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TimkenSteel Corp  (NYSE:TMST)
Q4 2018 Earnings Conference Call
Feb. 21, 2019, 9:00 a.m. ET

Contents:

Prepared Remarks:

Operator

Good morning. My name is Sharon, and I will be your conference operator today. At this time, I would like to welcome everyone to the TimkenSteel Fourth Quarter 2018 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. Mitch Byrnes, Senior Manager of Investor Relations, you may begin your conference.

Mitchell Byrnes -- Senior Manager of Investor Relations

Great. Thank you. Good morning, everyone, and thank you for joining us. I'm here today with Tim Timken, Chairman, CEO and President; as well as Kris Westbrooks, Executive Vice President and Chief Financial Officer to discuss our fourth quarter and full year 2018 financial results.

During today's conference call, we may make forward-looking statements as defined by the SEC. These statements relate to our expectations regarding future financial results, plans and business operations among other matters.

Our actual results may differ materially from those projected or implied due to a variety of factors, which we described in greater detail in today's press release, supporting information provided in connection with today's call and in our reports filed with the SEC, all of which are available on the TimkenSteel website. Where non-GAAP financial information is referenced, we have included reconciliations between non-GAAP financial information and its GAAP equivalent in the press release and/or supporting information as appropriate.

Today's call is copyrighted by TimkenSteel Corporation, and we prohibit any use, recording or transmission of any portion of the call without our expressed advanced written consent.

With that, now I would like to turn the call over to Tim.

Tim Timken -- Chairman, Chief Executive Officer and President

Thanks, Mitch, and thank you all for joining us today as we wrap up 2018 and begin to talk about the year ahead. TimkenSteel earnings have continued on an upward trajectory for three straight years. We've remained focused not only on taking advantage of more favorable market conditions, but also on taking strategic actions to improve customer service, pricing and product mix.

We are confident that our journey to improve the Company's performance is on track, so let's speak -- let me break some of that down for you. First, everything begins with people. 2018 was the safest year in our history even as we added new employees and increased production.

I'd like to offer a special congratulations to a team from our Material Services facility in Houston who won our Golden Glove award in 2018 for implementing a hand safety idea. The Golden Glove program has generated more than 80 new hand safety practices in the four years we've had it in place, and during that time, we've reduced hand injuries by 35%.

Operationally in 2018, we also sharpened our customer service. We're known for the superior quality and performance of our product, but in 2018, we further improved quality performance and had record low customer claims. A steep increase in demand challenged our delivery performance in 2018, but we improved on-time delivery to more than 90% by the end of the year.

Our plants also advanced our environmental goals. All six of our steel making and processing facilities achieved ISO 14001 certification. We also reduced our greenhouse gas emissions and energy intensity. In fact, we are among the best steel facilities in the world, according to World Steel's environmental measures. Safety, environmental responsibility, quality, service remain priorities for the Company.

Commercially, we also made strides. In 2018, we enriched the mix of our product we sold and improved our margin by focusing on sales of some of our most profitable products. In fact, our compensation plans for employees was in part based on sales of products for what we call our key process paths.

We also made enhancements to our value-added and long product business models, which will position us well for future growth. Pricing also improved. We implemented seven spot price increases last year and negotiated improved contract pricing for 2019. We also benefited from the US government tariffs on large bar imports, although overall overcapacity still remains an issue particularly in seamless mechanical tubing. We increased our business development pipeline and are entering new higher growth spaces.

We had share gains with our rich alloy products that outpaced the market. We also advanced several significant value-added programs including pending awards from automotive customers for light truck, hybrid and electric vehicle transmission components. In many ways 2018 was a great year for TimkenSteel.

The positive structural changes we made will have sustainable impact on our performance going forward. Unfortunately, 2018 also had some headwinds, which dampened our financial performance. We encountered unplanned maintenance and inflation in consumables that impacted our financial results, but a concentrated focus on continuous improvement helped to partially offset those expenses.

We finished 2018 strong and exceeded guidance in the fourth quarter for both shipped tons and adjusted EBITDA. We're prepared to carry that momentum into an even better 2019.

As we moved into the first quarter, we continue to have good operational performance and customer service. At the same time, we anticipate some planned downtime to balance inventories, both our own and what's out in the marketplace and this will come with added costs.

We're also seeing decreasing scrap and alloy indices that will affect raw material spread. The big question on everyone's mind is, what's going to happen in our key markets in the second half of 2019. Our markets continue to perform well, but we also are noting some caution in our customer base, particularly around inventory levels.

