Universal Stainless & Alloy Products, Inc. (NASDAQ:USAP) Q2 2016 Earnings Conference Call July 27, 2016 10:00 AM ET
Brian Rayle - Managing Director, Libertatis Consulting
Dennis Oates - Chairman, President, and CEO
Ross Wilkin - VP, Finance, CFO, and Treasurer
Michael Gallo - C.L. King
Phil Gibbs - KeyBanc Capital Markets
Good day ladies and gentlemen and welcome to the Universal Stainless & Alloy Products' Second Quarter 2016 Conference Call and Webcast. At this time, all participants are in a listen only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder today's conference is being recorded.
I would now like to introduce your host for today's conference Mr. Brian Rayle. Sir you may begin.
Hi, thank you. Good morning this is Brian Rayle with Libertatis Consulting and I would also like to welcome you to the Universal Stainless & Alloy Products conference call. We're here to discuss the company's second quarter 2016 results reported this morning.
With us from management are Denny Oates, Chairman, President, and Chief Executive Officer; and Ross Wilkin, Vice President of Finance, Chief Financial Officer, and Treasurer.
Before I turn the call over to management, let me quickly review procedures. After our management has made formal remarks, we'll take your questions. The conference operator 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 risks related to these statements, which are fully described in today's press release and in the company's filings with the Securities and Exchange Commission.
With these formalities complete, I would now like to turn the call over to Dennis Oates. Dennis, whenever you're ready to begin.
Okay. Thanks Brian. Good morning everyone. Thanks for dialing in today. Following a very challenging 2015, we delivered 25% sequential sales growth in the first quarter of 2016 and have continue to build on that performance with modest sequential sales growth in the second quarter.
Most notably in the second quarter, our profitability and cash flow generation continue to see meaningful, sequential improvement reflecting the benefits of operational productivity gains, higher plant activity levels, and continued commodity price stability.
Let me hit a couple key highlights. Our second quarter sales increased 4% sequentially to $41 million on a 10% volume increase. The sales increase was driven mainly by a 4% increase in aerospace revenues, a 26% increase in general industrial, and a 8% increase in heavy equipment, partially offset by a 15% decline in oil and gas revenues and a 2% decline in power generation.
Premium alloy product sales were down 7% sequentially, reflecting a customer postponement of shipments destined for the oil and gas market into the second half of 2016.
We continue to execute our strategic plan to add more premium alloy sales. Thus far in 2016, we received 11 new customer approvals with four new products having been commercialized and 17 new products in development process. There have been 43 direct customers for our premium products over the past 12 months.
Order entry was $38 million before surcharges and £16.8 million, representing the second highest quarterly bookings rate in the past year. Backlog was $38 million before surcharges, down 3% from March 31st. Mill lead-times remained incredibly short, destroying the normal relationship between backlog and sales.
Sales store or service center partners in the second quarter increased to 73% of sales from 69% of sales in the first quarter, an increase of an 8% sequentially. Plant activity levels in the first half of 2016 continue to be up significantly over the depressed second half of 2015, specifically the first half of 2016 as measured by pounds produced, electric art melting was up over 85%, remelting was up over 70%, radial forging was up 69%. Hot rolling was up 20% and all of our idle facilities were in full operation.
Our team has continued to do a great job managing the ramp posting impressive first 2016 productivity gains of 20% in pounds produced per man-hour and tightly controlling variable spend per pound produced to a 26% improvement compared to last six months of 2015.
Commodity prices have continued to be relatively stable with nickel trading in a band between $3.75 and roughly $4 per pound through the first half and reaching $4.70 per pound in July.
Mali and scrap have actually trended up this year by approximately 60% and 80% respectively before retreating modestly during July. While these commodity prices are well below 2014 and early 2015 levels, the moldable month's stability is improving the alignment between surcharges and melting cost which challenged profitability throughout 2015 in the first quarter of 2016.
The stabilization is also beginning to unlock some market demand from customers who are holding back purchases in order to assess the potential of further commodity price deterioration.
