Metallus Inc (MTUS) 2015 Q1 法說會逐字稿

Good morning. My name is Melissa and I will be your conference operator today. At this time, I would like to welcome everyone to the TimkenSteel first-quarter 2015 earnings conference call.

(Operator Instructions)

I would now like to turn the conference over to Ms. Tina Beskid, Director of Investor Relations. You may begin your conference.

Good morning and thank you for joining TimkenSteel's first-quarter 2015 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 conference call, we may make forward-looking statements as defined by the SEC. These statements relate to our expectations regarding future financial results, plans and business operations, among other matters. Our actual results may differ materially from those projected or implied due to a variety of factors, which we describe in greater detail in today's press release, supporting information provided in connection with today's 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 TimkenSteel Corporation.

We prohibit any use, recording, or transmission of any portion of the call without our express advance written consent. There will be an opportunity to ask questions at the end of Chris's prepared remarks. Now I would like to turn it over to Tim.

Thanks, Tina, and thank you all for joining us. Last year, we stood up this Company with the right structure and size, and on the strong foundation of a unique to business model. We have a clear strategy to expand our leadership position in profitable niche markets that require specialized steel for demanding applications.

We are confident that the strategy will deliver a long-term value to both our customers and our shareholders. We remain focused on long-term performance, but also know that navigating obstacles in the marketplace is part of operating of a steel company. As I said in our last call, 2015 will be a challenging year, but we're up for that challenge.

In the first quarter of 2015, we delivered increased volumes over this time last year. We had good performance in our Mobile and Industrial segments, which is more than one-half of our business. While that performance met expectation, we were faced with a number of headwinds that pressured margins.

The volatility in the scrap markets in the first quarter hit us hard in March, as higher-value scrap was indexed at significantly lower levels. This, combined with higher manufacturing costs, had a significant impact on profitability.

Obviously, the elephant in the room is the activity in the oil and gas sector. While we knew oil and gas demand would be low in 2015, North American rig count collapsed a lot quicker than anyone envisioned.

First-quarter shipments to the sector actually were not that bad, as we worked off our backlog. We will feel the true impact of that lower demand in the second quarter, when EBITDA will be somewhere between break-even and a $15 million loss. Chris will talk about this in a few minutes.

It's a tough environment, but we are a better business over the entire cycle, with oil and gas in our mix, and the oil and gas industry is better for the product innovation that we provide. When markets are down, energy customers value the industry-leading quality and service we provide. When markets are good, there's huge demand for the kind of sophisticated products that we offer, highly alloyed steels, seamless mechanical tubing, and boring, machining and other value-added services.

As a result, we're preparing for both parts of this cycle. We've been taking actions to deal with the current environment, while also taking steps to be even more competitive during the inevitable upturn.

First, we're focused on tightly managing working capital. We've significantly reduced costs by quickly scaling operations to demand. We're cutting about $25 million in costs throughout the Company, going beyond our ongoing continuous improvement efforts and identifying much deeper spending reductions.

We're also continuing to invest, focusing on areas that will deliver even greater value when the environment rebounds. We opened a new technology center in Canton, Ohio this quarter. We're combining sophisticated research and development equipment and a team of people who are leaders in their discipline to improve the performance of our customers' applications.

Our ability to reduce customers' total costs reinforces our long-term competitive position. This focused SBQ technology center is unique in North America.

Our investment in operations are another example of how we will support our long-term strategy. The start-up of the vertical caster is exceeding our very high standards for performance in both efficiency and quality, and we continue to ramp production.

About 20% of melt capacity of the Faircrest Steel Plant now moves through this operation. Combine that with the in-line forge press and we have a truly unique set of access; quite frankly, we're able to execute innovation that others can't.

We're also continuing to work on our new advanced quench-and-temper facility here in Canton. When this thermal treatment facility is operational in 2016, we'll have capacity for 50,000 processed tons the annually of 4-inch to 13-inch bars and tubes in our most profitable market. These are some of the most sophisticated products that we make and they are in sell-out demand in strong markets.

These are just a few of the examples of investment that fuel organic growth. Obviously, we are also continuing to evaluate opportunities to grow inorganically. This market will be challenging, but our leadership team has been here before.

We're taking the right actions to deal with this environment, while also investing resources, both money and brain power, to fuel the business model that delivers value to our customers and shareholders over the long-term. Customers trust the TimkenSteel brand, and that's a powerful competitive advantage in any market.

Now Chris will take you into a deeper dive into the numbers.

