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Universal Stainless & Alloy Products, Inc. (NASDAQ:USAP)

Q1 2013 Earnings Call

May 1, 2013 10:00 am ET

Executives

June Filingeri – President, Comm-Partners LLC

Dennis M. Oates – Chairman, President and Chief Executive Officer

Douglas M. McSorley – Vice President of Finance, Chief Financial Officer and Treasurer

Analysts

Dan Whalen – Topeka Capital Markets Inc.

Lloyd O’Carroll – Davenport & Company

Operator

Good day, ladies and gentlemen and welcome to Universal Stainless’s First Quarter 2013 Conference Call and webcast. At this time, all participants are in listen-only mode. Later, we’ll conduct a question-and-answer session and the instructions will be given at that time. (Operator Instructions) As a reminder this conference call is being recorded. At this time, I would like to hand the conference over to Ms. June Filingeri, ma’am you may begin.

June Filingeri

Hi thank you, good morning. This is June Filingeri of Comm-Partners and I also would like to welcome you to the Universal Stainless conference call. We are here to discuss the company’s first quarter 2013 results reported this morning.

With us from management are Denny Oates, Chairman, President and Chief Executive Officer, Paul McGrath, Vice President of Administration, and General Counsel, Doug McSorley, 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 coordinator 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 would now like to turn the call over to Denny Oates. Denny, we are ready to begin.

Dennis M. Oates

Thank you, June. Good morning everyone. Thanks for joining us this morning. As expected, first quarter sales were $49.1 million, up 4% sequentially on 8% higher volume. But sales were down 34% on 31% fewer ton shipped compared with our record first quarter of last year.

The increased shipment volume in the first quarter versus the fourth quarter of 2012 came in every customer category except conversion services and in nearly every major end market. There was also a 39% increase in order entry in the quarter compared to the fourth quarter throughout. The increase in incoming business was not sufficient to reload our backlog which declined $5 million or 10% to $46.6 million.

We continue to see inventory correction within the supply channel during the quarter, especially in oil and gas and inventory control remained tight throughout with purchases been made on an as needed basis. Record level lead times at older mills and volatile raw material costs are further encouraging handling buying strategy on the part of our service center for our customers.

The difference between the sequential increase in our sales and volume in the first quarter was due mainly to a lower price mix characterized by proportionately more semi-finished products and less remelted and vacuum induction melted produced product.

Our operating income in the first quarter was essentially at breakeven as was our net income at a penny of share. The decline in margins compared to Q4 of 2012 was directly attributable to four factors.

First, higher depreciation expense on mainly North Jackson assets placed in service, approximately $0.05 a share. Second, our strategic decision to continue our focus on refining manufacturing processes for new products and achieving industry and customer approvals, which would include costs such as process and product experiments, lower than normal yields, audits, equipment surveys, consulting, extensive product testing at outside labs and inefficient equipment utilization.

Third, dispositioning test material, which is out of spec, and fourth the combined effect of the continued low level of plant activity and the lower priced, lower margin shipment mix. Cash flow from operations was positive at $4.4 million due to reduction of $2.8 million in managed working capital and $3.8 million in depreciation, partially offset by $3.6 million in capital spending. We finished the quarter with total debt of $104.7 million with 34.5% debt to total capital.

With the commissioning of most North Jackson equipment now successfully behind us and its integration in the Universal substantially completed, we have literally become a single manufacturing system consisting of four closely linked facilities.

As a result, we move to single segment reporting with this first quarter report to reflect the way we now capture information and manage the business. We have also added a new metric starting this quarter that looks at our sales of Premium Alloys versus Specialty Alloys.

Premium Alloys are any products that are vacuum induction melted, so this is a new window into our business and another way to access our progress going forward. In the first quarter, Premium Alloys represented approximately 5% of sales. Our strategy is to grow that percentage to 25% to 30% by 2015 with major approvals being achieved in 2013 and volume ramping in 2014.

We reached a major milestone in our plant with the winning of our first contract with Rolls-Royce as was announced last week. Qualifying our products and the introduction with major OEMs in our key end markets has been the foremost priority, which you heard me talk about many times.

