A. M. Castle & Co. (NYSE:CAS) Q2 2016 Earnings Conference Call August 9, 2016 11:00 AM ET
Dylan Schweitzer - Alpha IR Group
Steve Scheinkman - President & CEO
Pat Anderson - EVP & CFO
Welcome to the second quarter 2016 A. M. Castle and Company Earnings Conference Call. My name is Kristine, and I'll be your operator for today's call. [Operator Instructions]. Please note that this conference is being recorded.
I will now turn the call over to Mr. Dylan Schweitzer with Alpha IR Group. Dillon, you may begin.
Good morning. Thank you, everyone for joining us for A. M. Castle's second quarter 2016 earnings conference call. By now you should have received a copy of this morning's press release. If anyone still needs one, please call our office at 847-349-2510 and we'll send you a copy immediately following the conference call. The press release and the Company's filings are available on the company's Investor Relations website.
With us from management of Castle this morning are Steve Scheinkman, President and CEO and Pat Anderson, Executive Vice President and CFO.
As a reminder, this call is being recorded. Certain information relating to the projections of the company's results that will be discussed during today's call may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. Those statements are based on current expectations and assumptions that are subject to a number of factors that could cause actual results to differ materially. Additional information concerning these factors is contained in the Risk Factors section of the company's most recent Form 10-K for 2015, the Risk Factors section of our second quarter 2016 Form 10-Q which will be filed shortly and also in the cautionary statement contained in today's release. The company does not undertake any duty to update any forward-looking statements.
This presentation also includes certain non-GAAP financial measures in an effort to provide additional information to investors. All non-GAAP measures have been reconciled and the related GAAP measures in accordance with SEC rules. You will find the reconciliation in the financial information attached in today's release, which is available on the company's website at www.castlemetals.com under the investors tab in the Form 8-K submitted to the SEC.
And now I'll turn the call over to Steve Scheinkman. Steve?
Thank you, Dylon, and good morning, everyone. Thank you for joining the call today. In terms of our agenda, I'll start with a few high-level comments on our performance this quarter and on how we're positioning ourselves to compete and win new business across the end markets we focus on. I will then turn the call over to Pat for a more detailed discussion of our financial performance and then I will wrap up with a few closing remarks before we open the call for questions.
The second quarter was an exciting quarter for us at A.M. Castle as it marked the first full quarter since the completion of the strategic restructuring plan that we put in place in April of 2015.
As you may recall, that plan had two key thrusts. The first was our branch management initiative, which focused on improving the value proposition we delivered to our customers by driving more resources, capabilities and accountability down to the branch level.
These efforts are allowing our branches to become more increasingly closer to our customers and are responsive to their evolving needs, and our results today show that these initiatives are clearly working. With the branch management initiative in place, we now have a lead manager at every Castle branch across the globe, each having ultimate responsibility for sales, operations and profitability along with the management of assets of that particular location.
To support the branches, we added a number of highly experienced and talented individuals from the market to our team to service EPs, general managers and other senior sales staff, welcoming back several who had previously contributed to Castle's successes.
The second thrust of our strategic restructuring plan was focus on the generation of cash by more efficiently managing our inventory and selling some of our real estate and other non-core assets, such as our Total Plastics subsidiary, our energy-oriented inventory and the closure of our Houston and Edmonton facilities. While a number of these initiatives were formidable, I'm proud to report that our team has executed on our plan on time and within budget.
In addition, we recently announced that we entered into an agreement, subject to formal corporate approval by both joint venture partners' boards of directors, for the sale of our 50% equity interest in our joint venture Kreher to our joint venture partner for approximately $31.6 million. We plan to use the proceeds from the sale to further pay down our long-term debt.
Now I'd like to talk in a little more detail about our specific performance during the second quarter. As a quick reminder, given all the portfolio repositioning and asset sales that we've done, our financials are a little complex to review year-over-year without adjusting for a number of items. I'll let Pat walk down the income statement more formally, but the key takeaways in terms of the performance of our ongoing operations are as follows.
We realized both year-over-year and sequential quarter improvement in a number of key financial performance metrics, including gross material margin, operating loss and EBITDA. Specifically, while replacement prices for the majority of the products we focus on remained flat, our gross material margin, which improved each sequential month of the quarter was 25.3%. The gross material margin in the quarter, which did not require adjustment for any one-time or unusual items, represents an improvement of 340 basis points compared to the adjusted gross material margin in Q2 2015 and 300 basis points against the adjusted gross material margin in the first quarter of this year.
Excluding sales attributable to our Houston and Edmonton facilities closed earlier this year, we believe we outpaced the market. In the quarter, our sales tons per day increased by almost 1% from the second quarter of 2015 and by 5% from the first quarter of 2016 compared to recent MSCI data and various industry publications, which indicate the metal service center industry declined by 5% off the second quarter of 2015 and growing 1% sequentially off the first quarter of 2016.
