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TimkenSteel Corp - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to            
Commission file number: 1-36313
 
TIMKENSTEEL CORPORATION
(Exact name of registrant as specified in its charter)
 
Ohio
 
46-4024951
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
1835 Dueber Avenue SW, Canton, OH
 
44706
(Address of principal executive offices)
 
(Zip Code)
330.471.7000
(Registrant’s telephone number, including area code) 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  ý   No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ý   No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act
Large accelerated filer
 
o
  
 
Accelerated filer
ý
 
 
 
 
 
 
 
Non-accelerated filer
 
o
  (Do not check if smaller reporting company)
 
Smaller reporting company
o
 
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial reporting accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  ¨  No  ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding at October 13, 2017
 
 
Common Shares, without par value
 
44,441,647
 


TimkenSteel Corporation
Table of Contents
 
 
PAGE
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 6.
 


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Table of Contents

PART I. FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
TimkenSteel Corporation
Consolidated Statements of Operations (Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
(Dollars in millions, except per share data)
 
 
 
 
 
 
 
Net sales

$339.1

 

$213.8

 

$987.8

 

$654.8

Cost of products sold
320.6

 
206.3

 
928.5

 
629.6

Gross Profit
18.5

 
7.5

 
59.3

 
25.2

 
 
 
 
 
 
 
 
Selling, general and administrative expenses
22.5

 
21.8

 
67.7

 
66.8

Restructuring charges
—

 
—

 
—

 
0.3

Operating Loss
(4.0
)
 
(14.3
)
 
(8.4
)
 
(41.9
)
 
 
 
 
 
 
 
 
Interest expense
3.7

 
3.9

 
11.0

 
8.0

Other income (expense), net
1.9

 
(17.3
)
 
10.7

 
(12.1
)
Loss Before Income Taxes
(5.8
)
 
(35.5
)
 
(8.7
)
 
(62.0
)
Provision (benefit) for income taxes
0.1

 
(13.3
)
 
1.2

 
(23.5
)
Net Loss

($5.9
)
 

($22.2
)
 

($9.9
)
 

($38.5
)
 
 
 
 
 
 
 
 
Per Share Data:
 
 
 
 
 
 
 
Basic loss per share

($0.13
)
 

($0.50
)
 

($0.22
)
 

($0.87
)
Diluted loss per share

($0.13
)
 

($0.50
)
 

($0.22
)
 

($0.87
)
 
 
 
 
 
 
 
 
Dividends per share

$—

 

$—

 

$—

 

$—

See accompanying Notes to Unaudited Consolidated Financial Statements.


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TimkenSteel Corporation
Consolidated Statements of Comprehensive Loss (Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
(Dollars in millions)
 
 
 
 
 
 
 
Net Loss

($5.9
)
 

($22.2
)
 

($9.9
)
 

($38.5
)
Other comprehensive income, net of tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
0.3

 
(0.5
)
 
1.1

 
(2.8
)
Pension and postretirement liability adjustments
0.1

 
—

 
0.4

 
0.8

Other comprehensive income, net of tax
0.4

 
(0.5
)
 
1.5

 
(2.0
)
Comprehensive Loss, net of tax

($5.5
)
 

($22.7
)
 

($8.4
)
 

($40.5
)
See accompanying Notes to Unaudited Consolidated Financial Statements.

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TimkenSteel Corporation
Consolidated Balance Sheets (Unaudited)
 
September 30,
2017
 
December 31,
2016
(Dollars in millions)
 
 
 
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents

$25.8

 

$25.6

Accounts receivable, net of allowances (2017 - $2.6 million; 2016 - $2.1 million)
160.6

 
91.6

Inventories, net
219.5

 
164.2

Deferred charges and prepaid expenses
4.2

 
2.8

Other current assets
7.4

 
6.2

Total Current Assets
417.5

 
290.4

 
 
 
 
Property, Plant and Equipment, Net
701.6

 
741.9

 
 
 
 
Other Assets
 
 
 
Pension assets
9.8

 
6.2

Intangible assets, net
20.9

 
25.0

Other non-current assets
6.0

 
6.4

Total Other Assets
36.7

 
37.6

Total Assets

$1,155.8

 

$1,069.9

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable, trade

$133.8

 

$87.0

Salaries, wages and benefits
30.4

 
20.3

Accrued pension and postretirement costs
3.0

 
3.0

Other current liabilities
21.4

 
20.4

Total Current Liabilities
188.6

 
130.7

 
 
 
 
Non-Current Liabilities
 
 
 
Convertible notes, net
69.2

 
66.4

Other long-term debt
95.2

 
70.2

Accrued pension and postretirement costs
196.2

 
192.1

Deferred income taxes
0.7

 
—

Other non-current liabilities
13.2

 
13.1

Total Non-Current Liabilities
374.5

 
341.8

 
 
 
 
Shareholders’ Equity
 
 
 
Preferred shares, without par value; authorized 10.0 million shares, none issued
—

 
—

Common shares, without par value; authorized 200.0 million shares;
   issued 2017 and 2016 - 45.7 million shares
—

 
—

Additional paid-in capital
842.3

 
845.6

Retained deficit
(204.1
)
 
(193.9
)
Treasury shares - 2017 - 1.3 million; 2016 - 1.5 million
(37.6
)
 
(44.9
)
Accumulated other comprehensive loss
(7.9
)
 
(9.4
)
Total Shareholders’ Equity
592.7

 
597.4

Total Liabilities and Shareholders’ Equity

$1,155.8

 

$1,069.9

See accompanying Notes to Unaudited Consolidated Financial Statements.

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Table of Contents

TimkenSteel Corporation
Consolidated Statements of Cash Flows (Unaudited)
 
Nine Months Ended September 30,
 
2017
 
2016
(Dollars in millions)
 
 
 
CASH PROVIDED (USED)
 
 
 
Operating Activities
 
 
 
Net loss

($9.9
)
 

($38.5
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
56.4

 
56.2

Amortization of deferred financing fees and debt discount
3.1

 
1.9

Impairment charges and loss on sale or disposal of assets
0.4

 
1.0

Deferred income taxes
0.7

 
(24.9
)
Stock-based compensation expense
4.9

 
4.6

Pension and postretirement expense
4.6

 
23.4

Pension and postretirement contributions and payments
(2.5
)
 
(3.1
)
Reimbursement from postretirement plan assets
—

 
13.3

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(69.0
)
 
(23.0
)
Inventories, net
(55.3
)
 
18.5

Accounts payable, trade
46.8

 
23.6

Other accrued expenses
10.7

 
(8.4
)
Deferred charges and prepaid expenses
(1.4
)
 
7.6

Other, net
(1.2
)
 
3.3

Net Cash (Used) Provided by Operating Activities
(11.7
)
 
55.5

 
 
 
 
Investing Activities
 
 
 
Capital expenditures
(11.9
)
 
(26.1
)
Net Cash Used by Investing Activities
(11.9
)
 
(26.1
)
 
 
 
 
Financing Activities
 
 
 
Proceeds from exercise of stock options
0.2

 
—

Shares surrendered for employee taxes on stock compensation
(1.4
)
 
—

Credit agreement repayments
(5.0
)
 
(130.0
)
Credit agreement borrowings
30.0

 
—

Debt issuance costs
—

 
(4.8
)
Proceeds from issuance of convertible notes
—

 
86.3

Net Cash Provided (Used) by Financing Activities
23.8

 
(48.5
)
Effect of exchange rate changes on cash
—

 
—

Increase (Decrease) In Cash and Cash Equivalents
0.2

 
(19.1
)
Cash and cash equivalents at beginning of period
25.6

 
42.4

Cash and Cash Equivalents at End of Period

$25.8

 

$23.3

See accompanying Notes to Unaudited Consolidated Financial Statements.

