Synalloy Corporation (SYNL) Q4 2018 Earnings Conference Call March 5, 2019 9:00 AM ET

Company Participants

Craig Bram - President, Chief Executive Officer
Dennis Loughran - Senior Vice President, Chief Financial Officer

Conference Call Participants

Mike Hughes - SGF Capital

Operator

Good day ladies and gentlemen, and welcome to the Synalloy fourth quarter earnings conference call. At this time, all participants are in a listen-only mode. Later during the call, we will conduct a question and answer session and instructions for how to participate will follow at that time. During the conference, if anyone should require assistance, please press star then the number zero on your touchtone telephone. As a reminder, this conference call is being recorded.

I would now like to introduce your host for today’s conference, Mr. Craig Bram, President and CEO. Sir, you may begin.

Craig Bram

Good morning everyone. Welcome to Synalloy Corporation’s fourth quarter 2018 conference call. With me today is Dennis Loughran, our CFO. Dennis will provide a review of the Q4 financials and then I’ll provide some comments on our business segments and what we are seeing so far in 2019. We will then open the call to questions.

Dennis?

Dennis Loughran

Hello everyone. As usual, the financial results will be presented using three different methods: first, GAAP-based EPS, second adjusted net income, a non-GAAP measure as defined in the earnings release, and third, adjusted EBITDA, a non-GAAP measure also defined in the earnings release.

Fourth quarter GAAP-based net income was $0.5 million or $0.06 diluted earnings per share as compared to net income of $1 million or $0.11 diluted earnings per share in the fourth quarter of 2017. Significant differences in the year-over-year performance include: Q4 of this year was negatively impacted by $2.1 million in mark-to-market valuation losses on investments in equity securities compared to no such losses in the fourth quarter of last year; Q4 of this year contained $0.2 million of inventory price change losses compared to the fourth quarter of last year, which incurred inventory price change losses totaling $1 million; Q4 of this year includes a favorable net one-time adjustments and amortization of prior period manufacturing variances totaling $0.3 million compared to no impact in the fourth quarter of 2017; Q4 of this year included $0.8 million of reduced earn-out accrual compared to an unfavorable earn-out adjustment of $0.5 million in the fourth quarter of 2017. The decrease in projected earn-out liability represents the present value of expected payouts under the Marcegaglia acquisition agreement as a result of lower prognosis for sales than previous projections over the remaining contract. Fourth quarter non-GAAP adjusted net income was $2 million or $0.22 diluted earnings per share as compared with adjusted net income of $1.2 million or $0.13 diluted earnings per share for the fourth quarter of 2017.

Fourth quarter non-GAAP adjusted EBITDA totaled $5.9 million or 8.1% of sales compared to the prior year’s fourth quarter adjusted EBITDA of $4.0 million or 7.5% of sales. Those comparable figures topped off a tremendous growth year for the company with full-year adjusted EBITDA totaling $34.1 million compared to just $12.5 million for the full year 2017, based on incremental profits from the company’s latest two acquisitions and strong performance across our core metals and chemical markets. The combined adjusted EBITDA as a percent of sales for the operating businesses in the fourth quarter was 10.5%, up substantially from the prior year’s fourth quarter of 3.4%.

At the end of the fourth quarter, our outstanding borrowings against our ABL facility totaled $76.4 million, up $13.6 million from September 30, 2018 total primarily related to working capital increases. The calculated ABL facility remaining availability as of December 31, 2018 was approximately $17.5 million.

I will now turn the call back over to Craig.

Craig Bram

Thanks Dennis. 2018 was a record year on multiple fronts: record sales, record EBITDA, and record adjusted net income per share. In late summer, our share price hit a 10-year high of over $24 and in December we nearly doubled our dividend from the previous year. On top of stellar operating results, we completed the purchase of Marcegaglia’s galvanized tube business on July 1, 2018 and followed that up with the acquisition of ASTI’s assets on January 1, 2019.

