Metallus Inc (MTUS) 2014 Q4 法說會逐字稿

Good morning. My name is Michele, and I will be your conference operator today. At this time, I would like to welcome everyone to the Timken Steel fourth quarter 2014 earnings call.

(Operator Instructions)

I would now like to turn the call over to Miss Tina Beskid. Please go ahead.

Thank you. Good morning, and thanks to all of you for joining Timken Steel's fourth quarter 2014 conference 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 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 conference 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 Timken Steel Corporation. We prohibit any use, recording or transmission of any portion of the call without our expressed advanced written consent. There will be an opportunity to ask questions at the end of Chris's prepared remarks. With that, I would like to now turn the call over to Tim.

Thanks Tina. And thank you all for joining us. 2014 was a great year for Timken Steel. We performed well both operationally and financially through a disciplined focus on delivering results for our customers and our shareholders. We grew both top-line and bottom-line results in the fourth quarter and for the full year.

Over the prior year quarter, sales increased 24% with volume increases in both energy and industrial markets. The full year showed 21% growth. EBIT was up 51% over adjusted 2013. Adjusted earnings per share were up 53% which generated $2.11 per share, (technical difficulties) [33,000] shares of common stock at an aggregate cost of $31 million.

Our team not only maintained a sharp focus on financial and operational performance, they did it while addressing the additional priorities that came along with an exciting and historic year, our first as an independent company. We stood up this new company in an efficient way, building a lean corporate structure that is comparable to our peers.

We completed a five-year investment program in our operations, which culminated in the commissioning of our jumbo bloom vertical caster, the only one of its kind in the world. The caster, together with the in-line forge press that came online in 2013, further strengthens our ability to provide special bar quality steel in large sizes for the most demanding applications. This unique set of assets solidifies our competitive position and contributes to more efficient operations.

We also embarked on a new phase of our growth strategy, positioning Timken Steel to bring even greater customer and shareholder value in the years ahead. First, we began to work to add capacity in our most sophisticated and profitable product lines, advanced quench-and-temper heat-treated steels. When the new facility opens in 2016, it will serve a variety of markets and be especially valuable in positioning us for a rebound in the energy markets.

Second, we are close to finishing work on one of the most advanced special bar quality technology centers in the world. The center will support the kind of technical capabilities that keep us as an industry leader and result in continuous new product development.

We are also further extending our reach with the renewal of our global agreement with Daido Steel. That collaboration expands our global presence and accelerates our ability to access Asian markets.

We are also working with Daido to serve their Japanese customers, who are operating here in the United States. These are just a few of the examples, and there will be more to come.

We are evaluating paths to growth through acquisition of, and cooperation with, other companies who might fit our value proposition in adjacent areas. We remain committed to our capital allocation strategy, evaluating inorganic opportunities for our engineered products in high-end markets.

Investment in growth is a priority, as is our intent to repurchase at least another 2 million shares of common stock in 2015. These repurchases reflect the confidence we have in our strategy and our ability to reinvest in our business for the long-term profitability while driving initiatives that return capital to our shareholders in the short term.

As focused as we are on long-term performance, we know that navigating short-term obstacles in the marketplace is part of operating a steel company. 2015 will be a challenging year, particularly in the energy sector. We believe in energy markets in the long term, but as I said, we anticipate weaker oil and gas markets this year due to lower oil prices and the associated decrease in energy exploration and production spend.

In our energy and distribution segment, we expect shipments to be the highest in the first quarter with declines sequentially thereafter. We also have a long track record of using down markets to continue to build the business and accelerate performance when markets rebound.

So we will be concentrating on executing our strategy this year. Our new heat treat capabilities, which will come online in 2016, are a great example of that.

It is likely that scrap prices will also be a headwind for us. The rising dollar, coupled with low demand out of Europe, is compressing prices. Therefore, our raw material spread will likely be less favorable than in 2014, negatively impacting margins.

This isn't the first time we have ridden this roller coaster. We understand these types of cyclical challenges. In fact, we are prepared for them in the strong markets.

Every new engineer who joins us is assigned a continuous improvement project to immerse themselves in that culture from day one. And when we hit more challenging markets, we batten down the hatches to manage capital wisely, and spend with discipline.

