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

Q3 2010 Earnings Call

October 27, 2010 10:00 am ET

Executives

June Filingeri - Comm-Partners

Denny Oates - President and CEO

Doug McSorley - VP Finance, CFO and Treasurer

Analysts

Tim Hayes - Davenport & Company

Phil Gibbs - KeyBanc Capital Mark

Gregory Macosko - Lord Abbett

Operator

Good day ladies and gentlemen, and welcome to the USAP third quarter 2010 earnings call and webcast. At this time all participants are in a listen-only mode. Later we'll have a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder today's conference maybe recorded.

I would now like to turn the conference over to your host for today Ms. June Filingeri of Comm-Partners. Ma'am you may begin.

June Filingeri

Thank you, Mary. Good morning, this is June Filingeri. And I’d also would like to welcome you to the Universal Stainless & Alloy Products conference call. We are here to discuss the company's third quarter results, which were reported this morning. With us from management are Denny Oates, Chairman, President and Chief Executive Officer; Bill Beible, Senior Vice President of Operations; Paul McGrath, Vice President of Administration and General Counsel; and Doug McSorley, Vice President of Finance and Chief Financial Officer.

Before I turn the call over to management let me quickly review procedures. As Mary said after management will makes their formal remarks they will take your questions. The conference operate will instruct you on the 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 risk 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 would now like to turn the call over to Denny Oates. Denny, we are ready to begin.

Denny Oates

Okay, June. Thank you very much. Good morning everyone. Thanks for joining us today. Our third quarter performance reflects modest sales growth, solid profit margins, positive cash flows and a 28% increase in our backlog.

Third quarter sales of $51.9 million doubled those of the same quarter last year and about 1% ahead of the second quarter.

With supply chain re-stocking mostly completed in the first half of the year. Third quarter sales mainly reflected end used demand, as well as our progress in market and product expansion initiatives. From an end market standpoint positive momentum in aerospace was the major positive driver of our sales in the third quarter. Our operating margin remained above 12% of sales in the third quarter, despite the recent price fluctuations in nickel and other raw materials.

We continue to drive improvements in operating performance. The increase in inventory returns achieved thus far is less than the impact of nickel volatility. The melt shop upgrade and other recently completed capital projects along with process improvements are reducing costs and increasing yields. By way of update on our Melt shop projects daily melt productivity has increased 33%, materials are up more than 2% and work in process inventory returns are 50% higher.

In total our Melt shop production in the first nine months of 2010, was 50% greater than its production for all of 2009.

As I said on our last call, the operational improvements achieved to date are sustainable and there is still more we can do.

Cash flow from operations was a positive $8.8 million in the third quarter and managed working capital per dollar a sales is consistently improved over year.

Let me turn to our end markets, aerospace remained our largest market growing up to 37% of sales in the third quarter compared to 32% of sales in the second quarter of this year and 31% in the third quarter of 2009.

Aerospace sales rose 20% sequentially and were 150% greater than the 2009 third quarter. Boeing’s earnings report last week shows the positive momentum in the market.

For the third quarter Boeing reported booking at net 221 commercial airplane orders compared with 68 net orders in the 2010 second quarter and 79 in the third quarter of last year.

They also have raised the production level for the 737 for the third time, starting the resurgence in air travel and strong demand from their customers. The current backlog includes over 2000, 737s and they are optimistic that number is going to increase, based on existing customer options and their sales efforts.

Boeing also [have set] the demand for a 777, 787 and the stretch (inaudible) rather supports their current production schedule and they anticipate prolonged market recovery overall.

The Petrochemical market was our second largest market in the third quarter, representing 21% of sales essential even over the second quarter of 2010 and the same period last year.

Our potential chemical sales which are primarily for the oil and gas exploration market, were up 2% sequentially or being nearly double the level the third quarter of 2009. As noted on the last call, some excess inventory remains in the distribution supply chain, which we expect to come into balance by year end.

For the third quarter Halliburton and Schlumberger both reported sequentially flat international sales with strong growth in North America with a shift to more land based fields from offshore drilling. Both companies are forecasting further recovery in 2011. The good news from our standpoint is that our customers have started adding to payroll and our coding activity has picked up in recent weeks.

Power generation represented 17% of third quarter sales, compared with 19% in the second quarter of 2010 and 32% of sales in the third quarter of 2009. Our Power Generation sales were down 10% sequentially, but up 9% from the third quarter of 2009.

