Earnings Call Transcript - WOR Q2 2022

Operator, Operator

Good afternoon, and welcome to the Worthington Industries Second Quarter Fiscal 2022 Earnings Conference Call. All participants will be able to listen-only until the question-and-answer session of the call. This conference is being recorded at the request of Worthington Industries. If anyone objects, you may disconnect at this time. I'd now like to introduce Marcus Rogier, Treasurer and Investor Relations Officer. Mr. Rogier, you may begin.

Marcus Rogier, Treasurer and Investor Relations Officer

Thank you, Rachel. Good afternoon, everyone, and welcome to Worthington Industries Second Quarter Fiscal 2022 Earnings Call. On our call today, we have Andy Rose, Worthington's President and Chief Executive Officer; and Joe Hayek, Worthington's Chief Financial Officer. Before we get started, I'd like to remind everyone that certain statements made today are forward-looking within the meaning of the 1995 Private Securities Litigation Reform Act. These statements are subject to risks and uncertainties that could cause actual results to differ from those suggested. We issued our earnings release earlier this morning before the market opened. Please refer to it for more detail on those factors that could cause actual results to differ materially. Today's call is being recorded, and a replay will be available later today on our worthingtonindustries.com website. At this point, I will turn the call over to Joe for a discussion of the financial results.

Joe Hayek, Chief Financial Officer

Thank you, Marcus. And good afternoon, everyone. We had another strong quarter in Q2 with reported earnings of $2.15 per share compared to a loss of $1.40 in Q2 a year ago. Excluding a small one-time restructuring gain, we generated a second quarter record $2.12 per share in Q2. In the prior year period, excluding restructuring and the unrealized loss and one-time charges associated with our investment in Nikola, we generated earnings of $0.95 per share. Consolidated net sales in the quarter of $1.2 billion were up significantly compared to $731 million in Q2 of last year. The increase in sales was primarily due to higher steel prices along with increased volumes across our businesses and our recent acquisitions. Our gross profit for the quarter increased to $185 million from $135 million in the prior year quarter and gross margin was 15% versus 18.5%. Our adjusted EBITDA in Q2 was $168 million, up from $96 million in Q2 of last year. And our trailing 12 months adjusted EBITDA is now $677 million. I'll now spend a few minutes on each of the businesses. In Steel Processing, net sales of $938 million doubled from $469 million in Q2 of last year, primarily due to higher average selling prices and a slight decrease in volumes. Total shipped tons were up 4% from last year's second quarter through the inclusion of Shiloh's BlankLight business and were flat excluding that acquisition. Direct tons in Q2 were 47% of the mix compared to 48% in the prior year quarter. Automotive demand is still difficult to predict, but late in the quarter, production forecasts began to improve, and we're optimistic that trend will continue. Production levels in automotive are not approaching historic averages, and a myriad of risks and challenges will persist for several quarters, but we are seeing indications that the worst of the semiconductor-related production interruptions may have passed. Demand across our other major end markets remains robust. And while supply chains and steel availability remains tight, we continue to navigate those challenges exceptionally well. In Q2, steel generated adjusted EBIT of $72 million compared to $34 million last year. A large year-over-year increase was primarily driven by higher spreads combined with slightly higher volumes. In the quarter, the scrap gap remained wider than historic averages. In Q2, we had pretax inventory holding gains estimated to be $42 million or $0.61 per share compared to negligible gains in Q2 of last year. Based on recent declines in steel prices, we believe we will have meaningful inventory holding losses in Q3 and will also face continued headwinds from the scrap gap. In Consumer Products, net sales in Q2 were $144 million, up 20% from $118 million in the prior year quarter. The increase was driven by the inclusion of sales from GTI, which we acquired in January, combined with higher average selling prices. Adjusted EBIT for the consumer business was $18 million, and adjusted EBIT margin was 13% during Q2 compared to $17 million and 15% in the prior year quarter. The consumer team continues to do an excellent job managing through a fluid environment. Demand remains robust, and we have invested in new equipment and headcount to increase our production capacity. Margins have been under some pressure due to higher input costs, and we're limited in our ability to pass those costs along because of fixed-price contracts with customers. Late in Q2, we were able to start recapturing some of that margin, and as a result, we expect margins will improve moving forward. Building Products generated net sales of $121 million in Q2, which was up 29% from $94 million in the prior year quarter. The increase was primarily due to higher volumes as construction markets continue to grow and higher average selling prices. Building Products adjusted EBIT was $55 million, and adjusted EBIT margin was 45%, up significantly from $26 million and 28% in Q2 of last year. The large year-over-year increase was driven by record results at ClarkDietrich, contributing $27 million in equity earnings, combined with solid results from WAVE who contributed $22 million. Those teams have done a great job continuing to deliver value for their customers in a rising price environment. Our wholly owned Building Products business generated 47% year-over-year EBIT growth in the quarter due to an improved demand environment and higher average selling prices. The markets for our products and solutions, which are driven by commercial and residential construction, continue to show strength as the economy recovers, and we are maintaining and growing our share through new product development and our ability to add value to our customers' efforts. In Sustainable Energy Solutions, net sales in Q2 were $33 million, down slightly from $34 million in the prior year. Despite continued demand headwinds related to semiconductor chip shortages at their customers, the business was profitable and reported adjusted EBIT of $1 million in the current period compared to $2 million in the prior year. This business is in the early stages of repositioning itself to serve the global hydrogen ecosystem and adjacent sustainable energies like compressed natural gas. We're very pleased with our progress and some early wins. The markets we serve will take time to develop, but we're very excited about our growth prospects over the long term. With respect to cash flows and our balance sheet, operations used cash of $119 million in the quarter driven by a $235 million increase in operating working capital, primarily associated with higher steel prices. For context, we've added $568 million of working capital over the last 12 months, and our free cash flow in that same period is an outflow of $201 million. As steel prices decline, these increases in working capital should subside and ultimately reverse, as they are converted back into cash. During the quarter, we received $29 million in dividends from our unconsolidated joint ventures, invested $24 million in capital projects, paid $15 million in dividends, and spent $13 million to repurchase 235,000 shares of our common stock. Following our Q2 purchases, we have slightly over 8 million shares remaining under our repurchase authorization. Looking at our balance sheet and liquidity position, funded debt at quarter end of $702 million and interest expense of $7 million were both down slightly compared to the prior year, primarily due to favorable exchange rates for our euro-denominated debt. We ended Q2 with $225 million in cash which we used to fund our December 1 acquisition of Tempel Steel. Earlier today, the Board declared a $0.28 per share dividend for the quarter, which is payable in March of 2022. At this point, I will turn it over to Andy.