But equally important, we begin to prepare for the inevitable upturn so we can rebound in a stronger position. This sort of discipline at all points in the cycle is what has made us successful and it is a tremendous advantage.

The challenges of the year ahead are not the whole story. We see bright spots in the industrial and mobile markets which remain favorable.

We expect shipments to follow normal seasonality, and we will see growth in our industrial end markets. That rate will be slower than 2014, but growing. We also expect automotive demands to remain strong.

This Company has been around for 100 years; its management team has decades of experience in the steel industry. This year, market dynamics may be a bit different, but in every cycle, the dynamics are different.

We believe Timken Steel is well positioned to manage through this environment. We have strong market positions and positive indicators in a number of our end markets.

We will add capacity in our most profitable product lines, including those that serve the energy markets, not only to recover, but to grow. We have a great track record and a sharper focus than ever on delivering value for both this year and over the long-term.

Before I wrap up my comments I want to extend my thanks to all of you and to the shareholders who invested in us, to our employees have dedicated their expertise and hard work to Timken Steel, and to our Board of Directors, who just yesterday added two additional members who bring great depth of market and functional expertise. I would like to welcome Randall Edwards, President and COO of Premier Pipe LLC as well as Ron Rice, President and COO of RPM International Inc.

Chris is going to take you on a deeper dive into the numbers, and when he's done, we will open it up and allow you to ask questions. Chris.

Thanks, Tim. Sales for the fourth quarter were $408 million, an increase of $78 million or 24% from 2013. Increased demand from energy, industrial and automotive end markets were the primary drivers of the sales increase.

The Company shipped 270,000 tons in the quarter which was a 26% increase over 2013. Geographically, 97% of the sales were to North American customers in both years.

Gross profit of $56 million was flat to the fourth quarter of 2013. Gross margin of 13.8% for the quarter was 310 basis points lower than the fourth quarter of 2013. Favorable volume and mix were more than offset by raw material spread, LIFO, higher electricity and separation related costs.

For us, raw material spread is the difference between our raw material costs and the number one busheling index which we used to calculate surcharges. The raw material spread is primarily caused by movement in the busheling index that creates a timing impact as the price paid for raw materials can differ from the busheling index at the time the finished product is shipped.

We also buy various types of scrap, not just busheling, which can contribute to the spread. In the second half of the year, the busheling index dropped by about 10%, which compressed EBIT margins by 270 basis points in the fourth quarter.

SG&A was $30 million for the quarter, which was in line with last year's adjusted figure. SG&A was 7.3% of sales, which represented a decrease of 180 basis points from last year.

EBIT for the fourth quarter came in at $24 million, representing an increase of 6.1% over the same period a year ago. Fourth quarter 2014 EBIT margin was 5.9% compared to 6.9% last year.

The effective tax rate for the quarter was 29.8%. The lower quarterly rate was driven by deferred tax adjustments recorded in connection with the June 30 separation.

On an adjusted basis, the fourth quarter 2013 tax rate was 35%, which is the rate we expect going forward. As a result, net income for the quarter was $17 million or $0.37 per diluted shares.

Now I will walk through the business segment results. In our industrial mobile segment, sales were $235 million for the quarter, an increase of 15% from last year. Industrial end market sales increased 39%, primarily due to general economic improvement.

In the automotive sector, revenues increased 4%, in line with rising North American cargo weights. EBIT of $13 million for the quarter was flat to fourth quarter of 2013, while margin dropped 60 basis points versus the same period. Increased volume and improved mix impacts were offset primarily by unfavorable raw material spread and electricity costs.

In the energy and distribution segment, sales were $174 million in the quarter, up 38% over the prior year. The energy end market sales increased by over 50% from the prior year, and benefited from a 9% increase in US rig count and more balanced inventory in the channel compared to 2013.

Industrial distribution revenues increased 17% and were helped by stronger US economic activity. EBIT for the quarter was $15 million or 8.6% of sales compared to adjusted EBIT of $9.7 million or 7.7% of sales last year. The increase in earnings is primarily driven by a [30]% increase in shipped ton volume offset by unfavorable raw material spread and electricity costs.

