Earnings Call Transcript - MTUS Q1 2021

Operator, Operator

Good day, and thank you for standing by. Welcome to the TimkenSteel First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Jennifer Beeman. Ma'am, please go ahead.

Jennifer Beeman, Senior Manager, Communications and Investor Relations

Thanks and good morning, and welcome to TimkenSteel's First Quarter 2021 Conference Call. I'm Jennifer Beeman, Senior Manager of Communications and Investor Relations for TimkenSteel. Joining me today is Mike Williams, President and Chief Executive Officer; and Kris Westbrooks, Executive Vice President and Chief Financial Officer. You all should have received a copy of our press release, which was issued last night. During today's conference call, we may make forward-looking statements as defined by the SEC. Our actual results may differ materially from those projected or implied, due to a variety of factors, which we describe in greater detail in yesterday's release. Please refer to our SEC filings, including our most recent Form 10-K and Form 10-Q and the list of factors included in our earnings release, all of which are available on the TimkenSteel website. Where non-GAAP financial information is referenced, additional details and reconciliations to its GAAP equivalent are also included in the earnings release. With that, I'd like to turn the call over to Mike. Mike?

Michael Williams, President and Chief Executive Officer

Thank you, Jennifer, and thanks to everyone on the call for joining us this morning. We have enjoyed a strong start to our year thanks to the recovery in the automotive and industrial markets and our improving cost structure. As a result, in the first quarter, our adjusted EBITDA nearly doubled from the prior quarter and we continued to generate positive operating cash flow. The systemic changes we've put in place over the past 18 months have allowed us to leverage recovery markets and improve profitability. Before I continue with my remarks regarding the quarter, I'd like to cover a few changes at TimkenSteel. As announced in our earnings release, our Board of Directors has named Ron Rice as our new Chairman, following the retirement of Jack Reilly. Ron has been an Independent Member of TimkenSteel's Board of Directors since 2015 and brings a wealth of knowledge to the role. I speak for the team when I say we look forward to working with Ron more closely in the future. Furthermore, we sincerely thank Jack for his dedication and leadership as Chairman over the years. He was a founding member of our Board of Directors, and under Jack's guidance, TimkenSteel has built a strong foundation for future growth. We are grateful for his contributions and we wish Jack well in his retirement. We also announced that Tom Moline, Executive Vice President of Commercial Operations, and Bill Bryan, Executive Vice President of Manufacturing and Supply Chain, will both be leaving the Company. Kevin Raketich, currently serving as Executive Vice President of Strategy and Development at TimkenSteel, will assume a new role as Executive Vice President of Sales, Marketing and Business Development. We expect smooth transitions in light of these changes. I'd like to thank Tom and Bill for their many years of service and we wish them all the best. Turning to safety, this year we're focusing on special initiatives to ensure we keep our employees safe. In 2021, we will implement extensive confined space training, refocus on machinery safety, continue with our COVID-19 safety protocols and host our Annual Iron Shield awards. As a reminder, this is a program where we gather safety recommendations from our employees and reward teams for innovative ideas. As always, we will continue to leverage our relationships with our union safety representatives to ensure that we provide the right level of training in the right areas. The well-being of our people is a core belief and nothing we do is more important than returning employees home safely at the end of their workday. Moving to markets, we continue to see steady automotive demand, particularly in the light truck and SUV categories, and inventories remain at a historic ten-year low. We have all read about the commodity shortages, such as semiconductors, rubber and resin, which are disrupting automotive OEM production. We are staying close to customers as they plan for recovery in the second half of the year and beyond. Regarding the global semiconductor shortage, in the fourth quarter of 2020, we had not yet experienced a meaningful impact to our order book. For the first quarter, we estimate this shortage has impacted our orders by approximately 2,000 tons. We expect this will have a larger impact in the second quarter and thus far we have been successful filling any open capacity with short lead-time opportunities elsewhere in our customer base. In our industrial markets, we continue to see positive momentum as evidenced by a 33% sequential increase in our shipments into that end market. We are encouraged that the majority of the industrial categories we serve, such as industrial machinery, agriculture, power generation and defense, continue to improve with the overall economy. Distributor inventories are at historic lows, which is presenting us with restocking opportunities. Overall, short-term energy demand still remains weak. We remain cautious regarding the energy market, but there have been some signs of life with modestly improving industry statistics and a slight improvement in demand to fill inventory requirements. Regarding scrap pricing, the number one Bushling Index rose by $170 in the first quarter, reaching $567 per gross ton. We're optimistic that scrap prices will hold for the remainder of the second quarter due to higher steel mill utilization. To highlight other events in the quarter, we announced that we signed an agreement with Daido Steel to sell our TimkenSteel Shanghai subsidiary for approximately $7 million in cash. This deal aligns Daido Steel's strategy to strengthen its sales, technical and business management team in the Chinese market with our desire to provide our customers a sustainable and high-quality supply chain in the region. Together, we have enjoyed a long relationship with Daido Steel, and this will continue as we support key customers in both Asia and the United States. The deal is contingent upon completion of usual and customary due diligence and is expected to close sometime in the third quarter of 2021. As previously discussed, we indefinitely idled our Harrison melt and casting assets in the quarter. We worked collaboratively with our employees, suppliers, and a number of customers to ensure a well-organized and efficient transition. Going forward, all of our melting and casting activities will take place at the Faircrest location, and to date we're fully manned at Faircrest melt, with increased staffing in mid-April to support improving customer demand. By operating one melt shop, we will be using our manufacturing assets more efficiently while producing the best possible mix of products to meet our customers' needs. We expect our melt utilization to reach at least 80% or higher in the second quarter of 2021. Before I turn the call over to Kris, I wanted to highlight some of our current corporate sustainability efforts. At TimkenSteel, operating responsibly and sustainably is as important to us as making clean steel. For years, the Company has been focused on sustainability in our safety and environmental practices and we're proud of what we've accomplished. Currently we are working on enhancing our ESG reporting and we recently posted our first-ever SASB disclosure on our website. We believe this is an important step in becoming more transparent in terms of how we manage critical natural resources. For example, this year alone, we expect to reduce our greenhouse gas emissions over 10%. We look forward to sharing our long-term goals, including GHG reduction targets, later this year. Our culture is rooted in continuous improvement and being a good corporate citizen where we work and live. With that, I'd like to turn the call over to Kris. Kris?

