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Universal Stainless & Alloy Products (NASDAQ:USAP)

Q1 2009 Earnings Call

April 29, 2009 10:00 am ET

Executives

June Filingeri - Comm-Partners

Denny Oates - President and CEO

Rick Ubinger - VP of Finance and CFO

Analysts

Edward Marshall - Sidoti & Company

Nat Kellogg - Next Generation Equity Research

Timothy Hayes - Davenport & Company Llc

Michael Gallo - C. L. King & Associates

Phil Gibbs - KeyBanc

Operator

At this time, I would like to welcome everyone to the Universal Stainless & Alloy Products first quarter 2009 conference call and webcast. (Operator instructions).

Thank you. Ms. June Filingeri, you may begin your conference.

June Filingeri

Thank you. Good morning. This is June Filingeri of Comm-Partners. I'd also like to welcome you to the Universal Stainless call this morning. We are here to discuss the company's first quarter 2009 results, which we reported this morning.

With us from management are Denny Oates, President and Chief Executive Officer; Bill Beible, Senior Vice President of Operations; Paul McGrath, Vice President of Administration; Rick Ubinger, Vice President of Finance and Chief Financial Officer; and Chris Zimmer, Vice President of Sales and Marketing.

Before I turn the call over to management, let me quickly review procedures. After management has made formal remarks, we will take your questions. The conference operator will instruct you on procedures at that time.

Also please note that in this morning's call, management will make forward-looking statements under the Private Securities Litigation Reform Act of 1995. I would like to remind you of the risks related to these statements, which are more fully described in today's press release and in the company's filings with the Securities and Exchange Commission.

With these formalities out of the way, I'd like to turn the call over to Denny Oates. Denny, we are ready to begin.

Denny Oates

Thank you, June. Good morning everyone. Thanks for joining us today. This morning, we reported first quarter sales of $42 million, which was at the high-end of our forecast and trailed first quarter 2008 by 26% and 18% fewer tons shipped.

We also reported a net loss of $200,000, before including $6 million of pre-tax and unusual charges which we preannounced in March. These unusual charges were directly attributable to depressed market conditions, fluctuations in raw material costs and surcharges, severance cost and the lack of credit availability.

With regard to credit availability, it’s interesting to note that we had self-imposed credit holds at March 31, on approximately $4 million in sales originally scheduled to shift during the first quarter. We estimate gross profit on these lost sales would have been approximately $1 million. Rick will provide some more details here in a moment.

We have been executing plans to aggressively reduce cost, generate cash and adjust the operating levels to market realities. Cash flow from operations was positive in the first quarter and we completed the first phase of our melt shop upgrade on time within budget and without interfering with our customers needs.

The quarter ended with a very strong balance sheet, including cash at $26 million, working capital at $100 million and long-term debt of $13 million.

From our advantage point, the depressed market conditions were very broad-based. In comparison to the first quarter of 2008, sales declined by double-digit rates in each customer category, with the exception of sales to forgers. The 44% increase in sales, the forgers reflects our focused marketing programs, which target power generation, aerospace, and oil and gas markets.

Sales were also lower in each customer categories sequentially, with the exception of OEMs where sales increased 11% from 2008 fourth quarter fueled by defense applications. Our backlog at March 31 was $58 million, a drop of about 20% during the quarter.

What we experienced and continued to see today is lower end-use demand leading the significant destocking throughout the metal supply chain. This destocking is amplifying the effect of the recession on our sales and order entry. Entry reactivity has been generally good, but customers have been reluctant to pull the trigger and place orders.

Let's look at our results by end market, aerospace our largest end market represented 45% of first quarter 2009 sales. Aerospace sales were down 12% year-over-year and 3% sequentially. Conditions in aerospace market are somewhat mixed, billed rates and activity levels and barring airbus are strong by historical standards. Each manufacturer expects to deliver approximately 480 commercial airplanes for the year and backlogs have held up reasonably well.

Nevertheless, short declines in passenger and cargo traffic, the lack of credit availability around the globe, deferrals on delivery dates and a growing number parked jets are all leading to uncertainty and drive to adjust inventories downward in the metal supply chain. Our aerospace customers are largely service centers, and they have been particularly sensitive to the need to reduce their inventories.