Indicators today lead us to expect general, industrial and mining to continue to grow. We're seeing growth in rail and military markets in which we are also gaining market share. SAAR remains stable, however production of both light truck and SUVs, which is our sweet spot in the automotive markets continue to grow.

In energy, we've seen an increase year-over-year on drilling activity, US rig count and starts of new wells. Customers are actually even beginning to talk about offshore activity again, something we've not heard since 2014. We anticipate energy customers will be managing inventory levels, particularly in tubing in the first half of the year, but we anticipate a better second half of 2019 in the energy markets.

Our first quarter 2019 guidance reflects some of the customer caution that I mentioned, but we feel good about the remainder of 2019, given the overall positive market indicators. Of course we will continue to monitor global economic indicators for any change.

As we look for -- as we look to 2019 and beyond, we are clearly driven by a long-term vision to operate effectively at all points of the economic cycle, while we grow the business. This vision is guiding our -- the decisions we make today and it begins with putting people first.

Our competitive edge is based on industry leading design, quality production and technical sales and service teams. From safety to leading workforce policies, our priorities are aligned on keeping our employees engaged and committed to our vision.

Second, we're working to improve the core business. In 2019, we launched project sound-center, a multi-year initiative to ensure that the fundamentals are in place to realize our future goals. The project name was inspired by the sound center or core of our large steel bars. We're applying the same thinking to the entire enterprise.

The first phase already is producing tangible results. We've made improvements to customer service processes and systems, demand forecasting and master planning pricing and profitability.

Third, we're moving toward sustainable growth, building on the strategy is to enrich the mix of our products we sell, improve price and stabilize volume. We are driven to achieve top line growth. Our sales team is pursuing profitable growth opportunities in our most profitable markets while our business development team is evaluating expansion into new areas.

I join our Board of Directors and leadership team in thanking our investors for their belief in this Company and we want you to know that we are clearly driven to generate even greater shareholder value in the coming year.

Now, Kris is going to take us through more details on the numbers, and then we'll take your questions. Kris?

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

Thanks, Tim. Good morning everyone. I'm pleased to report that fourth quarter 2018 results exceeded guidance and the prior year. Our team stayed focus and disciplined to close the year strong, despite normal seasonality and customer inventory balancing. Fourth quarter 2018 net sales were $406 million, a $65 million or 19% increase from the prior year comparable quarter.

Higher net sales were driven by a 10% increase in base sales per ton from improved price and product mix as well as higher surcharge revenue. On a GAAP basis, the fourth quarter 2018 net loss was $40 million compared with the fourth quarter, 2017 net loss of $34 million.

Excluding pension remeasurement adjustments, adjusted EBITDA was $26.7 million in the fourth quarter 2018, which exceeded our guidance range of $15 million to $25 million. Adjusted EBITDA of $8.2 million in the fourth quarter 2017 included $11 million of scheduled annual maintenance costs.

You'll recall that we carried out our 2018 annual maintenance in the third quarter. Fourth quarter 2018 shipments of approximately 295,000 tons, were 3% above fourth quarter 2017. Year-over-year improvement of 49,000 shipped tons was a result of strong end market demand in energy, industrial and mobile markets.

Shipments to the energy end markets increased 55% in the fourth quarter of 2018 compared with the same quarter a year ago. Our oil and gas shipments recovered well in 2018, with an increase in the US rig count despite volatility in crude oil prices. For first quarter 2019, we expect energy shipments to be similar to the first quarter of 2018, as customers closely monitor their current inventory on hand.

Industrial shipments in the fourth quarter of 2018 were around the same as the prior year fourth quarter, as we expected, this end market was impacted by normal seasonality in an inventory balancing before year-end.

For first quarter 2019, we expect shipped tonnes to our industrial customers to be lower than first quarter last year as traditional first quarter industrial strength has started slower than expected even though economic indicators remain positive.

Our mobile shipments in the fourth quarter were about the same year-over-year. For 2019, the projected North America light vehicle production of 17 million units remained stable and then for the first quarter of 2019, we expect our mobile shipments to be slightly higher than the same period a year ago.

Our mobile business continues to benefit from an increase in market share in the launch of new products. SG&A in the fourth quarter of 2018 was $25 million, well controlled with 6% of net sales. Operating cash flow was a source of $47 million in the fourth quarter of 2018 as a result of the Company's improved financial performance and lower working capital levels.

Capital expenditures were $22 million in the fourth quarter. As we invest in profitable growth opportunities, we expect our full year 2019 capital spending to be approximately $50 million, an increase of around 20% from 2018.

During the fourth quarter of 2018, we repaid $30 million on our credit agreements. Our available liquidity continues to be sufficient at $204 million as of December 31st, 2018. For the full year 2018, net sales were $1.6 billion, which is a $281 million increase over 2017 primarily driven from improved volume, price, mix and surcharge.