In January, we provided our forecast for 2019 with targeted revenue of $340 million, up 21% from the record set in 2018, and adjusted EBITDA of $34 million. The adjusted EBITDA forecast for 2019 assumes no inventory profits for the year and represents a 24% increase over 2018’s adjusted EBITDA on a comparable basis.

While our share price finished 2018 up 24% over the prior year, we have seen it decline this year by as much as 23%. At our February board meeting, the directors authorized a share repurchase of up to 850,000 shares. It is the board’s belief that our share price does not reflect the value that has been created in recent years. At this year’s low of $12.79, Synalloy was valued at an enterprise value to EBITDA multiple of only 5.4 times. By comparison, the average historical multiple in a peak year of the cycle for Synalloy was 7.8 times. The median multiple in our peer group recently exceed 9 times. While pleased with the company’s financial performance and the completion of two complementary acquisitions, we are certain disappointed with the share price.

Let me make some general comments on Q4 and what we’re seeing so far in Q1 of this year. At the corporate level, we took a mark-to-market valuation loss on investments in equity securities in the fourth quarter totaling $2.1 million. Small cap and micro cap equities were hit hard in the fourth quarter and our two holdings were no exception. Unlike Synalloy, however, both holdings have staged a strong rebound so far in the first quarter of this year.

Turning to the metals segment, average selling prices continue to show a positive trend cross all product lines in the quarter as well as in our backlogs. We do anticipate price increases to moderate in 2019 and that is reflected in our forecast. Nickel prices and associated surcharges were under pressure in Q4, resulting in metal losses in the quarter which will carry over into this year’s first quarter. While finishing the year with metals profits of almost $5 million, all the gains occurred in the first three quarters of last year. Nickel prices and surcharges have started to rebound in 2019. Since the end of 2018, nickel prices are up 26%. Should this trend continue, then we would expect to start generating inventory profits in the second quarter of this year.

The integration of ASTI has gone smoothly so far and we are targeting conversion to Synalloy’s ERP system in May. Raw material savings are hitting assumptions and we’ve begun coordinating sales activities among our other stainless units within the metals segment. We are also working on several organic sales initiatives across the metals segment, including the possible addition of a new product line in the specialty pipe and tube unit.

Looking at the chemicals segment, we returned to organic sales growth in 2018 and we see reason for more of the same in 2019. The demand for increased bio-side volume at our CRI facility has created the need for additional equipment. We have approved a $450,000 capital project that should be completed in the second quarter. This project will have a payback period of less than one year and will support increased volume from four existing customers as well as one new customer. We’re also focused on better utilization of excess non-reactor capacity at Manufacturers Chemicals. We have opportunities to bring on some new simple blend products that will require little to no additional labor.

We recently installed a new horizontal grinding mill at CRI to manufacture a jet fuel additive for a well known chemical company. The new grinding mill is being paid for by the customer over the length of the contract. This new mill will increase throughput by at least four times over the previous method of production.

As noted in the earnings release, the level of business activity in the first two months of this year has exceeded our plan in both the metals and chemicals segments. While early, signs continue to point toward another solid year of end market demand. The M&A pipeline has some interesting prospects as well.

Dennis and I will now open the floor to questions.

Question-and-Answer Session

Operator

[Operator instructions]

Our first question comes from Mike Hughes with SGF Capital. Your line is now open.

Mike Hughes

Hey Craig, hey Dennis, how are you?

Dennis Loughran

Hey Mike.

Craig Bram

Good, thanks.

Mike Hughes

Good. Just wanted to start with the chemical division. I guess that was, in my opinion, the one disappointment for the year. I think the margins in the second half were shy of 7% and midyear you were thinking 12 to 13%, at least that was implied from the full year guidance, so what happened there and then what’s the outlook from a margin perspective for 2019 for chemicals?

