Metallus Inc. (MTUS) Q3 2016 Earnings Report, Transcript and Summary

Good morning. My name is Sharon, and I will be your conference operator today. At this time, I would like to welcome everyone to the TimkenSteel, Third Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Ms. Tina Beskid, you may begin your conference.

Great, thank you. Good morning and thanks for joining TimkenSteel's third quarter 2016 conference call to discuss our financial results. I am joined here today 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 as provided in connection with today's call and in our reports filed with the SEC, all of which are available at 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. We prohibit any use, recording or transmission of any portion of the call without our expressed advanced written consent. Now, I would like to turn the call over to Tim.

Thanks Tina, and good morning. I want to start today by recognizing the employees of TimkenSteel and thanking them for their relentless drive, their performance under challenging market conditions. They are doing a really remarkable job of improving continuing to improve our operating performance and fundamentally strengthening this company for the long-term. These efforts are clearly reflected in our third quarter EBITDA which was positive and exceeded guidance prior to the pension settlement charge. We also generated $29 million of free cash flow in the first nine months of the year. It shows good progress, but obviously we still have a long way to go. We faced all of the market challenges we anticipated in the quarter. Weak energy and industrial markets, seasonal automotive demand, and less favorable sales mix. Yet our operating performance improved in the third quarter and as $30 million better than a year ago on lower volume. We are fundamentally improving the company’s performance. In the last call, I talked a lot about the cost control actions that we have been taking which have resulted in more than $100 million in savings and have exceeded our initial estimates. So I won’t spend a lot of time talking about that today. What I’d like to talk about is the top-line work we’ve been doing to complement those cost efforts. Our sales, technologies, supply chain and manufacturing teams are working together to leverage our material knowledge and modern assets to deliver customer value in new ways and with record [Indiscernible] efficiencies. For example, we’ve recently gained new business with an automotive crank shaft manufacturer. The quality and consistency of our SBQ steel boost the performance of the crank shaft in the applications such as race cars and large industrial equipment. Another example is expanding our business through the supply chain doing more and more work for others in the steel industry. We are finding opportunities in everything from supplying billets and tube shells to providing conversion services. One example, we recently entered into a supply relationship with a domestic steel processor that we haven’t worked with in many years. We are now providing billets for their reroll operations that supply distributors who serve fabrication jobs. We are also winning business with new customers. Recently we began producing a new geometry of SBQ bar for two converters who serve downstream original equipment manufacturers. Our ability to create customized products and services is a key element of our business model and these are just a few examples of our ability to win new business because of that flexibility. We are testing the balance of our new assets to explore new market opportunities. Assets like the jumbo bloom vertical caster are highly efficient and unique in North America. We are using this period of lower demand to push these capabilities into new areas. We already are seeing value from those operations and it’s clear that we’ll deliver exponentially more value when we run that equipment full in a more robust market. All of these activities are laying a solid foundation for even better performance when markets begin to recover. As we look forward to the fourth quarter, markets will still be challenging and our guidance reflects that. This downturn is one of the longest to our energy and industrial markets of experience, but indicators are beginning to trend in a positive direction. We are seeing inventories balancing a bit in the industrial markets although demand remains weak. We also see rig count improve and the number of drilled but uncompleted wells falling. In automotive, we are seeing normal seasonality and some inventory adjustment in the fourth quarter, but their markets remain strong and we continue to increase our participation on new platforms. Our priorities at TimkenSteel for the fourth quarter remain much like the third quarter. Continue to focus on cost control and work together to drive new sales opportunities. This formula and all the actions that we have taken over last year or so continue to improve our short-term performance and position us to accelerate even faster when markets return. At this point, I’ll turn it over to Chris to talk – to walk you through the numbers and then we’ll take your questions at the end. Chris?

