Metallus Inc (MTUS) 2015 Q3 法說會逐字稿

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

(Operator instructions)

Tina Beskid, Director of Investor Relations. You may begin your conference.

Thank you, Chris. Good morning and thank you all for joining TimkenSteel's third-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 vary 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 www.TimkenSteel.com website.

Where not 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.

Good morning and thank you for joining us. The third quarter was filled with twists and turns for TimkenSteel. While we initially estimated that we might lose up to $15 million of EBITDA in the quarter, shifting market conditions early in the period forced us to change our view and revise guidance to an EBITDA loss of $30 million to $40 million.

As you saw in the release yesterday we came in at the low end of that range. While this performance falls well short of where we would like to be it does reflect a lot of hard work and the part of our team here at TimkenSteel to tackle significant market challenges. I would like to take a couple minutes to highlight what's gone on in the quarter, including some of the steps that we've taken to respond to a changed market outlook. So what happened since we last talked?

We anticipated a difficult third quarter due to continued weakness in energy and some industrial end markets, but the impact was deeper than expected. As we moved through the third quarter, operating with historically short lead times, we began to see additional changes in our industrial base. As market conditions further eroded, excess inventory levels worsened, and customers accelerated destocking efforts.

Market indicators also showed signs that the recovery would not come quickly. Global commodity markets and industrial machinery remained low, and rail builds dropped. On the other hand, automotive markets continue to run at near record levels. We expect current conditions, both good and bad, to continue through this year and into 2016, which led us to take further action.

As is always the case, but particularly in challenging markets with low demand and pressure from imports, we are staying very close to our customers, which has helped us hold market share across all of our segments. In our mobile markets we're not just maintaining business, we are winning new platforms based on our value-added model.

While our sales force is doing an excellent job, we recognize that aggressively managing our costs during this period is just as important as making the sale. As you will recall, we announced a wave of cost reduction in the second quarter that had a target of $25 million in annualized savings, which have already made a positive impact on our operating results. Most of these savings were generated by allying crews to a softer order book, with the remainder coming from organizational changes and other reductions.

This week we initiated a second round of cost reduction actions which will yield an additional $50 million in savings. While I believe that we did a solid job in setting up the business just over a year ago, there is always room for improvement. We challenge the entire organization to think differently about how we spend our shareholders money. Our people have risen to the challenge and a series of announcements that we've made this week will realign the business and will ultimately allow us to emerge from this current period stronger than ever.

In the fourth quarter we will realign my management team by consolidating our customer facing functions under a single head, Sean Seanor. Bob Keeler has decided to retire after 36 years of a significant contribution to TimkenSteel and I would like to personally thank you him for his service. In addition, we will reduce management and other salaried headcount by 8% through a mix of voluntary and involuntary layoffs, which will further streamline our structure to eliminate approximately 90 salaried positions. We will also continue to synchronize our operation with the order book, reducing headcount in operations another 30 people. Through both rounds of reductions this year we will reduce headcounts by 380 people -- positions.

While generating savings is critical we also recognized that cash is king, especially during times like these. Our sales team is actively leveraging our investment in new capabilities to service customers and we remain committed to organic growth. However, we are going to prudently manage additional investments at this time, which include delaying the startup of our advanced quench-and-temper facility until market conditions give us the opportunity to achieve the best return on that investment. In addition, we have taken inventory down faster, much faster than in previous cycles, while still maintaining customer service levels. While we remain committed to paying dividends, our board will consider the dividend level as part of their normal capital allocation discussion. At this point we don't anticipate any additional share repurchases in the fourth quarter.

As I've met with many of you over the last three to four months, you've heard me say that we have been here before, we know what to do and we're doing it aggressively. We're taking the right actions not only to get us through this trying time, but to emerge even stronger. At this point I'm going to turn it over to Chris who will walk you through the financials.