On a GAAP basis, including (inaudible) measurement (ph) adjustment, the 2018 net loss of $32 million compared with $44 million in 2017. Adjusted EBITDA for the full year 2018 was $105 million, a significant improvement of $36 million or 52% over 2017. In 2009, we plan to build on our foundation with continued improvements in price, product mix and operating effectiveness, while maintaining a best-in-class safety culture.

For the first quarter, we expect shipments to be approximately 30,000 tons less than fourth quarter 2018, primarily influenced by reduced OCTG billet demands. Price will be improved over prior year as new contract pricing is in effect from the start 2019 and we continue to benefit from the 2018 spot price increases.

From a LIFO perspective, we're not currently forecasting a significant increase in the year-end reserve. Raw material spread is expected to be a headwind due to decline in the Number 1 Busheling Index compared to fourth quarter 2018.

Planned production downtime to balance inventory with short-term demand will unfavorably impact fixed cost leverage along with higher maintenance and consumable spend.

As a result, we expect EBITDA in the first quarter to be between $20 million and $30 million. On a full year basis, we're expecting higher non-cash pension expenses of approximately $30 million in 2019 excluding the impact of the year end mark to market pension remeasurement adjustment.

The pension expense increase is a result of lower pension asset returns in 2018 and a higher assumed discount rate. More than offsetting the 2019 pension expense increase will be the full-year benefit of improved pricing and product mix.

To wrap up, 2018 has been a year of significant improvements and we're well positioned going into 2019.

Sharon, we'd now like to open up the call for questions.

Questions and Answers:

Operator

(Operator Instructions). And your first question comes from Martin Englert with Jefferies. Your line is open.

Martin Englert -- Jefferies & Company -- Analyst

Hi, good morning everyone.

Tim Timken -- Chairman, Chief Executive Officer and President

Good morning.

Martin Englert -- Jefferies & Company -- Analyst

So in 4Q, it looked like LIFO expense was pretty high at maybe $10.4 million, if that's correct and then also if you could just circle back on your commentary, as far as what's baked into your 1Q EBITDA guidance for LIFO.

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

Hi Mark, this is Kris. Yes, LIFO was higher as we wrapped up the year and calculated at year-end required reserve, primarily driven by the mix of inventory that we had on hand and the cost that came out of production in the year. And as we look forward to 2019, we're not seeing a significant increase in that overall reserve level and from an expense standpoint, not a significant amount there either.

So that's what the comments around LIFO were intended to mean.

Martin Englert -- Jefferies & Company -- Analyst

Okay, so you would be baking in something though as far as in expense as opposed to LIFO income for the full year 2019. Correct?

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

Yeah. It's minor overall in terms of what's baked into '19 given where we finished '18 at a pretty high level.

Martin Englert -- Jefferies & Company -- Analyst

Okay, got it. Thanks for that. And then as far as the 1Q guidance, can you provide a little bit more detail regarding the scale of several of the cost headwinds that you're facing such as the maintenance that you're planning, scrap spreads and then overall impact that you would expect from the reduced volumes there on EBITDA and also, do you still expect a seasonal maintenance in the second half of the year?

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

Yeah. So if we start with the first half of the question, we had a higher manufacturing cost and as you know, in the fourth quarter had that carryover impact from the third quarter of '18. As we get into '19, we're not seeing manufacturing being a significant headwind for us, we do still have some inflation that we're experiencing in the first half, but we hope to see that settling down as we get into the second half and maybe even softening a bit.

We do have manufacturing maintenance schedule, the annual shutdown is scheduled for the third quarter of 2019 and that'll be at a similar level than we experienced in the third quarter of '18. But as we mentioned, we are looking to have some downtime here in the first quarter balancing that inventory with short-term demand, which comes with some cost, because we'll be producing less tons.

So really lower fixed cost leverage in the first quarter of '19 where we had pretty solid fixed cost leverage in the fourth quarter of '18.

Martin Englert -- Jefferies & Company -- Analyst

Got it. And I guess why not pull -- is it just too soon to pull forward the maintenance, if you're going to have downtime anyway in 1Q as opposed to letting it run in the third quarter of this year?

Tim Timken -- Chairman, Chief Executive Officer and President

Yeah, we're doing a little of that on a selective basis where it makes sense, we're still planning to have our major outage done in third quarter.

Martin Englert -- Jefferies & Company -- Analyst

Okay, got it. All right, thanks for all the color there.

Tim Timken -- Chairman, Chief Executive Officer and President

Yeah, thanks.