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Table of Contents

TimkenSteel Corporation
Notes to Unaudited Consolidated Financial Statements
(dollars in millions, except per share data)

Note 1 - Company and Basis of Presentation
The accompanying Unaudited Consolidated Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States (U.S. GAAP) for interim financial information. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) and disclosures considered necessary for a fair presentation have been included. For further information, refer to TimkenSteel’s Audited Consolidated Financial Statements and Notes included in its Annual Report on Form 10-K for the year ended December 31, 2016.
TimkenSteel Corporation (the Company or TimkenSteel) manufactures 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. TimkenSteel’s portfolio includes special bar quality (SBQ) bars, seamless mechanical tubing (tubes) and value-add solutions, such as precision steel components. In addition, TimkenSteel supplies machining and thermal treatment services, as well as manages raw material recycling programs, which are used as a feeder system for the Company’s melt operations. The Company’s products and services are used in a diverse range of demanding applications in the following market sectors: oil and gas; oil country tubular goods (OCTG); automotive; industrial equipment; mining; construction; rail; aerospace and defense; heavy truck; agriculture; and power generation.
The SBQ bars and tubes production processes take place at the Company’s Canton, Ohio manufacturing location. This location accounts for all of the SBQ bars and seamless mechanical tubes the Company produces and includes three manufacturing facilities: the Faircrest, Harrison, and Gambrinus facilities. TimkenSteel’s value-add solutions production processes take place at three downstream manufacturing facilities: TimkenSteel Material Services (Houston, TX), Tryon Peak (Columbus, NC), and St. Clair (Eaton, OH). Many of the production processes are integrated, and the manufacturing facilities produce products that are sold in all of the Company’s market sectors. As a result, investments in the Company’s facilities and resource allocation decisions affecting the Company’s operations are designed to benefit the overall business of the Company, not any specific aspect of the business.
Change in Accounting Principle
On December 31, 2016, TimkenSteel changed its accounting principle for recognizing actuarial gains and losses and expected returns on plan assets for its defined benefit pension and other postretirement benefit plans. Prior to 2016, the Company amortized, as a component of pension and other postretirement expense, unrecognized actuarial gains and losses (included within accumulated other comprehensive income (loss)) over the average remaining service period of active employees expected to receive benefits under the plan, or average remaining life expectancy of inactive participants when all or almost all of plan participants are inactive. The Company historically has calculated the market-related value of plan assets based on a 5-year market adjustment. The value was determined by adjusting the fair value of plan assets to reflect the investment gains and losses during each of the last 5 years. The difference between the expected return on assets and actual return on assets was recognized at the rate of 20% per year (e.g., recognized over five years). Under the new principle, actuarial gains and losses are immediately recognized through net periodic benefit cost in the Statement of Operations upon the annual remeasurement at December 31, or on an interim basis as triggering events warrant remeasurement. In addition, the Company changed its accounting for measuring the market-related value of plan assets from a calculated amount (based on a five-year smoothing of asset returns) to fair value. The Company believes these changes are preferable, as they result in an accelerated recognition of changes in assumptions and market return on plan assets, as compared to the minimum amortization approach and market-related value of plan assets (i.e. delayed approach). Additionally, the Company believes the new accounting principles provide a better representation of the operating results of the Company and the impact of its benefit obligations (through the income statement) in the period when changes occur.
These changes have been applied retrospectively to prior periods beginning with the formation of the TimkenSteel pension and postretirement benefit plans during the second quarter of 2014. The cumulative effect of the change in accounting principles resulted in a reduction of additional paid in capital of $229.4 million per year as of the date of establishment of the TimkenSteel pension and other postretirement plans. For further information refer to our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC.



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Table of Contents

Note 2 - Recent Accounting Pronouncements
Adoption of New Accounting Standards
The Company adopted the following Accounting Standard Updates (ASU) during the nine months ended September 30, 2017. With the exception of ASU 2017-07, which is discussed below, the adoption of these standards did not have a material impact on the Unaudited Consolidated Financial Statements or the related Notes to the Unaudited Consolidated Financial Statements.
Standard
 
 
 
2015-11
Inventory: Simplifying the Measurement of Inventory (Topic 330)
2016-15
Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments (a Consensus of the Emerging Issues Task Force)
2016-16
 Accounting for Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory (Topic 740)
2017-07
Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (Topic 715)

In the first quarter of 2017, the FASB issued and the Company early adopted ASU 2017-07, “Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost (Topic 715).” This ASU requires entities to present non-service cost components of net periodic benefit cost in a caption below operating loss and provides that only service cost is eligible to be capitalized in inventory or construction of an asset. This ASU requires retrospective application of the change in the statement of operations and prospective application for the capitalization of service cost in assets. This ASU permits previously disclosed components of net periodic benefit costs as an estimation basis for applying the retrospective presentation as a practical expedient. Utilizing the practical expedient approach, based on amounts previously disclosed, the Company reclassified non-service components of net periodic benefit cost from cost of products sold and selling, general and administrative expenses, respectively, into other income (expense), net on the Unaudited Consolidated Statements of Operations. See Note 9 - Retirement and Postretirement Plans for additional information.

Accounting Standards Issued But Not Yet Adopted
In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. This ASU eliminates the requirement to consider “down round” features when determining whether certain equity-linked financial instruments or embedded features are indexed to an entity’s own stock. It is effective for annual periods beginning after December 31, 2018. Early adoption is permitted. TimkenSteel is currently evaluating the impact of the adoption of this ASU on its results of operations and financial condition.

In May 2017, the FASB issued ASU 2017-09, Compensation — Stock Compensation (Topic 718), Scope of Modification Accounting. This ASU clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. This ASU shall be applied prospectively to awards modified on or after the adoption date. It is effective for annual periods beginning after December 31, 2017. Early adoption is permitted, including adoption in any interim period for which financial statements have not yet been issued. TimkenSteel will apply this ASU for awards modified on or after January 1, 2018, as applicable. TimkenSteel does not expect this ASU to have a material impact on its results of operations or financial condition.

In January 2017, the FASB issued ASU 2017-01, “Business Combinations - Clarifying the Definition of a Business.” This guidance clarifies the definition of a business when evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. It is effective for annual periods beginning after December 31, 2017. TimkenSteel will apply this ASU to business combinations effective after January 1, 2018, as applicable.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” This ASU changes how entities will measure credit losses for most financial assets, including trade and other receivables. This guidance will replace the current incurred loss approach with an expected loss model. It is effective for annual periods beginning after December 31, 2019, and interim periods therein. Early adoption is permitted for annual periods

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Table of Contents

beginning after December 15, 2018 and interim periods therein. TimkenSteel is currently evaluating the impact of the adoption of this ASU on its results of operations and financial condition.
In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which requires lessees to recognize lease liabilities and right-of-use assets on the balance sheet for operating leases, and requires additional quantitative and qualitative disclosures. It is effective for annual reporting periods beginning after December 15, 2018. The Company regularly enters into operating leases. TimkenSteel is currently evaluating the impact of the adoption of this ASU on its results of operations and financial condition.
In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” which provides guidance for revenue recognition and will supersede Topic 605, “Revenue Recognition,” and most industry-specific guidance. Under ASU 2014-09 and the subsequently issued amendments, the core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. Additional disclosures will be required about the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. This standard is effective for reporting periods after December 15, 2017. TimkenSteel has substantially completed a review of its customer contracts and has preliminarily determined that its revenue transactions will continue to be recognized at a point in time. Based on the analysis completed to date, the Company’s expectation is that this standard will not materially impact the amount or timing of revenue recognized. The Company is finalizing its review of accounting policies, systems and related internal controls in anticipation of adopting ASU 2014-09 as of January 1, 2018, using the modified retrospective approach.
Note 3 - Inventories
The components of inventories, net as of September 30, 2017 and December 31, 2016 were as follows:
 
September 30,
2017
 
December 31,
2016
Inventories, net:
 
 
 
Manufacturing supplies

$36.6

 

$37.9

Raw materials
31.7

 
16.2

Work in process
96.3

 
58.6

Finished products
63.5

 
59.6

Subtotal
228.1

 
172.3

Allowance for surplus and obsolete inventory
(8.6
)
 
(8.1
)
Total Inventories, net

$219.5

 

$164.2

Inventories are valued at the lower of cost or market, with approximately 64% valued by the LIFO method, and the remaining inventories, including manufacturing supplies inventory as well as international (outside the United States) inventories, valued by FIFO, average cost or specific identification methods.
An actual valuation of the inventory under the LIFO method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations must be based on management’s estimates of expected year-end inventory levels and costs. Because these calculations are subject to many factors beyond management’s control, annual results may differ from interim results as they are subject to the final year-end LIFO inventory valuation.
The LIFO reserve as of September 30, 2017 and December 31, 2016 was $53.5 million and $44.6 million, respectively. TimkenSteel projects that its LIFO reserve will increase for the year ending December 31, 2017 due primarily to higher anticipated raw material costs and inventory quantities.

