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Universal Stainless & Alloy Products (NASDAQ:USAP)

Q1 2010 Earnings Call

April 28, 2010 10:00 AM ET

Executives

June Filingeri - Comm-Partners

Denny Oates - President and CEO

Rick Ubinger - VP of Finance and CFO

Chris Zimmer - VP of Sales and Marketing

Analysts

Michael Gallo – CL King

Nat Kellogg – Hudson Securities

Phil Gibbs – KeyBanc

Mark Parr – KeyBanc Capital Markets

Operator

Good morning. My name is Crystal and I will be your conference operator today. I would like to welcome everyone to the Universal Stainless first quarter 2010 conference call and webcast. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be question-and-answer session. (Operator instructions) As a reminder today’s call is being recorded, and now I would like to turn the call over to Ms. Filingeri. Please go ahead ma'am.

June Filingeri

Good morning. This is June Filingeri of Comm-Partners, and I'd also like to welcome you to the Universal Stainless conference call. We are here to discuss the company's first quarter results, which were 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 the formalities out of the way, I'd now like to turn the call over to Denny Oates. Denny, we are ready to begin.

Denny Oates

Thanks, June. Good morning everyone, thanks for joining us today. The financial results we reported this morning reflected further recovery and robust sequential growth. Although first quarter shipment volume was 12% below 2009’s first quarter, volumes jumped 37% over the fourth quarter of 2009. Shipments to services centers, forgers and rerollers increased 59%, 29% and 62%, respectively, over the fourth quarter. It’s good to see the volume improvements are broad-based by product and also by end use market.

The main drivers of the sequential growth were renewed stocking throughout the supply chain, modest improvement in end user demand and successful execution of our customer service and marketing initiatives.

Our total first quarter sales increased 30% over the 2009 fourth quarter while our operating income tripled. The improvement in profitability was due to the higher shipment volume as well as the progress being made company-wide to reduce costs, improve yield and shorten cycle times. Our capital projects and process improvement programs over the past two years are producing tangible results. Melt shop productivity has increased and first time (through) quality has remained excellent. Recent investments in low cost heat treating and the introduction of cellular manufacturing of bar products are also contributing to lower cost.

Turning to our end markets, aerospace remained our largest market at 34% of first quarter sales, up from 32% in the 2009 fourth quarter, but lower than the 45% of sales they represented in the first quarter of 2009. While our aerospace sale were down 38% year-over-year, they were up 38% sequentially. The increase is mainly attributable supply chain inventory replenishment given that aircraft build rates have remained fairly consistent.

Boeing has some optimistic comments on their earnings call last week, they pointed to an improving outlook. They noticed the global economic recovery is leading to increased passenger air traffic, especially in emerging markets, and therefore an improved financial outlook for the world’s airlines. Boeing also reported that the 787 is on schedule for first delivery in the fourth quarter and they increased the 737 production rate beyond the current 31 planes per month. They have already announced plans to increase production rate for both the 777 and 747-8

Our next largest market in the first quarter was the petrochemical market, primarily oil and gas which represented 22% of sales, about the same level as in both the first and the fourth quarters of 2009. Our petrochemical sales were down 13% from the first quarter of 2009 but they rose 37% sequentially.

As discussed before, we have been focusing on increasing our presence in the oil and gas market. Oil exploration is picking up due to higher oil prices and our steel is typically used in the exploration equipment.

Power generation represented 17% of our first quarter sales, up from 16% of sales in the year ago period, but down from 23% of sales in the fourth quarter. Our power generation sales were 14% from the first quarter of 2009 and 4% lower than the 2009 fourth quarter. This continued the trend we first saw last quarter. The market for new turbines is not expected to recover until 2011. However we did see higher than expected turbine maintenance spending in the first quarter.

GE’s first quarter report shed some light on the expected build schedule for new turbines. They reported orders for 10 gas turbines in the first quarter versus 18 last year.

Our service center plate sales moved up to 18% of sales in the first quarter of 2010 from 13% in the 2009 fourth quarter and 11% in the 2009 first quarter. Service center plate sales were up 30% from the first quarter of 2009 and 75% from the 2009’s fourth quarter with a 94% sequential increase in shipments. You may remember that our service center plate sales in the fourth quarter were up nearly threefold from the third quarter. This ramp up is being driven by the strong recovery in the domestic automotive industry. For example, earlier this month GM reported that combined sales for Chevrolet, Buick, GMC and Cadillac were up 43% in March from March of 2009.