Andy Rose, President and Chief Executive Officer

Thank you, Joe. And good afternoon, everyone. I'm proud of our employees for delivering yet another record, the best second quarter in the company's history and the third-best quarter ever. It's a great way to finish the calendar year and enter the holiday season. We have a lot of positive momentum in our businesses. But operating challenges remain, some of which we have been able to improve over the past few months. Supply chain issues still exist, but the chip shortage appears to be improving, although it is still impacting our automotive volumes. Our HR team has done excellent work reducing the number of open positions across the company, but labor availability is tight and not expected to change much in the foreseeable future. Our success is directly attributable to the efforts of our people who continue to do exceptional work meeting customer needs. Demand levels are good across almost all of our end markets, and backlogs are solid. In Consumer Products, price increases needed to offset rising costs are beginning to show up in our financial results and will help profitability going forward. We continue to invest in working capital during the quarter and have added almost $600 million in the past year, but the price of hot-rolled steel peaked during the quarter in the mid-1,900s and has already fallen close to $300 a ton. Our purchasing team believes there are more declines coming, although the pace of that decline remains open for debate. Consumer products, building products, and sustainable energy solutions all performed well during the quarter, but a special mention to the team at ClarkDietrich, who have successfully navigated the challenging environment to record profits. We continue to be very bullish on the future of all of these business segments as we refine and execute broader and more aggressive growth strategies. Leveraging innovation, transformation, and M&A will drive above-market growth and higher returns on capital. We also completed our Investor Day in November. For those of you unable to join, I encourage you to visit our website and take a look at the presentations from our business leaders on their strategies for growth. We are thrilled to have closed the acquisition of Tempel Steel on December 1. Tempel is already a global leader in the electrical steel laminations market, which supplies the manufacturers of transformers, electric motors, and electric vehicle motors. This business is led by a talented team and should experience significant growth in the coming years as the world converts to electric vehicles and the electricity infrastructure is upgraded and expanded to meet these demands. The business environment continues to be very dynamic, whether it's COVID, labor shortages, supply chain issues, or the volatility in commodities, particularly steel. Our teams continue to excel in managing through these challenges safely and effectively. Our customers' needs are being met, and our shareholders are being rewarded with record profits. Thank you to all of our employees for their efforts. We'll now take questions.

