Global Brass and Copper Holdings, Inc. (NYSE:BRSS) Q3 2018 Earnings Conference Call November 2, 2018 10:00 AM ET
Anne-Marie D'Angelo - General Counsel
John Wasz - President and Chief Executive Officer
Christopher Kodosky - Chief Financial Officer
Daniel Moore - CJS Securities
Good day ladies and gentlemen and welcome to Global Brass and Copper Holdings Inc. Third quarter 2018 Earnings Call. At this time all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call may be recorded.
I would now like to turn the conference over to General Counsel, Anne-Marie D'Angelo. Please go ahead.
Good morning, everyone and welcome to our third quarter 2018 earnings call. My name is Anne-Marie D'Angelo and I'm Global Brass and Copper's General Counsel. Joining me on the conference call today are John Wasz, our President and Chief Executive Officer and Christopher Kodosky, our Chief Financial Officer.
An archived version of this call will be available later this morning on the Investor Relations section of our corporate Web site at www.gbcholdings.com.
Before beginning our discussion, I'm going to provide some necessary [indiscernible] reminders, that our prepared remarks and responses to questions may include forward-looking statements that are made pursuant to the Safe Harbor provisions of the federal securities laws. These statements are subject to a variety of risks, uncertainties and assumptions that may cause actual results to differ materially from those stated or implied by the forward-looking statements.
Any forward-looking statements represent our views only as of today and should not be relied upon as of any subsequent date. Information concerning factors that could cause actual results to differ from those in the forward-looking statements may be found on the risk factors contained in our most recent Annual Report on Form 10-K and our other filings with the SEC.
This call will discuss non-GAAP financial measures such as adjusted EBITDA, adjusted sales, and adjusted diluted earnings per common share. Reconciliations to the most directly comparable GAAP financial measures are provided in our earnings release for the fiscal quarter ended June 30, 2018.
I now would like to turn it over to John Wasz.
Thank you, Anne-Marie. Good morning everyone and thanks for joining us today on the call.
Our third quarter results reflected solid growth in volumes and adjusted diluted earnings per share, but fell short of our expected EBITDA performance largely due to operational challenges at Olin Brass and Chase Brass. After an impressive string of quarterly improvements and productivity and efficiency Olin Brass experienced productivity and delivery issues in July and August. These issues stem from a difficult [vendiculation] [ph] of its equipment as it came out of their annual July maintenance outage. Operational performance and on-time delivery performance returned to strong performance levels in September.
Chase Brass manufacturing performance improved in the third quarter as compared to the second quarter of this year, but they continued to be impacted by the effects of the tight labor market in the region. Chase Brass' quarter-over-quarter performance was also negatively impacted by less favorable scrap prices and to a lesser extent pricing pressures from imported brass parts.
On a more positive note, AJ Oster had a solid quarter in the base business both volumes and margins experienced encouraging improvements in the integration of the Alumet acquisition continues to progress very well and is delivering expected results.
In all three businesses, we are encouraged by the business improvements, growth initiatives and continued deployment of our asset management and balanced book philosophy to create value for our customers and our shareholders. Despite a challenging operational quarter, I'm encouraged by the teamwork and swift corrective actions resulting in providing superior quality and service to our customers.
Turning to Olin Brass volumes increased in the munitions, coinage and auto markets. The munitions increase was the result of a more balanced inventory profile throughout the supply chain in the third quarter of 2018 as compared to the third quarter of 2017. As mentioned before, the coinage market is difficult to predict and will continue to ebb and flow on a quarterly basis as it is, has since colonial days.
Shipments to the automobile industry were up despite a slowdown in build rates. This is an encouraging data and supports our belief that volumes will grow with the increased electrification of cars.
Olin Brass adjusted EBITDA decreased primarily due to increased production costs caused by the operational inefficiencies. The Olin Brass team continues to focus on product profitability and its supply chain and manufacturing excellence initiatives while providing their customers with best-in-class quality and service.