Service centers have had to build inventory to meet this snapback in demand following several quarters of aggressive destocking. As we have said for the past two quarters, we expect 2010 to be much better year overall for service center plate than 2009. The first quarter gave us a good start.

Before I turn the call over the Rick Ubinger, I want to join with all Universal employees and the Board of Directors here to wish you the best as you leave to pursue a new opportunity. We appreciate your many contributions to the success of Universal Stainless over the 16 years you served as our CFO. Rick, best of luck to you from all of us.

Now, let me turn the call over to you for your report.

Rick Ubinger

Thanks, Denny. I simply want to add that my career at Universal Stainless has been personally rewarding. However after 16 years, it is time for me to pursue a new challenge. I would like to thank Mac McAninch, Denny, the Board of Directors and all Universal Stainless employees for their support. I would also like to thank everyone on this call for making the past 16 years a memorable experience.

Now for my report on the first quarter. Sales for the first quarter of 2010 were $34.7 million, which was below the $42.2 million reported in the 2009 first quarter but above the $26.7 million in the 2009 fourth quarter. The decline in sales from the year ago period is attributable to an overall 12% decrease in shipments and product mix. The decrease in shipments of aerospace products and petrochemical products of 43% and 15% respectively were partially offset by increases in service center plate products and power generation products of 42% and 10% respectively.

The second quarter increase in sales is attributable to 37% increase in shipments most of which relates to increased shipments of semi finished products and bar products as Denny has discussed.

Operating income for the first quarter of 2010 was $2.3 million in comparison to $6.4 million operating loss in the 2009 first quarter and operating income of $736,000 in the 2009 fourth quarter. The 2009 first quarter results included $6 million of unusual charges related to the effects of the recession and the imminent bankruptcy of a service center customer. Sequentially the improved results were due to increased shipments and operating cost reductions resulting from completed capital expenditure projects, process improvement and higher production volumes.

Production in our melt shop increased by 57% over the 2009 first quarter, and by 101% sequentially. The Universal Stainless segment sales were down 15% from the first quarter of 2009 primarily due to a 10% decline in shipments and product mix. The segment experienced lower shipments in each market category except for plate shipments to service centers, which increased by 41%. Sales increased 35% sequentially on a 39% increase in shipments resulting from improved demand from most markets.

The gross margin for Universal Stainless segment in the 2010 first quarter was $3.7 million or 11.9% of sales versus 7.9% in the 2009 first quarter after excluding the impact of the unusual charges and 9.5% in the fourth quarter of 2009. The year-over-year improvement was due to the decline in material cost as a percentage of sales to 45.3% from 49.1% in the year ago period. Material costs increased sequentially from 42.8% primarily due to the higher mix of semi finished product shipment in the first quarter.

Our operation cost of sales per ton shipped declined in comparison to the prior year period and sequentially due to the higher production volumes and process improvement.

Dunkirk segment sales were down 8% from the first quarter of 2009 and were up 22% sequentially. The year-over-year decline was also due to a 13% reduction in shipments partially offset by higher selling prices. The sequential increase is due to a 12% increase in tons shipped as well as higher selling prices. Dunkirk’s gross margin for the 2010 first quarter was $1.2 million or 11.6% of sales versus a loss of $756,000 in the year ago period after excluding the impact of the unusual charges. Dunkirk’s gross margin was $1.1 million or 12.9% of sales in the 2009 fourth quarter.

Material cost of sales of 57.1% were in line with the 2009 fourth quarter and significantly below the 70.8% reflected in the 2009 first quarter. Our operation cost of sales per ton shipped declined in comparison to the 2009 first quarter primarily due to the benefit of relocating the round bar finishing facility in 2009 while our operating cost of sales per ton shipped increased sequentially due to the mix of products shipped.

During the quarter we increased our managed working capital by $8.3 million to support increased sales activity and growing backlogs. $6.6 million of the increase is reflected within accounts receivable resulting from increased shipment activity especially in the month of March. We increased our work in process inventory volume by 45% during the quarter in response to the rising backlog.

Managed working capital as a percentage of sales fell to 42.5% compared to 46.7% at December 31st, 2009. Capital expenditures for the quarter were $1.1 million of which $629,000 is related to the Bridgeville melt shop upgrade.

At March 31st, the company had cash of $37.8 million and total debt of $12.9 million. The debt includes the $12 million term loan with PNC and principal payments of $600,000 per quarter will commence in May.