Operator, Operator

Thank you. Our first question comes from Phil Gibbs from KeyBanc Capital Markets. Your line is open.

Phil Gibbs, Analyst

Hi, good afternoon.

Andy Rose, President and Chief Executive Officer

Good afternoon, Phil.

Phil Gibbs, Analyst

Last quarter, you had I think mentioned some variability in the outlook maybe for automotive. It looked like your volumes for steel were reasonably stable sequentially, may be able to move some volume away from auto into other markets. But I think that's still your core business. And so trying to understand what you're seeing there right now.

Andy Rose, President and Chief Executive Officer

For automotive, specifically, Phil?

Phil Gibbs, Analyst

Yeah, within steel.

Andy Rose, President and Chief Executive Officer

Yes. At a macro level, I believe the demand for automotive is very strong, much higher than the current sales rate, which I think last quarter or last month was low-13 million. The supply chain issues continue to constrain production. They do seem to be easing. However, our team that monitors this very closely, particularly for the models we are producing and for the entire market, believes there will be a modest improvement next quarter in terms of the annual production rate, but it will not return to match the end market demand. End market demand could be as high as 16.5 million or 17 million cars if there were no production issues at all.

Phil Gibbs, Analyst

What does that mean for how we should be thinking about volume next quarter? Is it likely to remain reasonably similar? I know you usually experience some seasonality, but the auto sector is still not performing at the necessary levels. Additionally, we have a new acquisition to consider, so I'm just trying to understand the implications of that.

Joe Hayek, Chief Financial Officer

Yeah. You're right on both counts, Phil. There is some seasonality. Obviously, December is upon us. And then you have sort of the January, February kind of reset, reboot. So seasonally, Q2 and Q3 are not that dissimilar. And so I think the way that we look at it, given kind of some of that seasonality, I think sequentially flattish on automotive to slightly up. And then some of the other things you mentioned about kind of moving tons to other places is a reasonable way to think about it. That obviously is the acquisition.

Phil Gibbs, Analyst

Okay. And was that acquisition funded with revolving capital or cash on the balance sheet?

Joe Hayek, Chief Financial Officer

So yeah. So we had $225 million at quarter end in cash. And we funded the acquisition with that cash and the remainder being a drawdown of our revolver.

Phil Gibbs, Analyst

And just the last one here. Where is your approximate pro forma liquidity right now? Thanks, guys.

Joe Hayek, Chief Financial Officer

So again, pro forma liquidity is around $75 million due to the acquisition and some working capital increases. Our revolver has a limit of $500 million, and we believe that given our current working capital and funding availability, we could easily secure additional liquidity if needed.

Operator, Operator

Thank you. Your next question comes from the line of John Tumazos from Very Independent Research. Your line is open.

John Tumazos, Analyst

Thank you very much. Is the Tempel Steel acquisition going to be immediately accretive? Or is it something that over 5 to 10 years as electrification advances becomes robust but doesn't make a big difference in the short term?

Andy Rose, President and Chief Executive Officer

No. John, it's a profitable business and will be immediately accretive. I think in this quarter, there may be some purchase accounting, the first month or 2. But this is a business that in the steel processing world, we're excited for a lot of reasons about this business. It's a fantastic team. They've got great market share globally, but the growth prospects are fantastic. And when you throw on top of that, that it's already a nicely profitable business, it's easy to get excited about the future.

John Tumazos, Analyst

On the current balance sheet, there's about $35 million for assets held for sale. What are those particular items for sale? Or are there any that might come out a little better than expected?

Joe Hayek, Chief Financial Officer

No. We don't expect those to vacillate a lot from valuations that are in there. John, those are a couple of assets that have been held for sale for quite a while, actually one of our joint ventures, but we don't expect anything kind of out of the ordinary to take place there.

Andy Rose, President and Chief Executive Officer

The only other thing I would add, John, to that is there's not a meaningful amount of profitability associated with those assets held for sale. So if that helps.