Regarding the AJ Oster business, adjusted EBITDA volumes and margins in the base business all increased as compared to the prior year. Base volumes were favorable in the automotive and electrical components markets, again, the growth in automotive is an encouraging sign.
Alumet volumes were less than anticipated but margins were very solid as the commercial team drove product profitability in the various commercial elements of the asset management philosophy. The AJ Oster base business adjusted EBITDA was also favorably impacted by the positive improvements in selling prices and volumes. I'm pleased with the integration of Alumet and we'd like to thank the AJ Oster team for their teamwork and focused efforts towards achieving the synergies we targeted when we acquired this business.
Chase Brass volumes improved quarter-over-quarter; the largest increases were in the transportation and industrial machinery and equipment market. Building and housing was largely flat as compared to the third quarter of 2017. As previously mentioned adjusted EBITDA as compared to the third quarter of 2017 decreased due to increased production costs caused by labor induced operational inefficiencies, less attractive scrap prices and to a lesser extent pricing pressure from imported [grass] [ph] parts.
Chase continues to deliver exceptional quality, short lead times and the best-in-class on time delivery performance. During the third quarter, we continued to make meaningful progress on numerous areas of strategic focus which will translate into profitable growth in the future. We remain committed to improving the strategic foundation of our business generating significant cash flows driving organic profitable growth and making strategic acquisitions.
With that, I will turn the call over to Christopher for a more detailed view of our financials.
Thanks John. Good morning everyone.
Unless otherwise noted my comments and discussion will focus on our Q3 2018 results as compared to Q3 2017. Comparisons between these periods are difficult, however, as Q3 2017 includes $900,000 refinancing costs related to our July 2017 debt refinancing and $500,000 of professional fees related to our November 2017 Alumet acquisition, while Q3 2018 includes financial results from that Alumet acquisition.
From a volume perspective, volumes increased 23 million pounds or 19% to 142 million pounds, 15 million of which was generated by Alumet. Excluding Alumet, volumes increased 7% or 8 million pounds primarily due to increased munitions, coinage and automotive volumes.
Net sales for the quarter increased 20% to $430 million excluding Alumet; net sales increased 10%, a $35 million primarily as a result of increases in volume as well as sales of unprocessed metal.
We reduced net sales by the cost of metals and cost of goods sold to arrive at adjusted sales a non-GAAP revenue measure. Metal cost reflects, the cost replacement metals sold to the customer, whereas adjusted sales is our internal measure of the value-added or conversion revenue generated from our operations.
Third quarter adjusted sales increased by $27 million or 21% to $155 million primarily due to the $17 million of adjusted sales generated by Alumet and volume increases at Olin Brass.
Net income attributable to GVC for the quarter was $14.8 million or $0.66 per diluted share versus $12.3 million or $0.56 per diluted share in 2017. The increase can be attributable to the net of the following; $4.7 million decrease in tax expense largely stemming from decreased statutory tax rates as well as changes in IRS approved accounting methods taken on our 2017 tax return.
Favorable volumes, $1.3 million of income generated from Alumet $900,000 decrease in refinancing costs and $500,000 decrease in M&A fees related to the Alumet acquisition. A $500,000 decrease in share based compensation expense.
Unfavorable conversion costs and employee and employee-related costs and unfavorable lower cost of market adjustment to inventory of $1.9 million; unfavorable fluctuations and unrealized gains and losses on derivative contracts of $1 million and $800,000 increase in depreciation expense.
Third quarter adjusted EBITDA a non-GAAP financial measure decreased by $500,000 to $30 million stemming from the increased conversion costs, decreases in adjusted sales at Chase Brass and an increase in employee and employee related costs partially offset by favorable volumes and $1.7 million of adjusted EBITDA from Alumet.