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Note 4 - Property, Plant and Equipment
The components of property, plant and equipment, net as of September 30, 2017 and December 31, 2016, were as follows:
 
September 30,
2017
 
December 31,
2016
Property, Plant and Equipment, net:
 
 
 
Land

$13.4

 

$13.3

Buildings and improvements
418.9

 
420.6

Machinery and equipment
1,354.1

 
1,352.0

Construction in progress
51.6

 
63.9

Subtotal
1,838.0

 
1,849.8

Less allowances for depreciation
(1,136.4
)
 
(1,107.9
)
Property, Plant and Equipment, net

$701.6

 

$741.9

Total depreciation expense was $51.3 million and $51.0 million for the nine months ended September 30, 2017 and 2016, respectively. TimkenSteel recorded capitalized interest related to construction projects of $0.5 million in both the nine months ended September 30, 2017 and 2016. During the nine months ended September 30, 2017, TimkenSteel recorded impairment charges of $0.4 million in the caption cost of products sold on the Unaudited Consolidated Statements of Operations, related to the discontinued use of certain assets. There were no impairment charges recorded during the nine months ended September 30, 2016.
Note 5 - Intangible Assets
The components of intangible assets, net as of September 30, 2017 and December 31, 2016 were as follows:
 
September 30, 2017
 
December 31, 2016
 
Gross Carrying Amount
 
 Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Amount
 
 Accumulated Amortization
 
Net Carrying Amount
Intangible Assets Subject to Amortization:
 
 
 
 
 
 
 
 
 
 
 
Customer relationships

$6.3

 

$4.0

 

$2.3

 

$6.3

 

$3.7

 

$2.6

Technology use
9.0

 
5.8

 
3.2

 
9.0

 
5.2

 
3.8

Capitalized software
58.5

 
43.1

 
15.4

 
58.9

 
40.3

 
18.6

Total Intangible Assets

$73.8

 

$52.9

 

$20.9

 

$74.2

 

$49.2

 

$25.0

Intangible assets subject to amortization are amortized on a straight-line method over their legal or estimated useful lives. Amortization expense for intangible assets for the nine months ended September 30, 2017 and 2016 was $5.1 million and $5.2 million, respectively.
Note 6 - Financing Arrangements
Convertible Notes
In May 2016, the Company issued $75.0 million aggregate principal amount of Convertible Senior Notes, and an additional $11.3 million principal amount to cover over-allotments (Convertible Notes). The Indenture for the Convertible Notes dated May 31, 2016, which was filed with the Securities and Exchange Commission as an exhibit to a Form 8-K filed on May 31, 2016, contains a complete description of the terms of the Convertible Notes. The key terms are as follows:
Maturity Date:         June 1, 2021 unless repurchased or converted earlier
Interest Rate:         6.0% cash interest per year
Interest Payments Dates:     June 1 and December 1 of each year, beginning on December 1, 2016
Initial Conversion Price:    Approximately $12.58 per common share of the Company
Initial Conversion Rate:    79.5165 common shares per $1,000 principal amount of Notes

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The net proceeds to the Company from the offering were $83.2 million, after deducting the initial underwriters’ discount and fees and the offering expenses payable by the Company. The Company used the net proceeds to repay a portion of the amounts outstanding under the Amended Credit Agreement.
The components of the Convertible Notes as of September 30, 2017 and December 31, 2016 were as follows:
 
September 30,
2017
 
December 31,
2016
Principal

$86.3

 

$86.3

Less: Debt issuance costs, net of amortization
(1.8
)
 
(2.1
)
Less: Debt discount, net of amortization
(15.3
)
 
(17.8
)
Convertible notes, net

$69.2

 

$66.4

The initial value of the principal amount recorded as a liability at the date of issuance was $66.9 million, using an effective interest rate of 12.0%. The remaining $19.4 million of principal amount was allocated to the conversion feature and recorded as a component of shareholders’ equity at the date of issuance. This amount represents a discount to the debt to be amortized through interest expense using the effective interest method through the maturity of the Convertible Notes.
Transaction costs were allocated to the liability and equity components based on their relative values. Transaction costs attributable to the liability component of $2.4 million are amortized to interest expense over the term of the Convertible Notes, and transaction costs attributable to the equity component of $0.7 million are included in shareholders’ equity.
The following table sets forth total interest expense recognized related to the Convertible Notes:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
2016
Contractual interest expense

$1.3

 

$1.3

 

$3.9


$1.7

Amortization of debt issuance costs
0.1

 
0.1

0.1

0.3

0.2

Amortization of debt discount
0.9

 
0.7

 
2.5

0.9

Total

$2.3

 

$2.1

 

$6.7


$2.8

The fair value of the Convertible Notes was approximately $162.8 million as of September 30, 2017. The fair value of the Convertible Notes, which falls within Level 1 of the fair value hierarchy, is based on the last price traded in September 2017 .
Holders may convert all or any portion of their Convertible Notes, in multiples of $1,000 principal amount, at their option at any time prior to the close of business on the business day immediately preceding March 1, 2021 only under certain circumstances described in the Convertible Notes Indenture, based on the reported sale price of the Company’s common shares for specified trading days as a percentage of the conversion price of the Convertible Notes, and upon the occurrence of specified corporate events. On or after March 1, 2021 until the business day preceding the maturity date, holders may convert all or any portion of their Convertible Notes, in multiples of $1,000 principal amount, at their option.
Upon conversion, the Company will pay or deliver, as the case may be, cash, common shares or a combination of cash and common shares, at its election. If the Company satisfies its conversion obligation solely in cash or through payment and delivery, as the case may be, of a combination of cash and common shares, the amount of cash and number of common shares, if any, due upon conversion will be based on a daily conversion value calculated on a proportionate basis for each trading day in a 40-trading day period.
If the Company undergoes a fundamental change, subject to certain conditions, holders may require the Company to repurchase for cash all or part of their Convertible Notes at a repurchase price equal to 100% of the principal amount of the Convertible Notes to be repurchased, plus accrued and unpaid interest to the repurchase date.
Upon certain events of default occurring and continuing (including failure to pay principal or interest on the Convertible Notes when due and payable), the Trustee or the holders of at least 25% in principal amount may declare 100% of the principal and accrued and unpaid interest, if any, on all the Convertible Notes to be due and payable. In case of certain events of bankruptcy, insolvency or reorganization, involving the Company or a significant subsidiary, 100% of the principal and accrued and unpaid interest on the Convertible Notes will become due and payable immediately.

11

Table of Contents

Other Long-Term Debt
The components of other long-term debt as of September 30, 2017 and December 31, 2016 were as follows:
 
September 30,
2017
 
December 31,
2016
Variable-rate State of Ohio Water Development Revenue Refunding Bonds, maturing on November 1, 2025 (0.862% as of September 30, 2017)

$12.2

 

$12.2

Variable-rate State of Ohio Air Quality Development Revenue Refunding Bonds, maturing on November 1, 2025 (0.862% as of September 30, 2017)
9.5

 
9.5

Variable-rate State of Ohio Pollution Control Revenue Refunding Bonds, maturing on June 1, 2033 (0.862% as of September 30, 2017)
8.5

 
8.5

Amended Credit Agreement, due 2019 (LIBOR plus applicable spread)
65.0

 
40.0

Total Other Long-Term Debt

$95.2

 

$70.2

Amended Credit Agreement
On February 26, 2016, the Company, as borrower, and certain domestic subsidiaries, as subsidiary guarantors, entered into Amendment No. 1 to the Amended and Restated Credit Agreement (as amended by the Amendment, the Amended Credit Agreement) with JPMorgan Chase Bank, N.A., as administrative agent, and the other lenders party thereto.
The Amended Credit Agreement provides for a $265.0 million asset-based revolving credit facility, including a $13.3 million sublimit for the issuance of commercial and standby letters of credit, and a $26.5 million sublimit for swingline loans. The availability of borrowings is subject to a borrowing base calculation based upon a valuation of the eligible accounts receivable, inventory and machinery and equipment of TimkenSteel and the subsidiary guarantors, each multiplied by an applicable advance rate. The Amended Credit Agreement includes a block on availability equal to the greater of $28.9 million or 12.5% of the aggregate commitments (except that in the event of a mandatory reduction in the commitments, the block on availability will be equal to the greater of $20.0 million or 12.5% of the aggregate commitments), effectively reducing the Company’s borrowing base by the availability block.
The Amended Credit Agreement contains certain customary covenants, including covenants that limit TimkenSteel’s and its subsidiaries’ ability to, among other things, (i) incur or suffer to exist certain liens, (ii) make investments, (iii) incur or guaranty additional indebtedness, (iv) enter into consolidations, mergers, acquisitions and sales of assets, (v) make distributions and other restricted payments, (vi) change the nature of its business, (vii) engage in transactions with affiliates and (viii) enter into restrictive agreements, including agreements that restrict the ability to incur liens or make distributions. Further, the Amended Credit Agreement contains financial covenants that (i) limit the amount of capital expenditures TimkenSteel may make to $45.0 million in fiscal year 2016 and $50.0 million in fiscal years thereafter and (ii) require the Company to maintain a minimum specified fixed charge coverage ratio for the year-to-date periods beginning January 1, 2017 and ending June 30, 2017, July 31, 2017 and August 31, 2017. As of September 30, 2017, we are in compliance with all covenants.
Borrowings under the Amended Credit Agreement bear interest based on the daily balance outstanding at LIBOR (with no rate floor), plus an applicable margin (varying from 3.00% to 3.50%) and an additional 0.75% on the machinery and equipment component or, in certain cases, an alternate base rate (based on certain lending institutions’ Prime Rate or as otherwise specified in the Amended and Restated Credit Agreement, with no rate floor), plus an applicable margin (varying from 2.00% to 2.50%). The Amended Credit Agreement also carries a commitment fee equal to the unused borrowings multiplied by an applicable margin of 0.50%. The applicable margins are calculated quarterly and vary based on TimkenSteel’s average quarterly availability as set forth in the Amended Credit Agreement. The interest rate under the Amended Credit Agreement was 5.2% as of September 30, 2017. The amount available under the Amended Credit Agreement as of September 30, 2017 was $164.3 million net, after reducing for the block on availability of $33.1 million.
Revenue Refunding Bonds
On June 1, 2014, The Timken Company (Timken) purchased, in lieu of redemption, the State of Ohio Water Development Revenue Refunding Bonds (Water Bonds), State of Ohio Air Quality Development Revenue Refunding Bonds (Air Quality Bonds) and State of Ohio Pollution Control Revenue Refunding Bonds (Pollution Control Bonds) (collectively, Bonds). Pursuant to an Assignment and Assumption Agreement dated June 24, 2014 between Timken and TimkenSteel, Timken assigned all of its right, title and interest in and to the loan agreements and the notes associated with the Bonds to, and these obligations were assumed by, TimkenSteel. Additionally, replacement letters of credit were issued for the Water Bonds and the Pollution Control Bonds. The Bonds were remarketed on June 24, 2014 (Remarketing Date) in connection with the conversion of the interest rate mode for the