Kristopher Westbrooks, Executive Vice President and Chief Financial Officer

Thanks, Mike. Good morning everyone and thanks for joining us today. I'm pleased that we started off 2021 with a significant improvement in profitability, both sequentially and compared with the prior year first quarter. Our quarterly financial results reflect improving industrial and automotive customer demand, increasing raw material surcharge environments, the benefit of prior restructuring and cost reduction actions and continued working capital discipline. Our overall cash and liquidity position strengthened during the first quarter as we generated operating cash flow of $13.2 million. We finished March with a record $115.7 million of cash and $357.5 million of total liquidity, thanks to our employees for a successful start to the year while remaining focused on daily execution. Turning to our first quarter of 2021 financial results. On a GAAP basis, net income for the first quarter was $9.8 million or $0.20 per diluted share. Comparatively, the Company reported a net loss in the first quarter of 2020 of $19.9 million or a loss of $0.44 per diluted share. The fourth quarter of 2020 net loss was $12.8 million or a loss of $0.28 per diluted share. On an adjusted basis, net income for the first quarter was $22.6 million or $0.43 per diluted share, a significant improvement from prior periods. For comparison purposes, the first quarter of 2020 adjusted net loss was $11.3 million or a loss of $0.25 per diluted share. Adjusted net income in the fourth quarter of 2020 was $600,000 or one penny per diluted share. As it relates to earnings per share, I would like to point out that the diluted share count in the first quarter of 2021 was 55.7 million shares. For further details regarding the additional shares included in the calculation for the convertible notes and share-based compensation awards, as well as the treatment of the convertible debt interest expense, please refer to the earnings per share disclosure in our Form 10-Q filed yesterday. Turning back to profitability, adjusted EBITDA improved to $40.8 million in the first quarter of 2021. This was a substantial improvement of $31.8 million from the first quarter of last year, and an improvement of $20.1 million from the fourth quarter of 2020. Adjusted EBITDA in the first quarter of 2021 represented the Company's highest level of quarterly adjusted EBITDA since 2014. Moving now to the drivers of the financial results. Ship tons in the first quarter improved 18% to 193,400 tons compared with the fourth quarter of 2020, but declined 9% compared with the first quarter of last year. The order book expanded throughout the quarter in the industrial end market and we experienced continued strength in the automotive sector. Shipments to our industrial customers increased 21,100 tons sequentially, or 33%, to 84,400 tons, with demand improvement from both industrial OEMs and distribution customers. Automotive customer shipments increased 7,200 tons sequentially, or 7%, to 103,500 tons in the first quarter. In the energy end market, we continue to be impacted by weak demand with shipments of 5,500 tons, albeit an improvement from the fourth quarter. Net sales of $273.6 million in the quarter increased 13% compared with the fourth quarter of 2020 and improved 5% compared with the first quarter of last year. About half of the sequential increase in net sales was due to higher industrial and automotive shipments. The remainder of the sequential increase in net sales is primarily due to an improvement in surcharge revenue as a result of a 65% increase in the average raw material surcharge per ton on higher scrap prices. From a manufacturing cost perspective, our continued focus on cost control and improved utilization rates in the quarter contributed to an $8 million sequential manufacturing cost improvement and a $19 million improvement from the prior year first quarter. As Mike mentioned, we completed the indefinite idling of the Harrison melt and casting assets and moved all melting and casting activities to our Faircrest facility. Savings associated with this action remain in line with those estimates discussed in our year-end 2020 earnings call in February. From a melt utilization perspective, higher end-market demand in the industrial and automotive sectors resulted in an improvement in our first quarter melt utilization to 59% compared to 43% in the fourth quarter of 2020, and 47% in the first quarter of 2020. The first quarter of 2021 melt utilization rate was calculated using a melt capacity of approximately 2 million