Metallus Inc. (filing registrant: TimkenSteel Corporation) — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; balance-sheet figures are as of June 30, 2016, compared with December 31, 2015. The company manufactures specialty steel, seamless mechanical tubes, and value-added products and services. It reported as one business segment beginning in 2016 after reorganizing and eliminating its former two-segment structure.
Financial performance and liquidity
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net sales | $223.1 million | $278.2 million | $441.0 million | $666.9 million |
| Gross profit (loss) | $10.2 million | ($6.1 million) | $13.6 million | $35.5 million |
| Gross margin | 4.6% | (2.2%) | 3.1% | 5.3% |
| Operating loss | ($13.8 million) | ($37.4 million) | ($33.3 million) | ($25.3 million) |
| Net loss | ($10.5 million) | ($24.3 million) | ($24.1 million) | ($17.4 million) |
| Loss per share, diluted | ($0.24) | ($0.54) | ($0.55) | ($0.39) |
- Revenue and volumes: Q2 sales fell 19.8%; excluding raw-material surcharges, sales declined 16.6%. Shipments fell 10.5%, and average selling price per ton including surcharges fell 10.4%. First-half sales declined 33.9%, shipments 22.2%, and average selling price per ton 15.1%.
- Profitability drivers: Q2 gross profit improved by $16.3 million year over year, principally from approximately $21 million of favorable raw-material spread and $15 million of lower manufacturing costs; lower price/mix, LIFO income, and volume partly offset the gains. First-half gross profit fell $21.9 million, as lower volume, price/mix, and LIFO income outweighed favorable spread and lower manufacturing costs. SG&A declined 20.2% in Q2 and 20.7% in the first half, mainly due to cost reductions.
- Cash flow: First-half operating cash flow was $48.0 million, versus $62.2 million; capital expenditures were $15.2 million, versus $34.6 million. Financing activities used $38.0 million, including $120 million of credit-agreement repayments, partly offset by convertible-note proceeds. Cash decreased $5.2 million to $37.2 million.
- Balance sheet and debt: Total assets were $1,107.4 million and shareholders’ equity $683.9 million. Current assets of $300.6 million exceeded current liabilities of $110.5 million. Debt was $145.3 million on the reported carrying-value basis: $65.1 million of convertible notes, net, and $80.2 million of other long-term debt. The $86.3 million principal convertible-note issue carries 6% cash interest, matures in 2021, and has an initial conversion price of approximately $12.58 per share.
- Liquidity: The asset-based revolving facility had $119.0 million of net availability after the availability block; cash plus net availability totaled $156.2 million. The facility’s interest rate was 4.50%. Management said it expected cash, operating cash flows, and borrowing capacity to meet needs for at least 12 months and through the facility’s June 2019 maturity, subject to assumptions about operating improvement and cash generation.
Changes, outlook, and risks
- Demand weakness was concentrated in energy and industrial markets. Q2 energy shipments declined 67.9% and industrial shipments 16.5%; for the first half, the declines were 82.3% and 28.7%, respectively. Management cited depressed commodity markets, falling rig counts, and elevated distribution inventories.
- Melt utilization was 45% in Q2 and 46% in the first half, versus 47% and 57% in the comparable 2015 periods. Management estimated approximately 50% utilization could produce EBITDA breakeven in normalized scrap markets, while noting that volume, mix, pricing, and cost structure affect that level.
- The company had implemented a $75 million cost-reduction initiative. It reduced 2016 capital spending to a $45 million covenant limit and deferred final installation of its advanced quench-and-temper facility pending improved market conditions. Approximately $35 million of additional project costs were expected over the next one to three years.
- There was no specific sales or earnings forecast in the provided filing text. The company suspended its dividend in November 2015 and said the board would review it as conditions improve. No shares were repurchased in the first half of 2016.
- Management expected covenant compliance for at least the next 12 months and estimated EBITDA would need to be approximately $10 million in the first half of 2017 to meet the June 2017 fixed-charge coverage test, before considering capital expenditures. A covenant breach could lead to acceleration of revolving-facility debt if not amended or refinanced.
- Key exposures include continued weak energy and industrial demand, raw-material and energy price movements and surcharge timing, variable-rate debt, and the execution and return of capital projects. A 1 percentage-point rise in rates was estimated to increase annual interest expense by approximately $0.8 million. Environmental and other ordinary-course claims were disclosed; management did not expect their ultimate disposition to materially affect financial position, cash flows, or results.
- Unusual financing item: the May 2016 convertible-note offering generated $83.7 million net proceeds, used to repay revolving borrowings. The company also terminated a previously announced $20 million sale-and-leaseback agreement for its Canton offices; the filing states no further obligations remained.
Important facts for investors to verify
- Whether energy and industrial demand, shipment volumes, and melt utilization recover enough to support the company’s stated breakeven assumptions.
- Whether operating cash flow and available borrowing capacity remain adequate, particularly if losses persist or working-capital needs increase.
- Progress toward the 2017 fixed-charge coverage covenant, including the effect of capital expenditures and the company’s actual EBITDA.
- The terms, cash-interest burden, and potential dilution from the convertible notes, and the level of variable-rate debt.
- How raw-material spread, surcharges, and year-end LIFO valuation affect reported margins and cash generation.