12

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Bonds to the weekly rate and the delivery of the replacement letters of credit, as applicable. The replacement letters of credit had an initial stated term of one year that, upon request by the Company, and with approval by the issuing bank, can be renewed annually thereafter for subsequent one year terms. 
On September 1, 2016, the Water Bonds were remarketed in connection with the delivery of a replacement letter of credit issued by JP Morgan Chase Bank, N.A. The key terms of the Water Bonds did not change as a result of the remarketing.
As of September 30, 2017, the Company has requested and the issuing banks have approved renewal of the Air Quality Bonds and Pollution Control Bonds through June 2018 and the Water Bonds through August 2018.  TimkenSteel is responsible for payment of the interest and principal associated with the Bonds subsequent to the Remarketing Date.
All of TimkenSteel’s other long-term debt is variable-rate debt. As such, the carrying value of this debt is a reasonable estimate of fair value as interest rates on these borrowings approximate current market rates, which is considered a Level 2 fair value input as defined by Accounting Standard Codification (ASC) 820, Fair Value Measurements. The valuation of Level 2 is based on quoted prices for similar assets and liabilities in active markets that are observable either directly or indirectly.
Advanced Quench-and-Temper Facility
In the second quarter of 2015, TimkenSteel entered into a lease arrangement with the Stark County Port Authority in connection with the construction of a new advanced quench-and-temper facility in Perry Township, Ohio and the issuance of an Industrial Revenue Bond. The bond is held 100% by TimkenSteel Material Services, LLC (a wholly-owned subsidiary of TimkenSteel) and, accordingly, the obligation under the lease agreement and investment in the Industrial Revenue Bond, as well as the related interest income and expense, are eliminated in the Unaudited Consolidated Financial Statements. As of September 30, 2017, $39.6 million has been spent on the new advanced quench-and-temper facility and is reported in property, plant and equipment, net in the Unaudited Consolidated Balance Sheets. Of this amount, $11.8 million has been financed through the lease arrangement described above.
Note 7 - Accumulated Other Comprehensive Loss
Changes in accumulated other comprehensive loss for the nine months ended September 30, 2017 and 2016 by component are as follows:
 
Foreign Currency Translation Adjustments
 
Pension and Postretirement Liability Adjustments
 
Total
Balance at December 31, 2016

($7.0
)
 

($2.4
)
 

($9.4
)
Other comprehensive income before reclassifications, before income tax
1.1

 
—

 
1.1

Amounts reclassified from accumulated other comprehensive loss, before income tax
—

 
1.1

 
1.1

Income tax benefit
—

 
(0.7
)
 
(0.7
)
Net current period other comprehensive income, net of income taxes
1.1

 
0.4

 
1.5

Balance at September 30, 2017

($5.9
)
 

($2.0
)
 

($7.9
)

 
Foreign Currency Translation Adjustments
 
Pension and Postretirement Liability Adjustments
 
Total
Balance at December 31, 2015

($5.0
)
 

($2.9
)
 

($7.9
)
Other comprehensive loss before reclassifications, before income tax
(2.8
)
 
—

 
(2.8
)
Amounts reclassified from accumulated other comprehensive loss, before income tax
—

 
1.2

 
1.2

    Income tax benefit
—

 
(0.4
)
 
(0.4
)
Net current period other comprehensive (loss) income, net of income taxes
(2.8
)
 
0.8

 
(2.0
)
Balance as of September 30, 2016

($7.8
)
 

($2.1
)
 

($9.9
)
The amount reclassified from accumulated other comprehensive loss for the pension and postretirement liability adjustment was included in other income (expense), net in the Unaudited Consolidated Statements of Operations. These accumulated other comprehensive loss components are components of net periodic benefit cost. See Note 9 - Retirement and Postretirement Plans for additional information.

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Note 8 - Changes in Shareholders' Equity
Changes in the components of shareholders’ equity for the nine months ended September 30, 2017 were as follows:
 
Total
 
Additional Paid-in Capital
 
Retained Deficit
 
Treasury Shares
 
Accumulated Other Comprehensive Loss
Balance at December 31, 2016

$597.4

 

$845.6

 

($193.9
)
 

($44.9
)
 

($9.4
)
Net loss
(9.9
)
 
—

 
(9.9
)
 
—

 
—

Pension and postretirement adjustment, net of tax
0.4

 
—

 
—

 
—

 
0.4

Foreign currency translation adjustments
1.1

 
—

 
—

 
—

 
1.1

Stock-based compensation expense
4.9

 
4.9

 
—

 
—

 
—

Stock option activity
0.2

 
0.2

 
—

 
—

 
—

Issuance of treasury shares
—

 
(8.4
)
 
(0.3
)
 
8.7

 
—

Shares surrendered for taxes
(1.4
)
 
—

 
—

 
(1.4
)
 
—

Balance at September 30, 2017

$592.7

 

$842.3

 

($204.1
)
 

($37.6
)
 

($7.9
)
Note 9 - Retirement and Postretirement Plans
The components of net periodic benefit cost for the three and nine months ended September 30, 2017 and 2016 were as follows:
 
Three Months Ended
September 30, 2017
 
Three Months Ended
September 30, 2016
Components of net periodic benefit cost:
Pension
 
Postretirement
 
Pension
 
Postretirement
Service cost

$4.6

 

$0.4

 

$3.9

 

$0.4

Interest cost
12.3

 
2.1

 
13.2

 
2.4

Expected return on plan assets
(17.7
)
 
(1.3
)
 
(18.1
)
 
(1.5
)
Amortization of prior service cost
0.1

 
0.2

 
0.1

 
0.2

Net remeasurement loss
2.3

 
—

 
20.4

 
—

Net Periodic Benefit Cost

$1.6

 

$1.4

 

$19.5

 

$1.5

 
Nine Months Ended
September 30, 2017
 
Nine Months Ended
September 30, 2016
Components of net periodic benefit cost:
Pension
 
Postretirement
 
Pension
 
Postretirement
Service cost

$13.8

 

$1.2

 

$11.7

 

$1.2

Interest cost
36.8

 
6.3

 
39.8

 
7.1

Expected return on plan assets
(52.9
)
 
(4.0
)
 
(53.6
)
 
(4.4
)
Amortization of prior service cost
0.3

 
0.8

 
0.4

 
0.8

Net remeasurement loss
2.3

 
—

 
20.4

 
—

Net Periodic Benefit Cost

$0.3

 

$4.3

 

$18.7

 

$4.7

The service cost component is included in cost of products sold and selling, general and administrative expenses. The non-service cost components of net periodic benefit costs are included in other income (expense), net in the Unaudited Consolidated Statements of Operations. The Company utilized the practical expedient approach, based on amounts previously disclosed, to reclassify non-service components of net periodic benefit cost from cost of products sold and selling, general and administrative expenses, into other income (expense), net on the Unaudited Consolidated Statements of Operations.
The following table sets forth the amounts reclassified into other income (expense), net for the three and nine months ended September 30, 2016.

