Metallus Inc. (MTUS) Q4 2015 Earnings Report, Transcript and Summary

Good morning. My name is Shaun and I will be your conference operator today. At this time, I would like to welcome everyone to the TimkenSteel Fourth Quarter 2015 Earnings Conference Call. [Operator Instructions] Tina Beskid, please go ahead.

Good morning and thank you for joining TimkenSteel’s fourth quarter 2015 call to discuss our financial results. I’m joined by Tim Timken our Chairman, CEO and President, as well as Chris Holding, Executive Vice President and Chief Financial Officer. 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 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. We prohibit any use, recording or transmission of any portion of the call without our express advance written consent. There will be an opportunity to ask questions at the end of Chris’ prepared remarks. Now, I would like to turn it over to Tim.

Thank you, Tina. Good morning and thank you for joining us. 2015 was quite a year filled with conditions that challenged many companies in our industry. In a century of operations, we have managed through many economic cycles. As I reflect back on the year, it’s clear that this downturn is as deep and as long as any. In 2015, we faced many hurdles, but also some new exciting opportunities. Fourth quarter demonstrates that we’re handling both effectively. As you saw in our release, we outperformed our guidance for the fourth quarter. We took aggressive actions while facing weak global commodity markets and high customer inventory levels. Our people are problem-solvers and innovators when it comes to our products, our processes, and especially in this challenging environment, our operational efficiency. As a result, we were able to reduce our anticipated EBITDA loss through our cost reduction efforts and a focus on new business development. Let’s take a look at 2015. We implemented two rounds of significant cost reductions with benefits that are outpacing original projections. We generated $29 million of free cash flow for the year through effective working capital management. In fact, we took down inventory much faster than in previous cycles, while still maintaining industry-leading customer service levels. We amended our $300 million credit agreement in December and ended the year with available liquidity of $84 million. We paid consecutive quarterly dividends of $0.14 per share through the third quarter. We reduced capital spending by 40% in 2015 and will take it down another 40% this year. This comes on the heels of a $500 million multi-year investment program that has reinforced our SBQ leadership position. And finally, we maintained our pace of innovation with new product sales ratio of 30%. Looking forward, we’ll have challenges in our market in 2016. In the first quarter, we expect an EBITDA loss of between $10 million and $20 million, with the benefits of continuing cost reduction and climbing melt utilization. Industrial end markets will continue to be weak due to the impact of low oil prices and depressed global commodity markets. We’ll also face continued pressure from imports. However, in automotive, where we’ve been gaining penetration, we expect continuing strong demand. And in the distribution channel, we’re beginning to see tapering of inventory destocking. This year, we’ll maintain a clear focus on performance improvements even under these tough market conditions. Our goal will be to generate cash while maintaining industry-leading customer service levels, further strengthen our liquidity and continue to win new business and reinforce our SBQ leadership position. That focus on performance in this type of environment also makes us stronger when the markets turn. Our ability to run this business at breakeven levels of about 50% melt utilization in normalized scrap markets still stands firm. The lower cost structure that we’re now creating combined with higher performing assets we’ve installed put us in an even stronger competitive position. I want to take a moment to recognize our people. The team has done so well working through some of the most challenging market conditions that we’ve seen. Their quick thinking and problem-solving in every corner of the organization is the reason we reported better than expected results for the fourth quarter. And through it all, they continue to lead in customer service and operate with safety, quality and environmental responsibility as their top priorities. I want to thank them all for their effort. I also want to thank you and all of our shareholders for the confidence that you have in TimkenSteel. Now, Chris will walk you through the financials and we’ll both be back to take questions at the end. Chris?