Turning to the balance sheet, we ended the quarter with cash of $35 million and net debt of $151 million, resulting in the net debt to capital ratio of 16.1%. We spent $30.6 million in the quarter to repurchase 833,000 shares of common stock or 1.8% of our outstanding shares.

Operating cash flow for the quarter was $25 million, reflecting the solid EBITDA for the quarter, partially offset by working capital requirements. Working capital net sales was 19%, and again reflects our efforts to balance service with efficient working capital management. Free cash flow for the quarter was $21 million use of funds after capital expenditures of $52 million.

Now I will turn to the 2015 outlook. For the full year in the industrial and mobile segment, we anticipate demand to remain strong in both automotive and industrial end markets and that quarterly revenues will follow normal seasonality patterns. In the energy and distribution segment, we look for lower sequential quarterly revenues through the year due to lower oil prices.

From an operations view, we expect lower sequential melt utilization and some headwinds from raw material spread. From a capital allocation perspective, we estimate 2015 capital spending will be between $90 million and $100 million, which is about $30 million less than our previous guidance. Additionally we anticipate repurchasing at least 2 million shares in the year, which will put our balance sheet to use and move us closer to our targeted leverage.

For the first quarter of 2015 we expect our revenues to be in line with the fourth quarter of 2014, with a shift in mix to the industrial and mobile segment from energy and distribution.

This ends our formal remarks. We will now answer any questions.

(Operator Instructions)

The first question comes from Luke Folta from Jefferies. Your line is open.

Good morning everyone. A number of questions here. I guess first because it's the focal point of the moment, the pullback we've seen in the oil and gas demand environment. Can you give us some sense in terms of magnitude of what you're seeing in the order book in that space right now?

And I guess in a broader context, when we think about the pullback that happened for the second half of 2012 and more so the 2013 timeframe now across the business. I guess can you compare and contrast what this year looks like with some of the moving parts relative to the 2013 timeframe when EBITDA was as low as $160 million?

Let me talk a little bit about order book, and then I will have Chris try to wrap some numbers around it for you. Right now, we are looking at a relatively solid first quarter.

I mean, the shipping rates in January are good. February looks solid, March as far as we can see looks okay, but obviously with rig count coming off, we will begin to feel that here eventually.

We have really pulled our lead times in, and so that is affecting our visibility a little bit. But so far through the first quarter, things look okay.

I think you can -- everyone has got their own estimate on rig count, Spears is out there with a pretty low number and there are a number of other ones. But I think right now it is all speculation at this point.

So compared to 2012, I will let Chris walk you through that. But right now, we have ridden this cycle before. We know what to do, we are battening down the hatches, looking at accruing, those kinds of things.

I think we're doing everything we need at this point. So Chris, do you want to take the rest?

Yes Luke, how are you? Your question is comparing 2014 to 2012?

Yes, 2013 was the bottom end of the last cycle where oil and gas demand pulled back and some other oil markets were weak. And of course, pricing has changed a bit since then and you've done some investments. So I just wanted to see if you could put in context just how some of these factors come together and what 2015 could look like relative to the last down cycle number that we have to compare to?

Right. So the primary thing would be the energy markets will be weaker in 2015 than they would've been in 2012. So that's big.

I think from a raw material spread, we will probably be a little less favorable than we would have been in 2012. And as you saw in our supplemental slides, our pension costs are going to be due to primarily discount rate change since 2012 and this mortality change. Those would be the three largest items.

Okay. I guess I was thinking more toward 2013. Because 2013 was really the trough in earnings.

Yes, and all three of those would apply to 2013 as well.

Okay. And then we think about pricing, some of the folks we spoke to heading into contract negotiations this year gave us an indication that contract prices for a lot of the business would be up somewhere in the neighborhood of $10, $35, $40 a ton. Can you give us some sense of how the contract negotiations went this year for your annual type business?

I would say in general given market conditions, our negotiations went reasonably well across all of our end markets. With falling scrap, with a number of the other market dynamics, I think we did okay.

Our bigger issue is going to be on mix. With the energy side coming off, we are obviously going to feel the pinch of that. The automotive markets though remained strong.