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Table of Contents

 
 
Three
 
Nine
 
 
Months ended
September 30, 2016
Cost of products sold
 

($13.3
)
 

($7.7
)
Selling, general and administrative expenses
 
(3.4
)
 
(2.8
)
 
 

($16.7
)
 

($10.5
)
The TimkenSteel Corporation Retirement Plan (Salaried Plan) has a provision that permits employees to elect to receive their pension benefits in a lump sum. In the third quarter of 2017 and 2016, the cumulative cost of all settlements exceeded 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 September 30, 2017 and 2016, which resulted in a non-cash pre-tax loss from remeasurement of $2.3 million and $20.4 million, respectively, included in other income (expense), net on the Unaudited Consolidated Statements of Operations.
.

Note 10 - Earnings Per Share
Basic earnings (loss) per share is computed based upon the weighted average number of common shares outstanding.  Diluted earnings (loss) per share is computed based upon the weighted average number of common shares outstanding plus the dilutive effect of common share equivalents calculated using the treasury stock or if-converted method.  For the convertible notes, the Company utilizes the if-converted method to calculate diluted earnings (loss) per share.  Under the if-converted method, the Company adjusts net earnings (loss) to add back interest expense (including amortization of debt discount) recognized on the convertible notes and includes the number of shares potentially issuable related to the convertible notes in the weighted average shares outstanding.  Treasury stock is excluded from the denominator in calculating both basic and diluted earnings (loss) per share.

Common share equivalents, which include shares issuable for equity-based awards and upon the conversion of outstanding convertible notes, were excluded from the computation of diluted earnings (loss) per share because the effect of their inclusion would have been anti-dilutive.

The following table sets forth the reconciliation of the numerator and the denominator of basic and diluted loss per share for the three and nine months ended September 30, 2017 and 2016:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Numerator:
 
 
 
 
 
 
 
Net loss for basic and diluted earnings per share

($5.9
)
 

($22.2
)
 

($9.9
)
 

($38.5
)
 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted average shares outstanding, basic
44,433,094

 
44,221,310

 
44,373,264

 
44,215,373

Dilutive effect of stock-based awards
—

 
—

 
—

 
—

Weighted average shares outstanding, diluted
44,433,094

 
44,221,310

 
44,373,264

 
44,215,373

 
 
 
 
 
 
 
 
Basic loss per share

($0.13
)
 

($0.50
)
 

($0.22
)
 

($0.87
)
Diluted loss per share

($0.13
)
 

($0.50
)
 

($0.22
)
 

($0.87
)

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Table of Contents

Note 11 - Income Taxes
TimkenSteel’s provision (benefit) for income taxes in interim periods is computed by applying the appropriate estimated annual effective tax rates to income or loss before income taxes for the period. In addition, non-recurring or discrete items, including interest on prior-year tax liabilities, are recorded during the periods in which they occur.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Provision (benefit) for income taxes

$0.1

 

($13.3
)
 

$1.2

 

($23.5
)
Effective tax rate
(1.5
)%
 
37.5
%
 
(14.0
)%
 
37.9
%
For the nine months ended September 30, 2017 and the year ended December 31, 2016, operating losses generated in the U.S. resulted in a decrease in the carrying value of the Company’s U.S. net deferred tax liability to the point that would result in a net U.S. deferred tax asset at September 30, 2017 and December 31, 2016. In light of TimkenSteel’s recent operating performance in the U.S. and current industry conditions, the Company assessed, based upon all available evidence, and concluded that it was more likely than not that it would not realize its U.S. deferred tax assets. As a result, in the fourth quarter of 2016, the Company recorded full valuation allowance on its net U.S. deferred tax asset of $15.6 million. Going forward, the need to maintain valuation allowances against deferred tax assets in the U.S. and other affected countries will cause variability in the Company’s effective tax rate. The Company will maintain a full valuation allowance against its deferred tax assets in the U.S. and applicable foreign countries until sufficient positive evidence exists to conclude that a valuation allowance is not necessary. The increase in the effective tax rate for the nine months ended September 30, 2017 is primarily due to a discrete charge of approximately $1.0 million recorded in the second quarter of 2017.
Note 12 - Contingencies
TimkenSteel has a number of loss exposures incurred in the ordinary course of business, such as environmental claims, product warranty claims, and litigation. Establishing loss reserves for these matters requires management’s estimate and judgment regarding risk exposure and ultimate liability or realization. These loss reserves are reviewed periodically and adjustments are made to reflect the most recent facts and circumstances. As of September 30, 2017 and December 31, 2016, TimkenSteel had a $0.7 million and $0.2 million contingency reserve, respectively, related to loss exposures incurred in the ordinary course of business.
Environmental Matters
From time to time, TimkenSteel may be a party to lawsuits, claims or other proceedings related to environmental matters and/or may receive notices of potential violations of environmental laws and regulations from the U.S. Environmental Protection Agency (EPA) and similar state or local authorities. Accruals related to such environmental matters represent management’s best estimate of the fees and costs associated with these matters. Although it is not possible to predict with certainty the outcome of such matters, management believes that their ultimate dispositions should not have a material adverse effect on TimkenSteel’s financial position, cash flows, or results of operations. As of September 30, 2017 and December 31, 2016, TimkenSteel had a $0.5 million and a $0.6 million reserve for such environmental matters, respectively, classified as other current and non-current liabilities on the Unaudited Consolidated Balance Sheets.
The following is a rollforward of the accrual related to environmental matters for the nine months ended September 30, 2017 and 2016:
 
Nine Months Ended September 30,
 
2017
2016
Beginning Balance, January 1

$0.6


$0.8

Expenses
0.1

—

Payments
(0.2
)
(0.2
)
Ending Balance, September 30

$0.5


$0.6


16

Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(dollars in millions, except per share data)
Business Overview
TimkenSteel Corporation (we, us, our, the Company or TimkenSteel) was incorporated in Ohio on October 24, 2013, and became an independent, publicly traded company as the result of a spinoff from The Timken Company (Timken) on June 30, 2014.
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) and value-add solutions, such as precision steel components. In addition, we supply machining and thermal treatment services, as well as 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: oil and gas; oil country tubular goods (OCTG); automotive; industrial equipment; mining; construction; rail; aerospace and defense; heavy truck; agriculture; and power generation.
Based on our knowledge of the steel industry, we believe we are the only focused SBQ steel producer in North America and have the largest SBQ steel large bar (6-inch diameter and greater) production capacity among the North American steel producers. In addition, we are the only steel manufacturer able to produce rolled SBQ steel large bars up to 16-inches in diameter. 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 with a competitive cost structure similar to that of a high-volume producer. 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. We believe our unique operating model and production assets give us a competitive advantage in our industry.
The SBQ bars and tubes production processes take place at our Canton, Ohio manufacturing location. This location accounts for all of the SBQ bars and seamless mechanical tubes we produce and includes three manufacturing facilities: the Faircrest, Harrison, and Gambrinus facilities. Our value-add solutions production processes take place at three downstream manufacturing facilities: TimkenSteel Material Services (Houston, TX), Tryon Peak (Columbus, NC), and St. Clair (Eaton, OH). 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.
The collective bargaining agreement between the Company and the United Steelworkers (USW) Local 1123, which had an expiration date of September 25, 2017 has been extended, and we remain in discussions with USW representatives regarding a new collective bargaining agreement. We continue to operate uninterrupted under the terms of the existing collective bargaining agreement.
Capital Investments
Our recent capital investments are expected to significantly strengthen our position as a leader in providing differentiated solutions for the energy, industrial and automotive market sectors, while enhancing our operational performance and customer service capabilities.
On July 17, 2014, we began investing in additional advanced quench-and-temper heat-treat capacity. The approximately $40 million facility will perform quench-and-temper heat-treat operations and, we believe, will have capacity for up to 50,000 process-tons annually of 4-inch to 13-inch bars and tubes. This facility will be located in Perry Township, Ohio on the site of our Gambrinus Steel Plant near three existing thermal treatment facilities. This facility will be larger than each of our three existing thermal treatment facilities in Canton, Ohio. The Company anticipates beginning operations in the fourth quarter of 2017.
Impact of Raw Material Prices and LIFO
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 that 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.