Thank you, Tim, and good morning on the phone. Net sales in the quarter were $233 million, comprising base sales of $202 million and surcharges of $31 million. Weak demand from North American oil and gas markets, coupled with other commodity driven impacts on our industrial business were the primary driver of our results.

Shipments of 179,000 tons were 16% lower than the second quarter. Base sales per ton held up well in the quarter despite a shift in end market demand and product mix. We expect these same market dynamics to continue into the fourth quarter.

The impact from lower volumes resulted in a $49 million EBIT loss for the quarter. Manufacturing costs were unfavorable due to load melt utilization of 40%, which was driven by fixed cost deleveraging and inventory reduction efforts. Maintenance costs were $7 million higher than the second quarter as we completed the majority of our seasonal plant maintenance activities. We anticipate operating below 40% melt utilization in the fourth quarter.

Scrap prices were relatively stable throughout the third quarter. As we discussed in our previous conference calls, scrap prices impact our results because of the timing associated with our customer surcharge mechanism. Sequentially, raw material spread was $10 million better than the second quarter of 2015.

EBITDA for the quarter was a loss of $31 million, included in the loss is $8 million of non-cash charges related to energy inventory valuation and asset impairment. For the third quarter of 2015 we generated a net loss of $31 million, or negative $0.69 per share. The income tax rate was 38.2% and we expect it to remain around 38% for the full-year 2015.

Turning to segment performance, our industrial and mobile segment sales were $180 million for the quarter, which is an 11% sequential decline. We continue to see strength in the mobile side of our business, as the North American light vehicle rate is on pace to reach the 17.5 million vehicle sales forecasted in 2015. The industrial end markets are more challenging as they continue to be negatively impacted by weak global commodity markets. Industrial ship tons declined by 25% compared to the second quarter of this year.

In the energy and distribution segment sales were $45 million for the quarter, or 34% decline sequentially. US rig count declined more than 50% since last year and has significantly impacted our energy and distribution business. Energy shipments dropped 32% sequentially and customer inventory levels remain inflated due to speed of the market decline.

Shipments to industrial distributors declined 31% sequentially due to reduced demand from mining and industrial equipment end markets. Additionally, customer purchases made in the first and second quarters of this year resulted in higher inventories within the channel. Distributors continue to adjust inventory levels to match demand expectations.

We generated $26 million of cash from working capital this quarter, as we reduce inventory and associated spend inline with demand. We have been pleased with the pace of our working capital reduction efforts and we plan to further reduce inventory in the fourth quarter. Capital expenditures during the first nine months totaled $53 million, with 40% of the spend going to growth projects. We estimate full-year 2015 capital spending will be about $75 million, which is a $5 million reduction from previous guidance.

Capital expenditures for the fourth quarter are higher than the year-to-date run rate, primarily due to project timing. As Tim commented in his remarks, we have decided to delay the startup of advanced quench-and-temper facility to align with market demand. Total debt increased by $30 million in the quarter to $205 million, and our net debt to capital ratio is 19.5%.

Due to the recent losses, we anticipate not being in compliance with our interest coverage loan covenant at the end of the fourth quarter. We have been in discussions with our lenders regarding refinancing of our existing debt to sell lease, which will result in covenant relief. We feel confident that the refinancing will be successfully concluded in the fourth quarter.

In July 2014 our Board of Directors authorized a 3 million share repurchase program over a three-year period. In the third quarter we purchased 611,000 shares at an average price of about $20 per share, or $12 million. We do not anticipate repurchasing shares in the fourth quarter.

Turning to the outlook for the fourth quarter, we expect industrial and mobile shipments to be about 10% lower compared with the third quarter, due to the seasonal impacts in automotive and industrial end market weakness from global commodity markets. In the energy and distribution segment we expect that the current market dynamics in oil and gas will not change for the fourth quarter and as a result expect shipments to be about 20% less than the third quarter.

