TimkenSteel Corp - Quarter Report: 2020 March (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2020

OR

☐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)

330.471.7000

(Registrant’s telephone number, including area code) 

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:

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  ☒   No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes  ☒   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

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  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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TimkenSteel Corporation

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TimkenSteel Corporation

Consolidated Statements of Operations (Unaudited)

See accompanying Notes to the unaudited Consolidated Financial Statements.

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TimkenSteel Corporation

Consolidated Statement of Comprehensive Income (Loss) (Unaudited)

See accompanying Notes to the unaudited Consolidated Financial Statements.

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TimkenSteel Corporation

Consolidated Balance Sheets (Unaudited)

See accompanying Notes to the unaudited Consolidated Financial Statements.

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TimkenSteel Corporation

Consolidated Statements of Shareholders’ Equity (Unaudited)

See accompanying Notes to the unaudited Consolidated Financial Statements.

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TimkenSteel Corporation

Consolidated Statements of Cash Flows (Unaudited)

See accompanying Notes to the unaudited Consolidated Financial Statements.

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TimkenSteel Corporation

Notes to Unaudited Consolidated Financial Statements

(dollars in millions, except per share data)

Note 1 - Basis of Presentation

The accompanying unaudited Consolidated Financial Statements have been prepared by TimkenSteel Corporation (the Company or TimkenSteel) 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, 2019.

Certain items previously reported in specific financial statement captions have been reclassified to conform with the current year presentation.

Customer Receivables

The Company’s accounts receivables arise from sales to customers across all end markets.  Historically, TimkenSteel’s allowance for doubtful accounts write-offs have been immaterial.  The allowance for doubtful account reserve has been established using qualitative and quantitative methods.  In general, account balances greater than one year of age or sent to third party collection are fully reserved.  Account balances for customers that are viewed as higher risk are also analyzed for a reserve.  In addition to these methods, for the first quarter of 2020 the allowance for doubtful accounts was adjusted for forward looking uncollectible balances, primarily in the energy and automotive end markets. The amount recorded was based on the Company’s assessment of the risk presented to customers in these end markets as a result of the COVID-19 pandemic as well as geo-political factors facing the energy end market. At this time, the full impact of COVID-19 is difficult to predict with the current uncertainty surrounding the pandemic and the timeline for economic activities to recover.

Change in Accounting Principle

During the fourth quarter of 2019, TimkenSteel elected to change its method for valuing its inventories that previously used the last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method. The Company believes that the FIFO method is preferable as it improves comparability with our peers, more closely resembles the physical flow of our inventory and aligns with how the Company internally manages the business. The effects of the change in accounting principle from LIFO to FIFO were retrospectively applied. As a result of the retrospective application of the change in accounting principle, certain financial statement line items in the Company’s consolidated balance sheets as of March 31, 2019 and the consolidated statements of operations, comprehensive income (loss), shareholders’ equity and cash flows for the three months ended March 31, 2019 were adjusted as necessary. 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, 2019.

The following tables reflect the impact to the financial statement line items as a result of the change in accounting principle for the prior periods presented in the accompanying financial statements (dollars in millions, except per share data):

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Note 2 - Recent Accounting Pronouncements

Adoption of New Accounting Standards

The Company adopted the following Accounting Standard Updates (ASU) in the first quarter of 2020, all of which were effective as of January 1, 2020, except ASU 2020-04, which became effective upon issuance on March 12, 2020. 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.

Accounting Standards Issued But Not Yet Adopted

The Company has considered the recent ASUs issued by the Financial Accounting Standards Board summarized below:

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Note 3 - Revenue Recognition

The following table provides the major sources of revenue by end-market sector for the three months ended March 31, 2020 and 2019:

⁽¹⁾ “Other” for sales by end-market sector includes the Company’s scrap and oil country tubular goods (OCTG) billet sales.

The following table provides the major sources of revenue by product type for the three months ended March 31, 2020 and 2019:

⁽²⁾ “Other” for sales by product type includes the Company’s scrap sales.

Note 4 - Restructuring Charges

During 2019 and into the first quarter of 2020, TimkenSteel made organizational changes to enhance profitable and sustainable growth. These company-wide actions included the restructuring of its business support functions, the reduction of management layers throughout the organization, the closure of the TimkenSteel Material Services (TMS) facility in Houston, Texas and other actions to further improve the Company’s overall cost structure. Through these restructuring efforts, to date the Company has eliminated approximately 160 salaried positions and recognized restructuring charges of $9.1 million, consisting of severance and employee-related benefits. Approximately 10 of these positions were eliminated in the first quarter of 2020. TimkenSteel recorded reserves for such restructuring charges as other current liabilities on the Consolidated Balance Sheets. The reserve balance at March 31, 2020 is expected to be substantially used in the next twelve months.

The following is a summary of the restructuring reserve for the three months ended March 31, 2020:

There was no reserve for restructuring at March 31, 2019.

