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Edited Transcript of TMST earnings conference call or presentation 27-Jul-18 1:00pm GMT

Q2 2018 TimkenSteel Corp Earnings Call

Canton Jul 30, 2018 (Thomson StreetEvents) -- Edited Transcript of TimkenSteel Corp earnings conference call or presentation Friday, July 27, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. A. Holding

TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP

* Mitchell Byrnes

* Ward J. Timken

TimkenSteel Corporation - Chairman, CEO & President

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Conference Call Participants

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* Justin Laurence Bergner

G. Research, LLC - VP

* Philip Ross Gibbs

KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst

* Seth R. Rosenfeld

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Good morning. My name is Kim, and I will be your conference operator today. At this time, I would like to welcome everyone to the TimkenSteel Second Quarter 2018 Earnings Conference Call. (Operator Instructions) Thank you. Mitchell Byrnes, Senior Manager of Steel Finance, you may begin your conference.

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Mitchell Byrnes, [2]

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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 Chris Holding, Executive Vice President and Chief Financial Officer to discuss our second 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 describe 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'd like to turn over the call to Tim.

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

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Good morning. Thanks, Mitch, and thank you all for joining us. We're off to a good start this year. Let me begin by congratulating our employees for our safety performance. The first half of 2018 was the safest in our history, topping a record we set in 2013. This is notable because our production levels were very high and nearly 500 new employees have joined us since the beginning of last year. I want to thank all of our team members for keeping a steady focus on safety.

The year is unfolding just as we anticipated with strong demand and improvements in sales and net income. EBITDA was up 45% quarter-over-quarter and the second quarter marked our highest ship ton months since early 2012. As our asset utilization has climbed, we've remained focused on producing a better mix of product. Through our variable pay plans, we've encouraged employees across the company to sell, make and deliver our most differentiated and profitable products, including large bar, seamless mechanical tubing, heat treated products and components. As a result, we're delivering a richer mix of products that makes the most of our unique asset base.

We make higher value products like no one else in the industry, with the quality, consistency and reliability that helps our customers' product platforms perform better. In the quarter, American Metal Market recognized that leadership. Our endurance steels were named best product innovation of the year. The metallurgist among us understand how difficult it is to achieve both strength and toughness in steel. We've achieved that in our line of endurance steels.

While leading -- while our leading edge innovation like this takes time to impact sales in a big way, collectively, our technology leadership provides the differentiation that keeps us competitive. One area of focus this quarter was improving customer service. We've had a steep increase in demand for our products over last year, and with that has come some delivery challenges. Our team has focused on creative scheduling, staffing and working with partners to provide the delivery performance that our customers require. We're making progress and have made a commitment to customers to continue to improve reliability of our delivery. This is critical because we continue to see strong demand in the marketplace. The North American light vehicle market, particularly in the large vehicles we serve, remains strong and stable with normal seasonality.

We're seeing growth in mining, general industrial and oil and gas. Even agriculture is starting to rebound after multiple years of low demand. And our distribution channels appear to be balanced and we're seeing improvements in the energy markets.

Pricing is also returning to levels that we enjoyed before subsidized imports gutted U.S. steel prices in the past. In the current market dynamics, where demand is high, prices naturally rise to healthier levels. The U.S. government has put the world on notice that it will defend our steel industry in the interest of national security and that unfair trade won't be tolerated. That too is helping to restore fair pricing. As I've said many times, we can compete with anybody in the world with our product performance, quality and cost structure when the playing field is level. We're demonstrating that now.

As I look at the rest of the year, we are set to perform well despite some headwinds from continued inflation in the manufacturing supply chain and planned maintenance in the third quarter. I'm -- I feel very confident about how we position the business for success going forward.

Our strategy of creating customized and innovative solutions, delivering quality products, providing integrated supply chain services and operating with integrity has put us on a path for a better 2018 and beyond. We have the team in place to do it and the vision to make it real.

Chris is going to offer a little bit more detail on the numbers and then we're going to take your questions. Chris?

