Q2 2022 TimkenSteel Corp Earnings Call
Vehicles and.
And we continue to drive greater market diversification as we aim to create an optimized portfolio.
As I have stated many times our goal is to sustain profitability through all business cycles, while effectively serving the needs of our customers.
Touching upon end market demand our lead times are now to the end of the year.
A majority of our customers in the mobile industrial and energy markets are telling us they are positive about the back half of this year.
And their businesses.
Steady.
However, we have heard from certain pockets of smaller customers that some uncertainty exists as these customers are navigating the challenges of the current economic environment.
In mobile shipments decreased by 4% sequentially as supply chain disruptions continue to impact these customers.
For the first half of 2022, we estimate that our sales have been negatively impacted by approximately $13 million.
The current thinking is the supply is expected to continue to stabilize in the second half with recovery starting late this year or early 2023.
On a positive note we continue to win in the EV space.
We were recently awarded additional new business for a major OEM, which is expected to launch in 2025.
This will be part of the next generation of EV light and medium trucks as well as commercial vehicles.
Our current EV portfolio consists of more than 15 awarded machine component applications and approximately $60 million in annual base sales when fully ramped.
Our industrial shipments increased by 8% compared with prior quarter due to strength in all of our industrial categories.
Distribution channel inventory levels have been replenished, but remain well managed as orders are closely aligned with shipments.
In the energy market, we continue to see robust demand from our customers as a result of continued increase in drilling and completion activity.
Similar to the first quarter with.
We've once again more than doubled our shipments on a year over year basis.
Timken steel has a history of developing and manufacturing materials for our customers in this space.
We have proven technical capabilities long standing relationships.
And the ability to innovate alongside an industry that is focused on a cleaner energy future.
Timken steel tubing bars and manufactured components are being used in some of the most demanding applications in both onshore and offshore rigs renewables and the supporting equipment.
Turning to our progress on our strategic imperatives, we remain on track to achieve our targeted $80 million of profitability improvements.
In 2022, we expect to realize approximately $25 million of profitability improvements from actions directly linked to our strategic imperatives with the remaining EBITDA improvement expected between 2023 and 2026.
As a reminder, our profitability improvement actions benefiting 2022 are primarily being driven by continued commercial portfolio optimization commercial terms adjustment and pricing improvements. Additionally.
Additionally, operational projects are underway to improve safety yield quality efficiency and asset reliability.
For example work is underway to relocate our scrap yard to be adjacent to our melt shop to improve efficiency.
This project is expected to be completed later this year and drive our run rate savings of $3 million beginning in 2023.
Our information technology transformation has also begun.
During the quarter, we successfully migrated our support services to a third party and have begun the next phase of work aimed at simplifying and modernizing our it environment.
This multiyear project is expected to achieve $7 million of run rate savings when completed.
These actions combined with our previous $100 million of savings achieved in recent years.
As us the confidence that we will execute and deliver on our long term commitments.
With that.
I think employees for their hard work our customers for their trust or.
Our suppliers for their partnership and our shareholders for their continued support.
As we move forward our leadership is committed to taking tangible actions to improve our safety culture.
Now I would like to turn the call over to Chris Chris.
Chris.
Thanks, Mike Good morning, everyone and thanks for joining us today.
During the second quarter, our collective team delivered record adjusted EBITDA results and strong operating cash flow, while also making progress on our long term strategic imperatives. Thanks to all of our employees for a successful second quarter and strong first half of 'twenty two.
Turning to our second quarter results.
Net sales totaled $415 7 million and net income was $74 5 million or $1 42 per diluted share.
Comparatively sequential first quarter net sales were $352 million with net income of $37 1 million or <unk> 70 per diluted share.
Second quarter of 2021, net sales were $327 $3 million with net income of $54 million or <unk> 98 per diluted share.
On an adjusted basis net income in the second quarter improved to $67 4 million or $1 29 per diluted share.
For comparison purposes, adjusted net income in the first quarter was $48 6 million or <unk> 92 per diluted share adjusted net income in the second quarter of last year was $52 5 million or.
<unk> 96 per diluted share.
Adjusted EBITDA improved to a record $84 $2 million in the second quarter and $18 $9 million sequential increase.
Drivers of the increase included higher base selling prices on an improved product mix as well as the impact of higher scrap and alloy prices on raw material surcharges compared with the same quarter in 2021, adjusted EBITDA increased by $13 2 million reflective of higher base selling prices and improved mix.
Turning now to the details of the financial results in the second quarter.
