Earnings Call Transcript - MTUS Q2 2021

Operator, Operator

Good morning and welcome to the TimkenSteel Second Quarter 2021 Earnings Conference Call. I would now like to turn the conference over to your host.

Jennifer Beeman, Senior Manager, Communications and Investor Relations

Thanks and good morning. Welcome to TimkenSteel’s second quarter 2021 conference call. I am Jennifer Beeman, Senior Manager of Communications and Investor Relations for TimkenSteel. Joining me today is Mike Williams, President and Chief Executive Officer; Kris Westbrooks, Executive Vice President and Chief Financial Officer; and Kevin Raketich, Executive Vice President of Sales, Marketing, and Business Development. 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 would like to turn the call over to Mike. Mike?

Mike Williams, President and Chief Executive Officer

Thank you, Jennifer and thanks to everyone on the call for joining us this morning. Like many in our industry, we benefited from robust market demand during the quarter. Most of our end markets performed well despite semiconductor-related customer outages, which slowed down our second quarter automotive shipments. However, I am pleased that our teams remained agile and effectively shifted our product mix to serve industrial customer needs, while maintaining a high level of service. In fact, our overall on-time delivery was at 92%, a testament to our continued operational focus. Our lead times have significantly extended, but remain competitive and our order backlog is strong. With the ongoing economic recovery, favorable pricing environment and continued cost discipline, we achieved record net income and adjusted EBITDA and continue to generate positive operating cash flow. Above all else, safety remains our priority and we continue to focus on driving continuous improvements throughout our organization. While there are many initiatives underway, most recently, we focused on the safe execution of a portion of our annual maintenance shutdown, which occurred in July with excellent safety results. I am also encouraged that our teams have made good strides with our corporate sustainability efforts. As we work to refine our future strategic direction, we recognize that ESG must play an integral role in our future growth. As you recall, last quarter, we published our first-ever SASB Disclosure. I am pleased that we have continued the positive momentum: not only have the teams been gathering data to build realistic and achievable targets, but they have begun work on sustainable initiatives. We look forward to sharing our long-term goals, including GHG reduction targets, as early as September. Moving to our markets, in automotive, we believe the semiconductor supply chain disruption was most profound in the second quarter as our automotive shipments decreased by 10% sequentially. We estimate that the disruption negatively impacted our automotive shipments by approximately 16,000 tons in the quarter. At this time, we expect third-quarter automotive shipments to continue to be negatively impacted by periodic customer operating schedule changes. However, with many of the OEMs signaling a strong second half of the year, we believe the supply chain will continue to stabilize throughout the rest of this year and into 2022. Before moving to our industrial market update, I want to congratulate the team at our facility in Eaton, Ohio, for being awarded the 2020 General Motors Supplier Quality Excellence Award. As a reminder, this facility supports the manufacturing of 10-speed ring gear blanks and 8-speed pinion blanks that shipped directly into GM transmission plants. This is the fourth time we have been awarded this honor. As a Tier 1 supplier to GM, TimkenSteel is evaluated on business performance metrics, such as supply chain effectiveness, launch delivery, total enterprise cost as well as cultural priorities, including transparency, communication, responsiveness and a total enterprise approach. This award originates from the GM quality team. We know that to be successful, quality must be supported by all of our functional teams. My sincere congratulations to the teams. As I mentioned earlier, our industrial markets continue to perform well in the second quarter. Sequentially, we saw a 33% increase in our shipments and we believe strong industrial demand is sustainable into the second half of 2021. Most industrial categories we serve such as distribution, defense, agriculture, mining, general industrial and bearings all increased sequentially. Turning to energy, short-term demand remains historically low; however, industry statistics are improving and our shipments into this market increased sequentially by 58% as we experienced some demand recovery to support inventory replenishment needs. Operationally, we are adjusting to operating with one melt shop, and I am pleased with the team’s efforts to make this much-needed transition. Not only are we laser-focused on optimizing our product mix and continued cost control, but we are making good progress on initiatives to drive manufacturing excellence at TimkenSteel. To kickstart some of our efforts, Andrew Bissot joined us in May as Vice President of Engineering, Manufacturing Excellence and Reliability. Reporting directly to me, Andrew is responsible for implementing our manufacturing excellence philosophy, processes, and best practices centered around company-wide maintenance effectiveness and efficiencies. He will help create a cost-effective and sustainable way to ensure the reliability of our equipment, our asset lifecycle and optimize our investments. Andrew and I have worked together for many years in the past and we have been successful in delivering on similar strategic priorities. On the commercial side, we have begun mapping out a path to commercial excellence in an effort to improve our margin profile, optimize our product portfolio, and best leverage growing markets. More to come on that in the future. Last week, we completed the sale of the TimkenSteel Shanghai subsidiary to Daido Steel for approximately $7 million in cash. My congratulations to all of our teams for getting this across the finish line and particularly to our team in China and at corporate for their hard work and dedication throughout this process. We wish them well and look forward to continuing our partnership working with Daido in the future. And lastly, many of you know that on Monday, we begin our discussions with the United Steelworkers regarding the current labor agreement that is set to expire on September 27. The current agreement covers approximately 1,180 bargaining employees in our Canton facilities. As always, our goal is to reach a fair and equitable agreement that supports the company’s vision and provides job security for our employees. With that, I would like to turn the call over to Kris. Kris?