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

Thanks, Martin.

Operator

Your next question comes from Tyler Kenyon with Cowen. Your line is open.

Tyler Kenyon -- Cowen -- Analyst

Hey, good morning.

Tim Timken -- Chairman, Chief Executive Officer and President

Hey, Tyler.

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

Good morning, Tyler.

Tyler Kenyon -- Cowen -- Analyst

Hey, I was just wondering if you could provide us any color just on the annual contracts, how those went this year, what proportion of your overall business you're anticipating in 2019 being on contract, I know that, that has shifted a little bit and I'm speaking ex-billet, and then also, just how to think about the timing of the realization of better contract pricing? I know last year, I think there was a bit of a delay in the realization of contract pricing.

Tim Timken -- Chairman, Chief Executive Officer and President

Yeah. Tyler, this is Tim. On the whole, I'd say we are very satisfied with the way the contract negotiations went, obviously we're in a bit of a different environment this year compared to last year when we were going through it.

So we think we achieved what we needed to achieve, we're running -- we're still running about 70-30 contract to spot and the bulk of that impact should be realized now going forward.

Tyler Kenyon -- Cowen -- Analyst

Okay, thanks. And in 70-30 spot, are you referring just to the value-added business or excluding those -- or including the billets that you have now?

Tim Timken -- Chairman, Chief Executive Officer and President

70-30 I believe includes billet, Tyler if I remember right.

Tyler Kenyon -- Cowen -- Analyst

Okay. And just, as we're on the subject, any thoughts on kind of the strategy with the billet business right now or any update there?

Tim Timken -- Chairman, Chief Executive Officer and President

Sure. You know, as we've said in past calls, we've reduced our dependency on billet going forward when we originally signed up, it was a -- it was pretty significant piece of business for us. We have reduced that exposure as other markets have improved, we think we've got it kind of about where we want it at this point, we've also broadened out the customer base for that product.

Initially, we were pretty much dependent on one customer. We've realized over time that that it makes sense to kind of broaden that out a little bit. So we are talking to a number of the OCTG producers here in the US from a supply point of view, obviously you're probably thinking about the Fairfield announcement the US Steel made here recently.

It was fairly obvious that over time they would look to be less dependent on billet supply externally and more capable of producing that internally. So we've kind of factored that into our thinking all along from a billet strategy point of view, and so I think we're kind of where we need to be, obviously the OCTG guys have taken a little bit of a breather here in the first quarter, we're confident with oil where it is, that's just a breather that we haven't seen a structural step down and that things will improve throughout the year.

Tyler Kenyon -- Cowen -- Analyst

Okay, great. Appreciate that. And then just one last one from me. On the CapEx guidance, the increase year-to-year, I know you mentioned just in your prepared comments about some investments that you're making. Wondering if you could elaborate on those?

Tim Timken -- Chairman, Chief Executive Officer and President

Sure. We announced a $50 million budget $30 million-ish of that would be maintenance, CI, safety, environmental, we do have a little bit of growth capital built into that, focused primarily on our value-add business. We've got a number of new automotive platforms that we're going to be bringing on here in the near future that require some -- will require some capital investment as well as some capability building investment in our long product business as well.

So it's a nice balance between the maintenance side and the growth side.

Tyler Kenyon -- Cowen -- Analyst

Great, thanks for taking our question.

Tim Timken -- Chairman, Chief Executive Officer and President

Thanks, Tyler.

Operator

Your next question comes from Phil Gibbs with KeyBanc Capital Market. Your line is open.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Hey, good morning, Tim, Kris and team, how are you?

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

Hey, Phil. Good, how about yourself?

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Doing well. In terms of 2018 and moving forward, what -- how can we think about your mix versus bar and tube maybe from a volume perspective or from a -- maybe from a sales perspective in '18 and whether or not you expect that to change here as we look into the New Year?

Tim Timken -- Chairman, Chief Executive Officer and President

You said '18, you mean '19. I assume.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Well, '18, where we were coming from and then how that may change in '19 (multiple speakers). Yeah.

Tim Timken -- Chairman, Chief Executive Officer and President

Yeah. I would say that, you know, we've seen a little bit of softness on the tubing side of late, we think part of that is just end market related, some of the tubing consuming markets have been a little bit slower. We don't see a fundamental shift in the ratio between bar and tube, but obviously that's somewhat dependent on what we're seeing from an important -- import, excuse me, import point of view. I guess another piece of it too is, as we are struggling with our on-time delivery performance last year, we did give up a little bit of share, and as we've improved that in the latter half of 2018, we've begun to see that share come back.

