TMST
#Thank you, and good morning.
I appreciate you all joining for our second quarter 2017 earnings call to discuss our financial results.
I'm joined here today by Tim <UNK>, our Chairman, CEO and President; as well as Chris <UNK>, 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 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 <UNK>Steel Corporation.
We prohibit any use, recording or transmission of any portion of the call without our expressed advanced written consent.
With that, I would like to now turn the call over to Tim.
Good morning, and thank you for joining us.
The first 6 months of the year have been a real sprint to ramp production and meet demand.
Sales have grown quickly as markets rebounded, and we continue to increase market penetration.
I'm pleased to say that sales are up 47% year-to-date versus the first half of 2016.
Operations ramped up in the first half, hitting record labor productivity levels, which is remarkable given that nearly 15% of our plant workforce came on board within the last year.
Melt utilization increased more than 25 percentage points since the end of last year, and safety performance continues to be top quartile among our peers.
In fact, OSHA recordables in the first half of the year were at a record low.
This has been a steep ramp in all respects.
We are now in the back side of it and gaining operating cost improvements, which will be beneficial as we expect continued improvements in market demand.
North American light vehicle demand remains at high levels even with some trimming of passenger car inventories.
Industrial markets continue to strengthen, particularly in the mining sector.
The slow and steady improvement of oil and gas market continues.
We also expect raw material markets to remain stable, similar to the second quarter.
As a result of this market outlook, we expect to see an increase in shipments in the third quarter and EBITDA between $10 million and $20 million.
As we manage both the opportunities and the challenges of the market environment, we also remain focused on long-term performance improvements.
We're executing a strategy that I've spoken about often on our calls that will improve and sustain profitability over the cycle.
We announced some leadership changes in the quarter.
Shawn Seanor has wrapped up a 33-year career in sales and marketing leadership at <UNK>Steel, and I want to thank him for helping us make the company we are today.
Tom Moline, who most recently led manufacturing for us, will now lead Commercial Operations.
Tom is uniquely positioned to help us extract every bit of marketplace value from the asset base we've invested in over the last few years.
In a smooth transition in operations, our Head of Supply Chain, Bill Bryan, will also lead Manufacturing, further integrating those 2 functions.
One significant project he takes on in this role is the start-up of our new advanced quench-and-temper facility.
We anticipate that this facility will be operational in the fourth quarter.
These individuals and the entire team at <UNK>Steel have demonstrated agility and perseverance in driving performance.
We put ourselves in a strong position with the actions that we've taken over the last several years to improve market share and operate more efficiently.
Now we have an opportunity to show that the actions that we took in the down cycle will benefit us in better markets.
And while an improved marketplace is a welcome sight, we're not letting up.
We have a long-term strategy to improve the performance of the business over the cycle, and so every decision we make is with that in mind.
At this point, Chris will take you through into more detail on the numbers, and we'll both be back to take questions later.
Chris.
Thanks, Tim.
Good morning.
Our second quarter results came in pretty much as expected.
Total shipments of 295,000 tons in the quarter were 5% higher sequentially and 55% higher year-over-year.
The improvement was a result of strengthened end market demand and increased market penetration.
Mobile shipments were down about 5% from the first quarter 2017.
The mobile sales decrease was in line with the decline in the North American light vehicle production rate from 18 million to 17.2 million vehicles, which resulted from the OEMs' effort to rebalance inventory levels.
For the third quarter, we expect mobile shipments to be about 3% lower sequentially due to seasonal customer production shutdowns.
Industrial shipments increased about 3% from the first quarter 2017, primarily due to market share gains and fundamental end market demand.
Global commodity markets began to stabilize in the first half of the year, which positively impacted our industrial end markets.
Moving into the third quarter, we expect industrial shipments to be about 10% higher than the second quarter as the general economic sentiment remains positive in most of the industrial sectors.
Second quarter shipments to the energy end market increased about 52% sequentially as customer inventory positions became more balanced with demand from the rising U.S. rig count.
We remain encouraged by the steady improvements in market supply and demand dynamics in the energy sector and expect third quarter energy shipments to be similar to the second quarter.
Net sales for the quarter were $339 million, with base sales of $262 million and surcharges of $78 million.
Base sales were $10 per ton lower than the first quarter 2017 due to increased billet shipments, end market product mix changes and price pressure.
Our strategy to broaden our base business includes products that are more carbon (inaudible) and less alloy-intensive compared to our prior mix.