Thanks, Tim. Good morning. You may have noticed that we filed our Form 10-Q yesterday which is earlier than previous quarters. We intend to continue this practice going forward, so you will have more information available prior to our earnings calls. Also you can find additional financial and operating schedules posted on the Investor Relations page of our website. Shipments of 178,000 tons in the quarter were 6% lower sequentially and flat year-over-year. We continue to see strength in the mobile side of our business. North American light vehicle production achieved a record third quarter build rate of 18.4 million units, a 4% sequential increase. 2016 is still on pace for a record volume year, but has shown signs of peaking. Mobile shipments were down 8% in the quarter due to anticipated seasonal production shutdowns. We project that fourth quarter mobile shipments will be slightly lower sequentially due to further seasonal production shutdowns and inventory rebalancing. Industrial shipments decreased 6% from the second quarter of this year. Global commodity markets began to stabilize in the first half of the year which positively impacted the industrial end-markets. Inventory levels are low in most cases, but customers remain conservative resulting in a slower pace of buying particularly in the industrial supply chain. We expect these market dynamics to continue into the fourth quarter. Shipments to the energy end-market increased more than 30% sequentially as US rig count had a similar increase since May. We remain encouraged by continuing improvement in market supply/demand dynamics in the energy sector. However customer inventory levels continued to be inflated and we do not expect any changes in our order book level in this market segment for the fourth quarter. Net sales for the quarter were $214 million, with base sales of $187 million, and surcharges of $29 million. Base sales per ton were $14 a ton lower than the second quarter due to end-market product mix changes and price pressure. EBIT for the quarter was a loss of $23 million, including just over $5 million for non-cash pension settlement expense. Our salary defined benefit plan offers retirees the option of receiving a lump sum payment in lieu of an annuity, which we believe reduces risk for both the company and the retiree. In the third quarter, because the plan’s total year-to-date lump sum payouts exceeded the annual service and interest cost, we were required to remeasure the salary plan. A remeasurement triggered in acceleration of just over $5 million of expense from equity. The settlement expense did not impact equity or cash however, the remeasurement decreased equity by about $26 million primarily due to a lower discount rate used to determine the pension liability. We expect to have some additional settlement expense in the fourth quarter. Excluding the settlement expense, we generated $2 million of EBITDA in the quarter, which exceeded the guidance range. The higher earnings compared to guidance were primarily due to lower seasonal maintenance cost, cost reductions in LIFO. SG&A was $23 million, excluding settlement expense of $2.4 million, a 5% sequential improvement and 15% decrease from the same quarter in 2015. The SG&A improvement reflects continuing efforts to reduce costs. Melt utilization is 44%, slightly lower than the 45% utilization realized in the second quarter 2016. Despite the relatively low utilization rate, we generated positive EBITDA excluding settlement expense, primarily due to our cost reduction actions and better scrap markets. We expect to operate at a similar melt utilization rate in the fourth quarter. In the third quarter, we generated net loss of $17 million or negative $0.38 per share. The income tax rate was about 37% for the quarter and we expect our tax rate to be around 37% for the year. The effective tax rate was higher than the US settled statutory rate of 35%, primarily due to US state and local taxes. Capital expenditures for the quarter were $10 million and year-to-date spend is approximately $25 million. We estimate full year capital expenditures of $45 million with fourth quarter spend related primarily to maintenance and safety items. Free cash flow was a cash use of $3 million. Cash from net operating cash flow was offset by higher capital expenditures or maintenance-related spending that coincides with our annual maintenance and shutdown activities. We paid down our outstanding revolving credit facility balanced by $10 million in the quarter, primarily from lowering our cash balance. At the end of the quarter, we had about $153 million liquidity between the revolver and cash. Our net debt-to-capital ratio was a healthy 14.1%. Turning to the outlook for the fourth quarter, we expect shipments to be down 5% primarily due to automotive seasonality. Additionally, we anticipate the recent decline in scrap prices to have a negative timing impact on raw material spread. As a result, we anticipate the fourth quarter EBITDA range to be between breakeven and a $10 million loss. At this time, we are unable to estimate the impact of the expected pension settlement expense since it is dependent on the year end remeasurement. In conclusion, the quarter came in better than expected as we’ve recorded our second sequential positive EBITDA quarter excluding the settlement charge. This is a testament to continuing improvements in our cost structure and other actions we have undertaken. While the fourth quarter will have some headwinds related to spread and sales seasonality. We are in a better position from both a profit and liquidity position than six months ago. This ends our prepared statements and we will now take your questions.