Given the lower volumes and the headwind from raw material spread due to the recent decline in the Busheling Index, we expect EBITDA to be a loss of between $25 million and $35 million. The cost reduction actions implemented last quarter came in better than anticipated, but were not enough. As Tim discussed, we have initiated another round of cost reductions, which will generate an additional $50 million of savings in 2016. This ends our prepared statements, and we will now take your questions.

(Operator instructions)

The first question is from Novid Rassouli with Cowen. Your line is open.

Thank you for taking my questions. So it looks like, based on the slides, that you had downgraded your view on machinery and rail since the last quarter conference call. I just want to see if you're seeing a deterioration on the industrial side that's accelerating, or if you could give color around those markets?

Yes, let me take a first cut at that, and I'll ask Chris to add any commentary, as well. Obviously one of the things we've seen as we've gone from the second quarter into the second half of the year is really the influence that the low oil and gas markets have had on the rest of industrial America. And that is where you're beginning to see the impact on the machinery side of things. Obviously you also have the mining markets staying low, which will impact that as well.

I'm not sure it's getting dramatically worse, but obviously it is not good at this point. Rail, I think we're just coming off a big rail build. And so we have seen that begin to soften. You're hearing other people who touch this space say the same thing. I don't see the traditional boom and bust in rail, but certainly we will come off some relatively high levels.

Okay and then on pricing. It looks like industrial base prices were essentially flat sequentially, while energy and distribution did see some downside, I'm assuming due to higher spot exposure. So regarding new contract pricing, can you walk us through important gates with respect to contract negotiations, and when we might see that reflecting in P&L?

We're right in the heat of battle at this point. We generally start our contract negotiations in October, November and try to wrap as many of them up by the end of the year. But we've got a couple that drag on into the first part of January.

I would say those discussions are going well. Obviously it's a pretty dynamic time in the marketplace with a lot of capacity looking for a home. But our sales folks are doing what they need to do. So we can't say anything now, but as we get into our fourth quarter call we will be able to give you a better idea of what we're seeing in the marketplace.

And then one more question, as far as lead times go, I think last time we checked-in it was about five weeks on bar and eight weeks on tube, I'm assuming we're relatively close to those levels still?

It's about the same. Obviously we're being opportunistic when we find business out there. But yes, those are still relatively good numbers.

Great. Thanks.

Thanks.

The next question is from Russell Philipski with Lightspeed.

Hi Tim, how are you?

Good, how about yourself?

Good. Just a question on the CapEx. So in the quarter about $18 million and for 2015 you are guiding for about $75 million in CapEx. Now obviously you said maintenance is about $45 million to $50 million. I'm just curious, given the uncertainty on the energy side, some of the weakness on the industrial side if it's prudent to reduce that further to increase the cash available to the company?

Obviously, we've got a couple months left in the year. We've got some program spending that we're wrapping up and as we began to look at 2016 we will look at that pretty aggressively. Chris you want to add anything?

Historically what you find in our business is that so much of the capital spend is backloaded. So the items that we can take out for 2015 we have, and as you mentioned for 2016 CapEx will be on our radar in terms of one of the things we try to improve upon.

Sure. Great.

You did a great job being able to liquidate working capital where you could and generating CFO in a pretty tough quarter. I just wanted to know -- if you would spend a little bit less on CapEx in the quarter it would've looked even better, so wasn't sure where the flexibility was there.

We're aggressively managing at this point, and again as we begin to lay out 2016 we'll have a pretty sharp pencil.

Okay and another follow-up, you are working closely with customers to win new business. So where are you winning new business? What is that business? Where is it being found? Is it industrial or is it in energy? If you're primarily on the upstream side of the energy business can you find stuff in the midstream area where maybe the growth isn't as stunted?

Again, we looked at all of our end markets opportunity to grow. Right now we're seeing good platform growth on the automotive side of the business. These are driven by the new engines and transmissions that we are seeing introduced in the marketplace, so we continued to expand there.