We expect these dynamics to continue into the third quarter.
Gross profit for the quarter was $24 million and included a $5 million onetime supplier refund related to prior periods.
Excluding the refund, gross profit improved 11% sequentially, driven by higher volumes and operating cost improvements.
Melt utilization increased to 76% compared to 71% in the first quarter.
SG&A for the quarter was about $22 million, which was 3% lower than the first quarter 2017.
We remain focused on carefully managing our cost structure, particularly during this time of increasing volume.
In the second quarter, we reported net income of $1 million or $0.03 per diluted share.
EBITDA was $20 million, excluding the supplier refund compared to EBITDA of $18 million in the first quarter.
The income tax rate was about 40% for the quarter, primarily from a $1 million discrete charge related to prior periods.
Looking forward, we expect our tax expense for the rest of the year to be close to 0 due to the valuation allowance that was established last year.
We generated $15 million from operating cash flow in the quarter despite an increase in working capital.
Free cash flow for the quarter was $11 million, including capital expenditures of $4 million.
We expect the majority of our capital spending will take place in the second half of the year, and we maintain our full year capital spending guidance of about $40 million.
Our liquidity increased by about $15 million in the quarter, primarily from the free cash flow generation.
We ended the quarter with $189 million of liquidity and a net debt-to-capital ratio of 17.3%.
Turning to the outlook for the third quarter.
Shipments are expected to be approximately 2% to 5% higher than the second quarter based upon positive sentiment across most of our markets.
We will renegotiate our current labor contract in the third quarter, and we are likely to incur some related incremental expenses.
Our normal outages for plant maintenance are scheduled for the fourth quarter this year, so we won't see heavier-than-normal maintenance costs in the third quarter.
As a result, we expect the EBITDA range to be between $10 million and $20 million, excluding pension settlement charges.
We may incur noncash pension settlement charges in the third quarter, but the amount of the expense cannot currently be estimated.
In conclusion, our operating performance improved in the quarter, highlighted by record-setting shipments, productivity and safety performance.
We've now fully ramped up our operations and manpower to take advantage of improved market dynamics.
The third quarter will likely have some normal sales seasonality and some costs related to the upcoming collective-bargaining negotiations, but we are structurally in a better position than 6 months ago.
This ends our prepared statements, and we'll now take your questions.
If we could start on mix.
Would you guys mind discussing mix in this 3Q and if we could see a drag from mix on potentially seasonally lower auto shipments or increased billet shipments.
If you could just maybe just speak to that for a second.
Yes.
<UNK>, this is Chris.
I'll take that.
We don't expect much in the way of mix differential between Q1 and Q3.
Net net-net, the mix ought to be fairly similar.
Okay.
And then commentary on SBQ was very strong from other steel players, including service centers and mills.
I'm guessing it's probably weighted more towards the smaller diameter.
But I just wanted to see if you guys can comment on if you guys are seeing the same thing.
Where are you seeing the strengths.
Is it small diameter.
Large diameter.
Across the board.
And maybe just give us some context there.
Yes, <UNK>, this is Tim.
I would say it's more or less across the board.
I mean, obviously, automotive has pulled in a little bit, but still running in a pretty healthy rate.
And that tends to consume the ---+ kind of the small size of our range up to maybe into intermediate a little bit.
But as you see the oil and gas markets fire back up or continue to fire up, as you see mining activity coming back through Caterpillar, that's beginning to consume the larger size of our range as well.
And we're also seeing some pretty healthy demand through the seamless mechanical side.
So we're really kind of seeing it across the product line at this point.
Got it.
And then my last question.
On contract negotiations, can you discuss the environment now or this year versus last year going into contract negotiations.
And if you can comment on the overall maybe potential order of magnitude, perhaps, and maybe just rough percentage terms for the potential lift in contract pricing and when we might see that hit the P&L.
Well, let me answer your first question and then not answer your second question.
Obviously, we're seeing a lot better environment this year than we did, really, the last 2 cycles.
Lead times are out.
Markets are firming.
All of the chatter on the trade side has injected an interesting wrinkle into the whole thing.
So we feel pretty good going into the end of the year that we'll be in a position to have good conversations with our customers.
And then on the pricing side, we obviously don't speculate on that.
Sure.
And then when would we see it come up in your P&L once they do reset.
It's calendar year.
So generally, we get most of them done.
A couple might drag into January, February.
But for the most part, we try to get everything wrapped up by the end of the year.
Yes.
<UNK>, this is Chris.