Shipments in the second quarter were 208900 tons, an increase of 12500 tonnes or 6% compared with the first quarter and consistent with our expectations. The.
The sequential increase in shipments was driven by higher energy and industrial shipments, partially offset by lower shipments to mobile customers.
Comparatively second quarter shipments decreased by 5300 tons or 2% from the second quarter of last year as a result of lower industrial and mobile shipments, partially offset by increased energy customer demand.
In the industrial end market shipments totaled 102100 tons in the second quarter, a sequential increase of 7200 tons or 8%.
The increase in industrial shipments was primarily driven by increased demand from both OEM and distribution customers across the wide range of industrial sectors, such as heavy equipment and rail.
Mobile customer shipments were 85400 tons in the second quarter, a sequential decrease of 3500 tons or 4%.
During the second quarter, we estimate the supply chain disruption negatively impacted our mobile shipments by approximately 6000 tonnes a similar impact as in the first quarter.
Lastly from an end markets perspective continued momentum and energy demand drove shipments of 21400 tons in the second quarter, a sequential increase of 8800 tons or 70%.
The energy end market accounted for 10% of our ship tons in the second quarter up from 6% in the first quarter.
Net sales of $415 7 million in the second quarter increased 18% compared to the first quarter and improved 27% compared to the second quarter of last year.
The sequential increase in net sales was driven by a 32% increase in average raw materials surcharge per ton as a result of higher scrap and alloy prices higher base selling prices and increased shipments are improved industrial and energy customer demand.
The substantial improvement compared with the prior year quarter was driven by higher base selling prices and a 50% increase in average raw material surcharge per ton as a result of higher scrap and alloy prices, partially offsetting these items were lower mobile and industrial shipments.
Based selling prices increased by $192 per ton or 18% in the second quarter on average across our end markets in comparison with the full year of 2021 average.
Sequentially based selling prices increased by 2% consistent with our expectations.
Turning to manufacturing cost increased sequentially by $13 million in the second quarter, driven by higher plant spend primarily related to maintenance as well as higher variable compensation expense.
The increase in second quarter maintenance spending was in targeted areas to enhance asset reliability and performance as well as required repairs at one of our two mills.
In comparison to the prior year second quarter manufacturing costs were $26 million higher given the current year inflationary cost environment as well as higher maintenance costs.
Melt utilization improved to 84% in the second quarter from 81% in the first quarter and consistent with the prior year second quarter.
From an inflation perspective.
<unk> is anticipated to remain on non surcharges raw materials manufacturing consumables and other operational items during the remainder of 2022.
We now estimate the 2022 inflationary impact to be approximately 20% over 2021 average prices as compared to our previous estimate of 10% to 15%.
Increased costs for spare parts and contract labor are the primary drivers of the inflation estimate change.
From an SG&A expense perspective in the second quarter, SG&A increased $3 $2 million on a sequential basis to $21 7 million.
Primary drivers included higher variable compensation expense as well as fees associated with an ongoing information technology application simplification and modernization projects.
The sequential SG&A increases were partially offset by lower employee expense as a result of prior restructuring actions.
In comparison to the second quarter of 2021 SG&A was relatively flat.
Overall, SG&A expense remained well controlled and significantly lower than historical levels.
Moving onto cash flow and liquidity.
During the second quarter operating cash flow was $57 million driven by quarterly net income partially offset by a use of cash to fund working capital requirements.
This marks the company's 13th consecutive quarter of generating positive operating and free cash flow.
Through the first half of 2022, we generated $64 million of operating cash flow and spent $10 million on capital expenditures.
We finished the second quarter with $238 $5 million of cash and cash equivalents and total liquidity was $558 7 million at the end of June .
Looking now at shareholder return activities during the second quarter the company repurchased approximately 438000 common shares at a total cost of $9 3 million.
Including the recent common share repurchase activity completed in July the company has repurchased approximately 794000 common shares to date in 2022 at a total cost of $16 million.
As of July 31, 2022, the company had $34 million remaining under its $50 million authorization.
Switching gears to convertible notes from a return on capital perspective in the second quarter, we negotiated the early repurchase of $15 $2 million of convertible notes due in 2025 at a total cash cost of $48 million.
The $25 $6 million of purchase premium was driven by an appreciation in the company's stock price, which was significantly in excess of the instruments conversion price.
This premium was excluded from non-GAAP adjusted EBITDA as a loss on extinguishment of debt.
The convertible note repurchase activity in the second quarter had the effect of reducing diluted shares outstanding. In addition to further reducing outstanding debt and interest expense.