We also lowered our operating expenses, exclusive of restructuring cost, to $42.3 million this period compared to $54.6 million in the second quarter of 2015 and $45.2 million in the first quarter of 2016. This represents a decrease in cash operating expenses of 24.1% per ton shipped on a year-over-year basis, and again, shows the effectiveness of our cost containment and branch realignment initiatives.
I think it's important to note that during the second quarter, our momentum got stronger during each month of the quarter. Even without improvement in market demand and the replacement cost of the majority of our products, we achieved sequential and year-over-year growth as a result of the aggressive organizational actions we have taken over the last year to restructure our branch network cost, better align our sales force with customer needs, increase our transactional business and improve our capital structure. We believe these results bode well for our ability to further improve our financial performance once market demand and pricing improves.
One of the really exciting developments that we're witnessing is that our customers and suppliers are recognizing the number of steps we've taken to strengthen our company, to prove our business, and to better service their needs. We're having more and more long-term conversations with very influential current and potential customers, as well as suppliers.
As I said earlier, we've hired back several of our former sales representatives and continue to focus a great deal of our efforts on improving our commercial processes. Our momentum is growing and we're gaining traction within our various industry circles. Further, the company is entering into long-term agreements with a number of top tier new customers and with existing customers that extended and even expanded their contracts with us well into the future. We continue to have high expectations for our performance in aerospace end market in the near and long-term. While the industrial space continues to face challenges, our cost base allows us to remain competitive. And we believe that we will see improvement as overall demand in pricing recover.
Before I pass the call to Pat, I also want to note that during the quarter we completed our refinancing with the exchange of our previous 7% convertible notes, due December 2017 into a mix of new 5.25% convertible notes, due December 2019 in common stock. This important step in our plan along with the exchange of our senior secured notes that was completed in the first quarter of this year has extended the maturity of substantially all of our senior secured notes and convertible notes on terms that greatly improved our capital structure.
With that, I'll hand the call over to Pat Anderson, our Chief Financial Officer, for a review of our financial results.
Thanks, Steve. Before I get into our financial results for the quarter, I'd like to remind our audience that the February 2016 sale of assets and subsequent closure of our Houston and Edmonton facilities was not accounted for as a discontinued operation per the authoritative accounting guidance. Accordingly, the following reported financial results include the impact of those pieces of our business for all of 2015 and halfway through the first quarter of 2016.
With the sale of substantially all of the inventory and subsequent closure of these facilities, going forward the company has eliminated the operating losses generated by these branches in prior periods and the accompanying negative impact on gross material margin. Net sales attributable to the Houston and Edmonton operations were $33 million in Q1 2016, which includes the $27.1 million sale of inventory at those facilities and $15 million in the second quarter of 2015.
The operating expenses of the Houston and Edmonton facilities were $3.5 million in the Q1 2016 and $4.9 million in Q2 2015.
The following discussion of the financial results for the second quarter of 2016 and the prior comparative quarters includes, among other things, restructuring gains and losses, costs related to our recent debt restructuring activities, and as it relates to Q1 2016 the $27.1 million sales of all the inventory at our Houston and Edmonton facilities in that quarter.
In addition, as discussed by Steve earlier, we recently entered into an agreement for the sale of our equity interest in our 50% joint venture Kreher for approximately $31.6 million. Related to this, we recognize a $4.6 million charge in Q2 2016 to reduce the estimated carrying value of our investment in the joint venture.
In certain circumstances, management feels it is useful to provide financial results which have been adjusted for the financial impact of these significant events, resulting in non-GAAP financial measures such as EBITDA and adjusted EBITDA, gross material margin and adjusted gross material margin, operating expenses, excluding restructuring charges, and adjusted non-GAAP net loss. Please refer to the earnings release posted earlier today for a full reconciliation of any non-GAAP items referred to in the following discussion.
With that, net sales in Q2 2016 were $131 million, a decrease of $36 million or 21% compared to Q2 2015. The decrease in net sales was mainly attributable to a 6.4 per day at to customers compared to the same period last year coupled with a 13.9% decrease in average selling prices.
Compared to Q1 2016, reported net sales in Q2 2016 decreased by $33 million or 20%. Excluding the tons sold from our Houston and Edmonton facilities in Q2 2015 and Q1 of 2016, tons sold per day in Q2 2016 increased by approximately 1%, compared to Q2 last year and increased by approximately 5%, compared to the first quarter of 2016.
Consolidated gross material margin in Q2 2016 was 25.3% compared to 8.5% in Q2 2015, and 18.4% in Q1 2016. The gross material margin in the second quarter 2015 was negatively impacted by $22.3 million of inventory scrapping expenses associated with restructuring activity in that quarter. And the gross material margin in Q1 was negatively impacted by the $27.1 million Houston and Edmonton inventory sale and the $0.50 million write down of inventory related to restructuring activities. Excluding these items adjusted gross material margin in Q2 2015 was $21.9% and adjusted gross materials margin in Q1 2016 was 22.3%.