Note 5 - Disposition of Non-Core Assets

During the fourth quarter of 2019, management entered into an agreement to dispose of the Company’s scrap processing facility in Akron, Ohio for cash consideration of approximately $4.0 million. An impairment charge of $7.3 million was recognized in the fourth quarter of 2019 in connection with the sale.  The sale was completed, and the Company received all cash consideration in the first quarter of 2020.  An additional loss on disposal of $0.2 million was recognized in the first quarter as the sale was completed.

Additionally, during the first quarter of 2020, management completed its previously announced plan to close the Company’s TMS facility in Houston, and initiated a plan to market and sell the assets at the facility.  Accelerated depreciation and amortization of $1.6 million was recorded in the first quarter to reduce the net book value of the machinery and equipment to its expected fair value.  Subsequent to the closure, certain assets were sold and a gain on sale of $3.2 million was recognized.  At March 31, 2020, the remaining associated machinery and equipment, with a net book value of $2.2 million, was classified as held for sale on the Consolidated Balance Sheet.  The land and buildings associated with TMS were not classified as held for sale, as they were not considered available for immediate sale in their present condition. The Company began selling the inventory associated with TMS in the first quarter of 2020 at prices that were in line with the net realizable value of the inventory that was established in the fourth quarter of 2019.  

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Note 6 – Other Expense (Income), net

The following table provides the components of other expense (income), net for the three months ended March 31, 2020 and 2019:

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

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

Note 7 - Income Tax Provision

TimkenSteel’s provision 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.

In light of TimkenSteel’s recent operating performance in the U.S. and current industry conditions, the Company assessed its U.S. deferred tax assets and concluded, based upon all available evidence, that it was more likely than not that it would not realize the assets. As a result, the Company maintains 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. 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 majority of TimkenSteel’s income taxes are derived from foreign operations.

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

Note 8 - Earnings (Loss) 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 method 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 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.

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Common share equivalents for shares issuable for equity-based awards were excluded from the computation of diluted earnings (loss) per share for the three months ended March 31, 2020 because the effect of their inclusion would have been anti-dilutive. Common share equivalents for shares issuable upon the conversion of outstanding convertible notes were excluded from the computation of diluted earnings (loss) per share for the three months ended March 31, 2020 and 2019 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 earnings (loss) per share for the three months ended March 31, 2020 and 2019:

Note 9 - Inventories

The components of inventories, net of reserves as of March 31, 2020 and December 31, 2019 were as follows:

Note 10 - Financing Arrangements

For a detailed discussion of the Company's long-term debt and credit arrangements, refer to “Note 14 - Financing Arrangements” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

Convertible Notes

The components of the Convertible Notes as of March 31, 2020 and December 31, 2019 were as follows:

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.

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The following table sets forth total interest expense recognized related to the Convertible Notes:

Amended Credit Agreement

On October 15, 2019, the Company, as borrower, and certain domestic subsidiaries of the Company, as subsidiary guarantors, entered into a Third Amended and Restated Credit Agreement (the Amended Credit Agreement), with JP Morgan Chase Bank, N.A., as administrative agent (the Administrative Agent), Bank of America, N.A., as syndication agent, and the other lenders party thereto (collectively, the Lenders), which further amended and restated the Company’s Second Amended and Restated Credit Agreement dated as of January 26, 2018. The interest rate under the Amended Credit Agreement was 2.2% as of March 31, 2020. The amount available for borrowings under the credit agreement as of March 31, 2020 was $224.4 million. As of March 31, 2020, the Company was in compliance with all covenants.

Fair Value Measurement

The fair value of the Convertible Notes was approximately $69.0 million as of March 31, 2020. The fair value of the Convertible Notes, which falls within Level 1 of the fair value hierarchy as defined by Accounting Standards Codification (ASC) 820, Fair Value Measurements, is based on the last price traded in March 2020.

TimkenSteel’s Credit Agreement is variable-rate debt. As such, the carrying value is a reasonable estimate of fair value as interest rates on these borrowings approximate current market rates. This valuation falls within Level 2 of the fair value hierarchy and is based on quoted prices for similar assets and liabilities in active markets that are observable either directly or indirectly.

Interest Paid

The total cash interest paid for the three months ended March 31, 2020 and 2019 was $0.8 million and $1.5 million, respectively.

Note 11 - Retirement and Postretirement Plans

The components of net periodic benefit cost (income) for the three months ended March 31, 2020 and 2019 were as follows:

The Salaried Plan has a provision that permits employees to elect to receive their pension benefits in a lump sum. In the first quarter of 2020, the cumulative cost of all lump sum payments was projected to exceed the sum of the service cost and interest cost components of net periodic pension cost for the Salaried Plan. The Company completed a full remeasurement of its pension obligations and plan assets associated with the Salaried Plan as of March 31, 2020, which resulted in a non-cash loss from remeasurement of $9.5 million, included in other expense (income), net on the Unaudited Consolidated Statements of Operation.  As of March 31, 2019, the cumulative cost of the 2019 settlements did not exceed the sum of the service cost and interest cost components of net periodic pension cost for the Salaried Plan.

Note 12 – Stock-Based Compensation

During the first quarter of 2020 the Board of Directors granted 598,919 time-vested restricted stock units, 143,280 performance-vested restricted stock units, and 511,020 stock options.