Industrial markets for the most part, with a few exceptions like mining and agriculture are all feeling pretty good. So that translated through to a pretty good negotiation season.

Okay. And then on the raw material price spread. The terminology is a little bit different than what I'm used to thinking about in that respect.

When you discuss that, you are referring mainly to the difference in -- it's a mostly timing difference between when your inventory costs catch up with the dollar movement in the market prices. Is that the right way to think about it? Or is there something embedded in there where if scrap prices are lower, you just make less money on that sale?

No, you've got it right. Primarily the issue is around timing. The biggest issue is when markets are ramping up and we have 100 days of inventory, so you get a good guide from that inventory.

When the index goes down, then it goes the other way. But once markets stabilize, then the timing impact disappears after the inventory's burned through.

Okay.

One other thing that we get a little bit, is change in index. So remember, it's index change and how the scrap that we buy, we don't necessarily line up with the busheling index which we used to surcharge our customers. That would be the second half of the equation.

Right, but I imagine that averages out over time?

Yes it does.

Okay. And then with the expectation for scrap to come down this year, how are we thinking about LIFO impact?

By and large, you see LIFO offsetting to a very large degree the scrap spread impact.

Okay. And one last question. Thank you for allowing me to ask all the questions.

The share repurchases, you mentioned 2 million shares at least for this year as a minimum. How high would you go on the max? Just give us some sense of how to think about it.

We had a board approved plan of 3 million shares. We did 833,000 so far, so we would look to complete that program through 2015. And depending on market conditions, we will come back and look at it again.

Okay, thanks Tim.

Thanks Luke.

The next question comes from [Barry Hanes] from [Citi].

Good morning. A couple of questions. One, just with the startup of the bloom vertical caster, I was wondering if you could talk a little bit about how that has gone so far versus expectations? If you could just give us a little color for how that's running so far?

The ramp has gone extraordinarily well. We are seeing quality out of this piece of equipment that quite frankly is exceeding our expectations, surface finish, interior cleanliness.

I mean, it really is surprising us daily to the positive side. So that has gone well.

The customer certifications we're on track, and we will continue to ramp those through the end of the year. I think we have a ramp schedule in the advance deck that we put out that gives you an idea of where we will end up for the year. So in general I would say it has gone extraordinarily well.

Great. Terrific. The second question is on energy. As you point out, it is a moving target. But I was wondering if you could give us a little bit of color on what you're hearing from customers so far?

And then just a reminder on how much of the exposure is exploration. So it would really move up and down with rig count versus how much if any might be production that might tend to be relatively more stable? Thank you.

Obviously there's a lot of uncertainty in the energy markets right now. This thing went faster than anybody was I think prepared for, and it went deeper than most people expected. So to a certain extent, people are still catching up and catching their breath.

What we are hearing and what we are seeing in our order book as I said earlier is people are taking first-quarter and then sitting tight managing their inventories into the second half. And we will see how that shakes out.

As I said, we pulled our lead times in to try to pick up any business that is out there. So we will see how it plays out.

I'm a little bit more optimistic I guess than most. I think we have ridden the oil cycle before. We know that when it snaps, it generally snaps back quick.

There are obviously some different market dynamics this time. But this thing might've been a little bit overcooked. So that's the approach we're taking.

We are managing our capital as Chris pointed out. We're managing our spending.

We've got our inventories, we are getting our inventories where they need to be to reflect the different market place. So we are pulling all the right levers at this point.

I will let Chris talk a little bit about the exploration versus the production side.

I think by and large, most of the sales are in the exploration, and we would probably categorize that as three quarters.

Great. Thank you. And then my final question is on the share repurchase, have you bought stock in January so far? And if so, can you let us know how much? Thank you.

Yes we did buy shares in January, and for a rough number, say 100,000 shares.

Great. Thank you.

Thank you.

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

Good morning Tim, good morning Chris, good morning Tina.

Good morning.

I have a handful of questions. So if you want me to get back in the queue at any point, just let me know. For starters, I was wondering if you could just help us better understand the mix headwind and maybe noting that there was a mix headwind in the fourth quarter versus the third quarter? Any color you can provide on the sequential change of energy and distribution shipments within that segment would be helpful?

