Business context and reporting period
TimkenSteel Corporation’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018. The company manufactures specialty alloy, carbon and micro-alloy steel products and related value-added services for mobile, industrial, energy and other markets. The filing is under the name TimkenSteel Corporation.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $409.9 million | $339.1 million | $1,204.2 million | $987.8 million |
| Gross profit | $24.6 million | $18.5 million | $77.8 million | $59.3 million |
| Operating income (loss) | $0.6 million | ($4.0 million) | $3.3 million | ($8.4 million) |
| Net income (loss) | $1.4 million | ($5.9 million) | $7.9 million | ($9.9 million) |
| Diluted EPS | $0.03 | ($0.13) | $0.17 | ($0.22) |
- Q3 gross margin was approximately 6.0%, versus 5.5% a year earlier; nine-month gross margin was approximately 6.5%, versus 6.0%. Operating income turned positive in both comparison periods.
- Sales rose 21% in Q3 and 22% for the nine months. Excluding raw-material surcharges, sales increased 16% and 17%, respectively. Management attributed growth mainly to favorable price/mix and higher volumes; shipments increased 2% in Q3 and 5% year to date.
- Industrial and energy demand strengthened. In the first nine months, energy sales increased to $188.0 million from $99.0 million, and industrial sales to $484.3 million from $357.1 million. Mobile sales increased more modestly; “other” sales declined.
- Costs offset part of the improvement: management cited scheduled maintenance occurring in Q3 rather than Q4 2017, consumables inflation and higher freight costs. SG&A increased $1.5 million in Q3 and $5.9 million year to date, partly due to variable compensation, employee costs and executive severance.
Cash flow, balance sheet and debt
- Operating cash flow was negative $28.4 million for the nine months, compared with negative $11.7 million in 2017. Working capital used $86.0 million, including inventory growth of $61.3 million and receivables growth of $22.3 million.
- Investing cash outflow was $16.7 million, including $17.7 million of capital expenditures. Financing provided $47.6 million, principally reflecting net borrowings under the amended credit facility. Cash increased $2.5 million to $27.0 million.
- At September 30, total assets were $1,207.3 million, current assets $497.4 million and current liabilities $196.6 million. Inventory was $285.3 million, up from $224.0 million at year-end; management cited higher raw-material costs and inventory built for expected industrial and energy demand.
- Debt consisted of $145.0 million outstanding under the variable-rate amended credit agreement and $73.0 million of convertible notes, net of discount and issuance costs. Convertible-note principal was $86.3 million; notes carry 6% cash interest and mature June 1, 2021.
- The amended asset-based revolving facility has a $300 million commitment, matures January 2023, and carried a 4.1% interest rate at quarter-end. Borrowings available were $152.4 million; cash plus net availability gave reported total liquidity of $179.4 million. The company reported covenant compliance.
- Shareholders’ equity was $574.3 million, up from $560.7 million at year-end. The cash dividend remained suspended; the board said it would review dividends as business conditions permit.
Outlook, risks and notable items
- No specific earnings or sales guidance is provided. Management said cash, projected operating cash flow and available credit were expected to meet working-capital, capital expenditure and debt-service needs for at least 12 months and through the credit facility’s January 2023 maturity, subject to assumptions including market demand, lower operating costs and working-capital management.
- The company expected approximately $36 million of additional project costs over the next one to three years, including growth initiatives and continuous improvement. It highlighted its new advanced quench-and-temper line, launched in Q4 2017, as a capacity and customer-service investment.
- Key exposures include customer demand and product mix, competition, raw-material and energy prices, inflation, manufacturing utilization, and the lag in passing costs through surcharges. The company reported $145.0 million of variable-rate debt; a 1 percentage-point rate increase was estimated to raise annual interest expense by about $1.5 million.
- Management maintained a valuation allowance against U.S. and certain foreign deferred tax assets, which may cause effective tax-rate variability. The nine-month tax provision was $1.2 million.
- Year-to-date impairment and asset-disposal charges were $0.9 million, including charges related to discontinued assets and capitalized software. The company adopted the new revenue standard in 2018; the opening retained-earnings adjustment was $0.7 million and the reported-period effect was not material.
- Environmental claims include EPA Notices of Violation concerning alleged Clean Air Act violations at two Canton plants. The company disputes many allegations and said negotiations were ongoing; management did not expect a material adverse effect. Environmental reserves were $0.9 million at quarter-end.
Investor verification points
- Confirm whether stronger industrial and energy demand and favorable price/mix persisted, and whether shipments and margins improved after Q3 maintenance and lower melt utilization.
- Track working-capital requirements, inventory conversion and operating cash flow, given the $86.0 million year-to-date working-capital use and increased facility borrowings.
- Review borrowing-base availability, variable-rate exposure, covenant headroom and the terms of the convertible notes as liquidity and debt needs evolve.
- Assess execution and returns on planned growth and improvement projects, and monitor raw-material surcharge timing, LIFO effects and inflation.
- Follow developments in the EPA matter, tax valuation allowances and other contingencies; the filing gives no quantified range for potential EPA resolution costs.