[Operator Instructions] Your first question comes from Novid Rassouli from Cowen & Company. Your line is open.

Good morning, Tim, Chris and Tina. I just had a question on the energy market. So, rallying rig counts are increasing, I realize there is a lag between, when oil price is rising when we see it materialize into shipments for you guys. So I was wondering if you can speak to the usual log between the two including potentially large amounts of inventory that need to burned off at this point and essentially, how to think about when we’ll see your energy shipments kind of make their way out of this 5,000 to 7,000 ton quarterly range?

Right, and then, one more thing. So if I can expand on that, so during the downturn, we saw the energy cotangent kind of spread into the industrial side and so, kind of show that you guys actually have a little bit greater energy exposure than maybe we previously thought. So, is it safe to say that you will benefit on the upside then and have you seen any impact, are there energy derivative markets given the rise in crude oil prices roughly kind of doubling from where we were at the beginning of the year?

Yes, I don’t think we’ve seen it translate yet, Novid, but obviously, to the extent that those supply chains are still in place and healthy that we will. Again, it’s a matter of working activity all the way through the chain and, because we are pretty close to there, we get whipped a little bit harder than everybody else and so, it will translate through, we just haven’t seen the start yet.

Great, thanks, Tim.

Great, thanks.

Your next question comes from Phil Gibbs from KeyBanc Capital Markets. Your line is open.

Good morning.

Morning.

Hey Tim, the mix, the mix in the quarter overall and then also in the oil and gas business, should we expect that mix that you saw in this quarter to be persistent as we move into the fourth quarter and next year or would you expect any changes up or down in that pricing mix component?

Well, let me talk about the quarter. We are not really going to talk about the year – next year this morning. I would say, yes, fourth quarter is going to look a lot like the third quarter. In fact, if anything, if seasonality persists on the automotive side and quite frankly our activity level on the oil and gas side and the industrial side are so low that, I think you are going to see a very similar kind of picture in the fourth.

Okay. Appreciate that and on the pension side, does the pension expense moving forward or in 2017 change materially from this contingent of your work force or your retiree basket taking this lump sum?

Yes, Phil, this is Chris. I’ll give you a little background on the pension. Right, we have a gross pension obligation of about $1.1 billion and so, - six years ago we put in lump sums to reduce the risk associated with pension plan and again it works well for both the employee because they have an option and for the company because we - on the salary plan which is frozen and no new entrances since 2003. It takes down our risk level and so, interest rates are – lower interest rates are enemy of pension plan funding. So, our expense for next year will really be determined by what the year-end interest expense would be. So that the discount rate effectively. So, I think you saw the bond market yesterday, so that was probably a good sign relative to pension expense.

Okay, so this doesn’t, but this action doesn’t change anything related to the pension expense or the contribution forward and so much in itself. It’s just something that’s happening here in terms of remeasurement?

Yes, exactly. Yes, exactly, right. There is no cash impact to fall and going forward it will not increase our pension expense.

Okay. And then, this is just more of a kind of a bridging the comments that you made. I think you said mobile is down 8% in the third quarter relative to the second and you’d expect slightly lower shipments in that business in the fourth quarter, but then I heard you say that shipments for the total business is close to be down 5% due to automotive seasonality. So, slightly, I am thinking about 1% to 2% and then, when you are saying that automotive is a driver for this thing to be down 5%, you maybe on being a little too fine here, but can you help me with that?

Yes, so, when we provide our guidance down 5% probably on a dollar basis, mobile is the most significant piece in the industrial piece would be the other area that we see more seasonal challenges.

Okay. Thanks.

And your next question comes from Justin Bergner from Gabelli & Company. Your line is open.