What we guided to was for 2015, we looked for lower sequential sales in oil and gas. The mix impact really gets to be -- we have some great positions in the energy market, and we provide products that have quite a bit of value.

So from a mix perspective, if some of those sales come out, it is unfavorable to our mix. And then sequentially, we really didn't have much of a mix prob from 3Q to the 4Q.

Said a little bit differently, we really haven't seen the impact of this cycle yet. We didn't see it in 2014, and as I said the first part, January February 2015, shipments are actually relatively decent.

So the impact that you saw was from Q3 to Q4 was normal seasonality. People taking time out at the end of the year. So no significant impact at this point from a volume point of view.

Okay. So the $10 million sequential decline in the EBIT bridge in the fourth quarter due to volume, price and mix, you would describe as normal relatively?

It's normal seasonality Q3 to Q4. People taking time out around the holidays. We had some manufacturing spending, some cost that we put into the facility. So I would say it's probably close to normal.

Yes, and is very much volume driven.

Okay. Okay thank you. Two quickies just in terms of financials. The CapEx reduction to $90 million to $100 million, what is primarily being delayed or curtailed in that $30 million stepdown?

We just had some projects on the drawing board that we hadn't announced that we just deferred out to the future. And we had a couple of belt tightening measures.

Justin, you will remember, our average annual maintenance CI spend is in the $50 million to $55 million range. We still have some growth capital in there on the [etrade] side of things. As I said, we will continue to position ourselves to grow over the long term by spending those dollars.

Yes, and specifically if you recall in July, we announced our advanced quench-and-temper facility, and we are going forward with that. That's one of the larger growth items in the capital budget for 2015.

Okay. And on pension, are you finishing the year in relative pension balance noting that you were in a surplus when you spun off from Timken?

That's a great way to categorize it. If you look at the plans that we fund, we're very close to 100% funded at year end. We have an unqualified plan that's unfunded that makes up any difference. So all in, we call it 98% funded at year-end.

That's post mortality change?

Yes, that's post mortality change.

Okay. And then just in terms of strategic direction for the company. I guess earlier in your remarks, Tim you mentioned inorganic opportunities being of interest. Then you qualified the area of interest. Can you provide a little more color there?

Justin, we have been clear from day one that growth is a priority of the business and that we saw a lot of opportunities inorganically in the value add space. It is taking our product to the next level of completion. So the strategy worked that we have done since the separation has been focused on identifying those opportunities.

Obviously I don't want to be too clear on where those are. But we have seen a number of opportunities come up of late that will move the needle for us. So we are in hot pursuit at this point.

Okay. Is the Daido collaboration a large opportunity? Or how should I see that in terms of changing the future trajectory for the company?

We have had a long relationship with Dido from a technical point of view. And they have obviously helped us from an operational point of view, but we also have some commercial agreements where we can take some of their product into parts of Asia that they don't currently serve.

Those are interesting opportunities, would I call them huge? No. Probably not. But I think it is teaching us about some markets that we have not been in, in the past. So we will continue to pursue those.

Okay great. Thank you. And then my last question because I've been on for a while, is the two new directors. Was there any trigger for adding those directors to the board at this particular time?

No. We have all said all along that we were targeting nine directors. We had seven, and I have been running the process for the last three or four months to try to identify some specific experience.

And in the case of Randall, he brings deep oil and gas knowledge. And given where we are in the oil and gas cycle, we probably couldn't have brought him on at a better time.

And then Ron has a varied background but very good operational focus. His prior life was at Watson Wyatt, so he knows the numbers, pensions, those issues. So it was really about filling out my skill matrix and nothing other than that.

Okay. Great, thank you for taking all of my questions.

Thank you Justin.

(Operator Instructions)

Your next question comes from Eric Andersen from Western Standard, your line is open.

Thank you. Good job growing your energy and distribution segment revenue and EBIT very well in 2014. It appears that incremental margins over the past few years have been about 30%. Is that how you guys see them?

Incremental margins? Yes, in the energy and depending on the mix and where we are in the cycle.