At this time the outstanding principal balance on the convertible notes is $28 million and the associated remaining diluted shares outstanding are $2 7 million.
This compares with the original issuance amounts of $46 million and $5 9 million diluted shares.
In comparison to diluted shares outstanding in the fourth quarter of last year. The previously discussed common share and convertible note repurchase activity completed between January and July 2022 represents a 7% reduction in diluted shares outstanding.
Regarding pensions in July the company purchased a group annuity contract from a highly rated insurance company settled $256 million of pension obligations related to the Companys bargaining unit pension plan using existing plan assets. This represents about 25% of the company's outstanding U S pension obligations.
Following the transfer starting October one the insurance company will pay future benefits to approximately 1900 participants and beneficiaries who are currently receiving payments from the plan.
It is important to note that the gross benefit amount payable to recipients will remain the same as a result of this transaction and the group annuity contract is an irrevocable commitment from the insurance company to make annuity payments covered under the contract.
Utilization had the effect of reducing total accounting funded status for all pension and retiree medical plans by approximately 3% in the third quarter from approximately 88% to 85%.
This new innovation activity was a significant step towards further strengthening our balance sheet and derisking our pension plans.
Moving onto other pension matters. The company recorded a noncash gain of $35 $5 million in the second quarter as a result of the remeasurement of certain pension plans. The gain was driven by an increase in discount rates more than offsetting investment losses on plant assets.
Re measurement of these plans as expected on a quarterly basis for the remainder of 2022.
Turning now to the third quarter of 2022 outlook.
Customer demand remained stable across our end markets with lead times extended to the end of the year.
Similar to prior quarters periodic customer manufacturing disruptions may continue to negatively impact shipments.
From a revenue perspective, our base pricing remains strong reflective of prior annual increases and continued favorable spot pricing.
Given market decreases in scrap prices to date in the third quarter, we anticipate surcharge revenue per ton to decline sequentially in the quarter.
Operationally, we expect our melt shop repairs to be completed by the middle of August , which will negatively impact our melt utilization rate and manufacturing costs compared with the second quarter.
Current inventory levels and planned purchases of melt capacity from third parties are expected to help us meet the majority of our third quarter customer demand.
As a result, we anticipate third quarter shipments to be moderately lower than the second quarter.
Lastly from an operational perspective planned annual maintenance shutdown costs are estimated to be approximately $10 million in the second half of 2022 with approximately 25% incurred in the third quarter and approximately 75% incurred in the fourth quarter.
Mount and timing is generally consistent with last year.
Given these elements the company expects adjusted EBITDA to remains strong in the third quarter, but lower than the second quarter, primarily driven by a market decline in scrap prices, which will reduce surcharge revenue per ton as well as impacts from the melt shop operational downtime.
From a cash perspective operating cash flow is expected to be positive in the third quarter, primarily driven by anticipated profitability and a release of working capital.
Additionally, we're updating our estimate for full year 2022 capital expenditures to be approximately $35 million a reduction of $5 million from the previous guidance due to timing of project spending.
To wrap up thanks to all of our employees customers and suppliers, who help timken steel delivered record adjusted EBITDA results in the second quarter.
As Mike said earlier, our leadership team is committed to taking tangible actions to improve our safety culture. We appreciate your interest in timken steel and look forward to sharing our continued progress in the future. We would now like to open the call for questions.
Thank you at this time I would like to remind everyone in order to ask a question press star one on your telephone keypad.
Your first question comes from Marco Rodriguez from Stonegate capital markets. Please go ahead.
Good morning, everyone. Thank you for taking my questions.
Good morning Marco.
Hi, I was wondering Mike if you could maybe.
And a little bit more time on the strategic initiatives you sort of touched on it briefly in your prepared remarks, specifically around.
Commercial improvements that you are aiming to make over the next five years that maybe you can kind of frame.
What might be on track what else was coming up the pipe I know you mentioned the scrap yard already done a little bit closer maybe you can kind of walk through some of those.
Patiency in hospitals.
Sure well around the commercial strategic initiatives Thats really focus around our product portfolio optimization.
As well as our.
Our participation in more of a diverse.
Particularly in the industrial space.
A more diverse end markets.
Participation.
There is particular markets around defense renewables that we're focused on that we have some participate participation today, but those are really high valued end markets.
<unk> put together and restructured a business development organization with high performing team members that are focused on expanding our participation in those high end valued markets on.
On the operational side I mean, there was a <unk>.