Third quarter adjusted diluted earnings per common share; a non-GAAP financial measure increased 20% to $0.77 per share. Adjusted diluted earnings per share fluctuated for reasons similar to the fluctuation in adjusted EBITDA as well as a $4.7 million decrease in tax expense as I mentioned before.
We ended the quarter with just over $100 million in cash, $314 million outstanding under our term-loan facility and $195 million of availability under our asset base revolving loan facility.
During the first nine months of 2018, we generated $73 million of cash from operating activities, $83 million from earnings and $10 million of increased investments in working capital, which continues to be impacted by the timing of total sales.
Year-to-date capital expenditures through Q3 2018 were $17 million consistent with the prior year period. We expect capital expenditures in 2018 to be around $30 million.
Now I will discuss performance in each of our three reportable segments for the third quarter. Increase munitions, coinage and automotive volumes were the primary driver behind Olin Brass' 12% volume increase to 63 million pounds.
As John noted the munitions increase was the result of a more balanced inventory profile in the third quarter of 2018 than what existed in the [indiscernible] market throughout much of 2017. However, these volumes along with the favorable metal mix and scrap sourcing were not enough to overcome the unfavorable conversion costs John mentioned leading to a $400,000 decrease in adjusted EBITDA at Olin Brass.
Chase Brass' net sales increased by 3% to $149 million primarily due to increased volumes as adjusted sales suffered from price pressures on metal margins, raw material prices and imported parts. Adjusted EBITDA decreased $2 million to $16 million driven by the unfavorable change in adjusted sales and increased production costs as a result of operational inefficiencies.
Turning to AJ Oster, Alumet shipped 15 million pounds and generated $1.7 million of adjusted EBITDA in the third quarter. Base business volumes increased 7% to 19 million pounds primarily due to increased volumes in the automotive and electronics and electrical component markets. Base business adjusted EBITDA increased to $1 million primarily due to favorable mix and volumes partially offset by unfavorable employee and employee related expenses.
Regarding our outlook for 2018, I would like to first remind you that we focus on a long-term and our ability to provide guidance is constrained by our short lead time and the tendency of our shipping volumes to lag published market indicators. Having said that based on a variety of factors including our 2018 results thus far industry trends and our own judgment; we are reaffirming our previous 2018 guidance of shipping volumes within the range of 570 million to 610 million pounds and adjusted EBITDA within the range of $127 million to $137 million.
Although we are reaffirming our annual guidance and now that we are three quarters of the way through the year, we caution that volumes will likely come in at the low end of our guidance range.
With that, I turn the call back over to John.
In summary our business remains solid and we believe we're well-positioned to drive growth through our organic initiatives as well through acquisitions. We continue to be pleased with the Alumet acquisition results and its integration to AJ Oster. We have a strong capital structure and cash flows. We're excited about the opportunities we have to improve our businesses and encouraged by the progress our employees have made advancing improvements across the enterprise.
We remain focused on driving profitable growth and we'll be disciplined on cost, productivity, margin management and working capital efficiency. Thank you to the employees at GBC for their teamwork and continued focus on improving our company and creating unique value for our customers. We look forward to continuing to serve our customers and shareholders. Thank you for your interest and continued support.
Now we're ready to take your questions. Operator please explain the question-and-answer procedures.
Thank you. [Operator Instructions] And our first question comes from the line of Daniel Moore with CJS Securities. Your line is now open.
Morning John, morning Christopher.
Good morning, Dan.
Good morning, Dan.
I guess first maybe just -- you gave good color, but if you could elaborate and describe some of the operating issues in the quarter at Olin Brass. If it's possible to quantify the impact from a segment EBITDA perspective and I think you said things were back to normal in September. Just wanted to make sure I heard that correctly.
Yes. I'll explain kind of the issues at Olin Brass and then pass it over to Christopher to provide a little bit more color on the numbers. But long story made short Dan. We historically have done a summer outage which essentially is taking the facility down for a week and working on very discrete improvements on various pieces of equipment. Over the last several years, we have continued to work on our maintenance systems and procedures so that over time we can inevitably get away from that summer outage. And the team is continuing to make progress on that and I'm hopeful as we look into the future we won't have to do a summer outage.