Thank you, Tim. Good morning. Net sales in the quarter were $207 million, comprising base sales of $188 million and surcharges of $19 million. Weak demand from North American oil and gas markets coupled with impacts from other commodities on our industrial business were the primary drivers of our sales results. Shipments of 175,000 tons were 2% lower than the third quarter. Base sales per ton were about 5% lower than the third quarter as a result of a shift in end market demand and product mix as well as pricing pressure from imports. We expect these market dynamics to continue into the first quarter 2016. The lower market demand and corresponding 41% manufacturing utilization resulted in a $38 million EBIT loss for the quarter, which was an $11 million improvement over third quarter results on similar volumes. The improved performance was primarily due to actions we’ve taken to reduce costs across the enterprise. The [three-city] average scrap index dropped over 25% in the fourth quarter from $265 per ton to $196 per ton. As we discussed in our previous conference calls, scrap prices impact our results because of the timing associated with our customer surcharge mechanism. Sequentially, raw material spread was $4 million worse than third quarter 2015 which was in line with our expectations. For the quarter, SG&A was $26 million, down $1 million or 4% sequentially, primarily from controlled spending and the realization of savings from cost reduction activities. EBITDA for the quarter was a loss of $19 million. Included in the loss is $4 million of severance costs related to our cost reduction programs. For the fourth quarter 2015, we generated a net loss of $26 million, or negative $0.58 a share. The income tax rate was about 37% for the year and we expect our tax rate to remain around 37% for 2016. Turning to segment performance, our industrial and mobile segment sales were $171 million for the quarter, which was a 9% sequential decline. We continue to see strength in the mobile side of our business. The North American light vehicle production rate met the 17.5 million vehicle forecast for 2015 and our mobile revenue increased to the pace greater than the vehicle production growth. The industrial end markets were more challenging as they continued to be negatively impacted by weak global commodity markets. Industrial ship tons declined by 10% compared to the third quarter. In the energy and distribution segment, sales were $35 million for the quarter, or a 21% decline sequentially. US rig count declined over 60% since last year and has significantly impacted our energy and distribution business. Energy shipments dropped 12% sequentially and customer inventory level remains inflated. Shipments to industrial distributors declined 10% sequentially due to reduced demand from mining and industrial equipment end markets. Additionally, customer purchases made in the first half of 2015 resulted in higher inventories in the channel. We believe inventory destocking at distributors has tapered and expect increased demand in the first quarter 2016. We generated $18 million of free cash flow during the quarter, primarily from our continued efforts to effectively manage working capital. We have been pleased with the pace of our working capital reduction efforts this year and this will remain a priority for 2016. Beginning in 2016, approximately $15 million of costs associated with other post-employment benefits for [bargaining unit] retirees will be paid from our VEBA trust rather than from operating cash flow. Additionally in the first quarter, we will receive a reimbursement from the VEBA trust for post-employment benefits for bargaining unit retirees paid from operating cash in 2015. Capital expenditures for the year totaled $78 million, with more than 40% of the spend going to growth related projects. We estimate full-year 2016 capital spending will be about $45 million. We amended and restated our credit agreement in the quarter. The new agreement provides for a $300 million asset based revolving credit facility. The availability of borrowings under the agreement is subject to a borrowing base calculation based on valuation of eligible accounts receivable, inventory and machinery and equipment. At the end of the year, we had $84 million of liquidity between the revolver and cash. Total debt decreased by $5 million in the quarter to $200 million, and our net debt to capital ratio was 17.8%. While our balance sheet remains strong, we’re evaluating options to further enhance our liquidity position. Before I move to the outlook, I’d like to note that we will no longer report out as two segments, given the organizational changes made last quarter. We believe the presentation of financial results as one reportable segment is consistent with the way we now operate our business. Turning to the outlook for the first quarter of 2016, we expect shipments to be approximately 5% higher than fourth quarter 2015. Automotive demand remains strong, but industrial and oil and gas end markets continue to be weak. We expect raw material spread to be favorable sequentially as we anticipate stable scrap markets during the first quarter. Manufacturing utilization will be around 45% and our cost reduction actions will continue to favorably impact financial results. Finally, we project EBITDA to be a loss of between $10 million and $20 million. This ends our prepared statements, and we will now take your questions.

[Operator Instructions] Your first question comes from the line of Novid Rassouli from Cowen and Company.

It looks like industrial and mobile shipments were up slightly quarter-over-quarter. However, your initial guidance, I believe, in the third quarter results, you’d expected shipments to be down 10%. So I was just curious what drove the better than expected results?

When we guided to our sales for the industrial and mobile, we guided down 10% and we came in about 9% lower on net sales. But I think we’re pretty much in line with our guidance on a net sales basis.