Good morning, Tim. Good morning, Chris.

Hey, Justin.

Good morning.

A few questions here, on the sequential EBIT bridge in your presentation, it looks like volume price and mix are a negative $2 million drag and I’d expect volume given sort of the decline in tons by about 12,000 to have been at least negative $2 million if not more. So, what is positive in that portion of volume price mix? Is it price or is it mix on a sequential basis?

Yes, Justin, if I understand your question, you are saying volume is down quarter-on-quarter and you do some high level math around volume and so you say net, net, net of volume is down either price or mix is got to be favorable. Is that your question?

Yes, I mean, negative 12,000 tons would seem to lead to more than a negative $2 million contribution to EBIT sequentially and so I look at that negative $2 million in the EBIT bridge and I am saying that price or mix has to be positive to get you to a number that’s not worse or negative to.

Yes, I get your question. I think price and mix were relatively flat. That $2 million is all volume.

Okay. All right.

Should I say primarily volume. Most of it is volume. It’s primarily volume. It’s probably a better way to say it.

Okay. That’s helpful clarification. Secondly, on the maintenance expense coming off this quarter, how much did that sort of boost operating profit versus where you expect the maintenance expense to be when you sort of provided guidance coming out of the second quarter?

Just about $3 million.

Okay. Will that come back in the fourth quarter or is that just sort of a lower maintenance expense because your facilities are running less than you can figure out how to triage your maintenance expense little bit better?

Well, it’s going to be relatively flat quarter-on-quarter between the third and fourth quarter. Keep in mind, most of the maintenance incur is in the second half. So year-over-year, the second half maintenance expense is lower in 2016 than 2015.

Okay. Great and one more question on the interest expense. I guess, it look like it ticked up sequentially from $2 million to $4 million. Is that $4 million sort of a go-forward runrate assuming net debt is flat or is there anything that sort of led to a slight – slightly higher than normal uptick in the interest expense this quarter?

Well, as you recall, right, we – the convertible bonds and they were effective in June. So we started accruing interest in June on the bonds. So that’s why this quarter the expense is higher. If you look and when you get into the 10-Q, you will see it laid out pretty well what the cash interest expense is a non-cash interest expense is and I would say going forward we are probably for the foreseeable future be call it around $3.5 million between cash and cash interest.

Okay, and a little bit less on the cash side?

Yes, what – and the cash side is in the quarter, only $1.1 million of the $3.9 million, now that will vary when we make our semi-annual convertible payments in June and December.

Okay. All right. Thanks, I’ll hop back in the queue.

Your next question comes from Aldo Mazzaferro from Macquarie. Your line is open.

Hi, good morning. On the..

Hey, Aldo.

Hey. A question on the – this might be a crazy question, but does the pension settlement charges that you are taking imply anything about headcount changes or is it retire?

No.

You are opting for the lump sum rather than employees, right?

No, the employees opt for lump sum for their own personal reasons and this has nothing to do with headcount.

I see. Would you do have a review your headcount change for the last couple quarters just on average employees drawing salaries? I mean, not, ROE and salary together?

You mean, what’s the trend in terms of headcount?

Yes, just roughly, were there any during the year?

It’s been relatively flattish for the last couple of quarters. Our reductions in headcount really occurred more last year and the first quarter this year.

Yes, although, let me just add though, I mean, we are keeping things pretty tight right from a spending point of view. So to the extent that we have people retiring, I mean, we are running really, really lean right now.

Right, so do you think there is a way you could run even leaner? If so, let’s say volume were to be sluggish or come back very slowly and you are – say a year or two down the road from here. Do you think you’d have the same relatively large headcount or you think you could make some more dramatic change?

Well, we’ve taken – what, 12% of our workforce out since the beginning of 2015. So we’ve taken pretty significant reductions. On the manufacturing side, we are running really flexible schedules kind of eight days on six days off, kind of stuff. If volume continues to decline, obviously those schedules would be further impact and we’d have to take action. So, there is always somewhere to cut, let’s put it that way.