That said as we came out of it this July, we had a few pieces of equipment that we were focused in on making some significant improvements and they were expected to start up on a certain day. And unfortunately, they didn't start up and didn't operate at the level we had anticipated resulting in having more manpower and obviously having some supply chain issues.
The team quickly addressed those issues as they moved through the first part of July. The equipment got up and running fine, and then, really took until probably the late part of August before the supply chain and everything got back on track. And in September, we were back to normal operating levels and service levels to our customers.
And with that, I will try to kick it over to Christopher to provide a little bit more detail on the numbers itself.
It's really a time element here some of these pieces of equipment take time to cool down so you can get in there and work on them. And when you bring them down for maintenance then bring them up again and you have issues running. You got to let them cool down again. So it extends the period of time.
But part of what happens here is, it is a mix between events in the quarter and also events as a comparison to the previous Q3 of last year which was pretty good. So it's almost a 50/50 [issue as work] [ph] to the cost increase came from the last year being a little bit better than expected and this year being a little bit worse than expected.
I'd say overall within the segment it's probably about a $0.04 to $0.06 per pound effect their performance for the quarter as compared to the third quarter last year.
Great color. That's very helpful. And then, shifting gears maybe to some of the end markets munitions, you mentioned supply chain starting to normalize. Any sense or whether that it would be -- are you seeing an up tick in end market demand in either military or commercial? It's really more just the inventory channels restocking, any sense any color you have there?
Dan, I think that from an end market demand we're hearing some good things, we're hearing some things that would lead us believe it is pretty flattish. What we're experience -- and what we experienced in the third quarter, I think was largely on a comparable to last year a much more balanced inventory and as we think about the balance of the year, I would anticipate us to have a positive outcome in the fourth quarter as compared to the fourth quarter of '17 for the -- a very similar reason.
Helpful. And your overall guide, you mentioned at the end of the prepared remarks pointing to sort of the low-end of the volume range the -- is there any in particular end markets that you expect to have a more challenging sort of comp or quarter in Q4?
No. I think everything will be pretty well laid out. But I think it's important to note that a couple things is, first of all, we provide the volume range at the beginning part of this year and as we look at where we're coming in as compared to that probably the biggest difference has been building and housing more so than anything else.
So every other market is a little bit of an ebb and flow and a little bit of a given take. But it's important to note that as we think about our business, we're driving this asset management philosophy we're about product profitability and we're about making money. So we feel really good about our positions for all three of our companies, the service levels, our positions with our customers. So we're comfortable with the volumes that we have. And as we think about our business the focus is on product profitability and creating good returns.
Helpful. Lastly for me, and I'll jump back in queue perhaps. But given the progress that you've made and despite that stock kind of sitting here at -- may 10x our estimated EPS for the year balance sheet gets better every quarter. I know M&A is still a priority but are you considering or looking at alternatives in terms of capital allocation certainly your own stock looks pretty attractive here.
I mean as you know we raised the dividend the last time to $0.09 a share. We've also announced a stock buyback program last quarter, which we did not execute on in the current quarter. Those are still avenues available for us on the table. We continue to invest. I said we'll have about $30 million of CapEx this year in our business. November 1 marks the 12-month anniversary of the acquisition of Alumet. We are extremely pleased with how that is going and the team has done a great job of being integrated and integrating into the organization. We'd like to preserve some cash for future M&A success. And I think those kind of remain our priorities.
I think Dan as we look at the third quarter we had some issues that resulted in us not achieving what we wanted to achieve from an EBITDA standpoint. But we feel very good about the direction we're heading as a company. We feel that we have a very strong fundamental business, strong balance sheet, good cash flows as Christopher mentioned and we've got a lot of different options relative to deploying that cash to create value for our shareholders.
