Metallus Inc. (MTUS) Q2 2019 Earnings Report, Transcript and Summary

Good morning. My name is Christina and I will be your conference operator today. At this time, I would like to welcome everyone to the TimkenSteel Second Quarter 2019 Earnings 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. Jennifer Beeman, you may begin your conference.

Good morning and welcome to TimkenSteel’s second quarter 2019 conference call. I'm Jennifer Beeman, Senior Manager of Communications and Investor Relations for TimkenSteel. Joining me today is Tim Timken Chairman, Chief Executive Officer and President and Kris Westbrook Executive Vice President and Chief Financial Officer. You all should have received a copy of our press release which was issued last night. Additionally, we have provided supplemental slides which are available on our Website. During today's conference call we may make forward looking statements as defined by the SEC. Our actual results may differ materially from those projected or implied due to a variety of factors which we describe in greater detail in yesterday's release. Please refer to our SEC filings including our most recent Form-10K and Form-10Q and the list of factors included in our press -- in our earnings release all of which are available on the TimkenSteel website. Where non-GAAP financial information is referenced, additional details and reconciliations to its GAAP equivalent are also included in the earnings release and supporting information as appropriate. With that, I'd like to turn the call over to Tim. Tim?

Thank you all for joining us today. Before I begin, I'd like to welcome Jennifer Beam into the team. Jennifer joins us with a wealth of experience in Investor Relations. It's been a pleasure to work with her so far, and I'm confident that you have the same reaction as you get to know her better. Okay. To begin, let me start by thanking our employees for their continued dedication to safety. During the quarter, employees across the company stepped up their efforts to develop new injury prevention ideas to further improve the safety of our workplace. These efforts are part of our new Iron Shield competition, which is an expansion of our hand injury prevention program that has been so successful over the last five years. The competition will culminate later this year in a series of implemented projects and team awards for the greatest impact. I'm looking forward to seeing the outcome of this work. Turning to our financial results. Second quarter performance showed sequential improvement in adjusted EBITDA and free cash flow. In fact, we were above the high end of our guidance range. That's the good news. Unfortunately, our performance year-over-year was impacted by challenging end markets which I will discuss more about in a moment. Let me take you back to the start of 2019. We committed to a few things that would drive our performance regardless of the market factors we faced. First, we said we would improve our on time delivery performance. We've done this, and have regained the confidence of our customers, which has created new opportunities for us. Second, we remain focused on enriching the mix of our products, the products that we sell. We were -- Excuse me, we are successful in driving year-over-year improvement and expect this trend to continue for the back half of 2019 and beyond. Earlier in the year, we also engaged our employees across the company in streamlining processes and creating greater efficiencies through our Lean Enterprise Program. We sustain that effort throughout the year, and began to deliver savings in the quarter, and that effort is still going strong and is now an integral part of our operating model. Lastly, the service model improvements we made help us helped us gain share in our targeted growth markets. We believe that our improved service combined, with our industry leading portfolio and the superior performance of our products will continue to drive market share gains as -- as we create lasting values for our customers. This steady progress was tempered by weak by weakness in many of our end markets. With that said, we are confident that we took the right steps in the quarter to lay the foundation for sustainable change, despite short term market weakness. Before I turn to the outlook of our markets, I'd like to give you an update on the impact of the process improvement I mentioned earlier. Our work to improve profitability, which includes continuous improvement, manufacturing savings and restructuring for growth surpassed our original estimates. And we feel confident raising our savings target to approximately $60 million on an annualized basis, with approximately $35 million expected to be realized this year. In addition to the profitability improvement projects in the quarter, we also continue to refine our organization. We completed a restructuring that improved improves our cost structure helps us effectively allocate resources to the areas of greatest opportunity, and ultimately better positions us for growth in our key markets. Specifically, we eliminated 55 salary positions, which was a 6% which represents 6% of our salaried workforce. At the same time, our technology and commercial teams were refocused on growth areas. These actions not only better positioned us to achieve our growth goals, but also are expected to generate savings of approximately $2 million in 2019 and roughly $7 million in annualized savings beginning in 2020. In operations we also took actions by reorganizing and reducing our crewing to better align with market conditions. While doing that though, we were careful to preserve the improvements that we've made to our operating – to our service model. The impact of these operational actions will be in addition to the $60 million of savings I just mentioned. Cost cutting makes us lean and more competitive, but it's our innovation and customer intimacy that really makes the difference in winning new business, which is why we're allocating resources towards growth. An example, is our work in the automotive and light truck markets. Customer value customers value not only our long products, but also the powertrain components that we can produce using our deep material engineering and processing knowledge. This year, we've won multiple new automotive programs and products that will expand our mobile on highway value added business by $90 million in sales when fully ramped. We'll see $35 million of that in 2020. As part of that, we're also expanding our St. Clair facility in Ohio, which is a found foundation for continued growth in the future. We continue to make progress on the strategy to strengthen our leadership position in powertrain components. As I turn to the outlook for markets, we expect to see the weakness in oil and gas and distribution continue. Inventory levels have improved, but distributors remain cautious. We're anticipating stability in light truck and SUVs as well as stability in rail and in general industrial markets. We are aggressively taking actions to gain market shares -- market share in those markets. We also anticipate continued strengthening and demand in mining and our government and government customers. Obviously we're not satisfied with our financial performance and are taking steps to help this company realize its true potential. We remain focused on engaging employees in both improving our operating efficiencies, and capturing market share with a richer mix of products. We are using our unique market position as a specialist and special bar quality steel and components to make progress towards that goal. Now Kris will walk you through the numbers and then we'll be back for your questions.