Our sales at our power generation market represented 13% of our first quarter sales and were down 24% from the first quarter of 2008 and 32% sequentially. After a strong 2008, our customers are saying that new projects are simply not being funded at the moment. There is some optimism about nuclear but that is further down the road.

Our sales at the petrochemical market represented 16% of our sales in the first quarter of 2009 they were down 19% year-over-year and 30% sequentially. The decline is mainly due to the drop in the oil and gas market especially in exploration which is our main market.

The biggest decline in the first quarter was in tool steel sales. Our tool steel sales were up 38% from the first quarter of 2008 and 40% from the 2008 fourth quarter. Tool steel represented only 8% of our total sales in the first quarter of 2009. A large overhang in inventory existed service centers as a result of the short drop in automotive activity, coupled with the general decline in global industrial activity.

Let me turn it over to Rick for more information on our financial performance.

Rick Ubinger

Thanks, Denny. Sales for the first quarter of 2009 were $42.2 million compared with our forecasted range of $32 to $42 million. We recorded a net loss of $3.8 million or $0.57 per diluted share which included unusual charges of $3.6 million or $0.53 per diluted share. The unusual charges which totaled $6 million pre-tax included the following items:

We increased our bad debt reserve specifically for one privately held service centre that has not paid invoices we issued in 2008 fourth quarter approximating $1.9 million. In addition, we added $500,000 to our inventory reserves for product with unique chemistry that can not be sold to other customers.

Another factor impacting our overall financial performance is the continued decline in the monthly average of raw material values. While nickel remained level, we saw double-digit declines in the monthly average value for moly, chrome and iron between 2008 and March 2009. We estimate these declines compounded by the use of high cost material melted in prior periods negatively impacted our operating results by $1.5 million in the quarter.

Finally, lower than expected order entry levels in the month of February and March caused us to expand our planned melt shop outage from two weeks to four weeks. In addition, we experienced an unplanned two weeks maintenance outage at our Universal rolling mill.

While these outages did not interfere with customer service, their ripple effect within our facilities increased our adsorption rate of fixed cost over direct manufacturing cost. This rate increase resulted in an additional $900,000 charge to cost of sales.

The reduced level of order entry also triggered our contingency plan to reduce cost through a 20% reduction in salaried personnel across the company, and we identified and scrapped approximately 3% of our work in process material, we do not believe can be sold under current market conditions. These decisions impacted first quarter results by $1.2 million.

Universal Stainless segment sales were down 24% from the first quarter of 2008, primarily due to a 19% decrease in Tons Shipped, while Dunkirk sales declined 43%, because of a 28% decrease in Tons Shipped. Both segments sales were negatively impacted by lower surcharges in comparison to the first quarter of 2008.

Our gross margin before the impact of the unusual charges previously discussed was $2.2 million for the 2009 first quarter or 5.3% of sales versus 17.7% in the first quarter last year and 7.2% of sales in the 2008 fourth quarter.

Our selling and administrative expenses before the impact of the unusual charges were $2.6 million, a decline of approximately $422,000 from the year ago period.

During the quarter we generated cash flow from operations of $2.6 million. Our managed working capital, consisting of accounts receivable and inventory minus accounts payable, fell by $8 million. This was achieved through a 16% reduction in work in process inventory, lower material values and the impact of curtailing operations.

Capital expenditures during the quarter were $3.7 million, of which $2.5 million related to the Bridgeville Melt Shop upgrade. In February we executed a new unsecured loan agreement with PNC Bank to support this initiative that provided a $12 million 5-year term loan and a $15 million three-year revolving credit facility.

That completes my review of the financials. I will now turn the call back to Denny.

Denny Oates

Thanks, Rick. Today our operations are focused on cost reduction and generating a healthy cash flow, while we continue to drive our strategic initiatives to provide unparallel customer service, invest in our facilities and develop our organization for future profitable growth.

Currently, we are being very proactive with our customers. We increased prices by $0.05 per pound on air melted steels and increase appears to be holding. We are running significantly reduced operating schedules, but still maintaining our ability to flex our operations as dictated by customer demands.

We continue to expand our access to new markets with the awarding of AS 9100 Certification at Bridgeville facility and we are headed for certification at Dunkirk soon.

