we'd now like to open up the call for questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And your first question comes from the line of Theodore O'Neill with Litchfield Hills.

--------------------------------------------------------------------------------

Theodore Rudd O'Neill, Litchfield Hills Research, LLC - CEO & Research Analyst [2]

--------------------------------------------------------------------------------

Just a quick question on the fourth quarter. So to find the seasonality that you're talking about, I've got to go back to 2015 to see a down quarter December versus September, which I understand is what you're saying. But what I want to know is, do I get the seasonality -- the traditional seasonality back in the first quarter?

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [3]

--------------------------------------------------------------------------------

Yes. Usually, what we see going into the tail end of the year is our distributors, a number of OEs adjusting inventory levels going into the tail end. And generally we see that pop back in early in the first quarter. And based on what we're seeing in the order book, that would seem to be the case for this year as well.

--------------------------------------------------------------------------------

Operator [4]

--------------------------------------------------------------------------------

Your next question comes from Stephanie Yee with JPMorgan.

--------------------------------------------------------------------------------

Stephanie L. Yee, JP Morgan Chase & Co, Research Division - Analyst [5]

--------------------------------------------------------------------------------

You have talked about improving your delivery reliability, and I was wondering what additional steps you're looking to take? What other initiatives you have in place to further improve on-time delivery that you are targeting?

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [6]

--------------------------------------------------------------------------------

Well, we've actually showed really good progress through this year despite some -- the 2 manufacturing issues we talked about earlier. We don't generally give the numbers on on-time delivery performance, but we've seen a consistent improvement throughout the year, and we're confident that as we run our manufacturing playbook that they will continue to get better. Our customers are seeing it directly, and we're hearing very positive feedback from them. At the end of the day, we just have to run our manufacturing assets extraordinarily well. We've got to make sure that we have the appropriate inventory on the ground to service our customers. And we're in the process of continuing to drive that.

--------------------------------------------------------------------------------

Stephanie L. Yee, JP Morgan Chase & Co, Research Division - Analyst [7]

--------------------------------------------------------------------------------

Okay, got it. And you had mentioned some cost inflation from consumables. Do you anticipate that to continue into 2019? Or will you have absorbed most of those cost pressures, especially on the electrodes front?

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [8]

--------------------------------------------------------------------------------

Yes. I see no -- it's been kind of hard to read the electrode market this year. I think the general sense is that we've begun to see that level of inflation taper off. And that anything that we see through the end of this year, into next year will be at a more -- at a lower level than what we saw in 2018. I would say the same probably goes for refractory as well.

--------------------------------------------------------------------------------

Operator [9]

--------------------------------------------------------------------------------

Your next question comes from Justin Bergner from Gabelli & Company.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [10]

--------------------------------------------------------------------------------

My first question just relates to the manufacturing issues that affected utilization in the third quarter. So were there any sort of meaningful costs associated with the -- those issues as they float into the third quarter? Or are most of them effectively those issues getting sort of capitalized in inventory and expensed in the fourth quarter?

--------------------------------------------------------------------------------

Kristopher R. Westbrooks, TimkenSteel Corporation - CFO & Executive VP [11]

--------------------------------------------------------------------------------

Thanks, Justin. There were some costs not overly significant in the third quarter, but the bigger cost is the piece that's going to impact us in Q4, just as you described as that inventory is sold.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [12]

--------------------------------------------------------------------------------

Okay. And were there other aspects of the third quarter EBITDA, whether it was sort of raw material spread or LIFO that came out materially different than you expected? Or was the strength all sort of price and mix and the manufacturing issues, obviously, not flowing into the third quarter, but into the fourth quarter?

--------------------------------------------------------------------------------

Kristopher R. Westbrooks, TimkenSteel Corporation - CFO & Executive VP [13]

--------------------------------------------------------------------------------

It was primarily mix that we talked about the energy, volumes there driving a lot of that and price. LIFO was pretty flat with the second quarter, so not a big driver of the results there in Q3 versus our expectations.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [14]

--------------------------------------------------------------------------------

Okay. And given that the shipments came up light of where you were targeting, I mean, was the mix and to a lesser extent the pricing that strong that it sort of offset the shortfall in the shipments?

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [15]

--------------------------------------------------------------------------------

It certainly helped, Justin.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [16]

--------------------------------------------------------------------------------

Okay. And then, I guess, lastly, I haven't had a chance to fully review the end market slide, but are there any end markets that have materially changed, looking forward now at the end of the third quarter versus where you stood at the second quarter?

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [17]

--------------------------------------------------------------------------------

No, we don't think so. Pretty much across the board, we're seeing pretty good activity. But the one yellow dot -- well, I guess, we had 2 yellow dots. Rail is kind of flattish, but doing reasonably well. And then obviously, we're seeing the distributors taking a breather in the fourth, but we assume they're coming back in the first. And as I indicated earlier, the order book would validate that. So no significant changes at this point. In fact, if anything, with the oil prices kind of percolating a little bit and jumping around, we're beginning to see a little bit of better activity there. So we remain positive about the start of the year. I think we just got to work through some inventory issues here at the end of the fourth.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [18]

--------------------------------------------------------------------------------

Okay. And then just lastly, there was a big jump up in the base sales per ton in the mobile segment sequentially. Was that just a reflection of sort of the unusual dip in the second quarter that was maybe mix driven and you sort of bounced back to a more normal level? Or any color there?