Our customers continue to expect significant market recovery in 2012 which implies a pick up in Power Gen business for us as we move to 2011. Their expectation seem to be in sync with what we are hearing on the end market.

On the third quarter call GE reported a total of 15 new orders for turbines in the quarter compared with 23 in the third quarter of 2009. It was good to see the announcement earlier this week that GE won a large deal for natural gas and steam turbines from Reliance Power of India.

Until the market recovery gains traction we are focusing on continuing to capture maintenance business as it becomes available based on shortly times and quick turn around. We are also upgrading our re-melt facilities to meet our customers’ needs and what we feel will be a very robust market in the future.

Our service center plate sales represent 14% of third quarter sales versus 17% of sales in the second quarter of 2010. But just 5% in the 2009 third quarter, our service center plate sales were 16% lower sequentially, but six times higher than on the same quarter a year ago.

The current sales level seems stable, now that restocking has been completed in a channel. Domestic auto sales appeared to be selling in at around 12 million units annually and the offer equipment manufacturers continue report healthy backlogs and strong bookings.

Let me turn the call to Dough at this point for report on third quarter financial results.

Doug McSorley

Thank you Danny, our third quarter sales of $51.9 million and volumes shipped of to 11,800 tons more than doubled from the same quarter in 2009 to the stronger open shipments to all end markets. Sequentially our sales increased 1.1%, while our tonnes shipped were essentially flat. The sales increase was due to the improved shipments to aerospace and our pricing levels on those products that offset the volume variability and our other end markets.

For the first nine months 2010, our sales of $137.8 million were up 40.3% from the same period of 2009 with an increase of 45.4% in our tonne shipped.

Our third quarter gross margin of $10.3 million was 19.1% of sales compared to 10.7 and then 2009 third quarter an 18.9 in the 2010 second quarter. Our cost of sales can include book the physical inventory adjustments, our third quarter of 2010 included a favorable adjustment of $1 million for the additional metal recovery as a result of a capital project in streamlining our scrap loading area. Excluding this adjustment, our gross margin was 17.9% of sales for the quarter. For the first nine months of 2010 our gross margin of 24.9 million was 18 .1% of sales, compared to 3.8% in the same period of 2009.

Our selling general administration expenses of the third quarter with $4 million for 7.7% of sales compared to 8.9% in the 2009 third quarter and 6.4% in the 2010 second quarter. There was a $700,000 increase in our SG&A from the 2010 second quarter. This increase is primarily due to an unfavorable adjustment for increase stock option compensation expense. The adjustment was accumulative non-cash adjustment require to fully expense that productions and change the estimated forfeiture rates of current and invested options.

Our third quarter operating income of $6.3 million was 12.2% of sales compared to 1.8% in the third quarter of 2009 and 12.5% in the 2010 second quarter. Our operating income for the first nine months of 2010 was $15 million over 10.9% of our sales. The company’s cash position at the close of 2010 third quarter $15millionor the 2010 third quarter was 41.2 million an increase of 6.6 million from the second quarter.

Our managed working capital which includes receivables and inventory less accounts payables improved rather the 33.1% of sales in the third quarter from the second quarter level of 34.7% of sales.

Capital expenditures for the third quarter was 1.7 million bringing our year-to-date spending to 5.1 million. Total debt at the end of the third quarter was 11.5 million; this debt includes a term loan with DMC against which we are making quarterly principle payments of $600,000.

That concluded my report Denny I'll turn the call back to you for final remarks.

Denny Oates

Okay. Thanks, Doug. In summary then sales remained at strong levels in the third quarter as the market shifted from restocking to end user demand, and we continue to execute on market and product expansion initiatives. Our backlog grows 28% and order entry increased in the quarter. Manufacturing improvements and targeted capital spending programs contributed to profitability and our margins remained strong in the third quarter despite the fluctuations in nickel.

Our balance sheet remains very strong. For the balance of 2010 beyond we will continue to focus on high service levels, process improvements and lower cost, while investing in our operations all which are aimed to driving growth and profitability.

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

Question-and-Answer Session

Operator

(Operator Instructions). And our first question comes from the line of Michael Gallo from CL King.