On our other markets, oil and gas as you point out, there is some still activity out there and we continue to take our value-added model into that space. And then, obviously, industrial is a little bit of everything and we've got a very sharp eye on those markets, as well. So it's really across the board.

Okay, great, thank you for your time.

Thanks.

(Operator instructions)

Justin Bergner with Gabelli & Company.

Good morning.

Good morning

Hi. My first question relates to the melt utilization rate. You ran it 40% this quarter, you're thinking you'll dip below 40% next quarter. How much of that low utilization do you think is being driven by destocking, either at your Company or at your customer's level?

If you look at the stepdown from third to fourth, a lot of that is just our normal seasonality. So you have people taking times out around the holidays, and specifically on the automotive side of business. The other markets, the industrial and oil and gas markets, we continue to see people truing up their inventories, focusing on working capital going into the end of the year. So it's probably a little bit of both at this point.

Okay. And with respect to your work-down of inventories. Would you hazard to guess how much utilization was weighed down in the third quarter by your work-down? Of inventories?

I don't have that number specifically, but it's a pretty significant part of the difference. Obviously, what happened is the second half is come in from a demand perspective much weaker than we thought. So as a result, we've cranked down on our inventory build and its reduced our melt utilization. So a significant part of the melt utilization is from inventory destocking from not only our customers, but it gets pushed to us too as we've taken out over $100 million of inventory so far this year.

Okay thank you. And then in the fourth quarter do you expect to do further destocking at the TimkenSteel level beyond what would occur per normal seasonality?

Yes. We do. We expect to take some more inventory out in the fourth quarter.

Okay. Thank you.

Switching gears to the $50 million cost-saving plan, I wanted to make sure I understood how much headcount you're anticipating having to reduce with the current restructuring versus the earlier $25 million restructuring, in total?

Yes, Justin, this is Chris I will take a shot at that. I mean if you look for the year, as Tim said his prepared statements, we're taking out 380 people for the entire year. A little over 120 in the second wave, so it's been very significant from a headcount reduction perspective.

Okay great. That's helpful.

So you're only taking out a third of the total in the second wave, but you're anticipating two-thirds of the total cost savings between the two programs in the second wave, what are the major drivers of the $50 million? Is it just more expensive employees?

Yes, there's a whole lot of activities going on. It's not just headcount reduction, in fact headcount reduction is less than 25%. We are cranking back on a number of different expenses. So manufacturing is another probably 30% and spend across the border is going to be 50% lower. So 50% of the savings is spend, 30% manufacturing and the rest is headcount reductions.

Okay, thank you, that's really helpful. And then the manufacturing side. Are you anticipating taking another shift out, or doing some intermediate step short of taking on another shaft?

Yes, I won't get that far down into the weeds. But it's various processes we will try to idle, reduce outside services and those type of things.

Okay. Thank you.

Would we expect to see the $50 million -- when would we expect to see the $50 million run rate of expense savings kicking in on a 100% basis?

You'll see it ramp up very significantly in the first quarter, and by the second quarter be fully ramped up.

Okay. Great. Thank you for taking all my questions, Chris

You're welcome.

Thanks.

The next question is from Phil Gibbs, KeyBanc Capital Markets.

Thanks, good morning.

Hi, Phil.

On that savings plan. Anything baked into Q4 in terms of the guidance that you provided? Any of that $50 million in that number?

No. Very little. It's really just being implemented now, so we won't see much of anything in the fourth quarter. Again, it ramps up very significantly in Q1 and fully in effect in Q2.

The bulk of the people, the salaried folks who will be impacted will be talked to. We started communicating yesterday, today and into next week but there's timing associated with that, as well.

Okay. And then when you said, Chris, that 50% of it is on spend, we're purely talking OpEx right, not CapEx here?

Correct. These are expense items.

Okay. And then in terms of your view in the near term, what do you think is most likely to restore, call it a healthier level of free cash flow generation? Do you think it's going to be volume, price or mix?