Yes, our ramp-up costs were incurred all through the first half of the year, with a little bit more in the second quarter than the first.
We are fully ramped up.
We don't expect additional cost to come in that are meaningful in the second half of the year.
Yes, <UNK>.
No, we look for Q3 to be pretty much in line with Q2.
At this point, we can see ---+ have clear visibility to both July and August, so we feel pretty good about that.
And September so far, we have no reason to see anything different there either.
So in line with ---+ I think you probably heard this from the other folks in our space that scrap dynamics are pretty stable.
And so I don't think we're anywhere out on a limb on this outlook.
Tim, I had a question on the oil and gas market in particular and why as we look into the third quarter that the outlook is perhaps not a bit more optimistic given the rise in the rig count and the fact that you're coming off of a reasonably low level.
Yes.
Phil, obviously, when you go from the high, high peaks that we ran into the depth of this downturn, reading inventory is always a challenge.
We've said consistently in the last couple of calls that we think it's getting in the balance.
We still think that that's happening.
So the dynamic ---+ end market dynamics are good.
You've seen oil inventories down.
But 14 of the last 16 weeks, it put ---+ Baker Hughes claimed 6 more rigs in the field last week.
So all that is positive.
We just have to continue to kind of churn through the supplies that are sitting on the shelves.
We're seeing good activity in the shale side, both on the completion side and increasingly on the drilling side.
So that should help consume some of the inventories that are sitting out there.
But it's a process.
Would you anticipate at this point in time that once you get the Q&T line operational that you'll be able to tap into a bigger share in the market.
We hope that as the markets continue to grow that, that capacity will come online in a stronger market.
Again, we should be able to take a larger portion of that market.
You remember, in the past, we've been throttled by the amount of Q&T capacity that we've had in place when the markets run, and we're determined not to be in that position this time.
Okay.
And then I just had a second question on the net working capital.
What's the outlook in the second half in terms of source or use of net working capital.
Yes.
If you look at the second half of the year, the main driver is going to be CapEx, right.
We guided $40 million for the year in CapEx.
In the first half, we've only spent $6 million.
So the back half, we will see higher CapEx with probably, call it, $10 million to $12 million next quarter.
And, Chris, I was more asking on the side of inventories and receivables and payables just in terms of the cost to run the business on the net working capital side.
Yes.
We filled up for the year about $50 million of net working capital in the first half of the year, and we don't expect to build more in the second half.
First question just relates to, I guess, the sequential EBITDA guides or the $10 million to $20 million in the third quarter versus the $20 million in the second quarter.
Clearly, your shipments are expected to go up a bit.
Maybe if you can just sort of talk about the headwinds on a sequential basis, seasonal or otherwise, that might constrain third quarter EBITDA, that would be helpful.
Yes.
<UNK>, this is Chris.
Yes, basically structurally, there's not much difference between Q2 and Q3 when you take out the supplier refund and then recognizing you're going to have some bargaining contract-related costs.
When you look at the midpoint of our guidance, there's not much difference there.
So you think midpoint of $15 million and then you make some subtraction for those other 2 items, you'll get pretty close.
Okay.
Is there normally some seasonality in the third quarter.
Just even if shipments are going up, are there any sort of cost headwinds that you would seasonally incur in the third quarter.
Yes.
I think, by and large, SG&A is a little bit seasonal.
Typically, our SG&A gets to be a little bit backloaded.
But other than that, there's nothing significant.
We also normally take some shutdown time that we now pushed into the ---+ later into the year this year.
Yes.
So for Q3, we're not going to have any planned outages.
They'll all be in the last quarter.
Okay, great.
That's helpful.
And the increase for billet shipments in Q3 versus Q2, I think that was mentioned in the presentation, should we expect the Q2 shipment number on the billet side to go materially higher than it was this quarter or just sort of marginally higher.
Yes, marginally higher.
Okay.
Shifting to sort of another topic of questions.
The Section 232, potential tariffs, I'm sure you've done some thinking internally as to what they may or may not mean for <UNK>Steel.
Any sort of color you could provide on how they would affect the grades of steel that <UNK>Steel supplies should they go into effect in ---+ full or a limited version would be, I think, helpful.
Yes.
Well, I mean, step back from 232 for a second and look at the broader market dynamics.
I mean, everybody is concerned, the 232 sliding and that they may not do it, whatever.
At the end of the day, our markets are getting better.
Lead times are going out.
Utilization rates are going up.