Wide portfolio opportunities there, we mentioned couple of them, particularly the scrap yard when we were operating to melt shops. The scrap yard was in between both melt shops, so about a mile mile and a half away from each melt shop, and we are moving the melt shop adjacent to the fair crest melt shop. Therefore, we.
We're also contracting out the operation of the scrap yard to a third party versus our internal.
Our internal Manny.
We bring better variability to business conditions in that scenario, but really it's really the reduction in operating costs really tied to transportation costs of moving scrap amount of half versus a couple of hundred yards into the melt shop.
We have a number of projects around yield improvements we have already started to realize some of those projects, particularly in the melt shop.
But we have specific projects.
Just around a rolling mills.
We can improve our <unk>.
Yield and our quality and the quality improvements will reduce.
Rework costs, which.
In my view are a little bit higher than norm.
To the best in class in our industry. So I could go on and on on this there are specific projects around our people.
Skill developments.
Organization on SG&A optimizations.
I mentioned on our it transformation that's a key project that's a multiyear project.
So.
There is a quite a portfolio.
Several several 100 projects that we have identified in our pipeline. Many of them are in action right now and many of them will come in the future with a lot of projects focus around safety and asset reliability improvements as well.
So all of that improving asset uptime improved productivity improves yield improves quality and also improve safety.
Got it very helpful. And then also in terms of the comment that you made there about trying to move more towards the renewables and then also in your prepared remarks, you are talking about some wins that you had on the on the EV side.
<unk>, our mobile side can you maybe just talk about those two particular opportunities would you classify the <unk>.
Electric vehicle market as falling into the renewable focus or is that just more kind of.
Different type of mobile application.
Well no the ease as totally separate from the renewables.
And we have a team that's targeted.
Evs in the mobile market are very important to us, particularly for our manufacturer components business.
As.
The automotive Oems move away from the internal combustion engines that require crankshafts and transmissions and all kinds of other components.
We are actively pursuing EV programs as you know these programs tend to be multiyear programs between eight and 10 years.
And we're working closely with the automotive Oems.
Developing our capability to serve the EV market.
The motors and some of the smaller transmissions that go with those electric motors, that's our focus.
When you look at the renewable side, our focus there is really around wind.
There are tremendous amount of building applications for offshore windmills. There's also.
Gearing and rotary shafts that are in those.
Turbine applications. So we are actively pursuing and working with.
Like I said, we've restructured our sales organization to have dedicated high performing team members focused and penetrating those markets and expanding within those markets because we pretty much serve some of those markets in a small way today and we want to grow that because thats, where we see the value proposition for our product portfolio.
So.
Got it understood.
Then I'm just kind of wanted to get a bit of a clarification.
In your press release.
Now can you talk about some operational disruptions and you mentioned.
A negative impact on the melt utilization rate in the quarter.
And you obviously, obviously at the beginning of the call mentioned the accident.
And the one plant where those one and the same was there was there something different in relation to this on which if at all if I missed this or not can you quantify the <unk>.
The impact on the on the mountain utilization rate in the quarter.
So they are related so we had an incident in our melt shop is currently under investigation.
We're working with the United Steelworkers, and the regulatory agencies to investigate the incident and get to root cause and identify any recommended.
The actions we need to take.
The.
And our thoughts and prayers are with our employees their families that were injured and any other employee that was impacted by the incident.
The operational impact.
As we've said is we are in the middle of our repair activities to get to furnish back online and we expect that to be around mid August .
Okay.
And then I know you made some comments in terms of your expectations of base pricing at least in Q3, but if maybe you can share some of your thoughts on what sort of dynamics you might be thinking about for the remainder of the fiscal year.
Sure well again, we see we see demand steady through the remainder of this year and even.
The communications and interactions, we're having with our customers in discussions around 2023 look pretty favorable in regards to continued steady demand at least what I would say from a horizon standpoint, the first half of 2023.
And our expectation is.
Prices are going to align with that steady demand as they have been.
Got it thanks, a lot guys I really appreciate your time.
Thank you Marco Thank you.
Your next question comes from Seth Rosenfeld from BNP. Please go ahead.
Alright, good morning, Thanks for taking my questions today.
Good morning sounds a bit more detail.
The fourth just help us better understand how the recent decline in scrap prices in particular have a narrowing of the prime scrap was obviously premium earn back your characterize revenues and also profitability.
And looking forward, maybe could you give us a bit more color on your outlook for prime and obsolete as we move through Q3.
Yes.
