Universal Stainless & Alloy Products Inc (USAP) 2006 Q3 法說會逐字稿

Good morning. My name is Lisa and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Universal Stainless & Alloy Products third-quarter 2006 earnings conference call and webcast. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS)

Ms. Filingeri, you may begin your conference.

Thank you. Good morning. This is June Filingeri of Comm-Partners and I would also like to welcome you to the Universal Stainless & Alloy Products conference call. We're here to discuss the Company's third-quarter 2006 results and fourth-quarter outlook, which were reported this morning.

With us from management are Mac McAninch, President and Chief Executive Officer; Paul McGrath, Vice President of Operations; Rick Hack, Vice President of Sales and Marketing; and Rick Ubinger, Vice President of Finance and Chief Financial Officer.

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 would like to turn the call over to Mac McAninch. Mac, you may begin.

Thanks, June. Good morning. Thank you for joining us today. I am pleased to have Rick Hack, our new VP of Sales and Marketing, joining me this morning, along with Rick Ubinger and Paul McGrath.

As we reported this morning, we achieved better-than-expected results for the third quarter of 2006. Net income rose 73% to a record $5.7 million, or $0.86 per diluted share, exceeding our forecast of the $0.65 to the $0.70 that we made back in July. Third-quarter sales increased 28% to a record $55.1 million, which also was above the forecast that we had made.

Continued robust demand in aerospace and strong petrochemical and power generation markets were the fundamental drivers of our growth. That growth was further accelerated by a spike in the nickel costs during the quarter, which increased the selling prices of our products companywide, due to the effect of the surcharge mechanism.

Our Dunkirk operation had an especially strong third quarter because it received the added benefit from the timing of feedstock procurement; the continued workforce additions helped increase the throughput of the product; and effective cost management. As a result, Dunkirk's sales rose to a record $20 million and its operating margin reached 19% of sales.

Sales at our Universal Stainless segment also rose to a record level for the third quarter of 2006, reaching $47.2 million. Helped by the higher product prices, operating income remained level with the 2005 third quarter, and was 31% lower than the 2006 second quarter, due to the strong mix of products shipped, higher shipments of semifinished product to rerollers and forgers.

During a period of rapidly accelerating material cost, semifinished products are more likely to be impacted by the lag effect of the surcharge mechanism because of their shorter production cycle going through the system. I will remind you that nickel prices jumped 67% in a two-week period during the third quarter. Today, it hit $15.14, up substantially from the previous days. On the plus side, increasing the volume put through our melt shop also increases the efficiencies that we see there.

We ended the third quarter with a total backlog of $124 million compared with $128 million at the end of the second quarter. Our investments in the sixth VAR furnace last year and in two additional milling machines, another plate flattener, and more lab equipment this year have enabled us to increase production and work down some of our substantial backlog.

The installation of our seventh VAR furnace was finished ahead of schedule, actually in time for our customer appreciation day on August the 17th. We should see a full-quarter contribution from that furnace in the first quarter of 2007. Given our very positive outlook for 2007, we expect to put that increased remelt capacity to good use.

Our optimism is based on the prospects we see in each of our end markets, which I will now review for you. Our sales to the aerospace market rose 86% from the third quarter of 2005 and 25% from our very strong second quarter. We believe that a significant amount of the aerospace grades of steel that we deliver to the marketplace today are for use in Boeing aircraft, and the news from Boeing continues to be very good.

At the end of the second quarter, Boeing had forecast that it would deliver approximately 395 commercial airplanes in 2006, and as many as 445 in 2007. The first flight of the 787 Dreamliner is expected in 2007, with certification, delivery, and entry into service occurring in 2008.

As of October 10, Boeing had orders for 141 787s and a net total of 753 commercial aircraft orders. Dunkirk is continuing to work with Boeing to win in the titanium project that I had mentioned on our last call, and Boeing has added yet another special shape to those that we are currently working on.

In contrast to Boeing's good news, Airbus continues to run into delay problems with its A380. Boeing may be the beneficiary of that. Even so, Airbus entered into 2006 with a total backlog of 2018 aircraft, not all being the A380s. They will continue to build other aircraft and deliver to the commercial aircraft industry.