So as I said earlier, I think we're in a better position this year than we have been in the last 2 to begin talking with our customers about 2018.
So that's just background.
On the 232 itself, depending on the remedy that is recommended by Treasury, our understanding is that it would be a relatively comprehensive list of products.
So all steel products should be impacted in one way or the other, assuming it gets done.
In our particular case, we've seen imports on SBQ in the first half of this year go up by 20% to 25% on bar.
And tubing is up 50%.
So the imports are definitely returning to the market as markets continue to strengthen.
And so that import volume that we're seeing right now would be directly impacted, depending on the remedy that's put into place.
So it would have a significant impact, but I also would not underestimate just the overall strength of the market and the position that puts us in to have contract discussions going into '18.
Okay.
I mean, would you hazard to estimates ---+ or much of the U.S. or North American SBQ and tube market is imports today.
Let me give you an example rather than talking through all our product.
Let me give you an example that is important for us.
If you look at the 6-inch and above market, kind of 6- to 16-inch for us, we're obviously a significant player in the North American market.
In fact, a very few people who can make that range of products.
Approximately 30% of that product is from overseas, increasingly from China, but also Korea and a little bit out of Western Europe.
So that market itself is a very good one for us.
It's traditionally been our sweet spot.
And increasingly, it's been under pressure from foreign sources.
So that would be one of the areas that we would look at closely, assuming this 232 goes in place.
I just had a question on the Q&T start-up.
Have there been be any start-up cost associated with that and the numbers so far.
And then secondarily, what are you anticipating for LIFO in the third quarter relative to the second quarter.
So just more of a housekeeping standpoint.
Yes.
So Chris, we really haven't had much on the expense side relative to the quench-and-temper.
A lot of that has been capital spending just finishing up the project.
So it's not material.
And the second question escaped me, sorry.
Oh, LIFO.
Yes, our LIFO is going to be ---+ I mean, we'd look at year-end and work backwards.
So LIFO will be, call it, a $2.5 million run rate ---+ $2 million to $2.5 million run rate through the rest of the quarter ---+ through the rest of the year, I should say.
In terms of employee additions, I think, at the start of the call, you mentioned the percentage of employees that had joined in the last year.
Are there further ---+ is there further hiring taking place.
Or have you pretty much completed the hiring that corresponds to current market conditions.
Yes, we brought on about 200 people in the first half of the year.
At this point, we would think that, that will fill out crewing, and then anything after that would just be (inaudible) electrician.
Okay.
And on the continuous caster, I assume it continues to sort of ramp up in the background of sort of the operations of the company.
Could you maybe just give us an update as to where it stands and sort of the potential for further profitability improvement as it reaches higher levels of utilization from here.
Let me talk about loading, and I'll let Chris take a shot at the impact of it.
We continue to load the caster.
Obviously, the billet business that we picked up allowed us to put a pretty significant load through that piece of equipment.
As the industrial and oil and gas markets continue to build, that will help as well.
So we are very much focused on getting that piece of equipment loaded.
Yes.
So I'll give you a little bit more color.
We have continued to move more product to the caster because of the yield benefits, and that will go on through this year and well into next year.
So we have not realized the full benefit of the caster just yet.
And that's more a function of not only having more loaded, but in terms of the mix between our bottom core process and utilizing the caster.
Yes.
I would say, just a high-level statement about lead times, they are out pretty far.
Quite frankly, right now, we're doing our best to try to bring them back in.
From a crewing point view, we are running 4 crew at ---+ through most operations, all operations at Faircrest.
At Harrison, we are 4 crew everywhere but melt, but we are roll-constrained in that operation.
And then tubing, we are ramping tubing with an additional crewing, but we still have more capacity there to take to the market, assuming that the oil and gas markets continue to build.
So we continue to look at ways at breaking constraints.
In our Harrison operation, for instance, we're looking at outside converters, who could take our ---+ who could help us with the roll constraint side of things.
That work has actually gone pretty well.
Hopefully, we'll begin to see the impact of that soon.
So it's really just a matter of working through process by process to make sure we're getting every ton to the street.
Well, thanks for joining us today.
I'm feeling, obviously, optimistic about where we are not just because our markets are rebounding, but also because we've taken the action over the last few years that have positioned us better than ever to deliver value.
We appreciate your continued confidence in the business, and we remain focused on safety and profitability as our highest priorities.
If you have any follow-up questions, please don't hesitate to contact <UNK>.
Have a great day.