That completes my review of the financials. Now I would like to turn the call back to Denny.

Denny Oates

Thanks, Rick. Just to summarize, the market recovery that began in the fourth quarter gained strength in the first quarter. Operating income tripled on a broad-based 30% sequential increase in sales. Our backlog increased sequentially by 47% to $53 million. Our customer service metrics now place us in the best of class category. Deals have been improved 1% to 1.5% with more to come. Operating costs per pound were reduced by 4% versus the fourth quarter of 2009 and by 6% versus the first quarter of 2009.

The capital spending program is on time within budget and generating returns. Our financial condition remains strong with a net cash position of $25 million at March 31.

Based on these improvements and the increase in our backlog, we expect further sequential growth in the second quarter of 2010. Longer term recovery will require more than supply chain restocking however. That will require stronger growth in end market demand as well. The news from our end markets is improving but it is too early to expect market recovery to be more than gradual. We will continue to focus on operational excellence so that we may fully capture the opportunities to further recovery offers.

With regard to Rick’s departure, we have initiated a search and we are optimistic about filing the position by the summer months.

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 the line of Michael Gallo with CL King.

Michael Gallo – CL King

Just a couple of questions. First question – just want to touch on the power gen market, I think from your prepared remarks, Denny, it appeared clear that you were a little surprised by the strength of power gen on a sequential basis. But based on some of the turbine orders and build rates we are seeing out of people like GE, would you expect that rate to just kind of flatten out and not show the same kind of sequential improvement you would expect to see in the rest of the end markets? Or do you think at some point later in the year we will see the destocking finished and (mature)?

Denny Oates

The feedback we get from our customers that they are looking midyear 2011, kind of the second half of 2011, and then 2012 is being back on pace with where they were couple of years back. That’s the feedback we are getting. That slipped a little bit since the last quarter that we talked. Before it was the first half of 2011. So there seems to be some slippage in what the big players like the GEs of the world are seeing in a new turbine number. But you are correct, we have seen a surprising – I was expecting that market to be down more that it was quite frankly, and a lot of that we attribute to maintenance of existing turbines, purchase of parts for which we supply metal.

Michael Gallo – CL King

Based on now what you are seeing in order rates and backlog trends though, would you expect that level of improvement going forward or do you think the first quarter was more of an anomaly on that front?

Denny Oates

I think you are going to see gradual improvement the rest of this year with a steeper improvement as we exit 2010.

Michael Gallo – CL King

Second question I have is just for Rick. What was the nickel impact in the quarter on the gross margins?

Rick Ubinger

Michael, the nickel impact was pretty small actually because of the timing of our purchases and also the cycle time improvements that we are achieving. They are certainly not the way they were a couple of years ago.

Michael Gallo – CL King

Okay, and then just final question. It sounds like the melt shop upgrade is on schedule and on budget. I was wondering if you started to see – did you start to see any of the benefits from that in the first quarter? And if so, how much are you realizing in benefits? And do you still expect to save $6.5 million annually once it's fully implemented?

Denny Oates

As far as the – yes, we did start to see some improvements in our cost performance from the facility actually going back to last year when we started it up. We still have some more work to do in terms of the controls that we will be going in over the course of the next three to six months. And so, the full benefits won’t be seen until we exit this year. I remember that benefits figure was based upon 2008 volumes.

As far as what we are seeing right now today, a lion’s share that yield improvement that I mentioned that 1% to 1.5% you can track back to the melt shop, and a fairly sizable portion of the operating cost improvement goes back there as well.

Michael Gallo – CL King

Right. So is it fair to say kind of you are already getting maybe half of the improvement you would have expected once it's on track or is it not quite that much yet?

Denny Oates

I would say it’s not quite that much, more of like 35%, 40% of it.

Michael Gallo – CL King

Okay, great. Thanks a lot. And also I would like to send my regards to Rick for doing a great job with the company over the years. Good luck, Rick.

Rick Ubinger

Thank you, Mike.

Operator

Your next question comes from the line of Nat Kellogg with Hudson Securities.

Nat Kellogg – Hudson Securities

Just a couple of quick things. Could you guys say what D&A was in the quarter, depreciation and amortization?

Rick Ubinger

Depreciation, $1.3 million.

Nat Kellogg – Hudson Securities

And obviously a step-up here in the working capital which is no surprise given how (lean) you guys were at the end of last year; obviously it depends upon the slope and the shape of the recovery. But sort of as you see things today and considering a modest recovery but maybe not gangbusters, do you guys foresee a lot more increase in working capital or do you feel like you have done the lion's share right now? Just any sort of color on that would be great.