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Table of Contents

We value approximately 64% of our inventory utilizing the LIFO inventory valuation method. Changes in the cost of raw materials and production activities are recognized in cost of products sold in the current period even though these materials and other costs may have been incurred in different periods at significantly different values due to the length of time of our production cycle. In a period of rising raw material prices, cost of products sold recognized under LIFO is generally higher than the cash costs incurred to acquire the inventory sold. Conversely, in a period of declining raw material prices, cost of products sold recognized under LIFO is generally lower than cash costs incurred to acquire the inventory sold. In periods of rising inventories and deflating raw material prices, the likely result will be a positive impact to net income. Conversely, in periods of rising inventories and increasing raw materials prices, the likely result will be a negative impact to net income.
Results of Operations
 
Three Months Ended September 30,
 
2017
 
2016
 
Increase (Decrease)
 
% Change
Net sales

$339.1

 

$213.8

 

$125.3

 
58.6
 %
Net sales, excluding surcharges
261.2

 
184.9

 
76.3

 
41.3
 %
Gross profit
18.5

 
7.5

 
11.0

 
146.7
 %
Gross margin
5.5
%
 
3.5
%
 
NM

 
200 bps

Selling, general and administrative expenses
22.5

 
21.8

 
0.7

 
3.2
 %
Net income
(5.9
)
 
(22.2
)
 
16.3

 
(73.4
)%
Average scrap index per ton (30 day lag)
374

 
272

 
102

 
37.5
 %
Average selling price per ton, including surcharges

$1,170

 

$1,202

 

($32
)
 
(2.7
)%
Shipments (in tons)
289,942

 
177,823

 
112,119

 
63.1
 %
Melt utilization
74
%
 
44
%
 
NM

 
30
 pp
 
Nine Months Ended September 30,
 
2017
 
2016
 
Increase (Decrease)
 
% Change
Net sales

$987.8

 

$654.8

 

$333.0

 
50.9
 %
Net sales, excluding surcharges
773.8

 
587.2

 
186.6

 
31.8
 %
Gross profit
59.3

 
25.2

 
34.1

 
135.3
 %
Gross margin
6.0
%
 
3.8
%
 
NM

 
220 bps

Selling, general and administrative expenses
67.7

 
66.8

 
0.9

 
1.3
 %
Net loss
(9.9
)
 
(38.5
)
 
28.6

 
74.3
 %
Average scrap index per ton (30 day lag)
353

 
229

 
124

 
54.1
 %
Average selling price per ton, including surcharges

$1,143

 

$1,183

 

($40
)
 
(3.4
)%
Shipments (in tons)
864,446

 
553,646

 
310,800

 
56.1
 %
Melt utilization
74
%
 
45
%
 
NM

 
29
 pp
The table above presents net sales, adjusted to exclude raw material surcharges, which represents a financial measure that has not been determined in accordance with U.S. GAAP. We believe presenting net sales adjusted to exclude raw material surcharges provides additional insight into key drivers of net sales such as base price and product mix.
Net Sales
Net sales for the third quarter of 2017 were $339 million, an increase of $125 million compared to the third quarter of 2016. Excluding surcharges, net sales increased $76 million, or 41%. The increase was due to higher volumes of $124 million, offset by price/mix of approximately $48 million. For the three months ended September 30, 2017, ship tons increased by 112 thousand tons, or 63% compared to the same period in 2016, due primarily to market penetration and sales initiatives, including 56 thousand tons of new billet business to the tube manufacturers supplying the OCTG market.

18

Table of Contents

Net sales for the nine months ended 2017 were $988 million, an increase of 51% compared to the same period in 2016. Excluding surcharges, net sales increased $187 million, or 32%. The increase was due to higher volumes of $346 million, offset by price/mix of approximately $159 million. For the nine months ended September 30, 2017, ship tons increased 311 thousand tons, or 56% compared to the same period in 2016, due primarily to market penetration and sales initiatives, including 162 thousand tons of new billet business to the tube manufacturers supplying the OCTG market.
Gross Profit
Gross profit for the third quarter of 2017 was $19 million, an increase of $11 million, or 147%, compared to gross profit of $8 million for the third quarter of 2016. The increase was driven primarily by higher volumes of approximately $21 million, favorable raw material spread of approximately $10 million and production efficiencies of approximately $26 million as a result of increased melt utilization to 74% for the third quarter of 2017 compared to 44% for the third quarter of 2016, partially offset by price/mix of approximately $39 million and higher LIFO expense of approximately $7 million.
Gross profit for the nine months ended September 30, 2017 was $59 million, an increase of $34 million, or 135%, compared to gross profit of $25 million for the same period in 2016. The increase was driven primarily by higher volumes of approximately $58 million, favorable raw material spread of approximately $32 million, a supplier refund of approximately $5 million and production efficiencies of approximately $53 million as a result of increased melt utilization to 74% for the nine months ended September 30, 2017 compared to 45% for the same period in 2016, partially offset by price/mix of approximately $99 million and higher LIFO expense of approximately $15 million.
Our surcharge mechanism 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 costs being over- or under-recovered in certain periods. For the nine months ended September 30, 2017, the surcharge favorably impacted gross margin as a percent of sales.
Selling, General and Administrative Expenses
Selling, general and administrative (SG&A) expenses increased approximately $1 million in both the third quarter of 2017 and in the nine months ended September 30, 2017 compared to the same periods in 2016 due primarily to variable compensation costs.
Interest Expense
 
Three Months Ended September 30,
 
2017
 
2016
 
$ Change
Cash interest paid

$0.8

 

$0.9

 

($0.1
)
Accrued interest
1.9

 
1.9

 
—

Amortization of convertible notes discount and deferred financing
1.0

 
1.1

 
(0.1
)
Total Interest Expense

$3.7

 

$3.9

 

($0.2
)
 
Nine Months Ended September 30,
 
2017
 
2016
 
$ Change
Cash interest paid

$6.0

 

$4.2

 

$1.8

Accrued interest
1.9

 
1.9

 
—

Amortization of convertible notes discount and deferred financing
3.1

 
1.9

 
1.2

Total Interest Expense

$11.0

 

$8.0

 

$3.0

    Interest expense decreased $0.2 million in the third quarter of 2017 compared to the same period in 2016. Interest expense for the nine months ended September 30, 2017 increased approximately $3 million, compared to the same period in 2016, due primarily to the issuance in May 2016 of the 6.00% Convertible Senior Notes due in 2021 (Convertible Notes).

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Other Income (Expense), Net
 
Three Months Ended September 30,
 
2017
 
2016
 
$ Change
 
% Change
Non-service components of benefit cost

$4.3

 

$3.7

 

($0.6
)
 
16.2
 %
Loss from remeasurement of benefit plans
(2.3
)
 
(20.4
)
 

($18.1
)
 
(88.7
)%
Other
(0.1
)
 
(0.6
)
 

($0.5
)
 
(83.3
)%
Other income (expense), net

$1.9

 

($17.3
)
 

($19.2
)
 
(111.0
)%
 
Nine Months Ended September 30,
 
2017
 
2016
 
$ Change
 
% Change
Non-service components of benefit cost

$12.7

 

$9.9

 

($2.8
)
 
28.3
 %
Loss from remeasurement of benefit plans
(2.3
)
 
(20.4
)
 

($18.1
)
 
(88.7
)%
Other
0.3

 
(1.6
)
 

($1.9
)
 
(118.8
)%
Other income (expense), net

$10.7

 

($12.1
)
 

($22.8
)
 
(188.4
)%
Other income (expense), net was income of $1.9 million and $10.7 million for the three and nine months ended September 30, 2017, respectively compared to expense of $17.3 million and $12.1 million in the three and nine months ended September 30, 2016, respectively. The change in the three and nine months ended September 30, 2017 is primarily due to the change in the loss from remeasurement of benefit plans. See Note 9 - Retirement and Postretirement Plans in the Notes to Unaudited Consolidated Financial Statements for a discussion regarding the loss from remeasurement of benefit plans.
Provision (Benefit) for Income Taxes
 
Three Months Ended September 30,
 
2017
 
2016
 
$ Change
 
% Change
Provision (benefit) for income taxes

$0.1

 

($13.3
)
 

($13.4
)
 
(100.8
)%
Effective tax rate
(1.5
)%
 
37.5
%
 
NM

 
(3900) bps

 
Nine Months Ended September 30,
 
2017
 
2016
 
$ Change
 
% Change
Provision (benefit) for income taxes

$1.2

 

($23.5
)
 

($24.7
)
 
(105.1
)%
Effective tax rate
(14.0
)%
 
37.9
%
 
NM

 
(5,190
) bps
For the year ended December 31, 2016, operating losses generated in the U.S. resulted in a decrease in the carrying value of our U.S. deferred tax liability to the point that would result in a net U.S. deferred tax asset at December 31, 2016. In light of our recent operating performance in the U.S. and current industry conditions, we assessed, based upon all available evidence, and concluded that it was more likely than not that we would not realize our U.S. deferred tax assets. As a result, in the nine months ended September 30, 2017 and in the fourth quarter of 2016, we recorded full valuation allowance on our net U.S. deferred tax asset. Going forward, the need to maintain valuation allowances against deferred tax assets in the U.S. and other affected countries will cause variability in our effective tax rate. We will maintain a full valuation allowance against our deferred tax assets in the U.S. and applicable foreign countries until sufficient positive evidence exists to eliminate them. The increase in the effective tax rate for the nine months ended September 30, 2017 is primarily due to a discrete charge of approximately $1.0 million recorded in the second quarter of 2017.
Net Sales, Excluding Surcharges
The table below presents net sales by end market sector, adjusted to exclude raw material surcharges, which represents a financial measure that has not been determined in accordance with 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.