John Tumazos, Analyst

The inventory account rose to $840 million. In all 3 categories, raw materials, work in process, finished products rose a lot. Your sales in the second quarter looked very good or normal. And as you mentioned, the steel price fell since September throughout the quarter. So is the reasonable explanation that when the mill started to have less orders, all your steel showed up early?

Andy Rose, President and Chief Executive Officer

No. I think there is just a lag effect. The steel we purchase has seen a price reduction in the last three weeks. Therefore, we need to wait for the benefits of those lower prices. We mainly buy steel under contracts that are either monthly or quarterly, covering about two-thirds to three-quarters of our purchases. While some is bought at spot prices, those are the only ones that would have benefited us in this quarter.

John Tumazos, Analyst

And I sent you a note, Andy. In the wood business, there were big delays in the producers getting prices up in the second half of last year. And the retailers made out like bandits. Home Depot might have made more per unit than the people that manufacture the wood. Then when the wood prices started to fall in June, Home Depot didn't cut its price for a month. So it like made out on the way up and on the way down better than the mills. And the times were very compressed where when the prices fell, they fell fast and completely like in a month or 2. In steel, do you expect your customers to reduce your prices before you can cut the cost of the steel that's coming in?

Andy Rose, President and Chief Executive Officer

I think that's a bit of a unique situation. I would prefer not to speculate on that. I'm not entirely sure I understood the question. If you'd like to clarify, please go ahead.

Joe Hayek, Chief Financial Officer

Well, maybe, I'll try, John.

John Tumazos, Analyst

If prices go down in the market instantly where you have incoming steel that you can't stop at the higher prices.

Joe Hayek, Chief Financial Officer

Yeah. So I mean 100% appreciate the analogy with lumber, and we all watch that. But obviously, we don't buy on a contract and sell spot. As Andy mentioned, almost all of what we're selling has been contracted for at specific prices. And so there'll be some vacillation, and we think our folks are the best in the world at understanding how things are trending and where things are going. But it probably will not work that way as if we're selling sort of through a retail-type establishment.

Andy Rose, President and Chief Executive Officer

Every business operates differently, but your question pertains specifically to the steel company. We primarily conduct our business through contracts, mirroring those agreements. When a customer requests to buy based on the quarterly CRU, we purchase from the mill at that same rate, ensuring that our contracts adjust in tandem with price changes. Our earnings are influenced by FIFO gains and losses, particularly concerning our base inventory, which is the amount needed to operate the business. Consequently, we experience gains and losses related to that inventory level.

John Tumazos, Analyst

So given what you've said and that receivables and inventory should be falling with prices in the February quarter. Should we expect that $75 million drawn on the revolver to be paid during the quarter?

Joe Hayek, Chief Financial Officer

There might be a bit more of a lag, just given the cash conversion cycle. John, our anticipation is that our working capital builds will probably plateau and then begin to reverse themselves late in Q3. So think February, but then more pronounced in our Q4.

John Tumazos, Analyst

So by year-end, it might be repaid.

Joe Hayek, Chief Financial Officer

I expect that we will make some money and also anticipate a reasonable release of working capital by our year-end.

John Tumazos, Analyst

Are there any of the JVs that have managed inventory better or worse than the Worthington consolidated balance sheet we see?

Andy Rose, President and Chief Executive Officer

The joint ventures are unique in their own ways. Specifically, WAVE and ClarkDietrich stand out as distinct businesses. Both have excelled in managing their inventory and pricing strategies to stay ahead of cost inflation. ClarkDietrich has experienced a more stable market compared to previous cycles, as competition has acted more rationally, allowing them to perform better. However, there were recent challenges with steel supply chain issues that impacted availability. Although those issues have eased somewhat, they haven't completely disappeared, and in many instances, building up inventory wasn’t feasible.

John Tumazos, Analyst

Thank you and good luck.

Andy Rose, President and Chief Executive Officer

Thanks, John.

Joe Hayek, Chief Financial Officer

Thank you.

Operator, Operator

Thank you. There are no further questions at this time. Speakers, please continue.

Andy Rose, President and Chief Executive Officer

All right. Well, thanks, everyone, for joining us today. Everyone, have a great holiday season, and we'll look forward to speaking to you in 2022. Have a good afternoon.

Operator, Operator

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