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Christopher J. A. Holding, TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP [4]

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Thank you, Tim. Good morning. The second quarter results were in line with our guidance, apart from the impact of LIFO expense. EBITDA for the quarter was at the midpoint of our guidance range when adjusted for the $5 million of higher LIFO. Our markets remained robust and operational improvements made within the year have increased shipments and revenues. Total shipments of 310,000 tons in the quarter were 5% higher than in the same period last year and 3% higher than the first quarter of 2018. The year-over-year improvement was driven by a broad-based strengthening end market demand and operating improvements.

Mobile shipments were similar to the first quarter of 2018 and 3% higher than the second quarter 2017. The 2018 projected SAAR rate of 17.2 million units remained strong and is a slight increase over the 2017 production level. For the third quarter 2018, we expect mobile shipments to be slightly lower than the second quarter due to some platform-specific changes.

Industrial shipments were 8% higher than the first quarter 2018 and 20% higher than in the second quarter of last year, helped by the strength and demand for bearing and power transmission applications. In the third quarter, we expect a sequential increase in industrial shipments of about 8% as the general economic sentiment remains positive in most of the industrial market sectors and inventory levels remain balanced.

Shipments to the energy end-market increased about 41% sequentially and 57% compared to the same quarter a year ago, albeit off a low base. The U.S. rig count has risen to around 1,050 active rigs and we remain encouraged by more balanced customer inventory positions. We expect third quarter energy shipments to be about 13% higher than in the second quarter.

Net sales for the quarter were $414 million, with base sales of $310 million and surcharges of $104 million. Base sales were $31 a ton or 3% higher than the first quarter 2018 due to improved pricing and mix.

Looking ahead to the third quarter, we expect to see a price mix improvement from the continuing shift to higher alloy content products and pricing actions. As a result, we anticipate an increase in our base sales per ton of about 4% in the third quarter.

Gross profit for the second quarter was $32 million or 7.8% of net sales, which was a 230 basis point improvement in margins sequentially. Melt utilization was 78%, slightly higher than the 77% first quarter rate. The benefit from improved production efficiencies is partially offset by inflationary impacts and LIFO expense.

The LIFO expense is $5 million higher than anticipated in our guidance for the second quarter, primarily due to higher estimated year-end scrap prices and some inflation on other input costs. The largest inflationary impact in the quarter related to electrodes, which were almost $5 million higher than in the second quarter of 2017.

SG&A for the quarter was about $25 million or 6% of net sales, which was an improvement over the same quarter last year and sequentially from the first quarter.

EBITDA for the second quarter was about $31 million, a 25% increase from the same period a year ago, and a $10 million or 45% improvement from the first quarter. The improvement in earnings was primarily due to better price mix and operating improvements, offset by lower material spread and higher LIFO costs.

In the second quarter, we reported net income of $8 million. Income taxes in the quarter were about $200,000 and related to foreign sourced income. For the remainder of 2018, our tax expense will be related primarily to taxes paid outside of the U.S.

Operating cash flow for the quarter was a use of $11 million as we build about $30 million of working capital to support our customer service and increased sales.

Free cash flow for the quarter was an $18 million use of funds, including capital expenditures of $7 million. We project our full year capital spending to be $43 million, which is a $3 million increase from prior guidance.

At quarter end, our liquidity remained in good shape at $186 million, which was about a $16 million decrease from the prior quarter and our net debt-to-capital ratio continues to be low at 23%.

Turning to the outlook for the third quarter. Shipments are expected to be similar to the second quarter. We plan to take all our planned maintenance outages in the third quarter, which will add about $14 million of cost compared to the second quarter. Additionally, our raw material spreads are expected to be slightly lower than in the second quarter. As a result, we expect the EBITDA range to be between $15 million and $25 million, and structurally better compared to the second quarter. 2018, as Tim said, is lining up to be significantly better than last year and we're positioned to accelerate improvements into 2019.

This ends our prepared statements. And we will now take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Seth Rosenfeld from Jefferies.

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Seth R. Rosenfeld, Jefferies LLC, Research Division - Equity Analyst [2]

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Can you please help us better understand the increase in maintenance costs that you're forecasting for the third quarter? Can help us understand [what that's] attributed and how we should expect that the flows through, I guess, going into the fourth quarter as well, is this one-off or a higher run rate we should forecast thereafter? And then to better understand, I guess, assuming this is perhaps improving some of your efficiencies at the mill, what scale of uplift could you see in terms of the returns or margins going into 2019 on the back of this larger step up in CapEx?