Thanks, Tim. The first quarter was in line with expectations in all respects except that scrap prices dropped more than anticipated. As we discussed in prior calls, declining scrap costs negatively impact our results because of the timing associated with our customer surcharge mechanism.

The surcharge we pass on to our customers is generally about three months after the scrap is purchased. As a result, we end up with a timing difference between how much we pay for the scrap, and the surcharge recovery. The sequential earnings impact from the fourth quarter was $9 million unfavorable and we expect to have a similar sequential financial impact in the second quarter.

Sales for the first quarter were $389 million, essentially flat with 2014. Base sales increased by $13 million from the prior year, but were offset by lower surcharges of $14 million.

Base demand was higher in both segments than the prior year. The Company shipped 271,000 tons in the quarter, which was an 8% increase over the first quarter 2014. Geographically, 97% of the sales were to North American customers in the first quarter of both years.

Gross profit of $42 million was $32 million lower from a year ago. The decrease in gross profit was driven primarily by raw material spread and higher manufacturing costs, partially offset by increased volume price mix and LIFO. The unfavorable raw material spread was driven by timing associated with the declining scrap costs, which I previously discussed.

Manufacturing costs were higher due primarily to timing related non-structural items, along with additional depreciation expense associated with the caster and higher pension costs and mortality table changes that we noted last quarter. Gross margin of 10.7% for the quarter was 820 basis points lower than the first quarter of 2014. Melt utilization was 66% in the quarter compared with 65% for the first quarter of 2014.

For the quarter, SG&A was $29 million, down $1 million or 3% from last year's adjusted figure, due primarily to lower variable compensation costs. SG&A was 7.5% of sales, an improvement of 20 basis points from last year. EBIT for the first quarter came in at $11.2 million, or 2.9% of sales, compared with adjusted EBIT of $45.1 million, or 11.6%, for the same period last year.

The income tax rate for the quarter was 37.8%, higher than the prior year due to the absence of the Section 199 manufacturing deduction in 2015 and some higher state tax rates. For 2015, we expect our tax rate to remain around 37%. As a result, net income for the quarter was $7 million, or $0.15 per diluted share.

Now I'll walk through the business segment performance. In our Industrial and Mobile segment, sales were $234 million for the quarter, essentially flat from last year. Base sales increased by $9 million, or 6.4%, while surcharge revenue decreased by $8 million.

Industrial base sales increased by 12%, as demand grew from the general industrial, machinery and rail sectors. Mobile base sales increased by 3%, in line with expanding North American automotive demand.

EBIT for the quarter was $4.5 million, or 1.9% of sales, compared with adjusted EBIT of $24.2 million, or 10.4% of sales last year. Improved volume-price mix was more than offset by unfavorable raw material spread of $13 million and higher manufacturing costs.

Energy and Distribution sales were $155 million in the quarter, down $2 million, or 1.6%, over the prior year. Base sales improved by $5 million, or 4.5%, while surcharge revenue decreased by $7 million.

The energy end market base revenues fell 9%, as US rig count began to decline sharply. US rig count was down year-over-year by 20%, and is expected to decline by almost 50% in 2015.

The industrial distribution channel's base sales were up 25% over the prior-year quarter from stronger markets and improved inventory balances. EBIT for the quarter was $4.6 million, or 3% of sales, compared with adjusted EBIT of $25.1 million, or 15.9% of sales, last year. The decrease in earnings was driven primarily by raw material spread of $9 million, product mix, and manufacturing costs.

Turning to the balance sheet, we ended the quarter with cash of $31 million and net debt of $164 million, resulting in a net debt-to-capital ratio of 17%. Operating cash flow for the quarter was $15 million, reflecting the earnings for the quarter offset by an increase in working capital, primarily from lower accounts payable as we started to reduce inventory.

Working capital net sales was 18% and reflects our efforts to reduce inventory in line with lower demand. Free cash flow for the quarter was a $3 million use of funds after capital expenditures of $18 million. We repurchased 96,000 of our shares in the quarter for $2.9 million.

I'll turn to the second-quarter outlook. In the first quarter, we did not feel much of the impact from deteriorating fundamentals in the oil and gas markets, as our order book was able to sustain revenues.

In the second quarter, we could see the lowest revenues for the year. Our energy-related customers have significantly reduced orders and are rapidly taking inventory out of the channel.

Some of our industrial customers are also feeling the impacts from lower oil prices. As a result, we expect our second-quarter shipments in the energy and distribution segment to be about 50% lower than the first quarter. We anticipate that revenues in the Industrial and Mobile segment will be in line with the first quarter, and follow normal seasonality in the second half of the year.