One of the things that happens from a margin perspective is that when markets are going hot, in the past we've run out of quench-and-temper capacity. So that's one of the reasons we are in the process of adding more quench-and-temper capacity because it really is accretive to our margins.

Okay. So that helps me understand operating leverage, and if you guided your energy and distribution revenue falling sequentially to quarter, those incremental margins will become detrimental margins at about 30%. Is there any cost cutting that can lessen the impact?

There is clearly going to be a decrease in margins, and we are not going to probably at this point call and quantify what those are. But to the extent that we have revenues coming out, we will take appropriate cost measures too.

Okay. Thanks for that color. Maybe another way to look at is, obviously the number of drilling rigs operating in North America's the most important driver for your energy and distribution segment.

So following up on the Jefferies analyst question. At the current time, drilling rigs are I think about 1600, maybe1633, which I think is lower than any point at 2013 which he was noting. So 2013 energy and distribution EBIT was $45 million, is it likely that 2015 energy and distribution EBIT is lower than that if we are already below 2013 drilling rigs?

It is tough to make a call on where 2015 is going to come out in terms of the energy markets. Clearly it is a very profitable market to us, and to the extent we have revenues that come out, it is going to be detrimental to all of our margins.

Okay. Sorry to push so hard on this, but if oil stays down here at $45, $50 a barrel, will the energy and distribution segment generate positive EBIT? I guess maybe another way to think about it is if 12 months from now you're reporting Q4 2015 results oil is $50 a barrel, would Q4 2015 energy and distribution segment EBIT likely be negative?

This is an interesting question Eric, because I think as oil comes back, the question is what is the new norm going to be and how quickly does it come back? So we haven't been able to make a perfect call on how quickly the markets will come back. So it is probably a question I don't want to get too deep into.

I guess the other comment I would add to that is that our distribution also flows through our energy sector as well. And right now, we are calling -- industrial distribution is being relatively flat. And that obviously is going to help from a profitability point of view.

Okay. Great. A couple of days ago, Nucor addressed two challenges to their business. The first was the energy industry which obviously you've addressed.

The second was high levels of imported steel. Can you tell us the historical percentage of imports in your SBQ and seamless categories and if that is changing with the strong US dollar?

Traditionally on the SBQ side, we have seen like a 20% at any given time. It goes up and down a little bit, of the market being served by imports. Obviously with the dollar doing what it's doing, we are seeing more of that in this current cycle.

So we are obviously a little bit out of Asia, Korea, so we are seeing pressure. But obviously to this extent we can drive differentiation in our product mix, that gives us little bit of a buffer. But it is getting tougher.

Okay. How much debt are you willing to take on to ensure you buy back 2 million shares this year?

We are willing to do whatever it takes from a share repurchase to get our 2 million shares. We just think it's a good investment.

We've got a strong balance sheet to be able to do it. And at this point, we're very confident that we will execute on those 2 million shares.

Okay. I guess when you spun off, one of your key strengths was you had a much better balance sheet than the average steel company. And your year-end net debt was a little higher than I was thinking it would be at about $151 million, a little higher even than that when you include pension liabilities.

Based on at least how I'm modeling this, based on the number -- the drivers we discussed it seemed like 2015 EBITDA is probably at best $150 million. So you are already one turn levered.

So I will caution you to follow the advice my high school girlfriend frequently gave me and not take it slow, particularly when it comes to buybacks. You bought that stock last quarter at about $10 a share more than it's trading today.

Your high school girlfriend was very were wise.

Not in my eyes. But thanks a lot. I look forward to next quarter's results.

Thank you.

At this time, I have no further questions in queue. I will turn the call back over to presenters for closing remarks.

Thank you for joining us and for all the good questions. 2014 was an exciting and very successful year for the Timken Steel Corporation. We believe our business model and our people and the assets that support it and make us a leader in the industry.

This year is a clear proof point of that. In fact we also have a long track record of succeeding in both up and down markets. Our long experience in the steel industry has well-prepared us to continue to drive customer and shareholder value.

I want to thank all of you as our shareholders for your continued support of the company. If you have any follow-up questions, please don't hesitate to contact Tina. With that, we will sign off. Thank you.

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