Michael Gallo - CL King

Good. How are you doing? Just one, thinking a little bit on the SG&A question, I think that it was the whole increase Q2 to Q3 EBITDA stock option adjustment, the total increase over the prior quarter nickel was 700,000; 640 of that was the adjusted stock options. Okay and just what we feel a little bit how that came up there is something I presume shouldn’t reoccur here would be expected to reoccur?

Doug McSorley

No, it shouldn’t and won’t reoccur. It’s a change in our estimated perpetual rates of the different pools of options that are currently vesting in it was a full expense of options invested with an August anniversary date and some prior to that.

Michael Gallo - CL King

Just to change the way you did things, going forward you would expect that to be more inline with probably where it was in the second quarter. Expectation for a level with sales?

Doug McSorley

What will happen is some of the expense will be the quarter earlier, it’s a little more current with more appropriate rates. I would say compared to the second quarter you would see an increase related to stock options of $100,000.

Michael Gallo - CL King

And then just commentary Denny just on the overall supply chains for petrochemical and Power-Gen I know you indicated you expect us to improve in 2011. but just if you can comment I think on the supply chains of those two areas that’d be great? Thank you.

Denny Oates

Okay, toward the supply chains in the oil and gas area which is most of our petrochem business. A lot of that business that we sell goes to distribution. We still see some excess inventory along the supply chain which as I mentioned we expect to go in the balance.

On the Power-Gen side its not the same case I think inventory is there I would characterize as lean which means the timing of return in the market is going to be critical. You have been around this market long time, like so you know it tends to turns very quickly and I think when it does there will be a mad rush to get metal.

So there are two different markets, two different situations as the supply chain from an inventory standpoint as I say.

Operator

Our next question comes from the line of David Woodyatt from Keeley Asset Management

David Woodyatt - Keeley Asset Management

Yes, could you give us at least a rough estimate of where you think the overall company operating rate stands at the moment?

Denny Oates

Usually the operating rate is based offer, your melt capacity and your utilization re-melt shop today we are running in about 55% of capacity based upon that measure.

Question-and-Answer Session

Operator

(Operator Instructions). Our next question comes from the line of Tim Hayes from Davenport & Company

Tim Hayes - Davenport & Company

Two questions. The first is, could you give us a little more color on volume trends for the two segments?

Doug McSorley

If you look at the Dunkirk segment, most of that is finished core product and most of that is also aerospace related, so the backlogs in the order trends there. I would characterize as relatively strong and if you look at aerospace you should see Dunkirk follow that same basic pattern.

It’s a little more mixed when you get into the Bridgeville with the Universal Stainless & Alloy Product segment, which is mostly the Bridgeville facility. There you have some more puts and takes when it comes to the movements in power gen which were down and we expect to be flat, but with some improvements as I sighted in 2011 and into 2012 and tool steel plate is also relatively stable at this point in time. And the remaining two drivers of the various volumes.

Tim Hayes - Davenport & Company

And during the Q3, did both segments see volumes clash for the Q2 or is one segment stronger than the other.

Denny Oates

The universal segment term was slightly below the second quarter volume at 3% and the Dunkrik segment was slightly above.

Tim Hayes - Davenport & Company

Okay and then the last question given with recent rise in nickel prices have you seen any unusual from your customers during September, October timeframe just trying to get gauge on what they are doing, how they are reacting to this recent rise in nickel prices?

Doug McSorley

This is always an anecdote that when Nickel prices fluctuate like this customers will try and out guess the market and either advance order or postpone orders. And that is a reality, but its very hard to meet up pin a number on that. I don’t personally see much of that at this point in time.

Operator

Thank you our next question comes from the line of Phil Gibbs - KeyBanc Capital Mark.

Phil Gibbs - KeyBanc Capital Mark

I was curious about the power gen markets, it seems like the outlook as we look forward the second half of '11 and '12 and '13, I think it continues to look fairly favorable and have you seen a change in attitude from your customers as natural gas prices continue to, let's say, remain weak as they look for low-cost alternatives have a lot of them or have any of them increase expression of trying to pull forward orders has there been an increase in tone in the market place because of that?

Doug McSorley

I think the tone is turning more positive, if you recall the last call, I was commenting that the recovery in Power-Gen most of our customers while with some of the big OEM seem to be suggesting it was pushing out into 2012. I think our last two or three months given where industrial production has been, credit situations in the world and all list of other reasons there seems to be more optimist that they can get pull the closure in. That’s why it's important for us to maintain our flexibility because as I mentioned with Mike Gallo's question I think when the market does turn, it maybe sooner than 2012 that we want to be ready for that because when it turns it usually turns relatively quickly.