The perfect storm from the drop in energy-related demand, lower utilization, impacts from reducing inventory, and lower raw material spread will likely result in EBITDA for the second quarter to be between breakeven and a loss of $15 million. Our operating model reacts quickly to demand changes and we expect favorable cash flow in the second quarter, as we significantly reduce working capital and operating costs.

Our cost reduction efforts, which include headcount reductions and temporary plant shutdowns, will be fully in effect in the second quarter. On an annualized basis, we expect to take out $25 million in costs, with most of the savings beginning in the second quarter of the year.

From a capital allocation perspective, we estimate 2014 capital spending to be between $80 million and $90 million, which is $10 million less than our previous outlook. We are still committed to executing on the Board-approved share repurchase program, but given the current outlook for the second quarter, share repurchases could be at a slower pace. We will continue to evaluate repurchases as the year unfolds.

Obviously, we're disappointed with our outlook for the second quarter and are taking significant cost reduction actions in light of the environment. Our operating cost structure is highly variable, which allows us to rapidly reduce costs and working capital. Most of the $25 million cost reduction tactics are already in place and we will take additional taps, if warranted.

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

(Operator Instructions)

Luke Folta, Jefferies.

Just some questions on the second quarter. The EBITDA guidance, are you able to give us some sense of how that would split up between the divisions? Just trying to get a sense of what the lower production utilization from E&D, how that translates into the IM segment.

Yes, let me take that, Luke. A couple things. As you know, our resources are shared, and so when you have lower demand in one segment, it can have adverse impacts. So there will be negative leverage impacts that fall over into the Industrial and Mobile segment from Oil and Gas.

Overall, if you look at the second quarter, the big impact, obviously, is going to be the lower demand from oil and gas, and that's going to be the single largest driver of earnings in the second quarter. And then the associated costs with reducing inventory because we're going to take a significant amount of inventory out of the system, and lower fixed cost leverage. Those are the big items, and obviously, as I said in my prepared statement, we're still going to have some spread impact in the second quarter, too.

Right. But when we think about the distribution of consolidated EBITDA, I'm sure we're going to see the big impact in the Energy and Distribution statement, but given the shared nature of the assets, is I&M not profitable, just given the production impact you are talking about in scrap?

I'll tell you what. I don't want a call about profitability by segment, we're calling profitability for the quarter for the whole Enterprise. If you look at taking 50% out of the Energy and Distribution segment, you should be pretty close in your model.

Okay. All right. Then in terms of the scrap impact, you noted similar sequential change in spread, but just looking at it a different way, just to make it easier to understand for the quarter. If we just look at where raw material spreads, or I should say, surcharge recovery is versus your average inventory for scrap, what is that dollar mismatch for the quarter? If you didn't have the inventory issue and you were issuing buying spot, what impact would that have in 2Q?

I'm not sure how to answer that one, Luke. That might be one I'd have to noodle on a little bit offline.

Okay. Because you're coming into the second quarter -- 1Q had already seen some impact of that, about $9 million sequentially, and then you're going to see another, let's call it, $9 million, so you're at least $18 million impact in total, just given where pricing is, relative to surcharge, but I recall scrap prices had fallen in the second half of last year, as well, so I would imagine that there's even more cumulative impact?

You're thinking about it right. Keep in mind, it is a timing thing, so if you follow the bundles index -- pardon me, it's Busheling -- if you follow the Busheling Index, most of the pain of this will be gone three months after the sharp drop in the Busheling Index. So from a timing perspective, we anticipate it will stop in the second half.

(Multiple speakers.)

Depending on markets, right.

I'm just trying to get a sense of what that snap-back profitability would be when that happens, but, okay. And then the $25 million of cost reductions, it sounds like the measures that you've taken are going to be in place in the second quarter, but do you expect to realize the full benefits of the annualized $25 million in 2Q or is that more of a second-half thing?

No. We will have most of them in place in the second quarter, and actually, at this point in time, we have most of them in place already. But call it in on an 80%/20% basis. There's 20% more that will come in later in the quarter, so we will have most of this, if not all of it, ramped up by the first day of the third quarter.

Okay. And then just on the outlook for - - there's inventory destock cycle that's playing out. When you think about how shipments trend throughout the remainder of the year, have we seen the worst of the destock in 2Q? Does that start to abate, do you think into 3Q and 4Q, and can you just give us some sense of how much inventory is out there and what duration you think it'll take to work through that?