Kris Westbrooks, Executive Vice President and Chief Financial Officer

Thanks Mike. Good morning, everyone and thanks for joining us today. I also wanted to extend my thanks to our hardworking and dedicated employees. Excellent teamwork enabled the company to deliver record second quarter net income and adjusted EBITDA, strong operating cash flow, and record quarter-end total liquidity, while continuing to improve our cost structure and maintain working capital discipline. Turning to our second quarter results, on a GAAP basis, net income for the second quarter was a record $54 million or $0.98 per diluted share. Comparatively, the company reported a $15.3 million net loss in the second quarter of 2020 or a loss of $0.34 per diluted share. The first quarter of 2021 net income was $9.8 million or $0.20 per diluted share. On an adjusted basis, net income for the second quarter was $52.5 million, or $0.96 per diluted share, a significant improvement from prior periods. For comparison purposes, the second quarter of 2020 adjusted net loss was $14.3 million, or a loss of $0.31 per diluted share. Adjusted net income in the first quarter of 2021 was $22.6 million or $0.43 per diluted share. As it relates to earnings per share, our diluted share count in the second quarter of 2021 was 56.1 million. For further details, refer to the earnings per share disclosure and our Form 10-Q filed yesterday. Turning back to profitability, adjusted EBITDA was a record $71 million in the second quarter of 2021. This was a substantial adjusted EBITDA improvement of $65.3 million from the second quarter of last year and an improvement of $30.2 million from the first quarter of 2021. Through the first half of this year, adjusted EBITDA totaled $111.8 million and represented the company’s strongest start to a year since its inception in mid-2014. Moving now to the drivers of the financial results, ship tons in the second quarter improved 11% sequentially to 214,200 tons, exceeding our guidance of high single-digit sequential growth and primarily driven by strength in industrial demand. Additionally, second quarter 2021 shipments nearly doubled from the COVID-impacted second quarter of 2020. The order book strengthened throughout the second quarter with lead times now extending into the first quarter of 2022. Shipments to industrial customers increased 27,500 tons sequentially, or 33% to 111,900 tons in the second quarter, with growth from a diverse group of general industrial and distribution customers. We were successful in filling open second quarter capacity created by automotive semiconductor-related delays with short lead-time industrial demand. As Mike previously mentioned, automotive customer shipments declined 10% sequentially to 93,600 tons in the second quarter driven by semiconductor supply chain disruption in our automotive customer manufacturing locations. In the energy end market, second quarter shipments of 8,700 tons represented a 3,200-ton improvement from the first quarter. Net sales of $327.3 million in the quarter increased 20% compared with the first quarter of 2021 and more than doubled compared with the second quarter of 2020. About two-thirds of the sequential increase in net sales is due to higher surcharge revenue as a result of the 39% increase in the average raw material surcharge per ton from higher market prices for scrap. The remainder of the sequential increase in net sales is primarily due to strength in industrial customer demand. From a manufacturing cost perspective, our continued focus on cost control throughout the year, combined with improved melt utilization in the quarter, contributed to a $10 million sequential manufacturing cost improvement and a $26 million improvement from the prior year quarter. The efficient operation of a single melt shop at our Faircrest facility, coupled with higher end market demand in most sectors, resulted in an improvement in our second quarter melt utilization to 84%. This compares to the first quarter of 2021 when total company melt utilization was 59% and Faircrest-only melt utilization was 73%. Melt utilization was approximately 20% in the COVID-impacted second quarter of 2020. Now turning to SG&A expense, in the second quarter of 2021, SG&A increased $1.5 million on a sequential basis to $21 million, primarily due to higher variable compensation expense. In