We are committed to our strategic investment program, which squarely targets broader product offerings, reduced production cycle times, increased customer service levels, improve material yields, reduced operating costs and enhanced working capital management. These are all essential for current conditions and for positioning, Universal to win business as the market recovers.

We have also strengthened our company with addition of two accomplished industry veterans, Bill Beible has joined us as, Senior Vice President of Operations and Chris Ayers has recently joined our Board of Directors.

Turning to our outlook for the second quarter, as we said in today's release, we are not providing specific earnings guidance because of the unprecedented market uncertainty. However, based on current level of entry, the decline in our backlog since year-end 2008, we anticipate that second quarter sales will be below those of the first quarter of 2009.

Our performance will be aided by our cost saving initiatives and better alignment of material costs to surcharges. We expect to generate positive cash flow and preserve our very strong balance sheet.

That concludes our formal remarks. We are now ready to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Edward with Sidoti.

Edward Marshall - Sidoti & Company

Good morning, gentlemen.

Denny Oates

Good morning.

Edward Marshall - Sidoti & Company

My first question is how soon do you think you can match your material cost and current cost of the market this time?

Denny Oates

When you take a look at the trend in raw material cost over the last four or five months, I think we're coming out of that squeeze that we've been experiencing. I would say by the end of the second quarter, we should be in good balance, barring any unknown movement in raw material cost. Our expectation has now essentially moved sideways as we go through the second quarter.

Edward Marshall - Sidoti & Company

Okay. And then with the inventory, what's your expectation for the inventory for the year? Do you assume that will come down or stay flat?

Denny Oates

You're talking about our inventory or customer's inventory?

Edward Marshall - Sidoti & Company

No, your inventory, I'm sorry.

Denny Oates

We would expect our inventory to come down during the second quarter and the third quarter based upon our current expectation on market demand. It always has been a very exciting industry and things are changing week-to-week-to-week. And our current plan would be to have further inventory reductions here as we move through the second quarter.

Edward Marshall - Sidoti & Company

So, kind of looking at then your working capital for the year, do you expect to see that as an inflow or use of cash?

Denny Oates

When you say for the year, you mean through December of 2009?

Edward Marshall - Sidoti & Company

Right. With respect that it's, a lot of things can change.

Denny Oates

When after the year-end 2009, nine months out, it's a little hazy for us and that's why we've been reluctant and pulled some of our earnings guidance. But, I would tell you, over the short-term of the next three to four months, we would expect to see further decreases in inventory. That would be a generation of cash as you look at our working capital position.

Edward Marshall - Sidoti & Company

Okay. And then as far as the destocking is concerned, do you have a timeframe as to when this can be completed in the industry, and again with respect that it's very difficult to make those projections?

Denny Oates

Like everybody else in the industry, I think we are all getting gun shy trying to forecast that. The last two or three weeks, I think I visited with virtually everyone of our major service center accounts, the number of our forging accounts, the general vibe you get from the field, would be given the low level of demand today in their purchasing practices, we would expect to see something improved as we get to the latter parts of the third quarter of this calendar year.

But I would quickly add to that, that we felt that way about three months ago based upon customer feedback. I think what’s happening is the demand levels that they are seeing continues to surprise on the downside.

Edward Marshall - Sidoti & Company

Now, your service centers are for the tool steal of predominantly privately held and until the increase in the reserve that you mentioned that was for one in particular service center. How many do you foresee, kind of falling in that same pathway, knowing that the tool steel is related to the automotive industry.

Denny Oates

We are not anticipating any further issues at this magnitude. The $4 million that I mentioned that was on credit hold, relates to about four or five customers. Those customers are paying us, which is different from the one company we took the reserve on, but paying us a much lower rate than normal. So at this point in time, there is nothing when you are rising in terms of what we saw in the first quarter.

Operator

Your next question comes from Nat with Next Generation Equity.

Nat Kellogg - Next Generation Equity Research

Good morning, guys. How you’re doing?

Denny Oates

Hi. How are you?

Nat Kellogg - Next Generation Equity Research

Good. Just obviously, at the current activity levels you guys would still be nicely profitable as long as the material cost were more inline with the pricing in the environment, I mean that’s the primary headwind, I realized less profitable than a year ago. But that's the primary headwind, am I correct in looking at it that way?

Denny Oates

I think squeeze for the last 4 or 5 months was the rapid decline, yes.