tons, given that the Harrison melt and casting assets were operational for most of the quarter. Going forward, we plan to report melt utilization for Faircrest only, which as a reminder has a melt capacity of approximately 1.2 million tons. For comparison purposes, Faircrest-only melt utilization in the first quarter of 2021 was 73%. Now turning to SG&A expense. In the first quarter, SG&A increased slightly on a sequential basis to $19.5 million as a result of higher variable compensation expense. In comparison to the first quarter of last year, SG&A declined by nearly $4 million or 17%, largely driven by lower employment costs as a result of prior restructuring actions, supported by a continued focus on process simplification and efficiency. Moving on to cash flow and liquidity. The Company generated operating cash flow of $13.2 million in the first quarter. Working capital was a use of cash of $13.1 million in the quarter, driven by an increase in accounts receivable and inventory requirements given the higher sales activity. These cash uses were partially offset by an increase in accounts payable, primarily due to higher scrap purchasing levels and prices. Our working capital management actions implemented in 2020 remain in place and are an important area of continued focus going forward. The positive first quarter operating cash flow drove the corresponding increase in cash on hand from the end of 2020, resulting in $115.7 million of cash to close the quarter. From a liquidity perspective, our total liquidity of $357.5 million at the end of March represented a $43.4 million improvement from the end of 2020. The increased liquidity was the result of improved profitability, positive operating cash flow generation and an expanded asset borrowing base. From a pension perspective, the Company recorded a small non-cash re-measurement loss in the first quarter of 2021 as a result of the required salary pension plan re-measurement. Re-measurement of the salary pension plan, which is excluded from adjusted EBITDA results, will be required on a quarterly basis for the remainder of 2021. In total, the accounting funded status of all plans was 86% at the end of the quarter, up slightly from the end of 2020. In March, the American Rescue Plan Act of 2021 was signed into law. This Act includes pension funding relief that we anticipate will have a significant impact on the timing of future required Company pension contributions. As a result of this pension funding relief and based on current assumptions and expected asset returns, at this time we believe our required future U.S. Bargaining Plan pension contributions will likely be delayed until 2028. As further information is available regarding the timing and amount of future required pension contributions, we will provide updates accordingly. To wrap up, we're encouraged by the improvements in our order book supported by strength in industrial and automotive demand. We're closely monitoring customer supply chain disruption and uncertainty created by the ongoing COVID-19 pandemic and will remain flexible in our operations to meet customer demand. Looking forward, in the second quarter, we expect high single-digit sequential growth in our ship tons on a percentage basis, as well as a sequential increase in adjusted EBITDA. Second quarter Faircrest melt utilization is expected to be 80% or higher to support the current demand environment. Additionally, our cash balance will be impacted by the repayment of the remaining outstanding convertible debt due on June 1, 2021. At the end of March, the outstanding balance of the convertible debt due on June 1 was $40.2 million. Thank you for your interest in TimkenSteel, we look forward to sharing our continued progress going forward. We would now like to open the call for questions.

Operator, Operator

Your first question is from the line of Seth Rosenfeld with Exane.

Seth Rosenfeld, Analyst

Good morning. Thank you for taking our questions today. If I can kick off please with regards to your commentary on automotive demand. It sounds like to date that impact in the semiconductors disruption hasn't been so significant for your business, but might be more in Q2. When you think about that mix impact, what's the implication from a margin perspective of selling in the spot market today versus selling on those fixed auto contracts, please?

Michael Williams, President and Chief Executive Officer

By the way, thanks for the question. There is definitely a margin improvement on the spot business versus the contractual business with the automotive customers that we have.