comparison to the second quarter of 2020, SG&A increased $4.2 million largely driven by higher variable compensation expense and prior year COVID-19-related temporary cost reduction actions. Although SG&A is up versus comparable periods, principally from higher variable compensation expense given improved business performance, we remain intensely focused on process simplification, efficiency and overall cost control. Moving on to cash and liquidity, working capital was a use of cash in the second quarter of $40.6 million, with over half driven by an increase in accounts receivable given the higher sales activity. Record quarterly net income exceeded working capital requirements and drove operating cash flow of $39.2 million in the second quarter of 2021, a $26 million sequential improvement and a $23.1 million improvement compared to the second quarter of 2020. This marks the company’s ninth consecutive quarter of generating positive operating cash flow during which time we reduced its net debt, calculated as total debt minus cash, by over $275 million. Additionally, during the quarter, the company settled its $40.2 million convertible debt obligation due on June 1, 2021, with cash payments totaling $38.9 million and the issuance of 113,000 shares. We closed the second quarter of 2021 with $115.2 million of cash, similar to the cash balance at the end of the first quarter. Total liquidity was $376.5 million at the end of June, a $19 million improvement since the end of March. Thanks to our team for a strong first half cash flow performance which included $52.4 million of operating cash flow and an increasing demand environment supported by a daily focus on working capital discipline. From a pension perspective, the company recorded a non-cash re-measurement gain of approximately $700,000 in the second quarter of 2021 as a result of the required salaried pension plan re-measurement. Re-measurement of the salaried pension plan, which is excluded from adjusted EBITDA results, will be required quarterly for the remainder of 2021. As a reminder, the American Rescue Plan Act of 2021 was signed into law in March. Consistent with the prior quarter, we continue to evaluate the impact and timing of elections permitted by the act on required future U.S. pension plan contributions. There have been no significant changes since our last update where we indicated that we believe our required future U.S. pension contributions will be delayed until 2028. As further information is available regarding the timing and amounts of future required pension contributions, we will provide an update. Turning now to the outlook, given continued strength in end market demand, we anticipate third quarter shipments to be similar to second quarter levels. While our order book is full for the remainder of 2021, periodic automotive customer manufacturing outages due to the semiconductor chip shortage may delay some third quarter automotive shipments to future periods. From an operational perspective during the third quarter, melt utilization is expected to be at or above 85%. The annual shutdown maintenance was completed at the company’s rolling and finishing operations at a cost of approximately $5 million. Additionally, as Mike mentioned, we are beginning negotiations with the United Steelworkers regarding the labor agreement that is set to expire in late September. We anticipate incremental costs incurred during the course of normal and successful labor agreement negotiations to be in the range of $2 million to $3 million in the second half of 2021. Lastly, in the third quarter, cash proceeds of approximately $7 million are expected to be received from the sale of the TimkenSteel Shanghai entity. During the fourth quarter, annual shutdown maintenance is planned at the Faircrest melt shop for 10 days at an expected cost of approximately $5 million. We anticipate melt to be reduced by about 30,000 tons during the fourth quarter as a result of the planned outage. To wrap up, thanks to our employees for their execution of a strong first half of 2021. We plan to continue the momentum into the second half, while remaining focused on continuous improvement and efficiency opportunities. Thanks for your interest in TimkenSteel and we look forward to sharing our continued progress going forward. We would now like to open the call for questions.

