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MarketScreener Homepage  >  Equities  >  Nyse  >  TimkenSteel Corporation    TMST

TIMKENSTEEL CORPORATION

(TMST)
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TIMKENSTEEL : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

05/07/2020 | 04:52pm EST

(dollars in millions, except per share data)

Business Overview

We manufacture alloy steel, as well as carbon and micro-alloy steel, with an annual melt capacity of approximately 2 million tons and shipment capacity of 1.5 million tons. Our portfolio includes special bar quality (SBQ) bars, seamless mechanical tubing (tubes), value-added solutions such as precision steel components, and billets. In addition, we supply machining and thermal treatment services and manage raw material recycling programs, which are used as a feeder system for our melt operations. Our products and services are used in a diverse range of demanding applications in the following market sectors: automotive; oil and gas; industrial equipment; mining; construction; rail; defense; heavy truck; agriculture; power generation; and oil country tubular goods (OCTG).

SBQ steel is made to restrictive chemical compositions and high internal purity levels and is used in critical mechanical applications. We make these products from nearly 100% recycled steel, using our expertise in raw materials to create custom steel products. We focus on creating tailored products and services for our customers' most demanding applications. Our engineers are experts in both materials and applications, so we can work closely with each customer to deliver flexible solutions related to our products as well as to their applications and supply chains.

The SBQ bar, tube, and billet production processes take place at our Canton, Ohio manufacturing location. This location accounts for all of the SBQ bars, seamless mechanical tubes and billets we produce and includes three manufacturing facilities: the Faircrest, Harrison, and Gambrinus facilities. Our value-added solutions production processes take place at two downstream manufacturing facilities: Tryon Peak (Columbus, North Carolina), and St. Clair (Eaton, Ohio). Many of the production processes are integrated, and the manufacturing facilities produce products that are sold in all of our market sectors. As a result, investments in our facilities and resource allocation decisions affecting our operations are designed to benefit the overall business, not any specific aspect of the business.

In the first quarter of 2020, we closed our TimkenSteel Material Services facility in Houston, Texas. See "Note 5 - Disposition of Non-Core Assets" in the Notes to the unaudited Consolidated Financial Statements for additional information.

We conduct our business activities and report financial results as one business segment. The presentation of financial results as one reportable segment is consistent with the way we operate our business and is consistent with the manner in which the CODM evaluates performance and makes resource and operating decisions for the business as described above. Furthermore, the Company notes that monitoring financial results as one reportable segment helps the CODM manage costs on a consolidated basis, consistent with the integrated nature of our operations.

Impact of COVID-19 Pandemic

We continue to closely monitor the impact of the COVID-19 pandemic on our Company, customers, employees and supply chain. The full extent to which the COVID-19 pandemic will impact our operations and financial results is uncertain and ultimately will depend on, among many other factors, the duration of the pandemic, further Federal and State government actions and the speed of economic recovery. We estimate the impact on our first quarter of 2020 results was lost sales of approximately $10 million. The negative impact on our second quarter, remainder of the year and beyond remains unknown but at a minimum, we expect customer demand in the COVID-19 environment to be sharply lower in the second quarter of 2020, resulting in periodic production outages as the Company continues to balance production schedules with demand.

In response to the significant reduction in customer demand resulting from the COVID-19 crisis, the company has taken additional actions to further reduce operating expenses, conserve cash and maximize liquidity, such as:

   •  Reduced interim CEO and senior executives' base salaries by 20 percent and
      other executives' base salaries by 10 percent, effective May 1;


   •  Reduced cash retainer for its board of directors by 20 percent beginning
      with the second-quarter 2020, and reduced the value of the board's annual
      equity grant by 20 percent;


   •  Suspended company's 401(k) plan matching contributions for salaried
      employees, effective June 1;


   •  Implemented unpaid rolling furloughs for approximately 80 percent of
      salaried employees, beginning in early April;


   •  Aggressively reduced production schedules at all plants to align operations
      with customer demand, resulting in the temporary layoff of manufacturing
      employees;


   •  Reduced planned 2020 capital expenditures to a maximum of $25 million, a $5
      million reduction from previously stated guidance; and


   •  Deferred Social Security payroll tax remittance as permitted by the CARES
      Act.


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Impact of Raw Material Prices

In the ordinary course of business, we are exposed to the volatility of the costs of our raw materials. Whenever possible, we manage our exposure to commodity risks primarily through the use of supplier pricing agreements that enable us to establish the purchase prices for certain inputs that are used in our manufacturing process. We utilize a raw material surcharge mechanism when pricing products to our customers, which is designed to mitigate the impact of increases or decreases in raw material costs, although generally with a lag effect. This timing effect can result in raw material spread whereby costs can be over- or under-recovered in certain periods. While the surcharge generally protects gross profit, it has the effect of diluting gross margin as a percent of sales.