Nat Kellogg - Next Generation Equity Research

Okay. And the way that might be resolved quickly than the end of the second quarter would be either an uptick in commodity prices or if volumes picked up than it let you work through things a little bit faster.

Denny Oates

That's true.

Nat Kellogg - Next Generation Equity Research

And then, I just wondering on the power gen side, I mean I know that you guys are thinking in Q4 had said that the GE was still booking orders for the turbines. I'm just curious about sort of what you're seeing there, sounds like your being a little bit more cautious today than maybe you were three months ago.

Denny Oates

If you take a look at our sales to forgers in the in the first quarter we did see a nice increase year-over-year and even but if you look at sequentially they are somewhat down and as you go around and talk to our various forging customers that feed into the GE's of the world, you hear two things, one is lower demand and the need to reduce inventory.

They were kind of the last market that we served that really saw the impact of decreased demand and essentially it appears to me that they finished off a number of projects. But perception, that there is too much inventory in the pipeline and they are readjusting there inventories as we speak. They are all generally optimistic about the tail end of 2009 and 2010 however.

Nat Kellogg - Next Generation Equity Research

Okay, that's helpful. And then I just I know you guys given us this before, but, may be now that we are a little bit far along the process and was actually put some money towards the projects. I was wondering if you could just sort of maybe give us an uptight on what you now, what you expect, so the timeline looks like for this capital investment, when you expect to be completed, when would you expect to see benefits and I know we're looking out to 2010 but, and when you expect to all the cash to sort of go out, well that would be sort of helpful if you don't mind.

Denny Oates

Take a look at the project itself we are about a third complete, if you look at the spending.

Nat Kellogg - Next Generation Equity Research

Okay.

Denny Oates

We've got the line share of some of the big equipment in place already. What we've said at the last meeting, the last conference call still holds true, which is we would expect by the end of September this year to have the vast majority of the equipment in place and to be operating and we should start to generate the savings there tail end of the third quarter, early fourth quarter.

A large piece of the investment is the systems related to the equipment that is not scheduled to be completed until April of 2010. So the full bore of savings that we talked about in prior press releases I would not look for until mid-second quarter of 2010.

Nat Kellogg - Next Generation Equity Research

Okay. And the savings are really do because you are able to process orders more quickly and meet the delivery schedules that you promised I know. Anyway you guys there you wanted the things you talked about was sort of trying to make sure that Universal was better at sort of meeting the delivery schedules that you guys had promised customers and what not. Maybe you could talk about any other additional savings there?

Denny Oates

Reliability is the key part of what we're doing, alright. But the high tangible savings come in yields, quality improvement and lower consumption of those operating supplies in our Melt Shop.

Nat Kellogg - Next Generation Equity Research

Okay, that's great. Alright, guys. That's all I got. I appreciate the call and I will hop back in the queue.

Denny Oates

Okay.

Operator

Your next question comes from Tim with Davenport.

Timothy Hayes - Davenport & Company Llc

I just have two questions. First on the $1.5 million of unusual charges for the raw material values and the decline in the raw material values, do you have a breakout of how that affects the two segments?

Rick Ubinger

Yes, Tim, personal segment was $1.2 million (inaudible) segment was $300,000.

Timothy Hayes - Davenport & Company Llc

And then for your sales guidance for Q2, I'm assuming that the sequential decline is going to come both from, foreign volumes and foreign realization. Can you give a little more color on is it going to be more so volumes and lesser realizations or vice versa or just some more detail on that if you could?

Denny Oates

I think as the majority of it's going to be volume. Take a look at materials our expectation is it's going to move sideways, we have seen a little bit of movement up, which means that surcharges in June to summer, and we've also $0.04 to $0.05 per pound, price increase through, which appears to be holding as I said during my prepared comments. Looking at the second quarter, clearly, when you look at our backlog and current levels of order entry we will expect our volume to be the majority of our anticipated short fall on the topline.

Operator

Your next question comes from Michael with CLK.

Michael Gallo - C. L. King & Associates

Hi, good morning.

Rick Ubinger

Michael, how are you?

Michael Gallo - C. L. King & Associates

I've been good. How are you? Question I have is just on the credit side of things. Can you speak to whether you see larger issues then and just one or two or the handful of customers, how you are revaluating credit and how you feel about the rest of the customer base being able to weather the current down cycle? Thank you.