Kristopher Westbrooks, Executive Vice President and Chief Financial Officer

Expect to add on to that: to the extent it shifts to industrial, we would expect that to be a benefit as well.

Seth Rosenfeld, Analyst

Okay, thank you very much and just a follow-up: can you give us an update on how the annual auto contract negotiations progressed? I think on the last quarterly call, most were settled but perhaps not all of them. Given the increasing strength in the spot market, is there any opportunity to go back and try to renegotiate those contracts? When would you expect some lift potential?

Michael Williams, President and Chief Executive Officer

Yes, so we do have some automotive contracts that expire at the end of the first quarter; we began negotiating and completing contracts starting for the second quarter and they were favorable to our expectations. In regards to the existing contracts in place, that activity will start later this year—typically starts late August through September for the next year.

Seth Rosenfeld, Analyst

And is there an opportunity to go back and try to renegotiate January contracts at this stage?

Michael Williams, President and Chief Executive Officer

No. We made a promise and a commitment and we stick to it.

Seth Rosenfeld, Analyst

Okay, very clear. And just one more question on the ESG side. Your comments in your prepared remarks estimated a reduction in greenhouse gas emissions by 10% this year. Can you give us a bit more color on that in terms of what the base year is for that— is it year-over-year—and also what are the key drivers that you can expect for that significant one-year step?

Kristopher Westbrooks, Executive Vice President and Chief Financial Officer

Sure, Seth. That's based off of our 2020 emissions in our report, so we would expect that 10% improvement off of 2020. It's primarily driven by the manufacturing footprint actions that we have previously announced. We plan to provide more color as the year progresses on our targets for the future by the end of this year.

Seth Rosenfeld, Analyst

Okay, thank you very much.

Kristopher Westbrooks, Executive Vice President and Chief Financial Officer

You're welcome.

Operator, Operator

Your next question comes from the line of Phil Gibbs with KeyBanc Capital Markets.

Philip Gibbs, Analyst

Hey, good morning.

Michael Williams, President and Chief Executive Officer

Good morning.

Philip Gibbs, Analyst

Just to piggyback Seth's question on pricing and mix: it was a headwind in the first quarter relative to the fourth quarter, $6 million. With your spot increases and an opportunity to shift some auto tons to new industrial, and you did have a very weak mix in energy, do you think that the first quarter of '21 is the bottom for you for your pricing and mix cadence for the year?

Michael Williams, President and Chief Executive Officer

We do expect the mix to improve based on the demand going into the second quarter by market. Quarter-over-quarter, the major influence from a mix and price standpoint was more carbon versus alloy grades, and also we had a strong defense shift sales level in the fourth quarter that didn't repeat itself in the first quarter; however, we do expect that defense volume to increase, particularly in the second half.

Philip Gibbs, Analyst

So carbon versus alloy and then defense-rich in terms of your mix. Some of your spot increases that you put in, in both SBQ and in tubing over late last year and early this year—are those starting to hit their stride in the second quarter? I would presume you didn't get much given your lead times in Q1.

Michael Williams, President and Chief Executive Officer

On our base price quarter-over-quarter, we saw about a 6% increase overall. The price increases that were announced earlier in the first quarter are taking hold in the second quarter. So, we do expect price improvements going forward.

Philip Gibbs, Analyst

Okay. You have completed, it appears, your consolidation from Harrison to Faircrest. Did you have any frictional costs in the first quarter in your results that you didn't call out? I know you pulled some stuff out of the numbers to get your adjusted results, but was there anything in the results that you didn't pull out that you define as frictional that may dissipate?

Michael Williams, President and Chief Executive Officer

Yes, there were some MRO and spares type activities that we had to take charges on in Q1 that won't repeat themselves going forward.

Philip Gibbs, Analyst

Were those pulled out then? I know you did make a series of adjustments in the results; were those still in the results despite the exclusions? That's what I was trying to figure out.

Kristopher Westbrooks, Executive Vice President and Chief Financial Officer

Yes, Phil, the majority of that was excluded—both asset write-downs as well as the supplies write-downs; those were excluded from our non-GAAP results. There was a smaller amount of alloy raw material adjustments as we shifted all of our extra raw materials over to the Faircrest location that impacted Q1, but it was not overly material.

Philip Gibbs, Analyst

Okay, Kris, and then last one for me is net working capital. Clearly you've got continued inflation in raw materials, better demand levels—what should we be thinking about in terms of net working capital over the balance of the year? Thanks.