Craig Bram

Yes Mike, I would say a couple things. We rate our product opportunities in different phases, and we didn’t see some of the products that we expected to ramp in production, it didn’t happen in the latter part of last year. Some of those product lines have made good progress and we’re actually seeing the benefits of that in the first couple months of this year, so the chemical segment is definitely running north of our plan in 2019 so far, and some of that, as I said, are these products that we’d anticipated contributing some margin for us in the fourth quarter, moving into the first quarter of this year. In addition to that, we’ve gotten quite a few additional opportunities that have presented themselves, including the bio-side volume that I mentioned, the non-reactor product lines that I mentioned at MC, so we’re expecting that you’ll see some significant improvement in the chemicals segment in the first quarter of this year.

Mike Hughes

Okay, and then just one detail follow-up on that. Was there a bonus--reversal of a bonus accrual in the chemicals division in the fourth quarter? Just for modeling purposes, I was wondering.

Craig Bram

Dennis is looking at a couple things here, Mike.

Mike Hughes

Okay, do you want me to jump to just the metals division?

Craig Bram

Yeah, sure.

Mike Hughes

Okay. Palmer, you had some labor issues. Can you just talk about where the margins--I’m not sure if you’ll disclose this or not, but where the margins were in the second half of the year for Palmer, and if you’ve been able to address those issues and things are running more smoothly now?

Craig Bram

Yes, I won’t get into the specifics of the exact margins, but the margins for Palmer in the second half were definitely improved over the first half. They’ve been strong the last several months, and to address your question to labor specifically, the turnover among our welders is much reduced from what it was the first half of the year, so that’s definitely had a positive impact on throughput. The last three months, our production levels have been hitting targets, so we’re pleased with what’s going on there.

Mike Hughes

Okay. The backlog looks essentially flat sequentially, so are you still seeing good demand levels in the Permian?

Craig Bram

Yes, historically what happens is we get second and third quarter bookings are the highest booking quarters of the year. January is always a little soft, so we saw that again this year. February bookings picked up very nicely. Right now, we’ve got bookings as of March 1 that at current revenue run rates, there’s about five, a little more than five months’ worth of work in our backlog, and we expect that will continue to hold in that level. That’s where we’ve been the last 18 months.

Mike Hughes

Okay, and then just one more for me. The galvanizing and ornamental steel business, I think in the third quarter it did roughly $6 million. If I did the math correctly, it did roughly $5 million in the fourth quarter, and I think the ornamental steel business was supposed to be ramping during the fourth quarter and you’d exit the year at a run rate of $25 million. Can you just give us an update on those two businesses?

Craig Bram

Yes, the galvanized in the fourth quarter was probably one of the more significant reduction of inventory that we saw on the customer base, meaning some of our customers were saying please don’t ship that product to us right now, we’re trying to maintain inventory levels at a target that was either internal to them, maybe driven by their ABL lines, so we saw some more pressure in the galvanized area. So far this year, we’ve seen that volume pick back up. It’s a little bit below plan, but not materially so.

On the ornamental side, you may recall we’ve got high frequency mills up in our Munhall plant outside of Pittsburgh, and we’re starting to ramp that up. At the same time, we completed the ASTI acquisition - that’s a higher end ornamental product. That business has done very well the first couple months of the year, and we’re actually using that team to try and help us both on the manufacturing side at Munhall but more importantly doing some collaboration among their sales team and what I’ll call the commodity ornamental pipe sales efforts. So we’re seeing some good benefits from that acquisition, and we’ve also seen some positive things on the raw material side as well. Adding that volume into the Bristol Metals purchasing mix has actually at this point exceeded some of our projections on the raw material savings, so we’re very pleased with ASTI two months into the acquisition.

Mike Hughes

Okay, just two follow-ups and then I’ll jump back in the queue. It sounds like it’s safe to assume that the ornamental steel business did not exit the fourth quarter at $25 million in annualized revenue. Is that correct?

Craig Bram

No, absolutely not.