So you expected shipments to be flat though?

From a ship ton perspective, yes, ship tons we were flat, but our guidance was around net sales.

And then the second question I had was rig counts have continued to decrease, energy prices have moved lower and it looks like base sales prices have also moved lower. It sounds like you guys are getting some pressure from imports, but you are expecting an improvement in EBITDA for 1Q 2016. So I just wanted to see the sequential improvement, it looks like you guys had cited in the press release manufacturing improving sequentially and benefits from cost reductions, would you mind giving us some additional detail around those drivers and why you expect this to be able to more than offset the continued weakness in the energy sector?

If you go back to the announcements we made last year regarding cost reduction activities, we see most of those savings showing up in 2016. So that is the primary driver of what we see and of course we also look at a little bit higher volume sequentially from Q4 2015 to Q1 2016.

And then my last question for you guys is base sales prices seem to be relatively steady for industrial and mobile in the first three quarters of the year, but they did seemed like drop off a little sharper in the fourth quarter. Other than imports, was there anything else that was the driver of that? And do you expect that to continue into the first quarter?

I think as much as anything else, there’s a little bit of mix that goes on there in industrial and mobile segment, but we did see some deterioration on the industrial side.

[Operator Instructions] Your next question comes from the line of Phil Gibbs from KeyBanc.

Just trying to understand, Chris, the VEBA mechanics there in terms of getting some cash proceeds in 2016 and then how it works with your pension in terms of the contributions there? It sounds like to me that your foregoing cash outflow that you had last year was maybe what $15 million or so, so I’m just trying to understand that?

Your net conclusion is right, so let me take you through both. The pension plan is pretty much fully funded at the end of the year and so we haven’t put cash into the pension plan for a number of years and we don’t anticipate needing to fund the pension plan going forward in the near-term. From a OPEB perspective, we created a VEBA trust some years ago and at the end of the year had about $140 million of assets. And so in the past, we’ve paid these benefits that are, call it, $15 million a year out of operating cash flow. For 2016, we will pay these benefits out of the VEBA trust rather than out of operating cash flow and then we’ll also – the 2015 cost be reimbursed because they came out of operating cash flow.

And those were what around $15 million?

I’d say for the number for 2015 would be probably about $13 million.

And your non-cash pension and OPEB expense, what do you see that as being this year?

Slightly lower than 2015.

I think the question was just touched upon a little bit, but trying to understand the base pricing in the first half, I know you’ve got a lot of resets historically on January 1 or at least that’s the way we understand it. Pricing did deteriorate a little bit earlier, some of that is mix, how much do we expect base prices to be down quarter-on-quarter or how should we be thinking about that?

Phil, if you remember, 70% of our businesses is annually contracted, the rest is spot. So I’ll focus on the contracts and then we can talk about the spot environment. Our contracts are essentially done at this point and I would say as a whole relative to what we know happened in the market, I’d say we did a great job of protecting our base. Quite frankly, the customers that we deal with understand the value that we bring and obviously they have to take into account what’s going on in the market. But I’d say in general our people did just a fantastic job at working their way through those negotiations in light of downward pressure from the volume coming in from overseas, some of the domestic capacity that’s available and just the overall environment that we’re in.

And then you said you’re going to talk about spot, Tim, as well?

Spot is on an at-will basis, right. So right now, things are relatively settled. We’re going to watch it going through the year. You’re seeing some differing flows on the import side now, some accelerating, some decelerating. So that will be taken into account. And then obviously you get the whole raw material impact of that as well. So on the whole right now we’re saying that, yes, there is pressure out there, but we’re dealing with it on a contract by contract, order by order basis.

And to that point, whatever is happening or whatever you’re realizing in terms of pricing, that’s reflected in your commentary that you expect realized spreads to be up, obviously there’s a lag in the scrap moving down, but the totality of the two you still have got spreads moving up here in the first quarter relative to the fourth quarter. Is that right?

Yes.

[Operator Instructions] Your next question comes from the line of Aldo Mazzaferro from Macquarie.