Luke, this is Tim. You've heard all of the service center calls, as well as I have. I think there's still some uncertainty out there.

I can tell you, they threw the brakes on pretty hard already and so the inventories in the channel should begin to tighten up. A lot of it, obviously, will depend on oil and gas activity in the second half of the year and there's just still a lot of uncertainty there.

Automotive is going to be good. The base industrial economy is okay although we're seeing a little bit of spillover from oil and gas into some of the foragers and that kind of thing. Then the real question is what's rig count going to do in the second half of the year and how does that translate through the service centers from an inventory point of view, and so we're watching it pretty carefully at this point.

Okay. And last question and I'll turn it over. But when we think about the moving parts, with 50% drop-off in shipments in 2Q, there's significant inefficiencies associated with having to reduce inventory internally and I'm sure your production rates are below that of what you are shipping as a result.

As we start to move into the second half, production probably moves more in line with shipments, the inventory destock runs its course, you've got the scrap headwinds will abate. And I just -- thinking through these factors, it would seem to me the second quarter should be by far the weakest quarter of the year, and then as we get into the second half, just even if we don't get a pick-up in end-use demand, we should see a nice snapback in terms of profitability just because of those factors working through the system. Is that the right way to think about it?

Yes. I think you've got it read right, Luke. The second quarter, just because of the confluence of events, is going to be pretty bad, obviously, and we think it should be the bottom.

Okay. All right, I'll turn it over. Thank you.

Thanks.

(Operator Instructions)

Justin Bergner, Gabelli & Company.

I have a number of questions. I'll start with the waterfall chart on the EBIT performance on slide 4. I'm just trying to make sure I better understand the manufacturing bar on that chart or those charts. I'm not sure I understand what's leading to the negative manufacturing delta, both quarter-on-quarter and year-on-year.

All right. Justin, I will handle this one first. I'll probably start with the second chart and you can see the sequential Q4 to Q1, and it's a $5 million unfavorable impact and that's fully due to lower melt utilization. So sequentially, the answer is we just have a lot lower melt utilization in Q1 than Q4.

Year-over-year, you're really comparing different spots, but we'd say that most of the costs on a year-over-year basis were timing and not structural. Maintenance was probably the single largest item that I would point to and these are costs that we've already taken out in the second quarter. Again, the only items that weren't primarily timing was the depreciation on the caster and the pension expense in the mortality tables.

Okay. Thank you. With respect to the melt utilization, you mentioned that the melt utilization was relatively similar year-on-year but down quarter-on-quarter?

Yes. Quarter-on-quarter we're down to 66% from 74%.

Okay, and outside of the change in the melt utilization, do you think the fourth quarter base, in terms of the manufacturing, is a reasonable base? The fourth quarter base wasn't depressed in terms of where things were situated on that manufacturing delta?

No. I think fourth quarter is a good quarter to base from. There's nothing unusual in the fourth quarter.

Okay. Great. Secondly, I wanted to shift to the $25 million in cost take out. Does that include the reduced -- or the shift that you had eliminated from one of your plants, you [referred to] earlier?

Yes. It does. Again, some of the tactics have already begun to be put in place in the first quarter, call it 80% are already in effect right now, and the last, call it 15% to 20%, will be put into effect sometime during the quarter.

Great. Is there a rough percentage of that $25 million that is captured by the shift that you've eliminated?

Yes. I would say there's a small amount of the $25 million that was in the first-quarter results, and on an annualized basis, I'd call it about $4 million.

Okay. So the first quarter benefited from, on an annualized basis by $4 million and that was primarily the shift (multiple speakers)--?

No, that's annualized. Sorry, Justin, remember that's an annualized basis, so the impact in the quarter was about $1 million.

Okay. And the benefit in the first quarter was primarily related to the shift that you eliminated for that portion of the quarter?

Yes. It was just labor cost reductions.

Okay. Great. Switching gears to the issue of scrap and purchasing, I know that you lose operating profit on the raw materials spread in and then you obviously recover a decent percentage of that on the LIFO piece. Could you give us a sense as to what the profit decline associated with the comment that you made at the start of the call, about your high-value scrap not being fully recovered by the indexing? Could you provide some clarity as to the magnitude of that aspect specifically?

Justin, I'm not so sure if I fully understand your question. We've called out the raw materials spread year-over-year and sequentially, so I'm not fully comprehending your question.

Maybe I should ask it a little bit better. Is it possible to quantify the element of the raw materials spread that isn't timing-related, that may be related to the purchasing abilities that you have that aren't quite as monetizable when there's a softer environment?