Yes. Hopefully.

We're going to have to have a level of market. The first thing that will happen is the inventory burn out in the channels will stop. And so that will be issue number one. We need to be above 50% melt utilization to start being EBITDA positive, so there's no question we're going to have to have some market help.

Okay. And then Tim, any sense in how much of your volume degradation this year has been due to import share loss? I mean it sounds like from what you're saying your market share has been pretty constant, but I don't want to lead you to anything but maybe just a general comment.

No. I think the work that we've done, the communication we've had with our customers would indicate that we're -- where we decide to we're holding share. There's some business that we've opted out of, but for the most part really across all of our markets we're doing a very nice job of maintaining our position with our customers.

Okay. And then just two quick ones. As far as Q4 LIFO expectations it looked like it was $20 million of credit in Q3. What do you have baked in for Q4?

About half that, Phil.

Okay. That's helpful. And then out of that savings plan, how much of that do you think will be related to SG&A? Thank you.

Overall, in this plan it's about 70/30. From a dollar perspective. 70% cost of sales and 30% SG&A.

Thanks for the color. I appreciate it.

Thanks, Phil.

(Operator instructions)

The next question is from Luke Folta.

Good morning, Chris and Tim.

Hi Luke.

Couple questions here. When we look at your guidance for the fourth quarter, your LIFO is going to be about half the benefit in terms of the credit and you're going to have lower shipments, pretty meaningfully in both segments. It looks like the midpoint is around the same to what you generated this quarter, so can you give us some sense of what drives the improvement sequentially? Is it just your manufacturing costs are more in line?

Yes, I think that's part of it, obviously. The other thing to keep in mind is we have some seasonality in the maintenance in Q3 that we won't have in Q4. I will call that a $7 million improvement. So that's one of the other main items. And then we won't have the non-cash item that we had in Q3 also.

And what's the expected op rate for the fourth quarter?

Pardon me?

What's the operating rate you're expecting in the fourth quarter?

We call it somewhere south of 40% is where we see right now.

Okay. All right. Heading into 2016, when you're thinking about how you position the books next year, it seems to me that, you can crosscut and reduce spending and all that will help, but getting off this 40% capacity utilization number is really going to be key to getting you back to a level of positive EBITDA. I would guess over the last few years you've been able to position the book appropriately in high oil and gas consumption environment. You've probably more focused on mix than value add than you have been about trying to fill the mill. But heading into this year, there is, obviously, less out there. What I'm asking is, are there areas where, product areas where you haven't really been focused on over the last few years? Where you can return to, or is there things you can do strategically that would result in significant market share gains to help that utilization rate in the event that things stay where they are at for the full year?

That's a good question, Luke. I think the work that we've done over the last five years to realign our portfolio has helped us at the high points of the market and at the low points of the market. Now obviously with oil and gas likely to be slow next year, with the mining side likely to be slow next year we are aggressively looking at all of our markets for opportunities to sell value to our customers.

Obviously, the mobile side of the business looks a lot better for 2016 and we continued to invest in platform growth there. We've got a number of really exciting opportunities ahead of us. So really it's a matter of taking in the entire playing field and figuring out where our value-added model creates value for not only us, but for our customers and our shareholders. And then acting accordingly.

And then the other factor for 2016 is, keep in mind in the second half of 2015 in particular we've had a big inventory burn, so the question is when do we start to see the run rate come through, because the inventory has been burnt through.

I think the other issue too, the impact of raw material volatility in 2015 has been pretty significant. And everybody's got their own opinion as to what's going to happen with scrap next year. But my sense is we've seen a lot of the downward volatility already play out. And so, obviously that's going to help us as we get into more normalized, hopefully stable markets from a raw material point of view.