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Christopher J. A. Holding, TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP [3]

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Yes, Seth, I'll take a short at the maintenance and we can take a little bit about what we see going into 2019 later on. We have maintenance outages, where we shut down the plants and do large overhauls of all of our equipment. And this year, all of the planned maintenance outages will occur in Q3. So it is a onetime step up from Q2 and then we will return in Q4 to Q2 type of maintenance levels. Related to probably high level to the rest of this year, obviously our markets remained strong. We're working to improve our customer service and our -- clearly, our planned efficiencies are improving lockstep. If you -- in my script, you've heard that we anticipate, again, better price mix going into Q3. And as we get into 2019, we'd expect a little bit more of the same. Tim, you have any color?

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Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [4]

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No, I think, you covered it.

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Operator [5]

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Your next question is from the line of Phil Gibbs from KeyBanc Capital Markets.

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Philip Ross Gibbs, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [6]

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So kind of best way to read the bridge here in terms of the third quarter. So the third quarter midpoint, you've got $20 million of EBITDA, you've got $14 million of outage costs, which you're largely taking for the year. In that quarter, you've got your better pricing and mix and you've got better mix going into the fourth quarter. And there will be some seasonality, but I do -- I should think about that $20 million -- excuse me, that $20 million becoming, all else equal absent any change in shipments, something like a $35 million number in the fourth quarter just as we kind of normalize for the maintenance expense. Is that a good way to think about it?

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Christopher J. A. Holding, TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP [7]

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Yes, I mean, at a high level, clearly, you can take Q2 and normalize for the maintenance costs. And you're right, that takes you from a $20 million to kind of a $35 million to the fourth quarter. But we'll get to the fourth quarter obviously in about 3 months, but that maintenance clearly is onetime and won't appear in the fourth quarter.

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Philip Ross Gibbs, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [8]

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Got it. And any reason specifically why you're taking it all in the third quarter versus splitting it?

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Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [9]

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We've traditionally -- yes, we've traditionally used the third quarter as our big maintenance outage spread through July and August. So this is kind of a return to normal. Last year, it was a bit of an anomaly because we pushed everything -- we back-end loaded everything into the fourth quarter. So this is a more normal pattern for us.

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Philip Ross Gibbs, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [10]

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Got you. And any color on the billet shipments in Q3?

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Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [11]

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As we said in the beginning of the year, we've been working that down as our mix has improved. We're still in that business, but it's kind of about where we want it to be.

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Philip Ross Gibbs, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [12]

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And that's contemplated in your expectation that shipments will be flattish or so for the quarter?

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Christopher J. A. Holding, TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP [13]

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Yes, that's right.

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Philip Ross Gibbs, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [14]

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And then just last question, Tim, I know the automotive business is typically pretty stable in terms of 3-year pricing and we saw base prices dip a good bit in Q2 versus Q1. Any thoughts behind that, was that mix related? And should we expect that to sort of bounce back to the average that we saw in the first half of the year versus the second quarter of the year?

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

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Well, the step down was definitely mix related. Where we go from here? I mean, obviously, we're beginning to look at '19 already from a pricing point of view and have -- beginning to have those discussions with customers. And so we'll get into that as we get a little bit later into the year.

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Operator [16]

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(Operator Instructions) Your next question comes from Justin Bergner from Gabelli & Company.

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Justin Laurence Bergner, G. Research, LLC - VP [17]

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I guess, first off, in terms of the guidance, you indicated that third quarter was structurally higher EBITDA. So I guess, are you suggesting then that if that $35 million of sort of EBITDA without the maintenance expense were to be further nudged up for any additional sort of raw material spread, it would be above that $36 million that you would have done in the second quarter ex-LIFO?