Denny Oates

I feel we have done the lion’s share of that. We have very specific targets for inventory turnover as we move through this year to make continuous improvement there. We have mentioned cycle time improvements quite a bit in the last several quarters. And as you improve your cycle time, you obviously need to carry less inventory. Fighting against that is our plan, we have been boarding some strategic inventory in to make sure that our lead times are as fast as possible. So that kind of goes counter to what I just said.

I guess the overall metric we are looking at is the sales goes up, what’s happening to our working capital. So I think we have mentioned in Rick’s comments – Rick mentioned in his comments actually, our managed working capital, which is receivables inventories, less payables, that’s actually gone down as a percentage of sales.

So we are managing that whole category very carefully. You will see some modest improvements as sales continue to grow the way they are now but at a lesser rate than you have seen in the past.

Nat Kellogg – Hudson Securities

Okay, that's helpful. And then on the tool steel business, I know that that's come back particularly strongly but obviously part of that is just (inaudible) had some quarters last year where people just weren't ordering anything. Do you guys have a sense of how much this increase in demand is from restocking and how much is just because – I mean obviously auto production is moving higher here, I'm just curious on how much is due to actual real end demand or if you have any sense of that?

Denny Oates

Let me have Chris Zimmer, our VP of Sales answer that on.

Chris Zimmer

I think that there is a combination of destocking that happened in the supply chain that resulted in significant drop off in our bookings last year. So now that that supply chain is a little bit more in sync with demand we have seen that pickup in bookings. The feedback we get from our customers is that they expect the demand on their side to continue and they are booking at that demand rate with us. So we expect this booking activity to continue moving forward. We don’t see a major increase in their inventories being built right now but instead they are buying in line with their demand.

Nat Kellogg – Hudson Securities

Okay, that's helpful. And then last one, I know you guys have had a series of base price increases at the end of last year and so far in the first quarter. I am just curious on how those are being received in the marketplace and whether they are sticking to your liking.

Denny Oates

All the price increases that we have implemented are sticking.

Nat Kellogg – Hudson Securities

Okay, that's great. And then I have one other. Tax rate came in just a hair lower than I am expecting. Is 34% a good proxy for the full year or do you think it might pick up a little bit over the next couple of quarters?

Denny Oates

At this point, Nat, we are expecting 34%.

Operator

Your next question comes from the line of Jason Brocious with KeyBanc.

Phil Gibbs – KeyBanc

Hey, this is Phil Gibbs from KeyBanc. My question is just on the mix in the metal spreads, I think they were a little bit lighter than what we are looking for and that's probably due to the semi finished products as being a high percentage of volumes in the quarter. How should we look at that going forward? Should we anticipate mix improving or should we anticipate kind of the mix going right now being constant going forward?

Denny Oates

I think you should expect the mix to be improving as we move through 2010. You are correct, we have seen a relative increase in reroll, ingot and billet by business, but that will balance out as we go through the year, you will see more finished products.

Phil Gibbs – KeyBanc

What’s the temperature right now of the aerospace forging customer base? Do you believe that they are ordering right now based on any of the sentiment or pull forward in some of these aircraft commercial programs?

Denny Oates

I believe they clearly started destocking and they are now ordering closer to what they see as their demand. I still sense that they are very conservative and cautious about how they are ordering, not willing to commit to great deal on a longer term basis, still very concerned about where raw material costs are headed for the rest of the year. I think that's all feeding a healthy amount of conservatism in their buying.

Phil Gibbs – KeyBanc

How do you guys feel about the raw material cost position of just your company I mean given the increases that we have seen in ferrous scrap and nickel and cobalt? And are you guys comfortable with the way that you are managing that and your ability to pass that on going forward?

Denny Oates

We are very disciplined about passing that one via our surcharge mechanism. Our push on cycle times is really twofold. One is to allow us to provide short lead times to the marketplace but also the faster you can spin product through here, the less your exposure to raw material fluctuations. We don't do a lot of this, but when we do go longer term with customers, we do hedge to protect ourselves.

So I think we are doing all the things that you would expect in order to protect ourselves and mitigate the risk of fluctuation in the raw material.

Phil Gibbs – KeyBanc

Now do you believe that – just a follow-up here, I am sorry, but on the raw material position, do you feel that you have less raw material just exposure on the ground that your inventories are leaner and given the cycle time improvement?