The qualification process is lengthy. It’s intense and involves all of our facilities, not just North Jackson. Rolls-Royce is among the most demanding OEMs out there so our success with them and getting a five-year contract was a major accomplishment. We’ve also received product qualifications from a few additional OEMs as well showing our effort is gaining traction.

Just to complete my update on North Jackson, our vacuum induction melting furnace produced 41 heats in the first quarter. Our four vacuum-arc remelt furnaces processed 172 heats. Forge production remain low with about 8.9 million pounds processed across the dyes, including stainless, nickel alloys, true steel and titanium grades. Nadcap Heat Treat certification was awarded in February, a critically important foundation for other approvals. This heat treat operations processed about 5.8 million pounds during the quarter.

And turning to our sales by end market, let me mention first that we have renamed two of them, petrochemical is now oil and gas, and service center plate is now heavy equipment. Let me start with aerospace. Aerospace remained our largest market in the first quarter and represented 52% of sales versus 54% of sales in the fourth quarter of 2012 and 50% of sales in the first quarter of 2012.

Our sales to aerospace were up slightly on a 5% increase in volume from the 2012 fourth quarter, while sales and volume were down approximately 31% from the first quarter of 2012. As most of you know, gaining approvals of our vacuum induction melted production gives us a major new platform for growth in aerospace category which will benefit our results in a meaningful way beginning of 2014 and beyond.

There also continues to be favorable news in the aircraft manufacturers. Boeing reported last month and confirmed on our earnings call last week that commercial airplane demand is strong, their backlog is healthy and they planned to keep increasing production rates, they also underscored their confidence that the market will continue to be strong.

Backing that up, they have now rolled-out their first next generation 737 at the increased production rate of 38 airplanes per month and reiterated their plan to increase that rate to 42 airplanes for month in the first half of 14. While it slightly adjusted the rate of 747-8 production to 1.75 aircraft from 2 per month, they were successful in ramping up the 777 to a record 8.3 airplanes per month. They also are continuing their plan to increase production of the 787 to 10 per month by year-end from its current rate of 5 per month. Now that they have FAA approval for their battery solution, Boeing said they intend to complete all planned 2013 deliveries by year-end.

Meanwhile Airbus moved to the top spot for aircraft orders in the first quarter with 431 orders, Airbus now has a backlog of 4,948 aircraft, which is an industry record and represents about seven years of production. So, earlier this month, Airbus reported that construction officially began on their manufacturing facility in Alabama. Despite the continued strong outlook on commercial builds, demand for our aerospace grades in the first quarter was tempered by customer inventory concerns and flat-to-down demand in the Aftermarket and Defense segments.

Oil and gas market sales represent 13% of our first quarter sales compared with 16% of sales in the 2012 fourth quarter, 21% in the first quarter of 2012. Our oil and gas sales were down 17% sequentially, on 23% lower volume and sales were 60% lower than in the first quarter of 2012 on 62% lower volume.

As you’ve heard from others, there was inventory de-stocking in the supply channel during the quarter. That’s against the backdrop of a 3% decline in U.S. onshore rig count, slow dry gas drilling activity even with the drill down of storage because of the cold winter and recent weakness in oil prices.

Fortunately, drilling was active in Canada, the Gulf of Mexico and many international markets for the various oil service majors in the quarter. Baker Hughes and our recent earning report forecasted a modest increase in U.S. rig count at the several quarters decline. Realistically, we’re always maintaining a couple more quarters for channel inventory to come back in balance.

Power generation represented 12% of first quarter sales, which is inline with the 2012 fourth quarter, but below the 15% of sales that represented in the first quarter of 2012. Power generation market sales were down 2% sequentially on 17% higher shipments, but down 49% on 50% lower volume than in the first quarter of 2012.

Market demand for us continues to come from the quick turn maintenance side of the power gen market as expectations for new gas turbines builds continue to get pushed up. GE reported receiving eight orders for new turbines in the first quarter. However, they didn’t say they expect to get orders for 120 to 130 turbines for the year spread across Latin America and the Middle East. At this point, we expect maintenance to be the main source of power generation sales for the next few quarters.