Results of Operations

Net Sales

The charts below present net sales and shipments for the three months ended March 31, 2020 and 2019.




                      [[Image Removed]]  [[Image Removed]]

Net sales for the three months ended March 31, 2020 were $259.7 million, a decrease of $111.3 million, or 30.0%, compared with the three months ended March 31, 2019. The decrease was due to a reduction in volume of approximately 47.5 thousand ship tons, resulting in a decrease of $54.1 million of net sales, lower surcharges of $43.6 million, and change in mix of $9.3 million. The primary driver in the decrease in volume was lower customer demand across all end markets, partially offset by an increase in OCTG billet shipments. The decrease in surcharges was primarily due to a 38% decline in the average surcharge per ton due to lower market prices for scrap and alloys. Unfavorable mix was primarily driven by increased billet shipments. We estimate the impact of the COVID-19 pandemic on our net sales was a reduction of approximately $10.0 million. Excluding surcharges, net sales decreased $67.5 million, or 24.0%.


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Gross Profit

The chart below presents the drivers of the gross profit variance from the three months ended March 31, 2019 to March 31, 2020.




                               [[Image Removed]]

Gross profit for the three months ended March 31, 2020 decreased $20.6 million, or 72.5%, compared with the three months ended March 31, 2019. The decrease was driven primarily by lower volumes, unfavorable price/mix, and unfavorable manufacturing costs. The primary driver in the decrease in volume was lower customer demand across all end markets, partially offset by an increase in OCTG billet shipments. Unfavorable price/mix was driven by lower pricing, primarily in the industrial end market, and unfavorable mix, primarily due to increased billet shipments. Unfavorable manufacturing costs in 2020 were primarily due to a decline in melt utilization, resulting in lower fixed cost leverage, as well as the impact of accelerated depreciation related to the disposition of non-core assets, partially offset by the impact of cost reduction actions.

Selling, General and Administrative Expenses

The charts below present selling, general and administrative (SG&A) expense for the three months ended March 31, 2020 and 2019.



                               [[Image Removed]]



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Selling, general and administrative (SG&A) expense for the three months ended March 31, 2020 of $23.4 million was relatively consistent with the prior year quarter. The increase is primarily due to the increase in variable compensation and bad debt expense, substantially offset by lower wages and benefits, as a result of a reduction in employees following the Company's recent restructuring actions.

Restructuring Charges

During 2019 and into the first quarter of 2020, TimkenSteel made organizational changes to enhance profitable and sustainable growth. These company-wide actions included the restructuring of its business support functions, the reduction of management layers throughout the organization, the closure of the TimkenSteel Material Services (TMS) facility in Houston, and other actions to further improve the Company's overall cost structure. Through these restructuring efforts, to date the Company has eliminated approximately 160 salaried positions and recognized restructuring charges of $9.1 million, consisting of severance and employee-related benefits. Approximately 10 of these positions were eliminated in the first quarter of 2020. During the three months ended March 31, 2020, there were additional restructuring charges of $0.6 million, as well as a cash outflow of approximately $4 million primarily related to prior year restructuring actions. The Company expects to realize annual savings of approximately $20 million in 2020 and beyond as a result of these plans. Refer to "Note 4 - Restructuring Charges" in the Notes to the unaudited Consolidated Financial Statements for additional information.

Interest Expense

Interest expense for the three months ended March 31, 2020 was $3.2 million, a decrease of $1.0 million, compared with the three months ended March 31, 2019. The decrease in interest expense was primarily due to a reduction in outstanding borrowings as well as a lower interest rate environment. Refer to "Note 10 - Financing Arrangements" in the Notes to the unaudited Consolidated Financial Statements for additional information.

Other Expense (Income), net



                                                        Three Months Ended March 31,
                                                  2020               2019            $ Change
Pension and postretirement non-service
benefit loss (income)                         $       (6.6 )$       (2.8 )$       (3.8 )
Loss from remeasurement benefit plan                   9.5                  -               9.5
Foreign currency exchange loss (gain)                    -                0.1              (0.1 )
Miscellaneous expense (income)                        (0.2 )                -              (0.2 )
Total other expense (income), net             $        2.7$       (2.7 )$        5.4

Non-service benefit income is derived from the Company's pension and other postretirement plans. The Company's expected return on assets has exceeded the interest cost component, resulting in income for the three months ended March 31, 2020 and 2019.

