Metallus Inc (MTUS) 2016 Q3 法說會逐字稿

Good morning. My name is Sharon and I will be your conference operator today. At this time I would like to welcome everyone to the TimkenSteel third-quarter 2016 earnings conference call. (Operator instructions) Ms. Tina Beskid, you may begin your conference.

Great, thank you. Good morning and thanks for joining TimkenSteel's third-quarter 2016 earnings call to discuss our financial results. I am joined here today by Tim Timken, our Chairman, CEO and President, as well as Chris Holding, Executive Vice President and Chief Financial Officer.

During today's conference call we may make forward-looking statements as defined by the SEC. These statements relate to our expectations regarding future financial results, plans and business operations, among other matters. Our actual results may differ materially from those projected or implied due to a variety of factors which we describe in greater detail in today's press release, supporting information as provided in connection with today's call and in our reports filed with the SEC, all of which are available at the www.TimkenSteel.com website.

Where non-GAAP financial information is referenced, we have included reconciliations between such non-GAAP 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 advanced written consent. Now I would like to turn the call over to Tim.

Thanks, Tina, and good morning. I want to start today by recognizing the employees of TimkenSteel and thanking them for their relentless drive for performance under challenging market conditions. They are doing a remarkable job of continuing to improve our operating performance and fundamentally strengthening this Company for the long term. These efforts are clearly reflected in our third-quarter EBITDA, which was positive and exceeded guidance prior to the pension settlement charge. We also generated $29 million of free cash flow in the first nine months of the year. It shows good progress but obviously we still have a long way to go.

We faced all of the market challenges we anticipated in the quarter. Weak energy and industrial markets, seasonal automotive demand, and less favorable sales mix, yet our operating performance improved in the third-quarter and is $30 million better than a year ago on lower volume. We are fundamentally improving the Company's performance.

In the last call I talked a lot about the cost control actions that we have been taking, which have resulted in more than $100 million in savings and have exceeded our initial estimates, so I won't spend a lot of time talking about that today. What I'd like to talk with about is the top line work to we have been doing to complement those cost efforts. Our sales, technology, supply chain and manufacturing teams are working together to leverage our material knowledge and modern assets to deliver customer value in new ways and with record efficiency.

For example, we have recently gained new business with an automotive crankshaft manufacturer. The quality and consistency of our SBQ steel boosts the performance of the crankshaft in the applications, such as race cars and large industrial equipment. Another example is expanding our business through the supply chain, doing more and more work for others in the steel industry. We're finding opportunities in everything from supplying billets and tube shells to providing conversion services. One example, we recently entered into a supply relationship with a domestic steel processor that we haven't worked with in many years. We are now providing billets for their reroll operations that supply distributors who serve fabrication shops.

We are also still winning business with new customers. Recently we began producing a new geometry of SBQ bar for two converters who serve downstream original equipment manufacturers. Our ability to create customized products and services is a key element of our business model, and these are just a few examples of our ability to win new business because of that flexibility. We're testing the bounds of our new assets to explore new market opportunities. Assets like the jumbo bloom vertical caster are highly efficient and unique in North America. We're using this period of lower demand to push these capabilities into new areas.

We already are seeing value from those operations and it's clear that we'll deliver exponentially more value when we run that equipment full in a more robust market. All of these activities are laying a solid foundation for even better performance when markets begin to recover. As we look forward to the fourth quarter, markets will still be challenging, and our guidance reflects that. This downturn is one of the longest our energy and industrial markets have experienced, but indicators are beginning to trend in a positive direction. We're seeing inventories balancing a bit in the industrial markets, although demand remains weak.

We also see rig count improve and the number of drilled but uncompleted wells falling. In automotive, we're seeing normal seasonality and some inventory adjustment in the fourth quarter, but their markets remain strong and we continue to increase our participation on new platforms. Our priorities at TimkenSteel for the fourth quarter remain much like the third quarter: continue to focus on cost control and work together to drive new sales opportunities. This formula and all the actions that we have taken over the last year or so continue to improve our short-term performance and position us to accelerate even faster when markets return. At this point I'll turn you over to Chris to walk you through the numbers and then we'll take your questions at the end. Chris?