That’s good, but you have the flexibility to do that to go to six days off if you want?

We are running that right now.

Yes. Okay. And then, can you update us on the jumbo caster? How much of your steel is going through the jumbo caster at this point as a percent of your total production?

Yes, about 45% of Faircrest melt is running through the caster right now. As we said last quarter, we are seeing great results out of it. The yield productivity quality really that’s surpassing our original expectations. So, we continue to load that that asset as we get the customer certifications, we’ve been moving melt back and forth or shifting melt between Harrison and Faircrest pretty aggressively as well to get the advantages off that caster. So, you’ll continue to see that improve as we go forward.

Great. And Tim, it’s just a longer range question, do you consider the flexibility of adding like a new product line or it’s something in a rolling mill that would be able to utilize more of your excess melt? I mean, it might be kind of a fairly efficient way to increase utilization, you might have to step into some product lines that you are not in there yet like possibly you rebar or something like a small micro mill off of your melt shop could be – I would think quite profitable with – since the melt shop is already in place?

Although, we are always looking at our assets to trying to figure out how to optimize it from scrap all the way to a finished product and so, obviously, don’t want to share too much about that. I would say right now, that in normal markets, our balance is between melt and rolls actually not too bad and to the extent that we do have excess capacity, we’d look to fill it in alternate ways. I talked earlier in my remarks about selling billets and shells to other steel producers, potentially doing conversion work for other steel producers. So, yes, well, I mean, we look to optimize the performance all the way through our value chain.

Well, thanks, Tim. Congratulations on the cost reductions and making progress here at a very low weak cycle.

Yes, it’s been an experience. Thanks, Aldo.

Yes, take care.

Your next question comes from Martin Englert from Jefferies. Your line is open.

Hi, good morning everyone.

Good morning.

Would you be able to provide some color on the respective facility utilizations on the melt side? What it looked like this quarter?

Yes, we usually don’t break it out between the two facilities. In general, we ran about 45% in the quarter.

And that you’ve been gradually shifting more of that over to your more efficient facilities?

We’ve been looking to optimize between the two facilities?

Okay. Do you think that you could get to a point where you turn off melt completely at the one facility and just around one?

We said in the past that what we are trying to drive – we are trying to maximize the amount of flexibility between the two facilities. Just based on demand, right now, both of those facilities are necessary.

Okay. And can you provide a little bit of color what you are seeing thus far as far as contract renegotiations for your products?

We are kind of in the middle of that right now, Martin, so, I don’t really want to share too much. I would say, as expected, we are in a relatively weak market with a lot of available capacity. So, there is some pricing pressure out there. We continue to drive value for our customers and look to create stickiness by driving our value-added model and we’ll continue to push that. The markets obviously are different. Automotive is still running pretty high and so those conversations are always a little bit different than when you are dealing with weaker markets, but in general, I’d say we are getting through them on a timely basis and we’ll be able to share more detail with you at the fourth quarter call.

When you think about the puts and takes between the different end-markets, so, you have continued to strengthen automotive, would there be any opportunity for pricing increases there on contracts?

Yes, again, I think, we’ll probably hold off on that and give you a better sense in the fourth quarter call.

Okay, excellent. Thanks for the color.

Thanks.

Your next question comes from Phil Gibbs from KeyBanc Capital Markets. Your line is open.

Hey, Tim. Did I hear you right that you’ve done about $25 million in CapEx year-to-date? Is that right?

Did you say 25 Phil?

Yes.

Yes, that sounds about right.

Okay, and so that would include a heavy fourth quarter with – if you’ve got guidance of $45 million for the year. I am just trying to understand between what on a maintenance level basis, gets moved into capital expenditures versus what you expense, because I know you’ve had a couple of heavy maintenance expense quarters, particularly the third. So, what when you do these big maintenance projects gets determined to be in CapEx versus I guess, move to the P&L?