With the improved plant productivity, higher activity levels, and the stable to increasing trends in commodity prices, our gross margin returned to double-digits at 10.6% of sales and improvement from the gross margin of 3.4% of sales reported in the first quarter.
Despite the improvement to our gross margin in the second quarter, it's important to highlight two things. First, we still have not returned to normal plant activity levels and secondly, although the commodity driven misalignment between surcharges and material cost has eased, further alignment benefit can be realized in the third quarter. These two factors further improve the outlook for gross margin in the second half of this year.
Our net loss for the second quarter was $0.11 per share, an improvement from a loss of $0.34 per share in the first quarter.
We delivered strong cash flow in the second quarter with cash flow from operations totaling $5.2 million for a total $6.8 million in the first half. We also continued to lower total debt which was reduced to $71.6 million by June 30, a $5.1 million reduction from March 31st.
While the overall demand environment has currently improved during the first half of 2016, we remain cautious about the second half. Service centers, forgers, and re-rollers are signaling mixed outlooks for the second half of 2016.
In addition short mill lead-times continue to limit our visibility to the future. For example semi-finished products with lead-times of six to eight weeks a year ago are currently available in three to four weeks. Finished products with lead-times of 10 to 12 weeks a year ago are now available in five or seven weeks.
In the course we're hearing from our customers in the marketplace, we expect the demand in the second half of 2016 will be similar to the first half as opposed to our previous view of a stronger second half.
In addition to maintaining our industry-leading customer service, we continue to improve our mix with development of new higher value alloys. And operationally, we will continue to drive improvement programs to increase productivity and yields.
Taking a closer look at o the end markets, starting with aerospace. Our aerospace sales -- our sales to the aerospace market represented 64% of second quarter 2016 sales, unchanged from the first quarter, but higher than 61% of the sales in the second quarter of 2015.
Aerospace sales totaled $26.3 million in the second quarter of 2010, up 4% compared to $25.4 million in the first quarter. Aerospace sales were 14% lower than the second quarter of 2015 on 2% lower volume.
With last year's destocking the aerospace channel largely behind us, our aerospace sales continue to modestly improve. We continue to hear discussions on the pace of the transition from legacy to next-generation airplanes. Regarding this transition, we see a positive impact as our expanded product portfolio gains traction in the market.
The news on air passenger traffic remains very strong with year-to-date domestic air traffic up 6% year-over-year, 7.5% increase in 2015 which is a continued positive for the after-market.
Commentary from after-market suppliers indicate an increase in spares business and expectation of continued mid-single-digit growth for the next few quarters. In the results announced last Friday, GE was very positive when their aviation performance noting that the segment has s delivered 6% annual growth, service orders grew 8% in the quarter, with commercial services up 9% driven by spares which were up 5%.
Also while Honeywell experienced slight pressure on its OEM business due to product delays, its aftermarket business continue to experience improvement.
As to airfreight manufacturers both Boeing and Airbus increased their delivery in latest quarter and our maintaining their respective delivery targets for 2016 of roughly 740 planes for Boeing and 650 for Airbus.
While we see positive near-term demand for our aerospace products driven by current build rates and aftermarket demand, we also remain very positive about the future of the aerospace market given the eight year order backlog and long-term favorable industry trends coupled with our expanded product portfolio.
Power generation market was our second largest market in the second quarter of 2016, representing 8% of sales compared to 9% in the first quarter and 10% in the second quarter in 2015.
Sequentially second quarter sales were roughly flat with the first quarter, reflecting continued channel inventory balance and steady demand in maintenance requirements.
Importantly, GE continues to be very upbeat about the future power sect -- future of the power segment, primarily noting both strength in the [Oustem] business as well as strength in our organic power business.
GE noted that core equipment backlog excluding [Oustem] grew substantially driven by [Indiscernible] technology strength. Siemens also remains bullish on the combination of Dresser-Rand and the former Rolls-Royce business, reporting a 28% increase in backlog at the end of their fiscal second quarter. Ultimately, all this positive news from GE and Siemens appears to be positive for forger customers and through them for Universal.