Thanks, Tim. Good morning. You may have noticed that we our Form 10-Q yesterday, which is earlier than previous quarters. We intend to continue this practice going forward so you will have more information available prior to our earnings calls. Also, you can find additional financial and operating schedules posted on the investor relations page of our website. Shipments of 178,000 tons in the quarter were 6% lower sequentially and flat year over year.

We continue to see strength in the mobile side of our business. North American light vehicle production achieved a record third quarter build rate of 18.4 million units, a 4% sequential increase. 2016 is still on pace for a record volume year but has shown signs of peaking. Mobile shipments were down 8% in the quarter due to anticipated seasonal production shutdowns. We project that fourth-quarter mobile shipments will be slightly lower sequentially due to further seasonal production shutdowns and inventory rebalancing.

Industrial shipments decreased 6% from the second quarter of this year. Global commodity markets began to stabilize in the first half of the year, which positively impacted the industrial end markets. Inventory levels are low in most cases but customers remain conservative, resulting in a slower pace of buying particularly in the industrial supply chain. We expect these market dynamics to continue into the fourth quarter.

Shipments to the energy end market increased more than 30% sequentially as US rig count had a similar increase since May. We remain encouraged by continuing improvement in market supply and demand dynamics in the energy sector. However, customer inventory levels continue to be inflated and we do not expect any changes in our order book level in this market segment for the fourth quarter.

Net sales for the quarter were $214 million with base sales of $187 million and surcharges of $29 million. Base sales per ton were $14 a ton lower than the second quarter due to end market product mix changes and price pressure. EBIT for the quarter was a loss of $23 million, including just over $5 million for a noncash pension settlement expense. Our salaried defined benefit plan offers retirees the option of receiving a lump sum payment in lieu of an annuity, which we believe reduces risk for both the company and retiree.

In the third quarter, because the plan's total year to date lump sum payouts exceeded the annual service and interest costs, we were required to re-measure the salaried plan. The re-measurement triggered an acceleration of just over $5 million of expense from equity. The settlement expense did not impact equity or cash. However, the re-measurement decreased equity by about $26 million, primarily due to a lower discount rate used to determine the pension liability. We expect to have some additional settlement expense in the fourth quarter. Excluding the settlement expense, we generated $2 million of EBITDA in the quarter, which exceeded the guidance range. The higher earnings compared to guidance were primarily due to lower seasonal maintenance costs, cost reductions and LIFO.

SG&A was $23 million excluding settlement expense of $2.4 million, a 5% sequential improvement and 15% decrease from the same quarter in 2015. The SG&A improvement reflects continuing efforts to reduce costs. Melt utilization was 44%, slightly lower than the 45% utilization realized in the second quarter 2016. Despite the relatively low utilization rate, we generated positive EBITDA, excluding settlement expense, primarily due to our cost reduction actions and better scrap markets. We expect to operate at a similar melt utilization rate in the fourth quarter.

In the third quarter we generated net loss of $17 million or negative $0.38 per share. The income tax rate was about 37% for the quarter and we expect our tax rate to be around 37% for the year. The effective tax rate was higher than the US federal statutory rate of 35% primarily due to US state and local taxes.

Capital expenditures for the quarter were $10 million and year-to-date spend is approximately $25 million. We estimate full year capital expenditures of $45 million with fourth quarter spend related primarily to maintenance and safety items.

Free cash flow was a cash use of $3 million. Cash from net operating cash flow was offset by higher capital expenditures or maintenance related spending that coincides with our annual maintenance and shut down activities. We paid down our outstanding revolving credit facility balance by $10 million in the quarter, primarily from lowering our cash balance. At the end of the quarter we had about $153 million of liquidity between the revolver and cash. Our net debt to capital ratio was a healthy 14.1%.

Turning to the outlook for the fourth quarter, we expect shipments to be down 5% primarily due to automotive seasonality. Additionally, we anticipate the recent decline in scrap prices to have a negative timing impact on raw material spread. As a result, we anticipate the fourth quarter EBITDA range to be between breakeven and a $10 million loss. At this time we're unable to estimate the impact of the settlement expense since it is dependent on the year end re-measurement.