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Christopher J. A. Holding, TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP [18]

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Justin, I'll be honest with you. You lost me on the numbers, but I'll probably restate it a little bit different way. So if you look at the second quarter EBITDA of $31 million and we've guided to $15 million to $25 million, I mean, just the difference in spread and maintenance. You can see we should have structural improvements based on the $20 million range because you've got kind of $31 million in Q2 minus maintenance and spread at $18 million, which takes like $13 million and the midpoint to $20 million.

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Justin Laurence Bergner, G. Research, LLC - VP [19]

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Got it. So even if I was the add back the LIFO expense in the second quarter of $5 million, if I add back the maintenance and sort of raw material spread to the third quarter, it'd still be slightly above the second quarter number?

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Christopher J. A. Holding, TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP [20]

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Yes, Justin, let me talk to LIFO. LIFO is kind of funny, right. What the calculation is, and I'm sure, as you know, try to project what your year-end LIFO is, which is just a projection and then you try to equalize it throughout the quarter. But as the year-end changes, then you have to catch up in the quarter. So in Q2, we had a little bit of catch up, and that's what created the higher LIFO. So we would anticipate, at this point, if you do the math, that LIFO would be, call it, $2 million lower in Q3 and Q4 than in Q2.

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

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So it would be a sequential tailwind then because...

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Christopher J. A. Holding, TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP [22]

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Yes. So $2 million better than Q2, yes. And so that kind of puts you at like a $15 million structural Q2 and we provided a range of $15 million to $25 million. So that's kind of where the structural improvement math lies.

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Justin Laurence Bergner, G. Research, LLC - VP [23]

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Okay. I think I got that. I guess, this brings me to sort of a bigger picture question. So I mean, when I compare 3Q to 2Q, it's slightly better when you make adjustments for some of these timing and maintenance issues. So it seems then that the general framework is that most of the improvement in mix and pricing is being offset by cost inflation to keep EBITDA flat to slightly up on sort of a non-timing affected basis?

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Christopher J. A. Holding, TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP [24]

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Yes, I'll take that one, Justin. Clearly, our margins are improving sequentially. Obviously, Q3 is going to be a little bit different because of maintenance. But outside of the maintenance, our margins would look to increase structurally in Q3 also. And yes, while we have put price into the market, there's no question that inflation is pretty significant. And you're well aware because you follow the space, the electrodes and refractories are very significant throughout the industry.

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Justin Laurence Bergner, G. Research, LLC - VP [25]

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But you bought the -- you're buying some of the electrodes and refractories on spot or was that contracted and sort of known earlier in the year?

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Christopher J. A. Holding, TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP [26]

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Well, I think, what we would have talked to you last time is that we had -- have contracts for the whole year, and so we have guaranteed supply. We had known pricing for the first half, and now the second half pricing is coming and it's higher.

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

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Yes. None of these electrode guys are making contracts out past 6 months. I mean, they're playing it really tough.

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Justin Laurence Bergner, G. Research, LLC - VP [28]

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Okay. Got it. And then lastly, the industrial tonnage only being up 8%, I guess, quarter-on-quarter in the second quarter versus, I think, a guide of around 15%. What sort of constrained you there in, I guess, coming up a bit short for your overall volume target, I mean, mainly on the industrial side?

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Christopher J. A. Holding, TimkenSteel Corporation - CFO, Principal Accounting Officer & Executive VP [29]

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Yes, as much as anything else, it's just the mix of the product we ship. And we take our best shot in terms of guidance from a market sector mix perspective. But by and large, we were a little bit off on the industrial side. It's nothing from a market perspective.

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Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [30]

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Yes, nothing structural. We had some -- a couple of customers not take shipments and we had a little bit of transportation issues, but nothing structural from a market point of view.

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Justin Laurence Bergner, G. Research, LLC - VP [31]

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Okay. And are you expecting sort of any pickups there in the third quarter or is that just mainly in the second quarter?

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

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I think we're -- the industry in general is going to be fighting this transport issue going forward. The shortage of drivers and available trucking is definitely a challenge for all of us. But we fortunately have long-term relationships with our transport partners and we're kind of working our way through that.

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Operator [33]

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Your next question comes from Seth Rosenfeld from Jefferies.