In contrast, the news in the oil and gas market remains negative despite the modest improvement in overall commodity markets. Sales in the second quarter of 2016 were down 15% compared to the first quarter and 31% compared to the second quarter 2015.
In total our oil and gas sales represented 7% of total sales in the second quarter versus 8% in the first quarter and 8% in the second quarter of 2015.
We see continued negative sentiment in the oil and gas sector as demonstrated by crude prices below $50 per barrel and rig counts significantly down versus historical levels. However, there might be early reason for optimism based on recent announcement by some of the oilfield service providers.
Specifically, Schlumberger is gaining more confidence in an onset of recovery driven by the tightening supply/demand balance. Halliburton indicates North American market as turned and expects rig counts to increase modestly in the second half.
That said we, at Universal, remain cautious about near-term recovery and anticipate that it will be 2017 at the earliest before we see meaningful upside from the oil and gas market. However, we remain poised to take advantage of recovery demand when it does occur.
Heavy equipment market sales represented 11% of total sales and increased 8% sequentially in the second quarter from the first quarter, reflecting a continued rebound from the second half of 2015.
Consistent with what we have noted in the past, we expect a solid year of automotive production and a gradual improvement in the plate business as we move through the year.
Our first half of 2016 prove to be on track especially with a pace of model changeover is considered. We're not saying much volume driven by off-road or mining applications.
Let me now turn the call over to our Chief Financial Officer, Ross Wilkin for our financial report. Ross?
Thank you, Denny. Hello everyone. As Denny noted, our second quarter sales of $41 million delivered modest sequential growth of 3.6% and build upon the 25% sequential growth delivered in the first quarter.
Despite the sales growth thus far in 2016, demand has remained and sales in the second quarter were 17% below the second quarter of 2015.
Looking at gross margin, our second quarter gross margin of $4.3 million or 10.6% of net sales was substantially improved compared to the first quarter gross margin of $1.3 million or 3.4% of net sales and largely higher compared with the second quarter of 2015, which was 10.5% of net sales.
The two determine key contributors to the sequential improvement in gross margin include the benefit of operational productivity enhancements combined with significant improvement in the alignment of customer surcharges and commodity input costs.
The relative stability in commodity prices, most notably nickel, Mali, and scrap iron over the past several months has resulted in significantly improved alignment of surcharges and melt costs.
While we have sold through most of our higher cost inventory by the end of the second quarter, we will continue to see further expansion to gross margin in the third quarter. Gross margin in the second quarter improved sequentially each month and we expect this to carry forward as improved gross margin for the overall third quarter.
Looking at selling, general, and administrative cost. For the second quarter, SG&A was $4.6 million favorable 400,000 compared with the second quarter of 2015. Tight spending controls and reduced headcount levels from actions taken in the second half of 2015 continue to contribute year-over-year savings.
For the second quarter, our effective tax rate was 35.3% compared with 32.7% in the second quarter of 2015. The increase in the 2016 tax rate reflects the impact of recognizing current year R&D tax credits evenly throughout the year compared with 2015 where the R&D tax credits were not recognized until the fourth quarter consistent with the timing of the passing of the R&D tax credit legislation.
The net loss for the second quarter was $802,000 or $0.11 per diluted share. The second quarter loss was significantly improved from the first quarter which were the loss of $2.4 million or $0.34 per diluted share.
Going forward it remains the central focus of the management team to return the business to sustained profitability as quickly as possible and we are pleased with the progress in the second quarter toward achieving this goal.
Importantly, from an EBITDA standpoint, it is worth noting that the second quarter adjusted EBITDA was $4.6 million and was approximately double from what it was in the first quarter of 2016 of $2.4 million. The growth in EBITDA demonstrates the underlying strength of the business and its ability to generate positive cash flow.
Note that Q2 adjusted EBITDA of $4.6 million is adjusted by approximately $300,000 for the non-cash share based compensation.
Turning our attention to the balance sheet. During the second quarter, our managed working capital was reduced by $700,000 to $86.2 million. The key drivers for the improvement was a reduction to accounts receivable and an increase to -- in accounts payable, partially offset by increased inventory.
