TimkenSteel Corporation

Good morning and welcome to the Timken Steel's second quarter 2021 earnings conference call. I would now like to turn the conference over to your host.

Thanks and good morning. Welcome to Timken Steel's second quarter 2021 conference call. I'm Jennifer Beeman, Senior Manager of Communications and Investor Relations for Timken Steel. Joining me today is Mike Williams, President and Chief Executive Officer Chris Westbrooks, Executive Vice President and Chief Financial Officer, and Kevin Rakitic, 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 Timken Steel 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?

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. Yet, above all else is safety, 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 shutdowns, 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, and I am pleased that we've continued the positive momentum. Not only has the team 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 ship directly into GM transmission plants. This is the fourth time we've been awarded this honor. As a Tier 1 supplier to GM, Timken Steel 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 total enterprise approach. This award originates from the GM quality team, and 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, the short-term demand remains historically low. With improving industry statistics, though, 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 effort 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 Tempkin Steel. To kickstart some of our efforts, Andrew Bissett has 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've 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 Timken Steel Shanghai subsidiary to Dido 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 Dido 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 27th. 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'd like to turn the call over to Chris.

Chris? 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 gap basis, net income for the second quarter was a record $54 million for 98 cents per dilutive 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 is $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 in our Form 10-Q filed yesterday. Turning back to profitability, adjusted EBITDA improved the 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. Shipped 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 of 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 at 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 and alloys. 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 the 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 the 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 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 in an increasing demand environment, supported by a daily focus on working capital disciplines. From a pension perspective, the company recorded a non-cash remeasurement gain of approximately $700,000 in the second quarter of 2021 as a result of the required salary pension plan remeasurement. Remeasurement of the salary pension plan, which is excluded from adjustability with the 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 amount 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%, and 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're beginning negotiations with 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 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 Simpson Steel 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 improvements and efficiency opportunities. Thanks for your interest in Tenken Steel, and we look forward to sharing our continued progress going forward. We would now like to open the call for questions.

If you would like to ask a question, please press star then the number one on your telephone keypad. Again, that's star then the number one on your telephone keypad. We'll pause for just a moment to compile the community roster. Your first question is from Tristan Grisser with Exxon BNP Paribas.

Yes, hi. Thank you for taking my question. I'll start with two, please. You did not provide any EBITDA guidance compared to the last quarter with stable volumes, rising prices. Is there any particular reason why we should not expect better results in Q3? I know you mentioned the maintenance impact. That should be relatively small. And how good are Q2 margins for H2? Thank you.

Hi, Tristan. This is Chris. Good morning. And you are correct. We did not provide specific or even 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 on 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's some puts and takes we still believe the third quarter to be strong and we look forward to sharing those results as they are produced later in the quarter.

All right. That's helpful. If I may, just then on prices and ASP, how we should think about ASP moving forward? I believe you announced for a total of 200 per ton of base price hike for ASPQ effective this year. How much of that has already been in the P&L? I don't think we've seen much of the base sales, but on increasing Q2. So how we should think about ASP into H2? Thanks.

Yeah, so you have to remember that about 80% of our business is under contract for the year, and about 20% is more spot orientated. So, 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 both on BAR or SPQ and Seamless Tube in early July. So we should expect to see that appreciate throughout the rest of the year.

All right. Thank you.

Your next question is from Michael Leshock with KeyBank Capital.

Hey, guys. Good morning. Good morning. 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 pricing environment, contract pricing environment in 2022 versus what you were expecting maybe three months ago?

Sure. Good question. Yes, our lead times for both SBQ and seamless mechanical tubing are into next year. And we do expect, even though pricing conversations, from my perspective, are a private conversation between us and our customers, but I believe we're in a very good position. I'm very positive about the position we're in to negotiate 2022 pricing.

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 there within industrial? And then secondly, how quickly are you able to pivot between end markets should the chip shortage get resolved?

Sure. Another good question. As you know, the industrial recovery from the pandemic was a little bit slower than the automotive However, it's accelerated tremendously. And we expect that to continue. We basically are sustaining it. In the overall increase in demand, we're sustaining our market share position in industrial. And our ability to pivot, we're fairly flexible. We had to do that in Q2. We're able to do that throughout the remainder of the year as well. So, you know, we have, you know, Significant contractual arrangements with our automotive customers will support their needs and will serve them. As I think I mentioned, our service capability with regards to on-time delivery is extremely high at 92%. So we've been performing extremely well.

got it that's helpful um and then as we look on inventories we saw a modest pickup in the quarter uh but you anticipate a further build to meet demand going forward and in the absorption benefits that come with that again we'll you know we'll react to the markets appropriately we'll have the appropriate inventory to service our customers to maintain that high level of service um we um

We've had some inventory because we were planning for automotive sales that didn't develop. We had to quickly pivot to the industrial segment, and that's where we're focused across all our segments. Wherever the opportunities are, that's where we'll be, and we'll position our inventory accordingly to maintain that high level of service.

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

Good morning, Michael. It's Chris Westbrooks again. Not a lot of inflationary pressures in the SG&A area, so there it's just good cost control, managing all of the various professional fees that roll through there, as well as our overall headcount levels and feel that we're well positioned to move forward there. Percent of sales is going to vary depending on what the top line looks like in the surcharge levels, but it's improving, and that's going to be a continued focus for us going forward.

Got it. Thanks for all the color guides.

Thanks for the question.

Your next question is from Justin Berringer with Ability Funds.

Good morning. Good morning. Mike and Chris, hope you're doing well. First question relates to the melt utilization. I mean, how high can you get that in sort of a quarter with maintenance and a quarter without downtime?

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

Okay. Second question would relate to the pricing. It didn't seem to increase much sequentially on a base basis. I mean, I know that you did have some price increases that did kick in in the second quarter. Was there sort of a mix effect maybe in some of the short cycle industrial stuff being a little bit lower priced steel?

Good question. Yeah, there's primary two impacts here. The first impact is we had lower sales in the area of our manufactured components, which is, you know, formerly known as value-added segment. We rebranded that to manufacturing components because that's basically what they do. So we had lower sales there, which historically we have higher realized prices in that product segment or area. And then the other mix shift is a mix between small SBQ sizes, and we basically sold much larger SBQ sizes in Q2 versus Q1.

Okay, and the larger SPQ sizes actually have lower base sales per ton?

It's a lower unit price per ton, yes. However, the margins are better.

Okay. And how does mix look to be shaping up in the second half, similar to the second quarter?

Yeah, we believe right now what we see with one month under our belt, it's a very similar mix going forward. I think the real question is what happens with the automotive segment and with their production interruptions and what that impact is to us going forward. But as we've shown, we're able to pivot pretty quick and make ourselves goals and objectives.

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

Well, I think there's a two-fold approach there that we've been applying. One is that there are customers that want more steel from us than we can provide. So we can, if we fall short in the automotive area, we can pursue those opportunities, and we're also taking advantage of spot opportunities, particularly in the distribution channels, the distribution channel. Great. Thank you. That's it for my questions. Thank you for the questions.

As a reminder, if you would like to ask a question, please press star then the number one. And at this time, there are no questions. I would like to turn the call back over to Jennifer for closing remarks.

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

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