So that ought to help beef up the two business a little bit that we did see some weakness in.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Okay. That's helpful. And net working capital, Kris, as you're looking out to 2019 versus 2018, what's your expectation there?

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

So we've built quite a bit of inventory in 2018. We're sitting at pretty high levels here, worked that down some in 2019, but as a percent of sales, I see it about the same, I don't see it growing significantly in 2019 from a working capital standpoint, I feel pretty comfortable where we're at and we're going to try to optimize where possible, while still keeping that customer service number one in our mind.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

And the last question just here on the pension. Are you expecting to make any cash contribution to pension and/or OPEB in 2019? Thanks.

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

There is no material required contributions here in 2019 that we're looking to be making.

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Thanks everyone.

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

Cool. Thanks Phil.

Tim Timken -- Chairman, Chief Executive Officer and President

Thanks Phil.

Operator

(Operator Instructions). Next question comes from Justin Bergner with Gabelli & Company. Your line is open.

Justin Bergner -- Gabelli & Company -- Analyst

Good morning, Tim. Good morning, Kris.

Tim Timken -- Chairman, Chief Executive Officer and President

Good morning.

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

Good morning, Justin.

Justin Bergner -- Gabelli & Company -- Analyst

Just had a couple of extra questions here, just starting with the billet business, if we were to average sort of the fourth quarter shipments and what you've implied for the first quarter, just average that over two quarters, is that a decent run rate to how to think about your billet shipments going forward as things look at this point in time?

Tim Timken -- Chairman, Chief Executive Officer and President

Well, we talked about the weakness that we're seeing in the first quarter related to just the strength in the end market for the OCTG guys. I would say fourth quarter is probably a better kind of run rate level to think about, obviously that -- a lot of that depends on what's going on in the other markets, but certainly we've worked our exposure down over time to a level that we think is sustainable.

Justin Bergner -- Gabelli & Company -- Analyst

Okay. So the fourth quarter of the sort of 43,000 versus the low to mid 30,000 tons shipped in the second and third quarter, you think is indicative of where the market can sort of play out for TimkenSteel once things pick back up in the second half of '19?

Tim Timken -- Chairman, Chief Executive Officer and President

Yeah. We think so.

Justin Bergner -- Gabelli & Company -- Analyst

Okay, great. Secondly, I want to ask about the -- I guess price mix in the fourth quarter, I guess you saw some nice increase in base sales per ton sequentially in both the industrial and energy segments of your business or end markets. Was that more price or was that more mix and should we think about there being more room to go as we get into '19 are those sort of good launching points for the price mix in those end markets in '19?

Tim Timken -- Chairman, Chief Executive Officer and President

Yeah, I guess the best way to think about it is that it was kind of a 50-50 split between price and mix in the quarter. Obviously as we reset contract pricing for 2019, we'll see the benefit of that immediately and then increasingly as we return to what we would think would be more normal volumes.

Justin Bergner -- Gabelli & Company -- Analyst

Okay. That's helpful and then you started off the call by talking about business development activities. Are you thinking mainly in terms of organic initiatives to address new markets with new products or are you thinking about anything inorganic at this point of view?

Tim Timken -- Chairman, Chief Executive Officer and President

I guess my comments were more focused on the organic successes that we saw in 2018 and that we expect to see the impact of in 2019, but as we've said all along, we're continually looking externally for opportunities to grow as well so we do have an active program to look at the inorganic side also.

Justin Bergner -- Gabelli & Company -- Analyst

Okay, thank you.

Tim Timken -- Chairman, Chief Executive Officer and President

Great, thanks.

Operator

(Operator Instructions). And we do not have any questions at this time, I will turn the call over to the presenters.

Tim Timken -- Chairman, Chief Executive Officer and President

Well, thank you very much for your questions today. The team at TimkenSteel is working hard to improve performance. We're pursuing a strategy to improve the core of this business and reach it to new customers and applications that will benefit our value proposition.

The bottom line is, we are driven to generate even greater shareholder value. I want to thank you all for your interest in this Company. If you have any additional questions, don't hesitate to contact Mitch Byrnes. Thanks for joining us today and have a great day.

Operator

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

Duration: 30 minutes

Call participants:

Mitchell Byrnes -- Senior Manager of Investor Relations

Tim Timken -- Chairman, Chief Executive Officer and President

Kristopher R. Westbrooks -- Chief Financial Officer and Executive Vice President

Martin Englert -- Jefferies & Company -- Analyst

Tyler Kenyon -- Cowen -- Analyst

Phil Gibbs -- KeyBanc Capital Markets -- Analyst

Justin Bergner -- Gabelli & Company -- Analyst

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