Mike Hughes

Okay, and then the second question, I think part of the reason that you were excited about the galvanized business was the opportunity to increase the IBC business, the chemical companies. Can you give us an update on that front?

Craig Bram

Yes, we’ve signed two long-term contracts at volume commitments that are higher than what we were when we acquired the business, so we expect that to continue to be a positive development. Secondarily, we’ve started doing some work in the road construction market as well.

Mike Hughes

Okay, thank you. If you have the accrual information or you’re willing to provide it--

Dennis Loughran

Mike, this is Dennis. The chemical business total incentives for the fourth quarter were only off $20,000 lower than the average for the full year quarters, so no major reversal.

Mike Hughes

Okay, thank you.

Dennis Loughran

This is Dennis. Before we have any other questions, I would like to correct one of my statements. I found in my script a typo that I’d like to correct. In the statement where I mentioned the combined adjusted EBITDA of the operating units, the correct percentage for the fourth quarter of 2018 was 10.75%, and the fourth quarter of last year was 10.5%, so we had neglected to overwrite script from the prior periods, so that’s a correction of that statement.

Please continue with the questions.

Operator

Thank you. As a reminder, ladies and gentlemen, if you’d like to ask a question, please hit star then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, you may hit the pound key. One moment while we wait for any further questions.

Speakers, I am showing no further questions at this time. I’d like to turn the call back over to Craig Bram for any closing remarks.

Craig Bram

Looks like you have one more follow-up from Mike, maybe?

Operator

Yes sir, you are correct - sorry. We have a follow-up from Mike Hughes. Your line is now open again.

Mike Hughes

Hey, thanks guys. Just want to go back to the metals segment. Could you give us the specialty alloy mix for the backlog at year-end?

Craig Bram

Mike, I don’t have that handy, but if you want to check back in with Dennis offline, we could give you a breakdown on that.

Mike Hughes

Okay. Just high level, what are you seeing from a large project perspective, which tends to be, I think, more weighted towards specialty alloy?

Craig Bram

Well certainly the shipments--Bristol Metals out of the Bristol, Tennessee facility is where the bulk of the special alloy is produced, and their mix has been very good in the first couple months of this year from a shipment basis, and that’s a reflection of some of the bookings that occurred in the fourth quarter. I have not seen a significant uptick in project bookings so far, there have been a few. We’ve had a mining project that got booked in late January, and there’s also a plastics company booking that occurred in early February, but those are the two primary projects that I’ve seen that we actually reported on in our most recent board meeting.

Mike Hughes

Okay. I think the Koreans were out of the market because they hit their quota at the middle of last year. I’m not sure how much market intelligence you have on this front, but are they more active in the first half and is that an issue?

Craig Bram

No, I wouldn’t say--I mean, they are back in, in fact they’ve been bidding on projects since the end of the fourth quarter, but I can tell you that Bristol Metals’ market share in January, which is the latest month that we have, we actually increased our market share among domestic producers by 120 basis points.

Mike Hughes

Okay, and then do you happen to have the imports statistics [indiscernible] on maybe the second quarter call of last year, when even though the tariffs were in place, the imports were still pouring in. Do you have those numbers from maybe the fourth quarter?

Craig Bram

I know that, without getting into where it’s coming from, imports represented about 42% of North American consumption for all of 2018.

Mike Hughes

Okay. You made one comment about on the Brismet business, prices moderating. You’re not actually envisioning a price decline this year, are you?

Craig Bram

No, our plan actually has a price increase. Obviously a lot of that is dictated by the direction of nickel prices and the associated surcharges, so if you go back and look at the nickel prices really starting in September on a--it really got double digit declines starting in October of last year on a sequential month basis, and that carried through February-really through February of this year, and I’m talking about surcharges. We’ve seen surcharges reverse, so. At the end of last year, the surcharge on 304 was about $0.63 a pound, and in February it was roughly $0.53 a pound. In March, we saw it jump to $0.58, and right now the projected for April is $0.61, pushing $0.62. We had inventory losses in the fourth quarter, you’ll see some inventory losses in January and February, but based on the nickel price and the current surcharge, we’ll have double digit increases in surcharges starting in April.