And just in terms of how far you can flex mobile hiring for next year. And I'm assuming most of that is auto and a lot of it is small diameter stuff. Can you give us some sense of where Harrison is operating relative to Faircrest? And are you limited to some degree on how you far you can improve your position into that market because of the asset configuration?

No. We're still -- we're running pretty well at Harrison right now on the smaller 6-inch and down size of our range, driven mostly by the automotive markets. We still have flexibility there.

And to the extent that we can identify good profitable business then obviously we will do our best to serve those markets. Right now, through the end of the year we're a little bit lighter on the melt side, but that's just more seasonality than anything. And on the rolling side we're running pretty well.

Okay. And then lastly on CapEx, $40 million maintenance is likely given for next year. Are there any items, necessary growth items or other things in addition to that $40 million that you have to do in the event that you really want to strip to bare-bones level?

We're going to be in a better position to talk about the 2016 capital budget at the next call, but needless to say, given the current outlook, we're scrubbing pretty hard. But again, we will be able to talk to you on the next phone call.

Okay great, thanks a lot for taking my questions.

All right thanks Luke.

The next question is from Novid Rassouli from Cowen.

Thanks for taking the follow-ups. I wanted to touch on imports again. Clearly the domestic oil industry is being negatively impacted by imports in a variety of products. With the demand for SPGU still deteriorating, have imports been exacerbating the inventory levels that need to be destocked, or have we seen imports beginning to abate?

Yes, we've seen imports slow down a little bit, but obviously it's still very significant issue for the North American steel industry as a whole. It certainly doesn't help when you have some of the big traders bringing in large volumes, mostly on the commodity side of what would be our line. But certainly, that is a factor that we are looking at as we wrap up this year and get into next year.

All right. And then on the scrap side. You mentioned, Tim, that there's been a lot of volatility. Scraps once again follow pretty sharply in the last few months, how to you see scrap prices trending near-term? It seems like prices are low enough that flows should start to slow down. I'm just curious what the scrap market looks like from your view.

Between now and the end of the year, obviously, with the prices they're paying right now, I agree that we will begin to see some of the flow slow down. You've also got the whole seasonality question. When this stuff start freezing to the ground, it's a little bit harder to move around.

The import or the export side, currency is still keeping a lot of scrap bottled up. And I don't see that changing anytime soon. And obviously, automotive production, you've got a lot of busheling being generated. So a lot of puts and takes. But again, as I said earlier, I think we've seen the extreme volatility play its way out at this point, but clearly there will be some ups and downs. As we get into the early part of next year.

That's for taking the questions, Tim.

All right, thanks Novid

(Operator instructions)

The next question is from Justin Bergner with Gabelli & Company.

Good morning again Chris and Tim. I think my questions were answered on the prior set of questions. But I didn't remove myself from the queue. Have a great rest of the year.

Have a great week.

Thanks Justin.

Phil Gibbs, KeyBanc Capital Markets.

Thanks. On the $75 million in cost opportunities, how much of that would you consider fixed, and how much of that would you consider variable? Right now just what could come back with production is the question?

I think if you look, it's a great question number one, if you look at the cost of sales, quite a bit of the cost of sales stuff, if you look at the whole $75 million is volume-related, and clearly we've got some significant cost reduction tactics. But I would say a significant portion of cost of sales items are volume dependent. On the SG&A side it's probably a little bit more balanced in terms of what is structural and what is not.

Okay Chris, thanks so much.

Thanks, Phil.

(Operator Instructions)

And it appears that we have no further questions at this time. I'll turn the call back over to the presenters for any closing remarks.

Thank you all for your questions. We appreciate your interest and confidence in the business.

I also want to take a moment to thank the employees of TimkenSteel who have worked hard to get us to this point, and who even through this difficult time have continued to stay focused on creating value for our customers and our shareholders. We have a strong and unique business model and the actions we discussed today both address the current challenges we face and strengthen the Company for the future.

If you have any follow-up questions, don't hesitate to contact Tina. Thanks again and have a good day.

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