I get it, Justin, sorry. No, for the quarter and these comparisons in both charts, this is just about all timing.

Okay. So you don't expect, once things stabilize, you will be at a lower profitability due to the purchasing advantages you have not being as beneficial as they were in the past?

No. We don't see that at this point in time.

Okay. Thank you. Sorry for the confusion there. With respect to imports, are you seeing increased import pressure affect the demand for any of your products?

Justin, this is Tim. Obviously, imports are a big issue. You've heard all of the major producers talk about it. We are seeing increased imports coming in on the back of the dollar.

Because of our model, we're little bit buffered compared to the rest of the industry, just based on the diversified nature of the products that we make, but we are still feeling it, without a doubt, particularly in places like oil and gas and distribution. To date, we have done a very nice job maintaining pricing, maintaining penetration but obviously there's ongoing pressure there.

Okay. Would you say that, as you look forward over the next year or two, your view on challenges created by imports has become more of a headwind versus three to six months ago?

We've always dealt with imports, quite frankly, in the markets that we deal with. I would say over the last three to six months, because of the change in the currency, and because of the relatively low economic activity in Asia and Europe, that certainly the North American market has become more of a target.

Okay. Thank you and one last question, regarding repurchases, what is the primary driver for TimkenSteel to slow down the rate of repurchases as it looks out for the remainder of the second quarter?

Yes. I'll take that. This is Chris. It's really the economic environment more than anything else. When we provided our guidance last quarter, we had thoughts about revenues, profit, and really cash flow, and as the environment has become more negative, we decided that we did not want to be quite as aggressive on the share repurchases.

But obviously we're going to keep an eye on the way the year develops and look at it as part of our balanced capital allocation approach.

Okay. So is it safe to say that there's not as much emphasis on completing the share repurchase in 2015 as was indicated in the December quarter call?

Yes. Agreed. It's timing. We're still committed to repurchasing the remaining 2 million shares on the 3 million share Board authorization, but it's probably going to take longer than we originally thought.

Okay, Chris and Tim, thank you for taking all my questions this morning.

Luke Folta, Jefferies.

Just wanted to ask on -- you booked about $5 million in LIFO income in the first quarter. Should we think of that as 25% of your full-year assumption of around $20 million? Is that right?

Yes. The number for the first quarter was $6 million, Luke. And what are you using--?

Typically, it seems like the common practice is to take 25% of your full-year LIFO assumption in the first quarter and then true that up over the course of the year. I just wanted to make sure that that's how you looking at it?

Yes. That's not going to be too far off, although I suspect, because of the timing around the scrap, the second quarter will probably be a little bit higher in LIFO.

I see. Okay. All right. And then on oil and gas pricing, with the rate of shipments declining, as we're seeing, could you just give us some color in terms of how base pricing on the Oil and Gas side of the business is holding up so far?

You've got to remember, Luke, that 75% of what we sell in the average year is contracted. We've said in previous calls that we thought those negotiations went well and we've held that for the most part.

Spot markets are getting a little bit tougher, obviously, with some of the import pressure and the just lack of activity in the oil patch right now. I would say we have done a nice job at holding in there, but certainly if we do not see any turn in the second half of the year that that pressure could get a little bit more significant.

Okay. All right. Last question. I hate to beat the scrap thing to death, but I just hopefully want to make sure everyone understands how it works, so I looked at your fourth-quarter flowchart and in that you talked about there being a $6 million impact from raw materials spread. There was a $9 million impact in 1Q and then another $9 million in 2Q. So it's roughly almost $25 million in cumulative sequential negative impact from raw materials spread.

So in the event that scrap prices stabilize here and just trend flat for the next six months, we should look at that $25 million or so as coming back into the model as we get through the high-cost scrap and things normalize, all else equal? Is that the way to think about it?

Yes. That's the right way to look at it. Obviously, we're trying to protect scrap markets but directionally you're in line.

Okay. All right. That's all I have. Thank you.

(Operator Instructions)

And there are no further questions in queue at this time. I turn the call back over to Mr. Tim Timken for any closing comments.

Thank you for your questions and your continuing interest in the TimkenSteel Corporation. As I said, we're aggressively managing our current challenging conditions, but we're also preparing ourselves for the opportunities ahead.

TimkenSteel is a solid Company with tremendous potential and I want to thank all of our employees for their hard work, and you, all of our shareholders, for your continued support. If you have any follow-up questions, please don't hesitate to contact Tina. Thank you very much for joining us and have a good day.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.