Denny Oates

Absolutely. By definition we are increasing your cycle time per pound going out the door, you need less inventory.

Phil Gibbs – KeyBanc

Great, thanks guys. And, Rick, we are certainly going to miss you, you have done a great job.

Rick Ubinger

Thank you, Phil.

Operator

(Operator Instructions) And your next question comes from the line of Mark Parr with KeyBanc Capital Markets.

Mark Parr – KeyBanc Capital Markets

Hey, Rick, there is a rumor out there you are going to become CFO of Exxon Mobil.

Rick Ubinger

Not quite.

Mark Parr – KeyBanc Capital Markets

But I just wanted to wish you well and congratulations on – I just keep thinking about the first time we met when the operation had barely gotten started. And you guys have really come an incredible long way and you have done it the old fashion way; you kind of did it by your bootstraps and you earned your way along. And that's just really nice to see resuscitation of industrial enterprise in Western Pennsylvania.

So congratulations on that. It's a tremendous accomplishment and I'm sure it's something that you will treasure for the rest of your life.

Denny Oates

Absolutely, Mark. And this would not happen if it wasn't for the vision of Mac and the dedication of every employee whoever walked through the doors of Universal Stainless over the years.

Mark Parr – KeyBanc Capital Markets

Now we get Denny Oates to carry on the tradition, right?

Rick Ubinger

That’s what they say, Mark. A little taller than Mac.

Mark Parr – KeyBanc Capital Markets

That's right, but you are not nearly as good looking though.

Denny Oates

That’s right, he would agree with that and I thought but I still have some hair.

Mark Parr – KeyBanc Capital Markets

Along those lines, I wanted to get your updated thoughts on how you are going to take advantage of this new upgraded melt shop, you are going to have a tremendous capacity boost at your disposal. And what's the latest strategic thinking about how you might enhance the value of that electrode capacity?

Denny Oates

Well, what we are doing – obviously we spent the money and justified the money on pure cost reduction. The capacity kind of comes along, I won't say for free, but it kind of an added bonus. What did it do for us? If you look at our plans to grow the business, we have some work to do from a customer service standpoint to improve deliveries and so forth. A lot of our problems as we look at how we would do that went back to the melt shop. So this capital has really enabled us to significantly improve our own time performance.

As I said in my prepared comments, I feel we are best in class at this point in time and have been for the last six months in low volume as well some pretty high volumes here in the first quarter. That will bring this company additional business. We have also expanded the grades that we are producing and the size of the material we are producing at the melt shop as a part of the capital program and some of our process improvements.

So they are segments of the market that we have not played in before that will offer some additional growth opportunities. If you look at the international markets, we were 3%, 4%. Last year we increased our participation in international markets up to just by 11%. That percentage has slipped back to 8% in the first quarter but that's largely because of the growth in the non-export business not that we are losing position export-wise, but I don't see any reason why this company can't be exporting upwards of 25% of its sales. So I see a growth opportunity internationally.

The other thing that gives us the opportunity to flex up and flex down, the whole story in this market today is lead times and customer service being able to turn things around quickly and to the degree we have a shop that we can flex up and flex down reliably. We are going to be a much stronger player in the marketplace.

Mark Parr – KeyBanc Capital Markets

Any thoughts about additional downstream capability, new rolling mills or any sort of additional finishing or remelt capabilities?

Denny Oates

From a rolling standpoint, I think we are pretty well situated. We are looking very hard at our remelting facilities, there have been changes in technology in some of the remelting technologies. And I would expect that we will be looking at that very hard and some doing some things over the next 12 months. We are just not prepared to announce those at this point in time.

As far as finishing, the cellularization we did of bars is in a certain size range. There will be opportunities to apply some cellular manufacturing and other size ranges as well which we are looking at very aggressively.

Mark Parr – KeyBanc Capital Markets

Well, we will look forward to an update on the capacity ramps. And congratulations on the progress, that was a great first quarter, and look forward to the company's results as it unfolds over the course of this year.

Operator

(Operator Instructions) And at this time there are no questions in queue.

Denny Oates

Okay. Well, thanks again for joining us today. First quarter gave us a good start for 2010. We plan to make additional progress as the year continues and we look forward to reporting back to you on our progress on our next call. Have a good day.

Operator

This concludes today’s Universal Stainless first quarter 2010 conference call and webcast. You may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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