Heavy equipment market sales represented 11% of first quarter sales, compared with 10% in 2012 fourth quarter and 6% in the first quarter of 2012. Sales were up 15% sequentially, on 27% increase in volume and up 28% from the 2012 first quarter on a 56% volume increase.

Europe motor market continues to be the main demand driver for our tool steel products and remain the positive driver in the first quarter. On April 2, GM reported their best smart sales in the U.S. in five years and Ford said their U.S. sales in March was the best since May of 2007 with truck sales especially strong for both companies in tandem with the housing market recovery.

On the other hand from a different story for the off-road market for the first quarter and reduced their forecast for the full year mainly due to their increase tax benefit. We expect stable activity over the next quarter. We’re including an additional market category and I report today, General Industrial, which includes sales to a broad variety of industries including semiconductor and medical.

General Industrial represented 10% of first quarter sales compared with 4% in 2012s fourth quarter and 7% in the first quarter of 2012. General Industrial sales increased 152% sequentially, on 124% increase in volume and we’re up 3%, on 62% higher volume compared with the first quarter last year. That was driven mainly by semiconductor market sales.

At this point, let me turn the call over to Doug for the financial report.

Douglas M. McSorley

Thank you, Denny. As Denny said, our first quarter sales were $49.1 million, that’s a decrease of $25.5 million or 34.1% from the first quarter of 2012 and a 31.4% decrease in shipments. Sequentially, sales increased by $2 million or 4.2% on a 8.4% increase in shipments.

Our gross margin in the first quarter was $4.6 million, a decrease of $9.6 million from the same quarter of 2012. Sequentially, it was lower by $1.3 million or 22.1% than the gross margin recorded in the fourth quarter of 2012. As a percentage of sales, the gross margin was 9.5% compared with 19.1% in the first quarter of 2012 and 12.7% in the 2012 fourth quarter.

As Denny noted, we placed assets and services throughout the end of 2012 resulting in an increase in depreciation of $600,000 from the fourth quarter of 2012, primarily related to North Jackson, where project capital came into service related to the vacuum induction melting furnace and new VAR’s commissioned in the fourth quarter.

Selling, general and administrative expense for the first quarter was $4.5 million, a decrease of $100,000 or 2.3% from the first quarter of 2012 and $260,000 or 6% above the 2012 fourth quarter. As a percentage of sales, SG&A expense was 9.1% in the 2012 first quarter versus 6.1% in the same quarter last year and 8.9% in the fourth quarter of 2012. Operating income was $167,000 in the first quarter of 2013, a decrease of $9.5 million from the first quarter of 2012 and down $1.6 million from the 2012 fourth quarter.

Our effective tax rate for 2013 is 33.7%. In the first quarter of 2013, we recorded research and development tax credit, benefits booked as a component of tax expense. These tax credits are recognized in the first quarter of 2013, due to the American Taxpayer Relief Act of 2012, those passed in early 2013. They reinstated the research and development credit retroactively to 2012. Under the provisions of the act, eligible research and development expenditures incurred in 2012 generate credits on our 2012 tax return, however, the tax benefits of those credits are recorded in the first quarter of 2013.

Our net income for the first quarter of 2013 was $40,000 or $0.01 per diluted share. This included the benefit of the tax benefit recorded in the first quarter of 2013 of $368,000 or $0.05 of share. In the fourth quarter of 2011, net income was $6.3 million or $0.86 per diluted share and the fourth quarter of 2012 net income was $1.1 million or $0.16 per diluted share.

As we’ve noted in the release, with the North Jackson acquisition, the company’s operating facilities have become more integrated, resulting in management increasingly viewing the company as one unit. Given the progress of integrating our manufacturing operations and this change the management’s view, we have move to a single reportable segment beginning with this quarter.

It should also be planned out there as we drive our strategic focus on developing higher value products, we have introduced the table, reporting our sales in Premium Alloys and Specialty Alloys that’s intended to help in understanding and assessing our progress.