--------------------------------------------------------------------------------

Kristopher R. Westbrooks, TimkenSteel Corporation - CFO & Executive VP [19]

--------------------------------------------------------------------------------

So we're seeing the benefit of our price per ton coming through there.

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [20]

--------------------------------------------------------------------------------

Yes. And as you remember that we did roll off a platform in the second that hit that, and we've begun to recover from that a little bit. So a little bit of mix in there as well. So in general, that business is still performing well and kind of the way it's been running all year.

--------------------------------------------------------------------------------

Justin Laurence Bergner, G. Research, LLC - VP [21]

--------------------------------------------------------------------------------

Okay. But that's mainly priced annually. So mix would be a better driver of sequential than any pricing changes?

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [22]

--------------------------------------------------------------------------------

Yes.

--------------------------------------------------------------------------------

Operator [23]

--------------------------------------------------------------------------------

(Operator Instructions) Your next question comes from Phil Gibbs with KeyBanc.

--------------------------------------------------------------------------------

Michael David Leshock, KeyBanc Capital Markets Inc., Research Division - Associate [24]

--------------------------------------------------------------------------------

It's Michael in for Phil. So just first question here. There was an EBIT bridge in last quarter's presentation, Slide 4, I believe. And it was helpful to see the sequential bridge there given the volatility in the business. So I'm just wondering why the bridge was -- from 2Q to 3Q wasn't included in this quarter's presentation? And if you could, maybe walk through that bridge a bit, if possible?

--------------------------------------------------------------------------------

Kristopher R. Westbrooks, TimkenSteel Corporation - CFO & Executive VP [25]

--------------------------------------------------------------------------------

Yes. So the focus that we wanted to keep is just on our continued improvement year-over-year there. The data is out there to recreate that bridge. It's all public information. But we just didn't feel the need to walk everyone through that quarter-over-quarter. But we are seeing significant year-over-year improvement. There were some moves sequentially that we talked about before, primarily in the manufacturing cost area. Mix continues to improve sequentially from last quarter to this quarter. So those are a couple of the drivers. We saw lower LIFO expense a little bit, but not a big driver there either. So it's really just mix and manufacturing cost were the 2 biggest pieces there versus Q2.

--------------------------------------------------------------------------------

Michael David Leshock, KeyBanc Capital Markets Inc., Research Division - Associate [26]

--------------------------------------------------------------------------------

Okay. And then could you touch a bit on why energy shipments were light in the third quarter versus guidance?

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [27]

--------------------------------------------------------------------------------

Well, some of that was due to the manufacturing issues that we had showing up. Again, we assume that those markets continue to improve. That's a big part of the mix shift that we've been talking about, and we feel good about kind of where we look rolling into '19 on it.

--------------------------------------------------------------------------------

Michael David Leshock, KeyBanc Capital Markets Inc., Research Division - Associate [28]

--------------------------------------------------------------------------------

Got it. And then just lastly, what impact -- are you seeing a material impact at all from vanadium prices. They've just -- considering they've gone up quite a bit from $0.04 to $0.32 a pound in the past 2 years or so and a bit more sharply recently. Any impact you're seeing there?

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [29]

--------------------------------------------------------------------------------

Well, vanadium would be one of our surcharged alloys. So not a significant impact -- negative impact of the increase. And to the extent we can buy better than market, we actually get a little bit of a benefit. But it has obviously been very -- the most aggressive movement of all the alloys that we consume.

--------------------------------------------------------------------------------

Kristopher R. Westbrooks, TimkenSteel Corporation - CFO & Executive VP [30]

--------------------------------------------------------------------------------

Mariamma, do we have any additional questions?

--------------------------------------------------------------------------------

Operator [31]

--------------------------------------------------------------------------------

There are no further questions at this time.

--------------------------------------------------------------------------------

Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [32]

--------------------------------------------------------------------------------

Well, thank you very much for your questions today and for joining us. Before we wrap up, I want to thank our employees, again. Our team is made up of some of the deepest technical and operational experts in the industry, working in a culture that recently was recognized as one of the best places to work in our region, which is something we're, obviously, very proud of. This is a team who is focused squarely on growing the company and improving performance for our shareholders. The way we outperformed our guidance in the third quarter is indicative of the improvements we're driving in product mix and on-time delivery. We'll be working hard to optimize performance in the fourth quarter, and we'll position ourselves well to realize even better price, product mix and volume in 2019. I want to thank you for your interest in the company. If you have any additional questions, please do not hesitate to contact Mitch Byrnes. Thank you very much for joining us on the call today. And have a good day.

--------------------------------------------------------------------------------

Operator [33]

--------------------------------------------------------------------------------

This concludes today's conference call. You may now disconnect.