Gross material margin in Q2 2016 a 25.3%, which did not require adjustment for any one-time or unusual items, was higher than both the prior year and sequential quarter adjusted grows material margin due largely to the strategic decision to restructure our branch network cost, better align our sales force with customer needs, increase focus on transactional business, and improve inventory management activity.
Refer to our press release from earlier today for a reconciliation of gross material margin and adjusted gross material margin. Excluding restructuring charges, operating expenses decreased 22% from $55 million in Q2 2015 to $42 million in Q2 2016.
Sequentially, operating expenses decreased 6% compared to Q1 2016 operating expenses of $45 million. Total restructuring charges in Q2 2016 were $2 million and consisted primarily of moving cost associated with plant consolidations related to the April 2015 strategic restructuring plan and additional lease termination costs.
Interest expense was approximately $10 million in both Q2 2016 and Q2 2015. With the completion of our recent debt refinancing activities the company expects future interest expense to be approximately $7.1 million per quarter, depending on future common stock conversions of convertible notes and draw downs on the company's revolving credit facility.
Related to the completed exchanges of our convertible notes referenced by Steve earlier, in Q2 2016, the company recognized $1.3 million from the unrealized gain on the embedded conversion option associated with the new convertible notes, as well as the debt restructuring gain on the transaction of $0.50 million.
Other income of $3 million in Q2 2016 and $4 million in Q2 2015 represents foreign currency transaction gains from the company's foreign operations, including a portion which relates to gains on inter-company loans with the company's subsidiaries in Canada and United Kingdom. The company recorded an income tax expense of less than $1 million in Q2 2016, which resulted in an effective tax rate of negative 3.3% for the period. As a reminder, the company has a full valuation allowance recorded in most of the tax jurisdictions in which it operates.
As mentioned earlier, the company recorded a charge of $4.6 million to write down the estimated carrying value of its 50% investment in its joint venture. This charge coupled with its share of joint venture earnings of $0.2 million in the period resulted in equity and the losses of joint venture of $4.5 million in Q2 2016 compared of $0.5 million of income in the same period last year.
Including restructuring charges of $2 million, the company reported an operating loss of $11 million in Q2 2016. Comparatively, the operating loss in Q2 2015 was $56 million, which includes restructuring charges of $38 million.
Q2 2016 net loss from continuing operations was $21 million compared to $47 million in Q2 2015. Adjusted non-GAAP loss from continuing operations in Q2 2016 was $18 million compared to $11 million in the comparative prior year quarter and $26 million in Q1 2016.
EBITDA recorded in Q2 2016 was a loss of $7 million, an improvement over an EBITDA loss of $46 million in Q2 2015 and $30 million EBITDA loss in Q1 2016. Finally, adjusted EBITDA was a loss of $3 million in Q2 2016 and a loss of $10 million and $12 million in Q2 2015 and Q1 2016 respectively.
Looking at the balance sheet and working capital items, average day sales and inventory was 172 days for the first six months of 2016 compared to 224 days for the first six months of 2015. The decrease is the result of improved inventory management initiatives taken by the company under its new branch network strategy.
Average receivable days outstanding was relatively flat at 54 days for the first half of 2016 and 53 days for the first half of 2015. The operating activities of continuing operations has a cash flow use of $19 million in the first half of 2016 and a cash flow use of $20 million in the first half of 2015.
Capital expenditures in the first half of 2016 used $2 million in cash. Total capital expenditures for 2016 are expected to range between $4 million and $5 million.
The company had $46 million of borrowings outstanding under its revolving credit facility at June 30, 2016 and $14 million of additional unrestricted borrowing capacity available under the terms of its revolving credit facility.
There were $66 million in borrowings under this facility at December 31, 2015. The company's net debt-to-capital ratio was 94.6% at June 30, 2016 compared to 84.1% at December 31, 2015.
Total long-term debt outstanding net of unamortized discount, amortized debt issuance cost and the derivative liability for the embedded conversion feature of the company's convertible notes was $280 million at June 30, 2016 and $318 million at December 31, 2015.
Proceeds from the Q1 2016 sale of TPI, which were used to pay down the company's long-term debt and conversion of the company's convertible debt in 2Q 2016 resulted in a $38 million or 12% decrease in the company's long-term debt in the first half of 2016. We recently further lowered our long-term debt balance with an early payment of $5.5 million to settle the remaining principal balance of our senior secured notes due in December 2016.
Now I'll hand the call back over to Steve for a few closing remarks.
Thanks, Pat. To conclude, we are pleased with the improvement of our financial performance in the quarter. However, we realized there's still more work to do as we continue to aggressively pursue opportunities for further improvement. Although the third quarter is historically one of our slower periods due to normal seasonality in the summer months, we enter the second half of the year more confident that the positive financial trends we saw in the second quarter will position us well to expand our customer base and grow our business over the long-term.
With that, we'll open up the line for further questions.
And we have no questions at this time. So thank you, ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.
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