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Time-vested restricted stock units are issued with the fair value equal to the closing market price of TimkenSteel common shares on the date of grant. These restricted stock units do not have any performance conditions for vesting. Expense is recognized over the service period, adjusted for any forfeitures that should occur during the vesting period. The weighted average fair value of the restricted stock units granted during the three months ended March 31, 2020 was $5.26 per share.

Performance-vested restricted stock units issued in the first quarter of 2020 vest based on achievement of a total shareholder return (TSR) metric. The TSR metric is considered a market condition, which requires TimkenSteel to reflect it in the fair value on grant date using an advanced option-pricing model. The fair value of each performance share was therefore determined using a Monte Carlo valuation model, a generally accepted lattice pricing model under ASC 718 – Stock-based Compensation. The Monte Carlo valuation model, among other factors, uses commonly-accepted economic theory underlying all valuation models, estimates fair value using simulations of future share prices based on stock price behavior and considers the correlation of peer company returns in determining fair value. The weighted average fair value of the performance-vested restricted stock units granted during the three months ended March 31, 2020 was $5.23 per share.   

Stock options are issued with an exercise price equal to the closing market price of TimkenSteel common shares on the date of grant. The fair value of stock options is determined using a Black-Scholes option pricing model, which incorporates assumptions regarding the expected volatility, the expected option life, the risk-free interest rate and the expected dividend yield. The weighted average exercise price and weighted average fair value of the stock option grants during the three months ended March 31, 2020 were $5.26 per share and $2.23 per share, respectively.

TimkenSteel recognized stock-based compensation expense of $2.0 million and $2.1 million during the three months ended March 31, 2020 and 2019, respectively. Future stock-based compensation expense regarding the unvested portion of all awards is approximately $9.9 million. The future expense is expected to be recognized over the remaining vesting periods through 2024.

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Note 13 - Accumulated Other Comprehensive Income (Loss)

Changes in accumulated other comprehensive income (loss) for the three months ended March 31, 2020 and 2019 by component were as follows:

The amount reclassified from accumulated other comprehensive income (loss) in the three months ended March 31, 2020 for the pension and postretirement liability adjustment was included in other income, net in the unaudited Consolidated Statements of Operations.

Note 14 – 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. Accruals related to environmental claims represent management’s best estimate of the fees and costs associated with these claims. Although it is not possible to predict with certainty the outcome of such claims, management believes that their ultimate dispositions should not have a material adverse effect on our financial position, cash flows or results of operations. As of March 31, 2020 and December 31, 2019, TimkenSteel had a $1.0 million and a $1.5 million contingency reserve, respectively, related to loss exposures incurred in the ordinary course of business.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(dollars in millions, except per share data)

Business Overview

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

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

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

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

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

Impact of COVID-19 Pandemic

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

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

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Impact of Raw Material Prices

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

Results of Operations

Net Sales

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

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

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Gross Profit

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

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

Selling, General and Administrative Expenses

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

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

Restructuring Charges

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

Interest Expense

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

Other Expense (Income), net

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

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

Provision for Income Taxes

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

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NON-GAAP FINANCIAL MEASURES

Net Sales, Excluding Surcharges

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

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LIQUIDITY AND CAPITAL RESOURCES

Convertible Notes

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

Amended Credit Agreement

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

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

Additional Liquidity Considerations

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

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

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

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

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

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

Cash Flows

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

Operating activities

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

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

Investing activities

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

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

Financing activities

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

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New Accounting Guidance

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

FORWARD-LOOKING STATEMENTS

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

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.

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 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 March 31, 2020, we have $139.8 million of aggregate debt outstanding, of which $60.0 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 $0.6 million annually.

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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 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 are 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.

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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.

Canton, Ohio  U.S. Environmental Protection Agency Notice of Violation

The U.S. Environmental Protection Agency (EPA) issued two related Notices of Violation (NOV) to TimkenSteel on August 5, 2014 and November 2, 2015.  The EPA alleges violations under the Clean Air Act based on alleged violations of permitted emission limits and engineering requirements at TimkenSteel’s Faircrest and Harrison Steel Plants in Canton, Ohio. TimkenSteel disputes many of EPA’s allegations but is working cooperatively with EPA and the U.S. Department of Justice to resolve the government’s claims.  Negotiations to resolve the NOVs are ongoing, and it is not anticipated that the ultimate resolution of the NOVs will 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, 2019 filed with the SEC.

Risks Related to COVID-19

The COVID-19 pandemic could have a material, adverse impact on our operations and financial results including cash flows and liquidity.   

We continue to closely monitor the impact of the COVID-19 pandemic on our Company, customers, employees and supply chain. The full extent to which the COVID-19 pandemic will impact our operations and financial results is uncertain and ultimately will depend on, among many other factors, the duration of the pandemic, further Federal and State government actions and the speed of economic recovery. The negative impact on our second quarter, remainder of the year and beyond remains unknown.

The effects of the COVID-19 pandemic also may impact other risk factors previously disclosed in Item 1A. Risk Factors in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019. This impact could be to cause previously disclosed risks to occur or to increase the severity of the negative affect inherent in those other risk factors.  

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ITEM 6. EXHIBITS