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Net Sales adjusted to exclude surcharges
 
 
 
 
 
 
 
 
 
 
(dollars in millions, tons in thousands)
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30,
 
2017
 
2016
 
Mobile
Industrial
Energy
Other
 
Total
 
Mobile
Industrial
Energy
Other
 
Total
Tons
100.8

106.2

26.7

56.2

 
289.9

 
100.5

70.2

7.1

—

 
177.8

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Sales

$127.5


$126.3


$37.7


$47.6

 

$339.1

 

$120.4


$79.7


$8.7


$5.0

 

$213.8

Less: Surcharges
27.1

28.8

6.4

15.6

 
77.9

 
16.3

11.3

1.3

—

 
28.9

Base Sales

$100.4


$97.5


$31.3


$32.0

 

$261.2

 

$104.1


$68.4


$7.4


$5.0

 

$184.9

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Sales / Ton

$1,265


$1,189


$1,412


$847

 

$1,170

 

$1,198


$1,135


$1,225

N/A

 

$1,202

Base Sales / Ton

$996


$918


$1,172


$569

 

$901

 

$1,036


$974


$1,042

N/A

 

$1,040

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
2017
 
2016
 
Mobile
Industrial
Energy
Other
 
Total
 
Mobile
Industrial
Energy
Other
 
Total
Tons
324.4

308.4

69.3

162.3

 
864.4

 
317.4

216.8

19.4

—

 
553.6

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Sales

$399.7


$357.1


$99.0


$132.0

 

$987.8

 

$365.8


$246.2


$27.7


$15.1

 

$654.8

Less: Surcharges
78.2

76.9

15.3

43.4

 
213.8

 
38.0

26.9

2.7

—

 
67.6

Base Sales

$321.5


$280.2


$83.7


$88.6

 

$774.0

 

$327.8


$219.3


$25.0


$15.1

 

$587.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net Sales / Ton

$1,232


$1,158


$1,429


$813

 

$1,143

 

$1,152


$1,136


$1,428

N/A

 

$1,183

Base Sales / Ton

$991


$909


$1,208


$546

 

$895

 

$1,033


$1,012


$1,289

N/A

 

$1,061

Balance Sheet
The following discussion is a comparison of the Consolidated Balance Sheets as of September 30, 2017 (Unaudited) and December 31, 2016:
Current Assets
September 30,
2017
 
December 31,
2016
Cash and cash equivalents

$25.8

 

$25.6

Accounts receivable, net
160.6

 
91.6

Inventories, net

$219.5

 

$164.2

Deferred charges and prepaid expenses
4.2

 
2.8

Other current assets
7.4

 
6.2

Total Current Assets

$417.5

 

$290.4

Refer to the Liquidity and Capital Resources section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations for a discussion of the change in cash and cash equivalents. Accounts receivable, net increased $69 million as of September 30, 2017 compared to December 31, 2016, due to an increase in net sales of $124 million in the third quarter of 2017 compared to the fourth quarter of 2016. Inventories, net increased approximately $55 million as of September 30, 2017 compared to December 31, 2016 primarily due to efforts to align inventories with anticipated sales volumes as well as increased costs.
Property, Plant and Equipment
September 30,
2017
 
December 31,
2016
Property, plant and equipment, net

$701.6

 

$741.9

Property, plant and equipment, net decreased approximately $40 million as of September 30, 2017 compared to December 31, 2016. The decrease was primarily due to depreciation expense of approximately $51 million, partially offset by capital expenditures of approximately $12 million, during the nine months ended September 30, 2017.

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Other Assets
September 30,
2017
 
December 31,
2016
Pension assets

$9.8

 

$6.2

Intangible assets, net
20.9

 
25.0

Other non-current assets
6.0

 
6.4

Total Other Assets

$36.7

 

$37.6

Pension assets increased approximately $4 million as of September 30, 2017 compared to December 31, 2016, primarily driven by an annual pension contribution made in the first quarter of 2017 to the Company’s U.K. pension plan. Intangible assets, net decreased approximately $4 million as of September 30, 2017 compared to December 31, 2016, primarily due to amortization expense of $5 million recognized in the nine months ended September 30, 2017.
Liabilities and Shareholders’ Equity
September 30,
2017
 
December 31,
2016
Current liabilities

$188.6

 

$130.7

Convertible notes, net
69.2

 
66.4

Other long-term debt
95.2

 
70.2

Accrued pension and postretirement costs - long-term
196.2

 
192.1

Deferred income taxes
0.7

 
—

Other non-current liabilities
13.2

 
13.1

Total shareholders’ equity
592.7

 
597.4

Total Liabilities and Shareholders’ Equity

$1,155.8

 

$1,069.9

Current liabilities increased approximately $58 million as of September 30, 2017 compared to December 31, 2016, primarily due to an increase in accounts payable of approximately $47 million from increased inventory levels, and higher compensation related accruals.
See Note 6 - Financing Arrangements in the Notes to Unaudited Consolidated Financial Statements for a discussion of the change in the Convertible Notes.
Other long-term debt increased due to borrowings of $25 million on the Amended Credit Agreement primarily to fund working capital.
Refer to Note 8 - Changes in Shareholders' Equity in the Notes to Unaudited Consolidated Financial Statements for details of the decrease in Shareholders’ Equity.
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 the offering expenses payable. We used the net proceeds to repay a portion of the amounts outstanding under our Amended Credit Agreement.

Credit Agreement
During the third quarter of 2015, we projected that at December 31, 2015, we would not be in compliance with the interest coverage ratio covenant contained in our then-existing revolving credit facility, due to a steeper-than-expected drop in industrial demand driven by depressed commodity prices. Accordingly, on December 21, 2015, we amended and restated our existing revolving credit facility, effectively converting it from a cash flow-based facility to an asset-based facility in order to eliminate various financial covenants that are customary in cash flow-based facilities, including the interest coverage ratio covenant.


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On February 26, 2016, we entered into Amendment No. 1 (the Amendment) to the Amended and Restated Credit Agreement dated as of December 21, 2015 (as amended by the Amendment, the Amended Credit Agreement) in order to provide more flexibility with respect to the amount and form of financing we could obtain to enhance our liquidity.
Pursuant to the Amendment, we also reduced the size of the revolving credit facility from $300 million to $265 million given that, in the near-term, it was unlikely we would have a borrowing base sufficient to support such availability. The Amended Credit Agreement also includes a block on availability equal to the greater of $28.9 million or 12.5% of the aggregate commitments (except that in the event of a mandatory reduction in the commitments, the block on availability will be equal to the greater of $20.0 million or 12.5% of the aggregate commitments), effectively reducing our borrowing base by the availability block. Refer to Note 6 - Financing Arrangements in the Notes to the Unaudited Consolidated Financial Statements and the Covenant Compliance section within Management’s Discussion and Analysis for details on the Amended Credit Agreement covenants.
The Amended Credit Agreement has a term of five years through June 30, 2019. The following represents a summary of key liquidity measures as of September 30, 2017 and December 31, 2016:
 
September 30,
2017
December 31, 2016
Cash and cash equivalents
$25.8
$25.6
 
 
 
Amended Credit Agreement:
 
 
Maximum availability
$265.0
$194.4
Amount borrowed
65.0
40.0
Letter of credit obligations
2.6
1.6
Availability not borrowed
197.4
152.8
Availability block
33.1
33.1
Net availability
$164.3
$119.7
 
 
 
Total liquidity
$190.1
$145.3

Our principal sources of liquidity are cash and cash equivalents, cash flows from operations and available borrowing capacity under our Amended Credit Agreement. We currently expect that our cash and cash equivalents on hand, expected cash flows from operations and borrowings available under the Amended Credit Agreement will be sufficient to meet liquidity needs; however, these plans rely on certain underlying assumptions and estimates that may differ from actual results. Such assumptions include growing market demand and maintaining the benefits to our operating results and cash flows driven by the restructuring and cost reduction activities taken during 2015 that streamlined our organizational structure, lowered operating costs and increased liquidity.
As of September 30, 2017, taking into account the foregoing, as well as our view of industrial, energy, and automotive market demands for our products, our 2017 operating plan and our long-range plan, we believe that our cash balance as of September 30, 2017 of $25.8 million, 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 and through June 30, 2019, the maturity date of our Amended Credit Agreement.
To the extent our liquidity needs prove to be greater than expected or cash generated from operations are 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 that 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 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. For additional discussion regarding risk factors related to our business and our debt, see Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2016.
For additional details on the Amended Credit Agreement and the Convertible Notes, please refer to Note 6 - Financing Arrangements in the Notes to Unaudited Consolidated Financial Statements.