Thanks Tim. Good morning everyone. Despite challenging market conditions we made significant strides during the quarter to position our business for improved profitability. On a GAAP basis, the second quarter 2019 net loss was $4.4 million or a loss of $0.10 per diluted share compared to net income of $8.4 million or $0.19 per diluted share in the second quarter last year. On an adjusted basis, the company reported net income of $5.2 million or $0.12 per diluted share in the second quarter of 2019. Please refer to the tables attached to our earnings release for a reconciliation of GAAP to non-GAAP financial results. Adjusted EBITDA was $27.5 million dollars in the second quarter, above our previously communicated guidance range. Second quarter adjusted EBITDA includes an approximate $11 million benefit from LIFO as we expect the year end raw material costs to remain below prior year levels, combined with lower inventory quantities. Second quarter 2019 shipments of approximately $248,000 tons were 13,000 tons below last quarter, primarily due to continued inventory destocking in the industrial end market. Overall, we expect third quarter shipments across our end markets to be approximately 25,000 tons lower in second quarter shipments. Looking at each of our end markets, our mobile shipments in the second quarter were 2% below first quarter and similar to second quarter last year. For 2019, the projected North American light vehicle production of 16.6 million units is roughly 2% lower than last year. However, annualized sales have exceeded 17 million units in three of the last four months. With relatively consistent mobile demand and the continuing shift from compact cars to have your SUV and trucks, our focus remains on gaining share in our core products as well as expanding our value added capabilities. We expect third quarter mobile shipments to be similar to the third quarter last year where seasonal impacts from automotive shutdowns. Shipments to the energy market were consistent with first quarter as expected. Share gains during the quarter were achieved through successful execution of our customer service model at OEM accounts, offset by continued inventory management in the distribution channel as a result of the decline in drilling activity and a high level of drilled, but uncompleted wells. This trend is expected to continue for the remainder of 2019 as we expect third quarter energy shipments to be roughly 12,000 tons below second quarter 2019. Industrial shipments decreased 16% compared to the first quarter, primarily driven by continued distribution inventory managements. Bar and tube inventory levels are improving at distributors, but light and market demand is delaying distribution backfill orders. We expect distributors to remain cautious until their calculated inventory levels relative to shipments show improvements. Within industrial, we realized share gains in rail and government, but these gains have been more than offset by softness in the general industrial market. Looking ahead to the third quarter, we expect industrial shipments to be similar to the second quarter 2019. It goes without saying that we're prudently managing variable manufacturing costs to align with demand. This includes closely controlling costs such as hourly employee labor, maintenance and manufacturing consumables. As it relates to consumables, electrical costs trended upwards in the first half of 2019, but at a slower pace than the increase in 2018. In the second half of 2019, we're forecasting electrode costs to decline. Through six months in 2019, variable manufacturing costs flexed in line with volume and are down approximately $30 million compared to the same period in 2018. Please keep in mind however that variable manufacturing costs will increase as volume grows in the future. SG&A expense for the quarter was $20 million or 6% of net sales was approximately $5 million less than second quarter 2018. Focused efforts on cost reduction and lower variable compensation are the primary drivers of the lower SG&A expense. As previously discussed, we proactively launched the profitability improvement plan in early 2019 with projects being implemented that focus on improving manufacturing