The Salaried Plan has a provision that permits employees to elect to receive their pension benefits in a lump sum. In the first quarter of 2020, the cumulative cost of all lump sum payments was projected to exceed the sum of the service cost and interest cost components of net periodic pension cost for the Salaried Plan. The Company completed a full remeasurement of its pension obligations and plan assets associated with the Salaried Plan as of March 31, 2020, which resulted in a non-cash loss from remeasurement of $9.5 million. For more details on the remeasurement, refer to "Note 11 - Retirement and Postretirement Plans."


Provision for Income Taxes



                                                  Three Months Ended March 31,
                                              2020              2019         $ Change
    Provision (benefit) for income taxes   $      0.1$     0.1      $       -
    Effective tax rate                           (0.5 )%            1.3 %           NM



The majority of the Company's income tax expense is derived from foreign operations. The Company remains in a full valuation for the U.S. jurisdiction for the three months ended March 31, 2020 and 2019.


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NON-GAAP FINANCIAL MEASURES

Net Sales, Excluding Surcharges

The table below presents net sales by end market sector, adjusted to exclude surcharges, which represents a financial measure that has not been determined in accordance with accounting principles generally accepted in the United States (U.S. GAAP). We believe presenting net sales by end market sector adjusted to exclude raw material surcharges provides additional insight into key drivers of net sales such as base price and product mix.

(dollars in millions, tons in thousands)

                                                Three Months Ended March 31, 2020
                                   Mobile         Industrial      Energy       Other       Total
Tons                                    88.8             81.2        18.4        25.0       213.4

Net Sales                       $       97.7$      113.3$  25.2$  23.5$ 259.7
Less: Surcharges                        16.6             18.8         4.2         6.3        45.9
Base Sales                      $       81.1$       94.5$  21.0$  17.2$ 213.8

Net Sales / Ton                 $      1,100$      1,395$ 1,370$   940$ 1,217
Base Sales / Ton                $        913$      1,164$ 1,141$   688$ 1,002

                                                Three Months Ended March 31, 2019
                                   Mobile         Industrial      Energy       Other       Total
Tons                                   112.8            102.5        31.4        14.2       260.9

Net Sales                       $      144.2$      147.0$  60.8$  19.0$ 371.0
Less: Surcharges                        37.5             35.1        12.5         4.6        89.7
Base Sales                      $      106.7$      111.9$  48.3$  14.4$ 281.3

Net Sales / Ton                 $      1,278$      1,434$ 1,936$ 1,338$ 1,422
Base Sales / Ton                $        946$      1,092$ 1,538$ 1,014$ 1,078




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LIQUIDITY AND CAPITAL RESOURCES

Convertible Notes

In May 2016, we issued $75.0 million aggregate principal amount of Convertible Notes, plus an additional $11.3 million principal amount to cover over-allotments. The Convertible Notes bear cash interest at a rate of 6.0% per year, payable semiannually on June 1 and December 1, beginning on December 1, 2016. The Convertible Notes will mature on June 1, 2021, unless earlier repurchased or converted. The net proceeds received from the offering were $83.2 million, after deducting the initial underwriters' discount and fees and paying the offering expenses. We used the net proceeds to repay a portion of the amounts outstanding under our credit agreement.

Amended Credit Agreement

On October 15, 2019, the Company, entered into a Third Amended and Restated Credit Agreement (the Amended Credit Agreement), with JP Morgan Chase Bank, N.A., as administrative agent, Bank of America, N.A., as syndication agent, and the other lenders party thereto, which further amends and restates the Company's Second Amended and Restated Credit Agreement dated as of January 26, 2018.

The Amended Credit Agreement increases capacity to $400 million compared to $300 million in the previous facility and extends the maturity date to October 15, 2024. Furthermore, the Amended Credit Agreement provides for an enhanced asset base with reappraised fixed assets and investment grade foreign accounts receivable collateral in the borrowing base, improves interest rate spread pricing of 50 basis points, and reduces the unused commitment fee to a fixed 25 basis points from the previous 37.5 to 50 basis point range.

Additional Liquidity Considerations

The following represents a summary of key liquidity measures under the Amended Credit Agreement as of March 31, 2020 and December 31, 2019:



                                            March 31,       December 31,
                                              2020              2019
            Cash and cash equivalents      $      65.6     $         27.1

            Credit Agreement:
            Maximum availability           $     400.0$        400.0
            Suppressed availability(1)          (111.9 )           (103.0 )
            Availability                         288.1              297.0
            Amount borrowed                      (60.0 )            (90.0 )
            Letter of credit obligations          (3.7 )             (3.8 )
            Availability not borrowed            224.4              203.2

            Total liquidity                $     290.0$        230.3

(1) As of March 31, 2020 and December 31, 2019, TimkenSteel had less than $400 million in collateral assets to borrow against.