In conclusion, the quarter came in better than expected, as we recorded our second sequential positive EBITDA quarter excluding the settlement charge. This is a testament to continuing improvements in our cost structure and other actions we have undertaken. While the fourth quarter will have some headwinds related to spread and sales seasonality, we are in a better position from profit and liquidity position than six months ago.

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

(Operator instructions). Your first question comes from Novid Rassouli from Cowen and Company

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

Let me take a cut at that, Novid. This is Tim. If history is any guide you would you say somewhere between a quarter or two depending on the shape of the recovery. Obviously, we're seeing inventory stocking continuing to take place. We're seeing steel being consumed faster than our order rates, so that's always a good sign. As Chris indicated, there is however a considerable amount of inventory sitting in Houston. So we're watching it carefully. We're seeing obviously more activity on the completion side than the drilling side, so my guess is we'd see our book pick up on that side of the production instead of the drilling side.

But right now, I think we're heading in the right direction. For once we're seeing a little good news out of oil and gas. And the fact that we've see rig count up consistently since May and up 30% overall, those are all good signs.

Right. And then one more thing. If I could expand on that, so during the downturn, we saw the energy contagion spread into the industrial side. And so, kind of showed that you guys actually have a little bit greater energy exposure than maybe we previously thought. Is it safe to say you would benefit on the upside then? And have you seen any impact in other energy derivative markets given the rise in crude oil prices, roughly doubling from where we were at the beginning of the year?

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

Great. Thanks Tim.

Great, thanks.

Your next question comes from Phil Gibbs from KeyBanc Capital Markets.

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

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

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

Yes, Phil, this is Chris. I'll give you a background on the pension. We have a gross pension obligation of about $1.1 billion. And so, I don't know, six years ago, we put in lump sums to reduce the risk associated with the pension plan. And again, it works well for both the employee, because they have an option, and for the Company because we -- on the salaried plan, which is frozen; we have no new entrants since 2003 -- it takes down our risk level.

And so lower interest rates are the enemy of pension plan funding, so our expense for next year will really be determined by what the year-end interest expense will be. So the discount rate, effectively. I think you saw the bond market yesterday, so that was probably a good sign relative to pension expense.

Okay. So this doesn't -- but this action doesn't change anything related to the pension expense or the contributions moving forward in so much in itself, it's just something that is happening here in terms of a remeasurement.

Yes, exactly right. There's no cash impact at all. And going forward it will not increase our pension expense.

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

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

Okay. Thanks.

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

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

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

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

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

Okay.

I should say primarily volume. Most of it is volume. It is primarily volume is probably a better way to it.

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

Just about $3 million.

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

Well, it's going to be relatively flat quarter-on-quarter between the third and the fourth quarter, if that's your question.

Yes, that's helpful. Okay. But are you finding ways to sort of be a little bit more frugal on maintenance expense given low utilization?

Yes, we are. So keep in mind most of the maintenance incurred is in the second half, so year-over-year the second half maintenance expense is lower in 2016 than 2015.

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

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

Okay. And a little bit less on the cash side?

Yes. Well and the cash side is in the quarter only $1.1 million of the $3.9 million. That will vary when we make our semiannual convertible payments in June and December.

Okay. All right, thanks. I'll hop back into the Queue.

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

Good morning. A question on the -- this might be a crazy question but does the pension settlement charges that you're taking imply anything about head count changes?

No.

Or is it all retired? It's a few opting for the lump sum rather than the employees, right?

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

I see. Would you be able to review your head count change for the last couple quarters just on average employees drawing salary? I mean, not -- hourly and salary together.

You mean, what is the trend in terms of head count?

Yes, just roughly. Were there any -- during the year.

It has been relatively flattish for the last couple of quarters. Our reductions in head count really occurred more last year and the first quarter this year.

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

Right. So do you think there's a way you could run even leaner? Let's say volume were to be sluggish or come back very slowly and you're, say, a year or two down the road from here, do you think you would have the same relatively large head count or do you think you could make more dramatic change?