Tim, this is a little philosophical question. Your company makes some of the highest quality products in the industry, 70% under contract, why do you have to tie your pricing to scrap so directly? I would think you’d be able to negotiate price of the product and then not let the customers take so much control of your pricing policy, is that something that you ever think about possibly changing?

Again, Aldo, we negotiate base pricing with all of our customers and then the surcharge mechanism is meant to just pass the volatility in our raw material along in a very visible transparent way. So we’re comfortable with the approach that we take, it’s more or less the industry-accepted approach and quite frankly we don’t see a burning need to change it at this point.

It just seems funny as you say your prices were hurt because of decline in the raw material market, anyway.

Sales would be impacted by a decline in raw material; base pricing is negotiated for 70% of our business on an annual basis; and then the other 30% is at-will depending on what’s going in the market at that time.

Second question, on the cash flow statement, Chris, can you explain the line that says dividends paid, $37.4 million in the fourth quarter? And then also could you reconcile the cash balance at the end of the period doesn’t seem to match with the cash on the balance sheet at the end of the period unless I’m reading it wrong?

I’ll walk you through it, because if you look at dividends paid for the year, it’s $18.7 million.

It looks like a source of cash?

No, no, that’s a deduction, that’s a negative.

So the fourth quarter, $37.4 million dividends paid to shareholders?

Yes. I don’t know where you’re seeing it. So if you go over in the cash flow where we saw the $18.7 million, there’s just a dash there for the fourth quarter because we did not pay a dividend in the fourth quarter of 2015.

On the copy I have it says cash paid to shareholders is $37.4 million in the fourth quarter and full-year $18.7 million.

We’ll true that one offline because it sounds like you’ve got a little bit of a date issue that we can correct for you.

[Operator Instructions] Your next question comes from the line of Justin Bergner from Gabelli & Company.

I have a handful of questions here. I will do a few and maybe then get back in queue. To start off with the VEBA trust, is this a type of arrangement that you could keep going for a few years given that the plan has $140 million of assets?

Yes, that’s the case that was always designed to be that way. Sooner or later, we’re going to pay benefits out of the trust rather than pay out of cash flow.

And that is affecting earnings or just cash flow in 2016?

Just cash flow.

And then just to reaffirm, the pension deficit was essentially zero at the end of 2015?

That’s correct.

Turning my attention to the EBITDA bridge from the fourth quarter to the first quarter, I guess you’re going from negative $19 million to negative $10 million to $20 million. I’m not sure if the restructuring expense of $4 million is going away. You are also getting some benefits hopefully on the raw materials spread. Should I think about, outside of the restructuring expense and the raw materials spread, EBITDA being sequentially flat and the improved utilization and cost-cutting quarter-on-quarter offsetting the price mix headwinds? Is that a fair way of looking at things?

I will restate it a little bit differently, Justin. Have a couple of things going. We’ve called for 5% volume improvement. So we’ll have good volume and some of that will show up through a little bit higher melt utilization. So that’s clearly a good guy. The cost reduction is the continuing, the second pass of cost cutting will show up more heavily in the first quarter of 2016 than the fourth quarter of 2015 and so those are the two big things. Now, we’ll have hopefully if the markets stay flat on the surcharge that could be a positive.

And the restructuring expense, will it be the restructuring expense in the first quarter as well?

No.

So I guess when I adjust for a restructuring expense in the raw materials spread, it seems like the EBITDA is more or less sequentially flat. Is that a fair characterization?

Yes. I’m not sure, Justin, I follow you in terms of what’s in and what’s out, but by and large obviously at the end of the day there is some improvement from Q4 to Q1.

I will hop back in queue and maybe come back with a few more questions.

[Operator Instructions] Your next question comes from the line of Phil Gibbs from KeyBanc.

Tim, I just had a question on the question or comment that you would be looking at some alternative financing sources in the first half of the year to potentially meet liquidity thresholds. What are you pursuing there? And when should we expect something may be concluded?

Phil, you’ve seen the announcements to date. Obviously, we put the amendment on the $300 million credit facility. We talked about ending the year with $84 million of liquidity. We’re confident that we’re going to be able to achieve the requirements that are stated in our new agreement and we’re looking at a lot of different avenues to bridge that gap. And quite frankly, I don’t think we’re in a position right now where we want to get into the details of those. But we feel pretty good about making sure we hit that number.