Operator, Operator

Operator provided instructions to callers on how to ask questions. Your first question is from Tristan Gresser with Exane BNP Paribas.

Tristan Gresser, Analyst, Exane BNP Paribas

Yes. Hi, thank you for taking my question. Certainly two, please. You did not provide any EBITDA guidance compared to last quarter. With stable volumes and rising prices, is there any particular reason why we should not expect better results in Q3? I know you mentioned maintenance that should be relatively small. How well do Q2 margins guide for the second half?

Kris Westbrooks, Executive Vice President and Chief Financial Officer

Hi, Tristan, this is Kris. Good morning. You are correct we did not provide specific or directional guidance on EBITDA. We do still expect our profitability to be strong in the third quarter and we did provide the building blocks there. There are going to be higher maintenance costs as we alluded to and there are some other dynamics with surcharges in our raw material pricing as well as the volume impact as semiconductors affect the quarter. The second quarter also benefited from a release of inventory reserves as you probably saw in the tables in the back. So there are some puts and takes. We still believe the third quarter will be strong and we look forward to sharing those results as they are produced later in the quarter.

Tristan Gresser, Analyst, Exane BNP Paribas

Alright. That’s helpful. And finally, on prices and ASP, how should we think about ASP moving forward? I believe you announced a total of $200 per ton base price increase for SBQ effective this year. How much of that has already been in the P&L? I don’t think we have seen much of the base sales per ton increase in Q2. So how should we think about ASP into H2?

Mike Williams, President and Chief Executive Officer

Yes. So you have to remember that about 80% of our business is under contract for the year and about 20% is more spot-oriented. However, we do expect further price appreciation or positive development going forward throughout the remainder of the year. As you recall, the last price increases were announced to be effective on both bar or SBQ and seamless tube in early July. So, we should expect to see that appreciation throughout the rest of the year.

Tristan Gresser, Analyst, Exane BNP Paribas

Alright. Thank you.

Operator, Operator

Your next question is from Michael Leshock with KeyBanc Capital.

Michael Leshock, Analyst, KeyBanc Capital

Hi, guys. Good morning.

Mike Williams, President and Chief Executive Officer

Good morning.

Michael Leshock, Analyst, KeyBanc Capital

So first, I wanted to follow up on the prior question on pricing. During the call, you mentioned lead times are now extending into 2022. Was that for SBQ? And are you expecting those longer lead times to drive a stronger contract pricing environment in 2022, versus what you were expecting maybe three months ago?

Mike Williams, President and Chief Executive Officer

Sure, good question. So yes, our lead times for both SBQ and stainless mechanical tubing are into next year. And we do expect—while pricing conversations are private between us and our customers—I am very positive about the position we are in to negotiate 2022 pricing.

Michael Leshock, Analyst, KeyBanc Capital

Okay. And when I look at the shift from auto to industrial shipments, given some of the chip shortages that your customers are facing, have you made any share gains within industrial? And then secondly, how quickly are you able to pivot between end markets, should the chip shortage get resolved?

Mike Williams, President and Chief Executive Officer

Sure, another good question. The industrial recovery from the pandemic was a little bit slower than the automotive recovery; however, it has accelerated tremendously and we expect that to continue. In the overall increase in demand, we are sustaining our market share position in industrial. Our ability to pivot is fairly flexible. We had to do that in Q2 and we were able to. We are able to do that throughout the remainder of the year as well. We have significant contractual arrangements with our automotive customers that will support their needs, and we will serve them. As I mentioned, our service capability with regards to on-time delivery is extremely high at 92%, so we have been performing extremely well.

Michael Leshock, Analyst, KeyBanc Capital

Got it, that’s helpful. And then as we look on inventories, we saw a modest pick-up in the quarter. Do you anticipate a further build to meet demand going forward and to capture absorption benefits?