efficiency, aggressively realizing cost savings, reallocating resources and growing in targeted markets. As Tim noted, given the positive momentum and progress to date, we're raising the annualized profitability improvement target by $10 million to approximately $60 million in total with approximate $35 million to be realized in 2019. Included in the supplementary earnings presentation, is a slide that further describes the components of the profitability improvement target. From a cash cost perspective, we will spend $3.6 million to complete the restructuring activity previously discussed. Remaining cash costs to deliver to the profitability improvement plan are expected to be covered by our existing capital budget. I'd like to share an example of the type of projects currently underway. Within manufacturing, we recently implemented a new system to track and approve the hours worked and rates paid to our outside contractors. Historically, contractor time and rate tracking was performed manually. It was a challenging and time consuming process to manage. This new automated process will improve visibility and control within our contractor spending and I fully expect it is going to result in savings as well. As discussed in last quarter's conference call we amended our postretirement benefit plan during the second quarter to transition Medicare eligible union retirees to an individual plan on a Medicare health care exchange. The change is progressing well with impacted retirees successfully transitioned to their new plan by realizing enhanced benefits and savings. From a balance sheet perspective, this change resulted in a reduction in our postretirement benefit liability of approximately $70 million. The income statement benefit is a reduction in postretirement benefit expense by approximately $6 million in 2019 and approximately $8 million in future years. An additional benefit, is the cash payments from the plan's assets are expected decline by approximately $5 million per year in the future. As a result of this amendment, the company recorded a $4.4 million non-cash loss during the second quarter 2019 from the required planned measurements. This loss was excluded from our non-GAAP reporting of adjusted EBITDA. I look forward to providing further updates in future quarters regarding our progress towards achieving the approximate $60 million target and profitability improvement. Moving on cash flow. Cash provided by operating activities were $16 million in the second quarter of 2019. Adjusted net income and improvement in working capital contributed to our positive operating cash flow for the quarter. Capital expenditures were $8 million in the second quarter. We expect our full year 2019 capital spending to be consistent with our previous guidance of approximately $50 million. This includes any capital required to achieve the 2019 profitability improvement target and substantially complete the St. Clair plant’s expansion in Eaton Ohio previously discussed. Our available liquidity totaled $173 million as of June 30th 2019, an improvement of $8 million since the end of the first quarter now. Now turning to our third quarter outlook, we expect shipments to be roughly 10% below second quarter 2019. Aligning production with demand or result in a decline in plant production levels in the third quarter 2019 they are approximately 47% now utilization from 57% utilization in the second quarter. This lower level of production combined with the second half of our planned annual maintenance of approximately $6 million will have a negative impact on fixed cost leverage and profitability during the third quarter. Partially offsetting these costs, is a projected LIFO benefit of approximately $6 million. As a result, we're forecasting EBITDA in the third quarter to be in the range of negative $5 million the positive $5 million. To wrap up, despite current market challenges, encouraged by the progress during the third quarter or second quarter to position the company with a clear end market focus in an improving cost structure. When combined with the recovery in end market demand, we believe this will drive significant shareholder value. Christina, we now like to open up the call for questions.