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Seth R. Rosenfeld, Jefferies LLC, Research Division - Equity Analyst [34]

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Just wanted to understand a little better how you're seeing the competitive dynamics in the SBQ market. When we talk to some of your competitors, who are maybe a bit larger than you, they're pretty consistently talking about share gains in the SBQ market and also some meaningful capacity growth in that product category as well over the coming years. Can you talk a little bit about how you're seeing that impact your own market share and also broader pricing dynamics in SBQ?

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Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [35]

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Yes, let me reverse the order and talk a little bit about the capacity side then I'll come back to the share question. I think we've seen a lot of the announcements made already and most of that capacity is in the market at this point, we believe, with the exception of potentiality Republic bringing back their Lorain facility. And the investments made by the other guys, I believe, are up and running and in the marketplace. I think what you're seeing right now is a lot of share shifting going on with the impact of the 232, really beginning to have some teeth starting in April. We've seen bar imports down by 25% to 27% and May to June, we've seen it down another 32%. So there's a lot of movement going on amongst the players with that slowdown on the import side. There is no doubt though that, that we have to continue to focus on our competitiveness. We are definitely the preferred supplier, but there -- some of these other guys are again pretty good of making SBQ. So it's up to us to make sure that we can get our product to market competitively and continue to create value for our customers.

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Operator [36]

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Your next question comes from Phil Gibbs from KeyBanc Capital Markets.

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Philip Ross Gibbs, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [37]

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Tim, can you just kind of give us a feel for the energy markets right now, hearing lead times for a lot of those products, particularly heat treat are out quite a bit several months? And how -- and just based on existing market conditions, how much lag should we think that the energy sort of sequential momentum should have as we move into '19? And any kind of market pulse commentary you can make will be helpful.

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Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [38]

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Yes, I mean, obviously, the supply chain is struggling to keep up with the production side, with drilling side. All of the sentiment we're hearing out of the oil and gas markets are positive. If you look at our shipments, we're up 40% sequentially. Rig count is up another 10% year-over-year. They're at what 1,050 in that neighborhood. The DUC inventory is okay. So all of those market dynamics seem to line up pretty well. It's helped us actually ramp that -- the AQTF. We're seeing good shipments. In the second quarter, we shipped about 9,500 tons. We see that tonnage continuing through the year. So that, that's all positive. So on the whole, I would say, the market dynamics are healthy. The supply chains are definitely stressed but are doing their best to kind of keep up with the drilling side.

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Operator [39]

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

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Justin Laurence Bergner, G. Research, LLC - VP [40]

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You mentioned earlier that auto would be down, I guess, slightly sequentially in the third quarter on a line model shift, I believe. Is that just sort of a temporary 1 quarter disruption or does that represent sort of a small step down in your automotive volumes? And then, I guess, secondly, any sort of comments on additional sort of new product introductions that you're working on, on the automotive or other fronts?

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Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [41]

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Yes, as Chris said, we had one platform roll off that, that will impact the third quarter and going forward. Obviously, we're always looking at renewal of that portfolio, specifically on our value-added side. And so we have a number of different platforms in the works at any given time. So over the long run, we're still very committed to that market. We see it as a great growth opportunity for us. And so we're comfortable where we are right now despite the loss of the one platform. Market dynamics are good. SAAR rate is holding up, production rate is holding up despite some of the grumbling you heard on their calls the other day. When you look at the schedules, they're actually pretty good. And in our case, they're skewing to the heavy side now, away from the light vehicle -- from a light -- the passenger car to the light trucks and that, that's good for us. So all in all, that side of the -- that segment of our business is lining up really well.

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Justin Laurence Bergner, G. Research, LLC - VP [42]

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Okay. Got it. So the platform rolling off, that was sort of known couple of quarters ago expected?

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Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [43]

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Yes, yes.

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Operator [44]

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There are no further questions at this time.

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Ward J. Timken, TimkenSteel Corporation - Chairman, CEO & President [45]

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Well, thank you very much for the questions today. If you have any remaining questions, please get in touch with Chris. Before we wrap up, I want to thank our employees for their extraordinary efforts in the quarter to improve both safety and our financial performance. We'll continue those efforts into the second half and focus on improving our delivery performance. Thank you very much for joining us today, and have a good day.

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Operator [46]

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