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Table of Contents

Cash Flows
The following table reflects the major categories of cash flows for the nine months ended September 30, 2017 and 2016. For additional details, please see the Unaudited Consolidated Statements of Cash Flows contained elsewhere in this quarterly report.
Cash Flows
Nine Months Ended September 30,
 
2017
 
2016
Net cash (used) provided by operating activities

($11.7
)
 

$55.5

Net cash used by investing activities
(11.9
)
 
(26.1
)
Net cash provided (used) by financing activities
23.8

 
(48.5
)
Increase (Decrease) in Cash and Cash Equivalents

$0.2

 

($19.1
)
Operating activities
Net cash used by operating activities for the nine months ended September 30, 2017 was approximately $12 million compared to cash provided by operating activities of approximately $56 million for the nine months ended September 30, 2016. The $68 million decrease was primarily due to cash used by working capital of $68 million for the nine months ended September 30, 2017 compared to cash provided by working capital of $18 million during the same period in 2016. Refer to the Unaudited Consolidated Statements of Cash Flows for additional information.
Investing activities
Net cash used by investing activities for the nine months ended September 30, 2017 and 2016 was approximately $12 million and $26 million, respectively. Cash used for investing activities primarily relates to capital investments in our production processes. Capital spending decreased approximately $14 million due to lower spending compared to the nine months ended September 30, 2016, as a result of targeted strategic capital allocations.
Our business sometimes requires capital investments to maintain our plants and equipment to remain competitive and ensure we can implement strategic initiatives. Our $52 million construction in progress balance as of September 30, 2017 includes: (a) $42 million relating to growth initiatives (i.e., new product offerings, additional capacity and new capabilities) and continuous improvement projects; and (b) $10 million relating primarily to routine capital costs to maintain the reliability, integrity and safety of our manufacturing equipment and facilities. We expect to incur approximately $31 million of additional costs including approximately $23 million relating to additional growth initiatives and continuous improvement and approximately $8 million of additional costs to complete other remaining projects. These additional costs are expected to be incurred during the next one to three years.
Financing activities
Net cash provided by financing activities for the nine months ended September 30, 2017 was approximately $24 million compared to net cash used by financing activities of approximately $49 million for the nine months ended September 30, 2016. The change was mainly due to borrowings of $30 million on the Amended Credit Agreement during the nine months ended September 30, 2017 compared to repayments of $130 million on the Amended Credit Agreement, partially offset by the proceeds of $86.3 million from the issuance of the Convertible Notes during the nine months ended September 30, 2016.
Covenant Compliance
Under the Amended Credit Agreement, we are required to comply with certain customary covenants, including covenants that limit our ability to, among other things, (i) incur or suffer to exist certain liens, (ii) make investments, (iii) incur or guaranty additional indebtedness, (iv) enter into consolidations, mergers, acquisitions and sales of assets, (v) make distributions and other restricted payments, (vi) change the nature of our business, (vii) engage in transactions with affiliates and (viii) enter into restrictive agreements, including agreements that restrict the ability to incur liens or make distributions. Further, the Amended Credit Agreement contains financial covenants that (i) limit the amount of capital expenditures we may make to $45 million in fiscal year 2016 and $50 million in fiscal years thereafter and (ii) require the Company to maintain a minimum specified fixed charge coverage ratio for the year-to-date periods beginning January 1, 2017 and ending June 30, 2017, July 31, 2017 and August 31, 2017. The fixed charge coverage ratio is the ratio of EBITDA to fixed charges. Fixed charges include, among other things, cash interest, scheduled principal payments, cash taxes, dividends, capital expenditures, and capital lease obligation payments. As of September 30, 2017, we were in compliance with this covenant throughout the term of the Amended Credit Agreement.

24

Table of Contents

We expect to remain in compliance with our debt covenants for at least the next twelve months. If at any time we expect that we will be unable to meet the covenants under the Amended Credit Agreement, we would seek to further amend the Amended Credit Agreement to be in compliance and avoid a default or pursue other alternatives, such as additional financing. If, contrary to our expectations, we were unable to amend the terms of our Amended Credit Agreement to remain in compliance or refinance the debt under the Amended Credit Agreement, we would experience an event of default and all outstanding debt under the revolving credit facility would be subject to acceleration and may become immediately due and payable.
For additional discussion regarding risk factors related to our business and our debt, see Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2016.
Dividends and Share Repurchases
On November 13, 2015, our Board of Directors decided to suspend the cash dividend as we continued to manage through a challenging market environment. Our Board of Directors will review the dividend as business conditions improve.
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.
There have been no material changes to these policies during the nine months ended September 30, 2017. For a summary of the critical accounting policies and estimates that we used in the preparation of our Unaudited Consolidated Financial Statements, see our Annual Report on Form 10-K for the year ended December 31, 2016.
New Accounting Guidance
See Note 2 - Recent Accounting Pronouncements to our Unaudited Consolidated Financial Statements for a discussion of recently issued accounting pronouncements.

25

Table of Contents

Forward-Looking Statements
Certain statements set forth in this 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,” “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;
•
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 (including the jumbo bloom vertical caster and advanced quench-and-temper facility); the ability to integrate acquired companies; the ability of acquired companies to achieve satisfactory operating results, including results being accretive to earnings; 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; and
•
those items identified under Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2016.
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.


26

Table of Contents

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Our borrowings include both fixed and variable-rate debt. The variable debt consists principally of borrowings under our Amended Credit Agreement. We are exposed to the risk of rising interest rates to the extent we fund our operations with these variable-rate borrowings. As of September 30, 2017, we have $164.4 million of aggregate debt outstanding, of which $95.2 million consists of debt with variable interest rates. Based on the amount of debt with variable-rate interest outstanding, a 1% rise in interest rates would result in an increase in interest expense of approximately $1 million annually, with a corresponding increase in loss before income taxes of the same amount.
Foreign Currency Exchange Rate Risk
Fluctuations in the value of the U.S. dollar compared to foreign currencies may impact our earnings. Geographically, our sales are primarily made to customers in the United States. Currency fluctuations could impact us to the extent they impact the currency or the price of raw materials in foreign countries in which our competitors operate or have significant sales.
Commodity Price Risk
In the ordinary course of business, we are exposed to market risk with respect to commodity price fluctuations, primarily related to our purchases of raw materials and energy, principally scrap steel, other ferrous and non-ferrous metals, alloys, natural gas and electricity. 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 business. We utilize a raw material surcharge as a component of pricing steel to pass through the cost increases of scrap, alloys and other raw materials, as well as natural gas. From time to time, we may use derivative financial instruments to hedge a portion of our exposure to price risk related to natural gas and electricity purchases. In periods of stable demand for our products, the surcharge mechanism has worked effectively to reduce the normal time lag in passing through higher raw material costs so that we can maintain our gross margins. When demand and cost of raw materials is lower, however, the surcharge impacts sales prices to a lesser extent.
ITEM 4. CONTROLS AND PROCEDURES
(a)
Disclosure Controls and Procedures
As of the end of the period covered by this quarterly report, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)). Based upon that evaluation, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.
(b)
Changes in Internal Control Over Financial Reporting
During the Company’s most recent fiscal quarter, there have been no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of our management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
Item 1A. Risk Factors
We are subject to various risks and uncertainties in the course of our business. The discussion of such risks and uncertainties may be found under Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC. There have been no material changes to such risk factors.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.

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Table of Contents

Item 6. Exhibits
Exhibit Number
 
Exhibit Description
10.1*
 
12.1*
 
31.1*
 
31.2*
 
32.1**
 
101.INS*
 
XBRL Instance Document
101.SCH*
 
XBRL Taxonomy Extension Schema Document
101.PRE*
 
XBRL Taxonomy Extension Presentation Linkbase Document
101.CAL*
 
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB*
 
XBRL Taxonomy Extension Label Linkbase Document
101.DEF*
 
XBRL Taxonomy Extension Definition Linkbase Document
*
Filed herewith.
**
Furnished herewith.


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Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
TIMKENSTEEL CORPORATION
 
 
 
 
 
 
Date:
October 26, 2017
/s/ Christopher J. Holding
 
 
Christopher J. Holding
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)


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Table of Contents

INDEX TO EXHIBITS
Exhibit Number
 
Exhibit Description
10.1
 
12.1
 
31.1
 
31.2
 
32.1
 
101.INS
 
XBRL Instance Document
101.SCH
 
XBRL Taxonomy Extension Schema Document
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document


30