And in terms of the networking capital, sales look like they are stabilizing here. But any further potential to reduce inventories at this point, or do you feel like you are at a decent spot?

The comment I’d make on working capital is obviously we had a very good year, as you stated, in working capital reduction and took a lot of cash out of the business throughout the year. As we look forward to 2016, there’s still some pockets, I mean frankly we hope we get some working capital build because of market recovery. But if that doesn’t happen, we still have some spots but obviously it won’t be near as great as it was in 2015.

And then last one, Tim, what are the broader OEMs that you deal within the heavy equipment and later-cycle markets telling you guys about order books or expectations at this point relative to maybe last year?

You probably read all the same transcripts that I have, Phil. And quite frankly, the news isn’t great. I think they’re still seeing commodity markets under a lot of pressure and that translates through to fewer big yellow trucks. At this point, I would say that in a lot of these markets it’s hard to imagine them going a lot lower, but I think we’ve all been surprised. So if you look at it, mining is going to be down a little bit more; rail, we’re seeing some slow down there tied to some of the pipeline activities and some of the pullback on the railroad side; the oil and gas is anybody’s guess at this point. I looked at a number of different transcripts the other day just to try to get a feel for what was going on in the oil pad. And obviously, we stand very close to our customers there. And the sense is people are beginning to see a deceleration in the fall, but nobody wants to really call a bottom or a turn. I think the one comment being here out of all of them is that, listen, the longer this thing lasts, the more pronounced the rebound will come when it actually happens. And so the minute you begin to get demand signals, there’s a potential that this thing could part pretty quickly. So that’s the bad news. Obviously the good news on the automotive side, we’re seeing very strong orders out of automotive still despite some of the nervousness about leased lengths and that kind of thing. All the signals we are getting out of mobile seem very, very positive at this point. So I’d say we’ve got a realistic expectation for the year with marginal begin to a recovery in the second half of the year. But it’s going to be marginal. And so that’s the plan that we built, that’s what’s behind all the cost reduction initiatives that we continue to drive and the way we’re scheduling our facilities at this point.

[Operator Instructions] And your next question comes from the line of Justin Bergner from Gabelli & Company.

In terms of the breakeven EBITDA utilization being at 50%, would that not have moved up a – would that breakeven utilization not have moved down a bit given the cost take outs in the organization or are there offsets?

There is always offsets both ways overtime. The most important thing that we need is some stable scrap markets. And so we’ve been pretty consistent with the fact that we can breakeven around 50%. So in this case, we’ve had to make cost reductions to stay with that 50% breakeven.

And then in terms of the distribution destocking tapering, are you seeing that broadly in distribution or just non-oil and gas distribution?

It’s heavier on the industrial side obviously than it is in oil and gas, although we’re beginning to see spot orders here and there to fill shelves on the oil and gas side as well. So yes, we spend time with our distributors, there’s a sense that things are somewhat in balance obviously with the exception of certain pockets that we are seeing. I would say that’s probably a changeover mood that we’re hearing in the third quarter. So I think it’s headed in the right direction. The real question is when does it begin to take off again?

And then finally on the import and price pressure, just maybe if you could highlight which of your end markets that’s more pronounced in?

We’re seeing more of that product show up in the industrial side of the business, obviously oil and gas is the target for imports and it tends to be on the larger size of the range. On the smaller size, with the business model that we take into the auto or to the mobile sector, with its stickiness on the value-add side, we’re seeing less pressure there, more above 6 inch and higher in the industrial. Distribution obviously is flowing through there as well. But we’re fighting it on a order by order basis, and right now as we look at it, we feel we’ve done a very good job of maintaining penetration in our key accounts.

There are no further questions. I’d turn the call back to Mr. Tim Timken for closing remarks.

Thanks for all the questions. We appreciate your interest and confidence in the business. Our performance in the quarter, I think, exemplifies our result to deliver value to our customers and our shareholders now and over the long haul. So if you have any follow-up questions, please don’t hesitate to contact Tina. Thanks again and have a great day.

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