Turning to the balance sheet, our managed working capital as of the end of 2012 first quarter, which includes receivables and inventory less accounts payable was $106.6 million, a reduction of $2.8 million or 2.6% from the fourth quarter of 2012 levels. The value of end product and inventory increased to $14.3 million or 960,000 from the fourth quarter of 2012.

Capital expenditures for the first quarter were $3.6 million. During the quarter, the company amended its credit agreement. We did this to provide additional flexibility within the agreement as we operate in these cyclical markets. At the end of the quarter, our total debt was $104.7 million and our debt to total capitalization improved to 34.5% from 35% at the end of 2012.

This concludes my report. Denny, I’ll turn that back to you for final comments.

Dennis M. Oates

Thanks Doug. In summary then our sales shipping volume and order entry improved sequentially in the first quarter of 2013 or well below the first quarter of last year. And market trends were mixed in the quarter, but inventory control is uniformly tight throughout the supply chain.

Our lower production activity coupled with higher depreciation expense and cost associated with pursuing strategic product approvals resulted marginal profitability during the quarter.

From a strategic standpoint, however, the first quarter was a quarter of significant advancement. After a full year of effort, we started to attain qualification of our vacuum induction melting production for major OEMs, including our order in five year contract from Rolls-Royce. We and our customers expect improving demand to be gradual during the balance of 2013. Our focus is on seizing the opportunities our markets present while advancing step firstly and rapidly on a strategic plan.

I’ll turn the call over now for your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We have question from Dan Whalen from Topeka Capital Markets.

Dan Whalen – Topeka Capital Markets Inc.

Hey, I apologize if you touched it on and as I get on the call little bit late here. But can you just talk about a little bit in terms of how April worked in terms of the market? And also maybe just touch upon just maybe some of the conversations you’re having in terms of price negotiations and how competitive that is and the implications of the added pressure from imports?

Dennis M. Oates

Good morning Dan.

Dan Whalen – Topeka Capital Markets Inc.

Good morning.

Dennis M. Oates

Three questions and then I guess first of all, as you look at our bookings for April, we just wrapped up April yesterday. In April, it was about an average month compared than a typical month in the first quarter, so specifically our bookings would be about $15 million to $16 million.

Dan Whalen – Topeka Capital Markets Inc.

All right.

Douglas M. McSorley

We normally publish that number. So we came into this year with about just under $18 million in January went down to just under $12 million in February and we’re about $15 million in March, $14 million, $15 million, I’m doing this by memory.

Dan Whalen – Topeka Capital Markets Inc.

Okay.

Douglas M. McSorley

All right, and then in April, it is about the average of the first quarter. So what does that tell you, yes where we are at is with the market is giving us opportunities better than we saw in the second half of last year, that’s certain, but it’s nowhere near where it was a year ago.

Dan Whalen – Topeka Capital Markets Inc.

Right.

Douglas M. McSorley

It is not – there is not a strong positive momentum here at this point in time. Customers are pretty much hand them out.

Dan Whalen – Topeka Capital Markets Inc.

Yeah.

Douglas M. McSorley

They’re managing inventory very carefully. Raw material prices are not increasing. So if there is no incentive there to make longer-term commitments and from a lead-time standpoint, as I said in my comments they’re record low.

So there is no incentive really to pace longer-term commitment. So hence in the earlier part of my comments, if you didn’t hear Dan we will just pretty much hand them out. That’s what we see our customers doing and that’s pretty much in all the markets that they were dealing with at this point in time.

As far as pricing goes out there, every month it gets tougher. We are very disciplined about that subject because we recognize the impact on profitability. We have walked from some business based upon pricing, but it is getting more competitive out there. All the mills are hungry, every order is a battle. So you’re seeing more and more price competition out there. Does that answer the three? I think I covered the three.

Dan Whalen – Topeka Capital Markets Inc.

Yeah, and then imports are probably not helping. And then just, I mean, I think, I mean a lot of people I think in just the general space, first half has kind of I think written off so to speak people are hopeful for second half recovery.

But just given your transformation that’s your – really a 2014 story. I mean even in a flat or well single-digit revenue growth environment, can you give us a little color in terms of what your real leverages there and once we get a lot of these production cost out of the way, we get more of a normalized fixed cost absorption environment. Any kind of color you can add on that in terms of kind of giving over the half year in terms of this ramp up process?