Kristopher Westbrooks, Executive Vice President and Chief Financial Officer

Sure, Phil. Primarily in the second quarter, the EBITDA growth that we commented on in our guidance and the higher volumes should be a positive driver of cash flow in the second quarter. We do have some potential working capital build though for receivables given the higher sales prices and higher volumes. Ultimately, the outcome is going to be dependent on the level of that EBITDA growth and how we balance that with working capital. It's clearly going to be a focus for us and we're very well positioned in all of our working capital practices. I can't give you too much detail there, but it's definitely still a focus for us and starting with the strong top line definitely helps.

Philip Gibbs, Analyst

Can I squeeze in one more here, just for housekeeping purposes. I think the bottom-line diluted share count was 55.7 million in Q1. I know that probably included some convertibles; what is that number on a pro forma basis as we look ahead when you include the convertible paydown?

Kristopher Westbrooks, Executive Vice President and Chief Financial Officer

There's about 3.2 million shares associated with the 2016 converts that are due June 1, 2021. So you would expect that 3.2 million to come off that total of the share count that you mentioned, the 55.7 million. There is some additional shares for equity-based compensation that's dependent on stock price and other factors at the time, so that would be an incremental add. Then you also have to adjust the top line. The interest expense component that you add back to net income would be lower by about $600,000 to $700,000. So there's two moving pieces there: lower interest expense add-back and a slightly lower share count by about 3.2 million at current net income levels.

Philip Gibbs, Analyst

Okay. So the $1.3 million goes to $0.7 million or something on the add back. And then your 56 million, 57 million, wherever your number goes, goes down through your $3 million and change, absolutely depending on your compensation issues. Okay, thanks very much.

Kristopher Westbrooks, Executive Vice President and Chief Financial Officer

You're welcome. Thank you.

Operator, Operator

Your next question comes from the line of Justin Bergner with G. Research.

Justin Bergner, Analyst

Hi. Good morning, Mike. And good morning, Kris. I apologize I jumped on the call a little bit late, so I hope I'm not redundant here, but great performance in the first quarter and good outlook for the second quarter. How should we think about the effects of inventory profits flowing through the first quarter EBITDA and second quarter outlook? Once steel prices and scrap prices sort of flatten or normalize, is there any perspective you can give as to how much would come off of EBITDA for the first half?

Kristopher Westbrooks, Executive Vice President and Chief Financial Officer

It's a little tough, Justin. We're turning our inventory quickly; all the working capital practices that we put in place historically are continuing, especially on the raw material side. So we don't have a lot of cheaper raw material sitting in inventory—it's current purchases pretty much—and we try not to do any speculative purchasing or manufacturing. We're making products for customer shipments and working our hardest to get it out the door to meet those customer commitments.

Justin Bergner, Analyst

Okay, and then a reminder now that you've consolidated at Faircrest, what's the maximum level of shipments that you could do on an annual basis, assuming you're producing at that level?

Michael Williams, President and Chief Executive Officer

Based on the nameplate melt capacity at 1.2 million tons, that would basically net out to about 900,000 tons of shipments per year and that can vary slightly based on mix, but I would say that's a good number.

Justin Bergner, Analyst

And just remind us as well: you're on track to do about 400,000 tons of shipments in the first half—if normal seasonality takes effect, I assume we would annualize that at a little bit less than 400,000 tons. Any reminder you can give us on typical seasonality in the second half versus the first half, given production schedules, shifts and holiday outages?

Michael Williams, President and Chief Executive Officer

The seasonality really occurs in the fourth quarter based on what we see and that's typically driven by the holidays as well as year-end inventory reductions that customers take to manage their inventories for year-end. Historically, we typically see the fourth quarter about 10% to 15% lower than the prior quarter.

Justin Bergner, Analyst

That's helpful. Any optimism towards energy or is it still a small contributor to your shipment levels going forward?

Michael Williams, President and Chief Executive Officer

What we're experiencing is a decent increase in activity in terms of inquiries, but that hasn't necessarily translated to orders. The slight increase in shipments to the energy market is predominantly driven by inventory gaps or requirements to fill inventories that have been run out or are well below safety levels. So it's kind of hit-or-miss. Industry statistics are improving in regards to modest rate growth, but the orders haven't fully materialized. I wouldn't call it optimistic, but we do see some modest slight improvement going forward.

Justin Bergner, Analyst

Okay, thank you.

Operator, Operator

At this time there are no further questions. I would now like to turn the call back over to management.

Jennifer Beeman, Senior Manager, Communications and Investor Relations

Thank you all for joining us today, and that concludes our call.

Operator, Operator

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