As long as nickel prices are trending up or they don’t lose ground, then we would expect our average selling prices to show some increase over 2018 and be consistent with the plan that we’ve built and have shared, going back earlier this year.

Mike Hughes

Okay. Can you just talk about where you would take the leverage to? I think it’s around, I don’t know, roughly a little less than three times at this point, debt to EBITDA. Would you take it above three times?

Craig Bram

No, that’s not an area we would be comfortable with. If you look at--during my tenure as CEO going back to 2011, our leverage has averaged about 1.75 times. At the end of 2018 before we did the ASTI deal, it was about 2. Immediately following the ASTI deal, it was about 2.5, and if we don’t do any more acquisitions this year, we’re projecting that net debt would average roughly $55 million over the course of this year, so if we hit our plan, that would suggest that our leverage would fall back to about 1.5 times. But three times if not a level that we would be comfortable with, again recognizing that our businesses are cyclical and while we don’t see any signs at all of any softening in our end markets right now, we certainly don’t want to go out and be sitting over three and then have things start heading south a little bit.

Mike Hughes

Right, so you must be projecting fairly robust free cash flow for the year, so what are your working capital assumptions? I think your cash conversion cycle is over 100 days because of the inventories you carry, so you have working capital actually contributing this year to free cash flow?

Dennis Loughran

Mike, this is Dennis. As we mentioned in our commentary and the press release, working capital was up. We had all of our metals side of the business pursued higher inventories in the second half of the year, some of it related to SPT, long lead times brought in metal in the fourth quarter, anticipating not being able to get it in the first half for sales. So we’re looking at anywhere between $7 million and $14 million of free cash flow from reduction of working capital by year end, moving back to sort of historical targets, and just managing our working capital. Obviously we had a great year and we’re just trying to moderate that and make sure our cash flow is positive over the two-year period.

Mike Hughes

Okay, good. Have you put out a 2019 capex number?

Dennis Loughran

No, we have not.

Mike Hughes

Would you be willing to put a range out for us?

Dennis Loughran

Non-acquisition base would be in the $4 million to $6 million range.

Mike Hughes

Okay, and then the two equity investments, what do they total right now? I don’ think they’re broken out on the balance sheet. They’re probably in the 10-K, but I haven’t looked at that yet.

Craig Bram

As we sit right now, let me see. Have we got a calculator handy here?

Dennis Loughran

Yes, current market on them.

Craig Bram

Yes, we give you current market, so--.

Dennis Loughran

The beginning of the year, it was about $3 million. Mike, while he’s calculating that number--

Craig Bram

It’s just shy of $4 million right now.

Mike Hughes

Okay, okay. Then my final question, did you put out where the Brismet backlog is right now? I know at year-end you said it was 31.2, I assume it’s higher right now.

Dennis Loughran

The Brismet--? It’s about $28 million.

Craig Bram

Brismet right now is about $28 million.

Mike Hughes

Does that include Munhall?

Dennis Loughran

Brismet is--yes, Bristol and Munhall.

Craig Bram

Yes, Bristol and Munhall. That’s right.

Mike Hughes

Okay, thank you very much for your time.

Dennis Loughran

Mike, I did go--I looked at those stats. For Brismet for both facilities, excluding galvanized, backorder or backlog, the special alloy is about 15% on a pounds basis, which is a pretty good number historically.

Mike Hughes

Yes, okay. Thank you very much.

Operator

Thank you, and I am showing no further questions in the queue at this time. I’d like to turn the call back over to Craig Bram for any closing remarks.

Craig Bram

As always, we appreciate your support and again we’re looking forward to a strong 2019. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude your program and you may all disconnect. Everyone have a great day.