Dennis M. Oates

Our expectation is activity in the markets are going to improve gradually each quarter. So you’ll see some greater market activity out there. We’re not anticipating any tremendous red hot market place out there. So we would expect to see some improvement on the top line. These approvals were working on a very diligently.

As I thought, we’ll get approvals in each quarter and as we get those will be transitioning those into additional sales over or above normal market demand that we would expect to see improvement in our Premium Melted product as we move through each quarter of the year. If you look at the first quarter that did not happen compared to the fourth quarter, but our expectation is you’ll start to see improvement in that each quarters we go through.

Initially when you start out, you’re not going to get the normal margins you will get on those products, all right, because we are in a learning curve one there and so get all these processes tied down and basically we’re experimenting with customer product. So we’re going to have some unusual yields like we saw in the first quarter.

But as those higher value products come into stream and you will see our margins go up. And as you look at the general trend in these approvals are working on when they all come together. They pretty much come together as we move through the summer timeframe, and are all focused on first day of 2014 in terms of meaningful volume.

Dan Whalen – Topeka Capital Markets Inc.

So even almost in a flat revenue environment, this maybe the case or not, but even in the flat 2014 revenue environment, there is significant room for margin improvement as a lot of the learning curves has been state for so to speak.

Douglas M. McSorley

If you look at North Jackson itself and even the other plants, we have new people, new equipment, new products and new processes that we’re working on. Every month, we get better as we clubbed that learning curve, which would suggest you should see lower cost than higher margins as we go down the road.

Dan Whalen – Topeka Capital Markets Inc.

Okay, great.

Douglas M. McSorley

Right now, we’re at the peak level of the all the extraneous cost from an approval standpoint.

Dan Whalen – Topeka Capital Markets Inc.

I appreciate. That’s very helpful. All right, thanks a lot guys.

Douglas M. McSorley

You’re welcome, Dan. Have a good one.

Operator

Thank you. (Operator Instructions) Our next question comes from Lloyd O’Carroll from Davenport & Company.

Lloyd O’Carroll – Davenport & Company

Good morning, Denny.

Dennis M. Oates

He Lloyd, how you’re doing?

Lloyd O’Carroll – Davenport & Company

Yeah. All right. The, of the customers that were going through qualification on or expect we go through qualification on. What percentage of the volume that you expect to have in 2014 at the end of this process are already done and as oppose to what’s remaining. I am thinking it of the qualification process is how far along are you and trying to quantify?

Dennis M. Oates

You’re talking about the percentage of the number of customers we’re taking about or the volumes?

Lloyd O’Carroll – Davenport & Company

Yeah, it may help to give us both words.

Dennis M. Oates

I think we’re talking about; we’re in a second inning, third inning. There is a lot of intensity around for example, Rolls-Royce we announced. Rolls-Royce allowed us basically to announce that.

The other customers, we do not have the authorization to announce who we were dealing with, all right? Rolls-Royce has a very intense program to get approved, a very high cost program to get approved, and it’s very expansive when you look at the number of alloys, you’re talking about. So I would say it’s the most expensive. But if I look at all the customers we’re talking about developing here relatively short year and a half timeframe. I would say we’re about in the second inning.

Lloyd O’Carroll – Davenport & Company

Okay, I think that this helps give a little feel for where we are in the process in really just getting started.

Douglas M. McSorley

Yeah.

Lloyd O’Carroll – Davenport & Company

Yeah, thank you.

Dennis M. Oates

You’re welcome.

Operator

Thank you. (Operator Instructions) I am showing no one in queue, at this time. I would like to hand the conference over to Dennis Oates for any closing remarks.

Dennis M. Oates

Okay, so thank you. Thanks again for joining us today. We know that 2013 will continue to present challenges in our market, but also opportunities. We are focused on seizing on those opportunities while moving aggressively forward with our plan. We look forward to talking to you in July to update you on your progress. Have a great day.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes our program for today. You may now disconnect and have a wonderful day.

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