Certainly, thank you. [Operator Instructions] Our first question comes from Tyler Kenyon from Cowen. Your line is open. Please go ahead.

Hey good morning.

Hey, Doug.

Yes just wanted to get some clarity around the $60 million productivity target. Tim, I think I heard you say it, but it is inclusive or excuse me it is exclusive of the restructuring actions that you announced in early July? And then secondly, just where are we in terms of the realization of that run rate. In other words, how much have we realized through the first half of the year and how much do you anticipate to be realizing here in the third quarter?

Yes. So the restructuring that we announced a little while back is part of the 60s. And as I said, we would expect to realize 35 million of that in 2019. The bulk of those actions are have been executed and should be in the run rate for the rest of the year.

Okay, so we're kind of at that 35 million run rate right now for the year.

Yes, as we finish the year, we’ll have realized that amount. Right.

Yes. Okay. So are we done?

We're about $10 million in achieved through Q2 and a lot of the actions we put in place such as the restructuring we announced this quarter. We'll have a bigger benefit in the second half obviously than the first half. Same thing on the retiree medical, a bigger benefit on the second half than the first half. So we'll ramp up and deliver that 35 in 2019 by the end of the year.

Okay, great. Thank you. And then just on the maintenance that you're planning in the second half of the year. I think when you include the $4 million that you incurred through the second quarter, the $6 million that you're projecting in the second half of 2019. To me it appears a little bit lighter than normal. So is this part of the cost productivity plan? And secondly, you are clearly planning to reduce production here in the third quarter. And I understand that there's still some inventory that needs to be balanced in the market. But should market conditions improve, grapple with buyers off the sidelines, will you have the flexibility to respond to the market while also taking maintenance down there?

Yes. First the comment on the on the CapEx tied to maintenance. We've actually seen a lot of progress in the efficiency of our spend from a capital budget point of view on spending on maintenance. So we've actually did see the benefit of that. We – I believe we will see that in the third quarter as well as we wrap up the bulk of our maintenance for the year. So that's positive. On the ability to react to the market, we have pulled crewing down, but we're confident that we have the flexibility to adapt or to react to any changes in the market that we see later in the year. So yes, no we're okay there Tyler.

Okay. Great. And are you seeing any encouraging signs to see from customers and those area of the market particularly at the distributors. How long until you think we're a better balanced just within the supply chain?

Well I guess just to two pieces of data. One, if the MSCI bar data that we receive would indicate that they've got their inventory levels down to about three and a half months, which if you look at it by historical standards is not a crazy number. And generally we begin to see restocking in around that that number. We have seen distributors spot filling for holes in the shelves right now. We just haven't seen that that more robust demand signal that we really need to see to turn this thing back on. But I do think there's enough evidence out there that would say that they're being cautious but when they go they're going to go.

Thanks very much.

Yep. Thanks.

[Operator Instructions] Our next question comes from Justin Bergner from G. Research. Your line is open. Please go ahead.

Good morning Tim.

Morning, Justin how are you?

A couple of questions here. So in the second quarter, what came in better than planned? I mean if we take out that 11 million on year-over-year LIFO, I guess you are still at 16.5 million of EBITDA, so what part of the 2Q sort of equation came in better than planned?

And the other piece there was relatively significant in the quarter is the variable compensation which we adjusted downward during the quarter. Bringing that down that -- that was about $7 million of benefit when you compare quarter-over-quarter. So those are the two big items and that gets us closer to prior what you were expecting.

Got it. But you still I mean came in short of your I guess shipment guide. So that was a negative that you had to offset somewhere else. Right or serve another ingredient there? Or was it just a little bit here and there across the different categories like price mix manufacturing?

It is a little bit from everywhere, but the cost reduction as well that's starting to see the benefits that we've implemented and that will continue to benefit us in the future.

Okay, that's helpful. As I look at the base sales price per tonne, it looks to be down in most of your business units excepting for industrial. But if I look at the 2Q one IQ, I guess EBITDA bridge price mix is only a $1 million headwind. So maybe if you could just sort of elaborate on how price mix is trending sequentially in the second quarter and looking into the third quarter, I know there are a lot of moving parts there are a lot of moving parts there.

Yes, there are a lot of moving parts. When you look at just price per ton, mix is a significant driver throughout those end markets that you mentioned. And then you also have a higher level of billets [ph] than you had in the prior quarter as well. So that impacts your mix favorably. But we do see some price changes given the mix change within the product lines.

Okay. Would you say that price then is trending relatively flat sequentially in the second quarter and looking into the third? Would you think a bit think of it on sort of an apples-to-apples.

Yes. Yes. When you get product-by-product. Yes. It's holding. So you have price on an individual product level is pretty apples-to-apples there. It's really in the products. Yes.

All right. That's helpful. On the auto side you mentioned a big win and it seems based upon your guide for the third quarter of I think flat shipments, year-on-year if I remember correctly, that you pride doing a little bit better than the industry, so maybe if you could just quantify or how you think about your level of outperformance in automotive versus the broader market, whether it's wins, or more heavy exposure, versus late auto exposure?

I think there are two primary drivers of it Justin. One is, we as we said we are gaining market share. So we are targeting a specific set of customers in our mobile market to grow our overall presence and we're seeing, we're seeing good results there. But we're also winning new applications, so that some of the $90 million that we talked about coming on late in the year would be new applications for us. And so, and that's across a targeted group of customers as well. So I think its focus, it's having the right value proposition, the right service model and obviously are the differentiation in our technological capabilities I think has positioned us for that.