Our principal sources of liquidity are cash and cash equivalents, cash flows from operations and available borrowing capacity under our credit agreement. As of March 31, 2020, taking into account our view of automotive, industrial, and energy market demands for our products, our 2020 operating and long-range plan, we believe that our cash balance as of March 31, 2020, projected cash generated from operations, and borrowings available under the Amended Credit Agreement, will be sufficient to satisfy our working capital needs, capital expenditures and other liquidity requirements associated with our operations, including servicing our debt obligations, for at least the next twelve months.

The full extent to which the COVID-19 pandemic will impact our operations and financial results is uncertain and ultimately will depend on, among many other factors, the duration of the pandemic, further Federal and State government actions from the Federal and State governments and the speed of economic recovery. While the negative impact on our second quarter, remainder of the year and beyond remains unknown, at a minimum, we expect customer demand in the COVID-19 environment to be sharply lower in the second quarter of 2020. To the extent our liquidity needs prove to be greater than expected or cash generated from operations is less than anticipated, and cash on hand or credit availability is insufficient, we would seek additional financing to provide additional liquidity. We regularly evaluate our potential access to the equity and debt capital markets as sources of liquidity and we believe additional financing would likely be available if necessary, although we can make no assurance as to the form or terms of any such financing. We would also consider additional cost reductions and restructuring, changes in working capital management and further reductions of capital expenditures. Regardless, we will continue to evaluate additional financing or may seek to refinance outstanding borrowings under the Amended Credit Agreement to provide us with additional flexibility and liquidity. Any additional financing beyond that incurred to refinance existing debt would increase our overall debt and could increase interest expense.


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On March 27, 2020, the President of the United States signed the Coronavirus Aid, Relief, and Economic Security ("CARES") Act, an economic stimulus package intended to provide support, principally in the form of tax benefits and additional liquidity, to companies and individuals negatively impacted by the COVID-19 pandemic. Although the majority of the provisions included in the CARES Act will not immediately benefit the Company from a cash tax perspective due to its significant net operating losses, the Company has taken advantage of the deferral of the employer share (6.2% of employee wages) of Social Security payroll taxes that would otherwise have been owed from the date of enactment of the legislation through December 31, 2020, as afforded by the Act. The Company expects this to result in deferred cash payments of approximately $7 million to $10 million for the remainder of 2020, to be paid in two equal installments at December 31, 2021 and December 31, 2022.

For additional details regarding the Amended Credit Agreement and the Convertible Notes, please refer to "Note 14 - Financing Arrangements" in the Company's Annual Report on Form 10-K for the year ended December 31, 2019.

Cash Flows

The following table reflects the major categories of cash flows for the three months ended March 31, 2020 and 2019. For additional details, please refer to the unaudited Consolidated Statements of Cash Flows included in this quarterly report.




                                                      Three Months Ended March 31,
                                                        2020                2019

Net cash provided (used) by operating activities $ 63.8$ (33.6 )

 Net cash provided (used) by investing activities             4.9                (4.4 )
 Net cash (used) provided by financing activities           (30.2 )              24.2

(Decrease) Increase in Cash and Cash Equivalents $ 38.5$ (13.8 )




Operating activities

Net cash provided by operating activities for the three months ended March 31, 2020 was $63.8 million compared to net cash used of $33.6 million for the three months ended March 31, 2019. The increase in cash provided by operating activities of $97.4 million was primarily due to management actions to improve working capital.

The improvement in working capital between periods was due to inventories and accounts payable, partially offset by accounts receivable. The additional cash provided by inventory was primarily driven by the Company's inventory management program implemented late in 2019, which resulted in decreases in raw material inventory on hand, as compared to higher inventory in the first quarter of 2019. The additional cash provided by accounts payable was primarily driven by harmonization of the Company's payment procedures instituted in the first quarter of 2020, as well as a lower level of overall purchases and a decline in scrap raw material prices in recent months as compared to the prior year comparable period. The increased use of cash in accounts receivable was primarily due to higher sales in the first three months of 2020 in comparison to the last quarter of 2019, which resulted in first quarter of 2020 billings exceeding collections. In comparison, sales declined in the first three months of 2019 in comparison to the last quarter of 2018, which resulted in collections exceeding billings in the first quarter of 2019. Refer to the unaudited Consolidated Statements of Cash Flows for additional information.