Okay.
Hi, Seth this is Chris good morning.
You are correct, we are seeing that decline in the prime as well as the shredded grades and that will drive some contraction for us in Q3, the way I'm thinking about it is the incremental benefit that we received in Q2 that benefited our results I'd expect that to reverse in Q3 as those contractions.
Continue definitely through.
July and into August September is still Hasnt settled up yet so we'll see how that plays out but that's what we're seeing at least for the first two months.
Thank you maybe can you give us a bit more color with regards to the or quantify the scale of benefit you saw in Q2 I know in the past we talk not just about the surcharge revenue, but the fact you are able to have.
Surcharge based on on Prime purchase a mix of obsolete.
How large was that I can quantify in the course of Q2.
Q2 was about $23 million benefit is what we lay out in the earnings release.
Okay. Thank you.
And one more question please refer to working capital and as you see scrap prices and surcharges decline in <unk> can you give us there.
More color on your expectation for scale of working capital release that could be realized.
Yes that definitely has an impact on it I'd say the bigger impact is the operational disruption that Mike mentioned in us continuing to work through inventory on hand, we had.
A bit of inventory and receivables on hand at the end of June and that would get released into.
Q3, and and drive a more significant working capital release is what we're expecting.
Okay. Thank you very much.
Thanks Seth.
Again, if you'd like to ask the question Crestar one on your telephone keypad. Your next question comes from Phil Gibbs from Keybanc capital markets. Please go ahead.
Good morning.
Good morning Bill.
Mike and Chris and team the inflation rate for the year to 20% from $12 five.
Just curious what changed so drastically in the <unk>.
Last three months in terms of.
Primary versus maybe secondary drivers there.
Yes, Chris.
This can provide some additional color.
Perspective has been the.
The maintenance repair parts and supplies.
That come in at a higher level than we expected.
The other areas, we've seen we tend to use contractors, an ad hoc basis for.
Serge maintenance activity, we're seeing those rates increase and thats not what we really anticipated when we put our prior forecast our outlook together for Q2. So Chris do you have any more color you want to add there those are the two primary areas. The majority of other spend is contracted on.
On a fixed rate primarily for the full year as volumes change and you need a little bit more you pay a bit of spot rates there, but it's those two areas that Mike mentioned, the contractors and the spare parts that drove most of that change for us.
Thank you and then.
It was good to hear the volume impact being <unk>.
Reasonably benign given the use of inventories of purchase amount for the third quarter following the.
The accident, but.
Is there any way to couch the cost impact of the third quarter.
Due to the accident and cost to serve the customers versus what you would have been expecting a few weeks ago.
Well again thats.
Really undetermined, yet because we're still in the recovery process and the repair process.
What I do expect.
We are going to see higher cost.
Predominantly tied to the repair costs as well as the fixed cost leverage being lower and.
The third party purchase meld is also slightly higher than our.
Manufacturing.
Capability.
So.
That's how I see it Chris do you have anything to add there those are the drivers here, which we can quantify it better for you, but we're working through a real time.
To manage it the best we can as we go through the quarter to drive that profitability.
So I know a lot of year grades of.
Of of bar typically are higher alloy.
And very specialized than.
You guys on the secret sauce to a lot of the.
<unk> so.
Just curious how how easy it is to supplant that with.
Purchase amount than last year, just kind of buying the base substrate and then I guess re melting it yourself and al Lang and so.
Maybe just talk to that.
Well, we have been working with a partner.
And developing particularly around small.
Hi alloy grades we've been working and developing our partner since earlier this year.
That partners.
A fantastic partner and they're stepping up to help us.
The situation even more so we've already done some of the great development with them.
We.
We're looking to others.
One of the unique things from my perspective about this industry.
When you have somewhat of a situation that occurred like ours you are.
Our competitors step up to try to help you.
So we're seeing that we appreciate that.
And we're going to acquire what we need to try to satisfy all of our customers through this time and then we're going to be back up.
Running again very soon.
If I could just add to that Mike the mobile space, we're supporting with inventory on hand, that's not where you go outside for those purchases, but we do expect back online is that we're going to need to allocate our tons first to there given the contractual arrangements. So we may see a bit of a mix shift in Q3, a little bit heavier mobile and maybe even into Q4.
Good point Chris.
Thank you.
And there are no further questions at this time I will turn the call back over to the presenters for closing remarks.
Thanks, everyone and that concludes our call today.
This concludes today's conference call you may now disconnect.
Okay.
Yeah.
Yeah.