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

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

We're running that right now.

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

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

Great. And Tim, just a longer term question too. Do you consider the possibility of adding a new product line or something in a rolling mill that would be able to utilize more of your excess melt? I mean, it might be a fairly efficient way to increase the utilization but you may have to step into some product lines that you're not in there yet. Like possibly rebar or something like a small micro mill off of your melt shop could be I would think quite profitable since the melt shop is already in place.

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

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

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

Yes, take care.

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

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

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

And you've gradually been shifting more of that over to your more efficient facility?

We've been looking to optimize between the two facilities.

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

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

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

We're kind of in the middle of that right now, Martin, so I don't really want to share too much. I would say, as expected, we're in a relatively weak market with a lot of available capacity so there is some pricing pressure out there. We continue to drive value for our customers and look to create stickiness by driving our value added model, and we'll continue to push that.

The markets obviously are different; automotive is still running pretty hot and so those conversations are always a little bit different than when you're dealing with weaker markets. But in general I would say we're getting through them on a timely basis and we'll be able to share more detail with you at the fourth quarter call.

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

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

Okay. Excellent. Thanks for the color.

Thanks.

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

Hey Tim, did I hear you right that you've done about $25 million of CapEx year-to-date? Is that right?

Did you say $25 million, Phil?

Yes.

Yes, that sounds about right.

And so that would include a heavy fourth quarter with -- if you have got guidance of $45 million for the year.

Yes.

I'm just trying to understand between what on a maintenance level basis gets moved into capital expenditures versus what you expense. Because I know you've had a couple of heavy maintenance expense quarters, particularly the third. So what, when you do these big maintenance projects, gets determined to be in CapEx versus moved through the P&L?

Phil, so let me start with that. Typically you just have to follow GAAP in terms of what you capitalize and what you don't. So if it's a long-lived asset, an improvement in a long-lived asset, that's what gets capitalized. But I would say our maintenance has been relatively consistent. I think the maintenance costs will actually be down this year in terms of just overall cash conservation.

But typically steel mills are things that kind of eat themselves --particularly on the melt side, so you have to put money into them on a very frequent basis so don't get behind. And depending on the year, our maintenance costs are at least every bit of $35 million. And by and large it's back loaded. So when you think about that figure, it's -- most of it is in the second half.

You're saying from a capital expense standpoint, most of that is --?

Yes, correct.

Most is back end loaded?

Yes, it really is.

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

Yes, you're north of 90%. It is an annual negotiation for the most part.

Okay. Thanks very much.

Great, thanks.

Your next questions comes from Novid Rassouli from Cowen and Company. Your line is open.

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

Yes. I would say what we're seeing is your traditional seasonality across all of our market segments. Obviously it's a little bit more noise around the oil and gas and industrial just based on levels of activity. But certainly from an automotive point of view this is fairly typical of what we see going into the end of the year. People trimming inventory levels, et cetera.

If history is any guide, you come into January and you begin to see a pretty decent first quarter. People leveling up inventories again, restocking shelves. Certainly on the mobile side. Again, we'll try to look pretty carefully at the industrial and the oil and gas markets going into the first quarter.

So you --

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

Right, so melt utilization under 44-ish for the first quarter would be surprising?

Yes, if normal seasonality holds, that would be true.

Great. Thanks guys.

Thanks.

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

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

That's the CapEx piece.

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

No, it's not.

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

Yes, if you consider most of the mobile business is on contract, the price doesn't change within the contract period, so you're conclusion is correct. It would be mix.

Okay. Thanks for taking my follow-ups.

Great, thanks.

(Operator instructions). The next question comes from Martin Englert from Jefferies. Your line is open.

One quick follow up. If you get into 2017 and profitability levels look similar as well as demand levels, would that prompt you to attempt to cut any more costs from what you've already done on top of the $100 million?

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

Any ideas as far as the magnitude that you could potentially pull out? It was pretty significant with the most recent round of cuts.

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

Okay. Thank you.

(Operator instructions). We do not have any questions at this time. I'll turn the call over to Mr. Tim Timken.

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

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