Yes, so let me start with that, you mean, typically, right, you just have to follow GAAP in terms of what you capitalize and what you don’t and so if it’s a long lived asset and improvement in a long lived asset, that’s what get capitalized. I’d say, our maintenance has been relatively consistent, I think the maintenance cost will actually be down this year in terms of just overall cash conservation. But, typically, steel mills are – things kind of eat themselves and that particularly on the melt side, so you’ve got to put money into them on a very frequent basis. So you don’t get behind and depending on the year, right, our maintenance costs are at least every bit of $35 million and by and large it’s backloaded. So when you think about that figure, it’s most of it is in the second half.

You are saying from a capital expense standpoint, most of that is?

Correct, yes.

Back-end loaded.

Yes, it really is.

Okay. Got it and then one more and then I’ll be finished here. Just on the mobile book. Tim, can you remind us how much of the mobile book is annually priced versus call it variable or spot based?

Yes, just you are north of 90%. I mean, it is an annual negotiation for the most part.

Okay. Thanks very much.

Great. Thanks.

Your next question comes from Novid Rassouli from Cowen & Company. Your line is open.

Thanks for the follow-up. I was wondering if you could speak to the typical seasonality into the fourth quarter and then into the first quarter and if the 5% quarter-over-quarter guide lowering shipments is within that range and how the traditional uptick usually impact to melt capacity moving into the first quarter? Thanks.

Yes, I’d say, what we are seeing is, kind of your traditional seasonality across all of our market segments. Obviously, it’s a little bit more noise around the oil and gas and industrial just based on level of activity, but certainly from an automotive point of view, this is fairly typical of what we see going into the end of the year. People trim in inventory levels et cetera. So, if history is any guide, you come into January and you begin to see a pretty decent first quarter. People leveling up inventories again restocking shelves. Certainly, on the mobile side, again, we’ll try to – we’ll look pretty carefully at the industrial and the oil and gas markets going into the first quarter.

If you look at the history there, Novid, you’ll see a pattern of increasing first quarter sales versus fourth quarter.

Right, so, not utilization, I guess, under 44-ish percent for the first quarter would be surprising.

Yes, if normal seasonality holds that would be true.

Great, thanks guys.

Thanks.

Your next question comes from Justin Bergner from Gabelli & Company. Your line is open.

Thanks guys. A couple of quick follow-ups. The $35 million of maintenance is that maintenance CapEx or maintenance expense flowing through the P&L?

That’s the CapEx piece.

Okay. And is the P&L piece sort of, of similar magnitude?

No, it’s not.

Okay. Secondly, on the mobile pricing, the base sales per ton increased I guess, about 2% sequentially in the third quarter. Should I interpret that sequential increase is mainly mix-driven or were you getting some positive price there too?

Yes, if you consider that most of the mobile business is on contract. The price doesn’t change within the contract period. So your conclusion is correct. It would be mix.

Okay, thanks for taking my follow-ups.

Great, thanks.

[Operator Instructions] Your next question comes from Martin Englert from Jefferies. Your line is open.

One quick follow-up. If you could enter 2017 and profitability levels look the similar as well as demand levels, would that prompt you to attempt to cut anymore cost from what you’ve already done on top of the $100 million?

If we see flat or declining activity levels in 2017, obviously, we will continue to look at every single dollar we spend.

And any idea as far as the magnitude that you could potentially, I guess, pull out, I mean, it’s pretty significant with the more frequent round of cuts?

Yes, they have been significant and quite frankly, we’ve been outperforming. And it’s a little bit too early to talk about that. We are getting through our contracts right now, trying to get a better look at 2017 and we will see how it goes.

Okay. Thank you.

[Operator Instructions] We do not have any questions at this time. I will turn the call over to Mr. Tim Timken.

Well, thanks a lot for your questions and your interest in TimkenSteel. Again, I’d like to thank the employees for their dedication and continuing to improve the performance of the business. We remained focused in the fourth quarter on controlling costs and working together to drive new sales opportunities. As I said before, we are not taking our foot off the gas. If you have any follow-up questions, please don’t hesitate to call Tina. Thanks again and have a great day.

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