Mike Williams, President and Chief Executive Officer

Again, we will react to the markets appropriately. We will have the appropriate inventory to service our customers to maintain that high level of service. We had some inventory because in automotive, we were planning for automotive sales that didn’t develop. We had to quickly pivot to the industrial segment, and that’s where we focused across all our segments. Wherever the opportunities are, that’s where we will be. We will position our inventory accordingly to maintain that high level of service.

Michael Leshock, Analyst, KeyBanc Capital

Great. And then just last for me on SG&A, you had some impressive cost control in the quarter despite the higher revenue baseline. I am wondering what you are seeing there in terms of inflationary pressures and how we should think about SG&A as a percentage of sales going forward.

Kris Westbrooks, Executive Vice President and Chief Financial Officer

Good morning, Michael. Not a lot of inflationary pressures in the SG&A area. We have good cost control, managing professional fees as well as overall headcount levels, and we feel that we are well positioned to move forward there. SG&A as a percent of sales will vary depending on what the top line looks like and surcharge levels, but it’s improving and it will remain a continued focus going forward.

Michael Leshock, Analyst, KeyBanc Capital

Got it. Thanks for all the color, guys.

Kris Westbrooks, Executive Vice President and Chief Financial Officer

Thanks for the questions.

Operator, Operator

Your next question is from Justin Bergner with Gabelli Funds.

Justin Bergner, Analyst, Gabelli Funds

Good morning. Mike and Kris, hope you are doing well. First question relates to melt utilization. How high can you get that in a quarter with maintenance, and how high in a quarter without downtime?

Mike Williams, President and Chief Executive Officer

Sure. I think we can get between 85% and 90% with the ebb and flows of maintenance requirements within a quarter. It could go higher in a given month, but you always have to maintain and keep your assets protected and operating efficiently.

Justin Bergner, Analyst, Gabelli Funds

Okay. Second question relates to pricing. It didn’t seem to increase much sequentially on a base basis. I know that you had some price increases that kicked in in the second quarter. Was there a mix effect, maybe some of the short-cycle industrial stuff being a bit lower-priced steel?

Mike Williams, President and Chief Executive Officer

Good question. Yes, there are primarily two impacts. The first is we had lower sales in our manufactured components area, which historically have higher realized prices. We've rebranded that segment to manufacturing components because that’s essentially what they do. Second, there was a mix shift between small SBQ sizes and larger SBQ sizes. We sold much larger SBQ sizes in Q2 versus Q1.

Justin Bergner, Analyst, Gabelli Funds

Okay. And the larger SBQ sizes actually had lower base sales per ton?

Mike Williams, President and Chief Executive Officer

Yes, they had a lower unit price per ton. However, the margins are better.

Justin Bergner, Analyst, Gabelli Funds

Okay. How does mix look to be shaping up in the second half—similar to the second quarter?

Mike Williams, President and Chief Executive Officer

Yes. From what we see with one month under our belt, it looks similar going forward. The real question is what happens with the automotive segment and their production interruptions. As we found, we are able to pivot quickly and make our sales goals and objectives.

Justin Bergner, Analyst, Gabelli Funds

So if the auto disruptions are greater, do you actually pull forward some of the industrial shipments you are planning for the beginning of next year or do you take near-term orders? How does that play out?

Mike Williams, President and Chief Executive Officer

There is a two-fold approach. One is that some customers want more steel from us than we can provide, so if we fall short in the automotive area, we can pursue those opportunities. We are also taking advantage of spot opportunities, particularly in distribution channels.

Justin Bergner, Analyst, Gabelli Funds

Great. Thank you. That’s it for my questions.

Mike Williams, President and Chief Executive Officer

Thank you for the questions.

Operator, Operator

Operator provided instructions to callers. At this time there are no further questions. I would like to turn the call back over to Jennifer for closing remarks.

Jennifer Beeman, Senior Manager, Communications and Investor Relations

Great. Thank you everyone for joining us today. We look forward to informing you next quarter. Thank you. This concludes our call.

Operator, Operator

This concludes today’s conference. You may now disconnect.