Fair enough. Thanks for the color. Appreciate it. Look forward to speaking to you after Q4.
Thank you. And our next question comes from the line of [indiscernible] with KeyBanc Capital. Your line is now open.
Hey, good morning guys.
Good morning. How are you?
Just first question, just wondering if you could break out some -- how much of that sequential cost increase was due to unfavorable conversion costs versus -related costs and conversion costs were up about 4% sequentially. Does that include some of the employee related costs you mentioned?
Not the majority of it. No. The employee-related costs really do more so to the improvement in performance at AJ Oster, spending on from last year when we had launched a new ERP system, performance suffered throughout the year. We recovered near the end of the year and comparatively quarter-over-quarter the performance this year is significantly on a year-to-date basis much better than last year and that's the majority of where the employee-related costs or increases are stemming from.
Okay. Did you expect any of the employee-related costs to remain elevated at all into fourth quarter '19?
I would expect a slight elevation.
Okay. And then, I guess just lastly could you touch on what factors that all led to the Alumet volumes coming in less than anticipated.
Yes. As we closed on the Alumet acquisition, we drove in our balance book system and really focus the organization on product profitability over the course of the last 12 months. The management team and the commercial teams have been focused in -- on making sure that the products that they're selling are making a satisfactory return and pricing the product to a level that makes sense for them and for their customers.
So with that focus on profitability, we've actually stepped away from some business that was less profitable. But on the remaining business have improved margins pretty smartly. And it's a testament to how we're trying to run our companies relative to making returns and making money on what we sell.
I think it's a great example of implementing the about book philosophy and implementing a return on assets philosophy neither of which was present in Alumet prior to the acquisition. So we've made some changes to the commercial team, supply chain team, the management team throughout the organization has done a great job of implementing both of those practices to the extent that now we are hedging and have a good protection against fluctuations in metal prices by pricing the outgoing inventory i.e., sales at a method whereas it is agnostic to the fluctuation of the incoming metal price to replace the outgoing metal quantity.
So that's been a great effort by the team, and I think that's largely done in an effort to increase the return on invested capital employed in the business to levels we thought could be achievable and I think we've got more room to grow.
Okay, great. And then actually one more for me. Could you talk on how scrap spreads trended at all versus 2Q and you may -- you touched on that a bit, but what is your outlook there going forward given the elevated scrap costs recently?
The elevated scrap costs that we referred to Michael was at Chase and it was really more of a situation where in the third quarter of 2017, the team was able to lean into some pretty favorable scrap opportunities that weren't available in third quarter of '18 much like we talked about what happened in the second quarter at Olin Brass that didn't refer in the third quarter of 2018. So the good thing is, is that we've got the management teams really broadening the varieties of scrap and from time to time are leaning into some nice opportunities that make sense.
I think overall from a scrap perspective, we would anticipate things being pretty much steady as we go as we move through the balance of the year, which really I think underscores some of the other activities regarding tariffs and things like that and that we did see over the last six to nine months scrap prices improve as a result of some of the decisions being made in China relative to the types of scraps that they would take and the types of scraps that they wouldn't take particular category 7 scraps, which I think has resulted in more abundance here in the U.S. and hence wider spreads.
I think -- from time-to-time there are dislocations in the scrap market especially with some of the vendors who we've partnered with over the years. And what you're seeing is two of those events like John said Q3 and Chase last year. And then as compared to Q2 it's more of an Olin Brass quarter-over-quarter dislocation of that scrap market.
Okay. Great. Thanks guys.
Thank you. [Operator Instructions] And I show no further questions at this time. I would like to turn the call back over to General Counsel, Anne-Marie D'Angelo for any closing remarks.
Thank you everyone for joining us today and for your continued interest in and support of Global Brass and Copper Holdings. We look forward to speaking with you again during our fourth quarter conference call. Thanks again and have a good day.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. Everyone disconnect. Everyone have a great day.