Rick Ubinger

If you look at the last three to six months credit has become an increasing issue with us. We look at that everyday. We do have a general trend where customers are paying slower. This one instance was a major issue that we've watch very carefully we've been in the almost daily contract with the customer involved. And we thought it was prudent due to, to address that situation today based upon everything we know and everything that we see. We do not anticipate anything else at this point in time of this magnitude.

The other customers that we have on credit hold are generally paying us, but [four] in that category are paying us slower. We have that numerous request from customers to extend terms, things of that nature. I think, this is all reflective of what you hear and read about the newspapers. The credit crunch and people are looking to stay as liquid as possible, and they can do that of their suppliers, some customers are going to try and do that.

Michael Gallo - C. L. King & Associates

Do you have a breakdown in terms of just this one customer? How big a customer they were in 2008 at all, Rick?

Rick Ubinger

This customer was I believe they were about 3% of our sales.

Michael Gallo - C. L. King & Associates

Then finally, I guess as you go through the order patterns over the last six to eight weeks, is there any signs that you've seen a bottoming in the patterns or is it spotty, is it lumpy, is it vary week-by-week, or is it kind of continue to long the deterioration that you saw the last couple quarters?

Denny Oates

If you look at the last several months, if I can take it back there, or January showed little improvement over December in terms of incoming business. February, we've lift up. March, we went back down. Right now as you look at where we are at today, it’s kind of moving sideways. So, when I do reflect back in the last three or four months, we kind of hit a low level and we stayed there except for the one blip there in February.

Michael Gallo - C. L. King & Associates

Great. And then any update on the European business or what you are expectations are for that this year?

Denny Oates

We continue to have a lot of discussions, interesting developments over the last quarter and it's nothing that's going to swing the needle or anything. But we did make our first shipment to a new customer in Germany. We've been exchanging some technical discussions with.

We are also shipping some additional plate products over to Sweden. So, they are new developments, but again if you take a look at that in a broader scheme of thing, direct international sales are only about 5% or 6% of our total mix.

Michael Gallo - C. L. King & Associates

Sounds like its progressing. That's all I have. Thank you.

Operator

Your next question comes from Mark with KeyBanc.

Phil Gibbs - KeyBanc

This is Phil Gibbs for Mark Parr. How are you guys?

Denny Oates

Good, Phil. How are you doing?

Phil Gibbs - KeyBanc

Okay. There was a question, just a couple of questions ago about the volume and pricing impacts in the second quarter. I just wanted a little bit more color on the pricing side. On a sequential basis, do we really have another life to go or the surcharge impacts, kind of being minimized at this point. Meaning, are we closer to sequential stability as each quarter passes on here?

Denny Oates

For more I'd say, I'd say we are closer to some level of stability. Let’s not the say there aren’t some crazy things you see happening in the market place every now and then, but if you look at surcharges and you look at the general trend in raw materials, they have their ups and downs, but they would appear to stabilize somewhat and may be in some of the commodities have their upper buyers in last 2 or 3 weeks.

From a base prize standpoint, there has been general support for some base price increases $0.05 per pound which is roughly about 5% as well. So I would say, it’s trending towards more stability.

Phil Gibbs - KeyBanc

On the bad debt reserve, the $1.9 million increase that was predominantly baked in the SG&A it looks like.

Denny Oates

That’s correct.

Phil Gibbs - KeyBanc

How should we view that as coming out in come quarter or how do we view that just for modeling purposes?

Rick Ubinger

The only way that will change Phil is, if this customer does obtain some financing that they will be able to payoff these invoices. So that’s the only way it will come out.

Phil Gibbs - KeyBanc

What do you guys view the likelihood of that as?

Denny Oates

I think the fact that we took the big adjustment tells you that we view the probability of that as swum.

Operator

(Operator Instructions). There are no further questions at this time. Mr. Oates, do you have any closing remarks?

Denny Oates

Yes. I just want to thank everybody once again for joining us today. These are certainly some very challenging times that we've taken important steps to strengthen our ability to manage through the times. We do plan to maintain our strong cash position and our strong balance sheet. We all look forward to updating you on our next conference call on how we are doing. Thank you very much.

Operator

This concludes today's conference call. You may now disconnect.

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