Continued focus on customer cash collections as seen our accounts receivable balance be reduced by approximately $2 million despite the overall increase in second quarter sales.
Capital expenditures for the second quarter were $918,000 compared with $2.8 million in the second quarter of 2015. The reduced level of capital spending reflects continued selective completion of capital projects with a focus on maintenance projects and high return manufacturing enhancement projects.
That said it remains a key focus of ours to invest in our mills, thus ensuring we maintain our infrastructure, expand our capability, and deliver productivity improvements.
From a cash flow standpoint, during the second quarter, as Denny already noted, we generated $5.2 million of cash flow from operating activities through improved profitability and reduction to working capital. Despite the recent downturn, this is the fifth consecutive quarter that we have generated positive cash flow from operating activities.
Total debt of $71.6 million at end of the second quarter was $5.1 million less than the balance at the end of the first quarter. Importantly, we remain in compliance with all covenants and we anticipate this to be the case going forward for the foreseeable future.
Lastly, during the second quarter, the company filed an S3 Universal shelf filing that is not yet effective. Importantly, no securities covered by the registration statement may be sold nor may offer us to buy, be accepted prior to the time the registration statement becomes effective.
Once effective, this registration statement will provide us with the ability to raise capital more efficiently should the need or beneficial opportunity arise. We are not offering any securities for sale or soliciting any offers to buy securities under on the registration statement and we have no current plans or need to utilize the shelf. However, we intend to maintain the shelf registration going forward in the event an appropriate need or opportunity arises.
This concludes my financial report. Denny, I'll turn it back to you.
Okay. Thanks Ross. In summary, our second quarter reflects generally improving market demand in aerospace, expanding profit margins due to a significant productivity improvements, higher plant activity levels and an improving alignment between surcharges and material cost.
Healthy cash flow enabling $5.1 million reduction in debt during the quarter and over $20 million reduction over the past four quarters and continued success in earning customer approvals and introducing new products to fuel future growth.
Our current outlook suggest business conditions in the second half will be about the same as the first half with expanding margins and solid cash flow.
Operator, let's take some questions from our callers please.
Certainly. [Operator Instructions]
And our first question comes from the line of Michael Gallo with C.L. King. Your line is now open.
Hi, good morning.
Hey, Mike. How are you?
Good. Couple of questions. Denny, I guess the 10.6% gross margin are you through the -- completely through the mismatch with raw material costs and from here it's going to be improving that margin further, assuming mix and other things kind of stayed the same, is really a functional volumes or is there still some misalignment that you should start to get benefit from -- in the second half of the year given where nickel prices are today.
As we look at the end June 30, there are still some benefit to be derived from -- strictly from the misalignment Mike. So, as you're looking at things, I'm comfortable that we have 10.60, another 200 or so basis points would be reasonable.
Okay. So you think without really improving volumes -- again assuming nickel prices stay where they are and you just work through that inventory, you should be able to get the kind of 12 margin at some point, is that reasonable?
I think we can do a little better than that.
Same goes [ph] for 13. 200 plus basis points I'd be comfortable with. And again, the assumptions there as you said, the stability we've seen in nickel remains in these other commodities are relatively stable. They have actually increased so far this year, but we don't see any further deterioration.
And frankly I'm hard-pressed to see any significant movement down in these commodities at this point in time. Although, it's always dangerous for forecast them as you know.
Denny, the backlog and the orders, down modestly from the first quarter. To wonder if we can kind of break that down by segment, I mean did you see aerospace backlog improve and it was just a further step down in oil and gas or what kind of went on there, because I would have thought with nickel prices moving up during the quarter that you would have actually perhaps seen some sequential improvement in orders.
When you look at the orders month-by-month, we saw improvement in each -- each month we saw improving order entry until the middle of May. And the last two weeks of May and the first two and a half weeks of June, there was a noticeable slowdown in order entry and then there was a spike at the end of June.
When you look at the individual, that was an overall -- just an overall trend. When you look at the specific market-by-market, there's really nothing that jumps out like aerospace is going one way and oil and gas is going the other. So, some of that reduction we saw in May, that slowdown if you will in late May early June was as much aerospace as anything else.