Okay. Could you elaborate a bit more on the differentiation in technology and service because the service one is not one that you've emphasized so much in the past on calls as well.

I mean, the service model is getting our -- is satisfying our customers and expectation from a delivery point of view. Right. So it is making sure we're operating our facilities in such a way that that our own time delivery rates are high, it's putting the right inventory programs in place to support that, it is targeted programs to put WIPP in place for short lead times, so that that we believe that positions us well relative to our competition. From a technological point of view, we've always -- we've always believed that we differentiate ourselves on our metallurgical knowledge, but also in the case of our value add business, the ability to manage a relatively complex supply chain to provide up at the right product into the right application for our customer. So all of those pieces combined, I believe to and to show the results that you saw in the quarter and for the rest of the year.

Okay that's helpful. And then lastly the 6 million LIFO benefit that you're expecting in the third quarter, that's the 6 million a year-on-year benefit or so last year was a cost….

So last year was the cost. Yes I don’t have, it’s an absolute numbers. So the third quarter, we expect income of $6 million currently forecasted and that would compare with the cost last year I don't have the number right off the top of my head, but it would be a change there is a bigger than $6 million number.

Okay. So the 6 million is comparable to the 17 second quarter and the absolute.

Absolute.

And absolute, yes absolute. Okay. Thanks for taking my questions.

Thanks Justin.

Our next question comes from Phil Gibbs from KeyBanc Capital Markets. Your line is open, please go ahead.

Hey, good morning. Tim, Kris how are you?

Good.

As we look out into the third quarter just relative to the second, are you expecting much of an impact positive or negative from raw material spread?

You have the busheling starting to show signs of trending upward. That should help us. That's been factored into our guidance, this 20 or so dollar improvements that we expect to see here in the next month. But that's always factored in thus far. Anything beyond that would be a benefit for us.

So a little bit of a benefit relative to Q2 factored in. And then your earlier comp your earlier comments on electrodes and refractory and alloys, I guess consumables in general. There is some release there that you're seeing or you're just saying that from a trend standpoint, it's moving in that direction and you eventually expect to see the release. I just want to qualify that.

Yes, we're starting to see it in the second half. We go typically on six month arrangements in the electrode market.

And then last question just on net working capital. What are you expecting that working capital to be in the second half in terms of a source or use and specifically what do you anticipate your inventory positioning to end the year? Thanks.

So we're actively managing working capital as we've done in the past. Working hard to manage that down, but at the same time make sure we're positioned for any recoveries in the market. But we'll be closely managing inventory levels as we approach the end of the year, trying to reduce where we can. But like I said, not impacting the customer service model. Sorry I can't give you a specific number other than to say, it's a focus for us.

Thank you.

And our next question comes from Justin Bergner from G. Research. Your line is open. Please go ahead.

Oh, thanks. One quick follow up here. The industrial, I guess shipment guidance were flat quarter-on-quarter in the third quarter. Is that assuming some end to de-stocking. I'm just sort of looking back and I guess historically it looks like you've been relatively flat sequentially in industrial third quarter versus the second quarter. I mean, I would assume the demand is still stepping down a bit sequentially, so are you're getting some benefit on the end of destocking side there, and how you're looking at the shipments for the third quarter?

Our expectation on the third is that it's pretty flat, that the distributors are still going to be pretty cautious in going from destocking to restocking.

So then the demand outlook for industrial would also be sort of flat sequentially. If you're thinking about flat shipments in the third quarter.

Probably, probably a little bit of a mixed bag some up some down.

Okay. And on the on the energy side, are you suggesting that there's also going to be de-stocking there that's weighing on the third quarter or the second quarter or is there also some weakening in demand that's contributing to the down 12,000 tons?

I think the problem is that there's just no demand coming out of the sector. I mean, that level of activity is very very low right now. So we just see that kind of stay in where it is right now based on what we're seeing from a -- from a rig count foot drill. The DUC inventory all of the factors that we look at says that they're just going to sit tight for the third looks like.

Okay. That's helpful thanks.

All right, thanks Justin.

And there are no further questions at this time. I turn the call back over to Tim Timken for closing remarks.

Well thank you all for your questions today. If you have any additional questions, please don't hesitate to contact Jennifer. Thanks again to our employees who are dedicated to making TimkenSteel better each day and to you, for your continued interest and support of our company. I look forward to updating you on our progress next quarter. Thank you.

Thank you. And that concludes our call today.