Investing activities

Net cash provided by investing activities for the three months ended March 31, 2020 was $4.9 million, as compared to net cash used of $4.4 million for the three months ended March 31, 2019. Cash provided by investing activities in the first quarter of 2020 primarily relates to proceeds from sales of property, plant and equipment in conjunction with the disposition of non-core assets, as discussed in "Note 5 - Disposition of Non-Core Assets" in the Notes to the unaudited Consolidated Financial Statements, partially offset by capital investments in our manufacturing facilities. Cash used for investing activities in the first quarter of 2019 primarily relates to capital investments in our manufacturing facilities.

Given the current economic environment, the Company reduced its capital expenditure budget by $5 million to a maximum of $25 million in 2020 (made up of approximately $6 million relating to growth initiatives and the remainder related to continuous improvement). The Company has no material capital expenditure plans or commitments beyond 2020 at this time.

Financing activities

Net cash used by financing activities for the three months ended March 31, 2020 was $30.2 million compared to net cash provided by financing activities of $24.2 million for the three months ended March 31, 2019, primarily due to changes in borrowings on credit agreements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our financial statements are prepared in accordance with U.S. GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. We review our critical accounting policies throughout the year.


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New Accounting Guidance

See "Note 2 - Recent Accounting Pronouncements" in the Notes to the unaudited Consolidated Financial Statements.

FORWARD-LOOKING STATEMENTS

Certain statements set forth in this Quarterly Report on Form 10-Q (including our forecasts, beliefs and expectations) that are not historical in nature are "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995. In particular, Management's Discussion and Analysis of Financial Condition and Results of Operations contains numerous forward-looking statements. Forward-looking statements generally will be accompanied by words such as "anticipate," "believe," "could," "estimate," "expect," "forecast," "outlook," "intend," "may," "plan," "possible," "potential," "predict," "project," "seek," "should," "target," "will," "would," or other similar words, phrases or expressions that convey the uncertainty of future events or outcomes. You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this Form 10-Q. We caution readers that actual results may differ materially from those expressed or implied in forward-looking statements made by or on behalf of us due to a variety of factors, such as:



   •  deterioration in world economic conditions, or in economic conditions in any
      of the geographic regions in which we conduct business, including additional
      adverse effects from global economic slowdown, terrorism or hostilities.
      This includes: political risks associated with the potential instability of
      governments and legal systems in countries in which we or our customers
      conduct business, and changes in currency valuations;


   •  the effects of fluctuations in customer demand on sales, product mix and
      prices in the industries in which we operate. This includes: our ability to
      respond to rapid changes in customer demand; the effects of customer
      bankruptcies or liquidations; the impact of changes in industrial business
      cycles; and whether conditions of fair trade exist in the U.S. markets;


   •  the potential impact of the COVID-19 pandemic on our operations, financial
      results, and liquidity;


   •  competitive factors, including changes in market penetration; increasing
      price competition by existing or new foreign and domestic competitors; the
      introduction of new products by existing and new competitors; and new
      technology that may impact the way our products are sold or distributed;


   •  changes in operating costs, including the effect of changes in our
      manufacturing processes; changes in costs associated with varying levels of
      operations and manufacturing capacity; availability of raw materials and
      energy; our ability to mitigate the impact of fluctuations in raw materials
      and energy costs and the effectiveness of our surcharge mechanism; changes
      in the expected costs associated with product warranty claims; changes
      resulting from inventory management, cost reduction initiatives and
      different levels of customer demands; the effects of unplanned work
      stoppages; and changes in the cost of labor and benefits;


   •  the success of our operating plans, announced programs, initiatives and
      capital investments; and our ability to maintain appropriate relations with
      unions that represent our associates in certain locations in order to avoid
      disruptions of business;


   •  unanticipated litigation, claims or assessments, including claims or
      problems related to intellectual property, product liability or warranty,
      and environmental issues and taxes, among other matters;


   •  the availability of financing and interest rates, which affect our cost of
      funds and/or ability to raise capital; our pension obligations and
      investment performance; and/or customer demand and the ability of customers
      to obtain financing to purchase our products or equipment that contain our
      products; and the amount of any dividend declared by our Board of Directors
      on our common shares;


   •  the overall impact of the pension and postretirement mark-to-market
      accounting; and


   •  those items identified under the caption Risk Factors in our Annual Report
      on Form 10-K for the year ended December 31, 2019.

You are cautioned that it is not possible to predict or identify all of the risks, uncertainties and other factors that may affect future results, and that the above list should not be considered to be a complete list. Except as required by the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

© Edgar Online, source Glimpses

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