I think what we're seeing -- my interpretation of that is on the service center side which is where the majority of our fluctuation occurred, I think some of the service centers as they now gotten into the year, four, five months under their belt, and have a good idea of what their year is shaping up to be and are dialing in some inventory, so you might see some modest -- I reflect back when it’s a modest inventory corrections going on.
I'm not calling out any massive destocking or anything like that, but I think they are just dialing their inventory there during the second quarter.
Ross, the increase in SG&A sequentially are relatively level increase in sales, what was the driver of that?
That is essentially the profile of variable compensation and how it was booked for the underlying SG&A was on change sequentially. And I think roughly we'll see about $4.5 million profile and G&A going forward.
Okay. Thanks very much.
You're welcome Mike.
Thank you. [Operator Instructions]
And our next question comes from the line of Phil Gibbs with KeyBanc Capital Markets. Your line is now open.
Thanks very much. I had a question on the comments you made about the new contracts or the interest in them I think you said something along lines of 43 customers. What does that mean in terms of how many of them are doing business with you now and what the potential is moving forward? Because I know we've been talking about the event [ph] for a bit, so I was just trying to get a sense of the magnitude and timing and all that good stuff.
What our -- the 43 customers are active customers of our vacuum induction melted product, Phil. People we've had actual billings with in the past 12 months what I was trying to do there was give you a sense for how many customers are interested in us and how many are beginning to do business with us. And typically the way that works as you get some orders, they process your material and they weave into their supply chain and that's currently what's happening.
In the past, the focus has been on some of the major guys where you get the approvals like Rolls Royce and GE and Pratt & Whitney all with whom we've had approvals, but these are the actual customers we're doing business with.
Got it. Okay, that's helpful. On the oil and gas, you talked about -- I think you talked about the cancellation or push out there, was that anything substantial or just indicative of the supply chain still--
It’s the [ownership] going out as originally scheduled. Premium melted sales would have been 11%, all right. And what we had was a situation where product, it was due to ship in June, and was ready to ship was postponed to the second half of the year.
So, to me, it's just the timing thing. I would not read anything into it beyond what's going on in the oil and gas business.
Got it. Perfect. And then any color in terms of the aerospace discussions with some of the service centers and forgers, where they feel like they are with inventory and when they may see -- or do they expect a pick up or just largely expect things to be stable.
I would say we met with everybody over at Farnborough. So, I got the opportunity to meet with -- all of our customers at that point. And I would say to answer your question, people are still relatively tentative. Their expectation for the second half is kind of mixed; there are some service centers that do plan to reduce their inventories by December.
There are others that would tell you that they are okay with inventories as they are. Everyone is looking at lead-times and knowing that there's really no need to push, to restock, the lead-times are so short at this current moment that if any trouble arises, any holed scrap-up, they can probably get coverage with no problem at all and I can arguably argue with that assessment.
So, that's kind of where they are at this point in time. Not a great deal concerned about commodity price as there was this time a year ago. General optimism about aerospace specifically. Again a mixed bag about when you'll see some improvement in oil and gas, some people feel it will be 17, some people are more pessimistic and say 18.
That's kind of --
There wasn’t a drumbeat of tremendous optimism on the second half of the year kind of things will be solid, activity will be good, business is pretty solid. But there's still a lot of tentativeness out there, uncertainty, whatever term you want to use for it.
All right. Terrific. Thanks so much.
Thank you. And I'm not showing any further questions at this time. I would now like to hand the call back to Mr. Dennis Oates for closing remarks.
Okay. Thank you. Once again let me thank everybody for listening this morning. And also thank you for your support and interest in Universal. We look forward to updating you on our progress during our next conference call, which will be in October.
In the meantime, we hope to see many of you at the Jefferies Industrial Conference on August 10 in New York, the C.L. King Best Ideas Conference on September 13 in New York, and the KeyBanc Basic Materials Conference in Boston on September 14. Have a great day.
Ladies and gentlemen thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.
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