Phil Gibbs - KeyBanc Capital Mark

Where have you seen the preponderance of these new projects coming online? North America we have better visibility into that market, but globally where are they maybe looking to...

Doug McSorley

The Far East and the Middle East. Two geographic regions where we are hearing about more optimism.

Phil Gibbs - KeyBanc Capital Mark

Perfect and then just a question regarding your lead times and I know you have positioned yourself to capture more market share with shorter lead times but can you comment on any products that maybe somewhat longer lead times just given the demand. Where you are seeing the demand, what product you seeing demand the stronger?

Doug McSorley

We have worked very hard to hold our lead times and our lead per [billing] varies by grade but its 8 to 12 weeks which is roughly the same place it was in the second quarter. (inaudible) products will be two to four weeks, our finished core product again varies a lot by grade is three to 10 weeks and plate product line will be six to eight weeks. So we don't have a stretch out in our lead times at this point in time.

Phil Gibbs - KeyBanc Capital Mark

Just other quick question for you, you said there, was it a positive scrap settlement in the third quarter that benefited you by million dollars is that what you had commented on?

Denny Oates

Yeah. The situation there you know as a matter of course we regularly take this go inventories. This year we've been working to improve our melt shop and our scrap operations. One of those capital projects is revamping our scrap building. So as we do these physical inventories we typically will zero out of bin, since we are doing a capital project there it will basically redesigning the whole place and we're taking bins replacing them and digging underneath it, there was additional positive adjustments made based upon material that we found under those winds just simple as that.

Phil Gibbs - KeyBanc Capital Mark

Okay. So we should be basing our forward expectations on more of an 18% gross margin then?

Denny Oates

Yeah, I would take a look at the $1 million at a one time affair.

Operator

Thank you. (Operator Instructions). And our next question comes from the line of Gregory Macosko of Lord Abbett.

Gregory Macosko - Lord Abbett

Just wanted to ask a little bit about revenue growth versus volume growth in the various aero petrochem Power-Gen and service center numbers you talked about it sound as if the volumes were a little bit higher than the revenue, does that imply more pricing or mix or give us some color on that?

Doug McSorley

Well, we surcharge our product just like everyone else in the industry. So if you look at the trends in nickel, we have a two months lag in our surcharge and nickel prices started to fall midway through the second quarter of 2010. So you had a negative effect there where surcharges would come down. We have the inverse of that now where nickel prices has started to firm over the last couple of months and you should expect to see higher surcharges each month of the fourth quarter.

Along with that, we monitor our pricing very carefully like everyone else does. So we have made selective pricing moves over the course of the year price increases that would be. We have also worked our mix very hard and I would also add that we just put out an official announcement over increasing prices effective January 1, 2011.

Gregory Macosko - Lord Abbett

Yes, I saw that, that looks good, but I guess the point is it has been priced but that will catch up as we move forward and the surcharges are implemented?

Doug McSorley

Yes.

Gregory Macosko - Lord Abbett

And just generally speaking with regard to that the SG&A line then again that forfeiture rate that is just in terms of relative to the stock price and what you expect employees to be taking their options. Is that correct?

Denny Oates

I would say it a little bit differently. As we have pools of stock options that are outstanding investing you realize the expense and you offset that by what you estimate to be assumed forfeiture rates. However we have changed the rates that we are going to use going forward and there was a catch up impact of that in this quarter.

Gregory Macosko - Lord Abbett

I understand the catch up, but the 100 going forward is, have you done any re-pricing of options or is this just the existing options that are in place?

Denny Oates

It’s just the existing one.

Doug McSorley

We have not got any re-pricing.

Gregory Macosko - Lord Abbett

Okay good. I'm glad to hear that. All right. Very good. And the order entry, I believe relative to the order entry rates, you said that those have been increasing, is that going into October as well?

Denny Oates

Yes.

Operator

I show no further questions in the queue. I would like to turn the conference back to Mr. Dennis Oates for closing remarks.

Denny Oates

Okay. Thanks once again for joining us today. We are pleased to share our results for the third quarter. And we look forward to talking to you in 2011 about our results for 2010 and our fourth quarter. Have a great day.

Operator

Ladies and Gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect at this time.

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