We are also continuing our discussions with GE's Jet Engine Division that I had discussed previously. Last Friday, GE reported that its aviation equipment backlog is 3.5 billion -- B -- year-to-date, which suggests that they will have a substantial ongoing need for specialty steel products like we make.

On balance, we expect the aerospace market to remain very strong for us for the foreseeable future.

Our sales to the petrochemical market rose 8% over the third quarter of 2005 and 25% over the 2006 second quarter. Despite the recent pullback in oil prices and current supply of natural gas, market demand should continue to be strong because of the consumption forecast and its continued growth.

Our power generation sales increased 6% from the third quarter of 2005 and 5% from the second quarter of 2006. We expect our participation in the power generation market in 2007 to exceed that of 2006, based on the fact that we have already booked 1 million pounds of steel for one of GE's turbine facilities, for the first half of deliveries in 2007.

We are also continuing to explore the opportunity in India that I had mentioned to you the last time we talked, and have quoted prices based on our desire to expand into the international markets, but also based on our discipline to add only profitable sales.

Our tool steel sales rose 13% from the third quarter of 2005, but were down 27% from a strong second quarter, mainly due to the market crosscurrents created by the problems of the U.S. automakers. Overall, our outlook for tool steel remains positive because of the projected requirements for off-road vehicles and heavy industrial manufacturers in 2007.

Turning to our fourth quarter forecast, we expect to report another strong quarter. If our forecast seems conservative, it is because we anticipate that normal seasonal patterns will come into play in the last two weeks of December, including year-end plant closings, inventory adjustments by our customers, and trucking constraints during the holiday season. I am especially concerned about the availability of trucks from mid-December through the end of the year. They have had a very good year.

We are well on our way to reporting a record year. In fact, in the first nine months of 2006, we have already surpassed the record earnings we reported for the full year of 2005. And as I said, we are very optimistic about our prospects for 2007, especially because of the long-term outlook for the aerospace and power generation markets.

We will also continue to focus on operational efficiencies in 2007, not only to improve our margins, but also to expand the number of products we take to the marketplace profitably to better meet the needs of our customers. In other words, we will continue to execute on the strategy that we established on day one of starting this Company.

I would like to take one more minute of your time. For those of you that read Forbes Magazine, Universal Stainless & Alloy Products was recognized as one of the 200 best small companies in their October issue. I am proud to say that this recognition is a tribute to the hard work of our employees and the commitment of our customers.

Thank you. That concludes my formal remarks. We are now ready to take your questions.

(OPERATOR INSTRUCTIONS) Michael Gallo, C.L. King.

A couple questions, if I may. First question was -- I know you had mentioned on the last call you felt power gen was at an inflection point of substantial upturn. You mentioned -- I believe I heard you say that you booked some power gen business to GE for the first half of 2007. Are you beginning to see that upturn on the power gen side starting to materialize?

Absolutely. I feel very comfortable in when I made the statement that I really expect our participation in the power gen market in 2007 to exceed our 2006 performance.

And then just second question. I was wondering if you can give us any more color on your efforts to secure both OEM business and international business, which I know you have been talking about for the last couple quarters.

Of course, yes. I might add, we were fortunate enough to hire one additional salesperson who has had a wealth of experience in the specialty steel long products. And based on the interview process and the time that I have personally spent with him, we had a long discussion about our desire to expand our focus on obtaining new OEM customers.

He understands exactly where I was coming from, and I feel very comfortable with him coming on board and with the results of the most recent sales meeting that Rick Hack, our new VP of Sales and Marketing, had with our salespeople, that I would expect that we are going to see substantial progress in that area in 2007.

And we have had some encouraging discussions with a couple of other contacts that pertains to our future as it relates to export sales coming out of Universal Stainless & Alloy Products. It is too premature for me to talk about those contacts that we have made, but every day I become more encouraged about that prospect. And I would expect that 2007 is going to be a turnaround for us in that area. I feel comfortable in saying that. And Rick is chomping at the bit to get involved in that process as well -- I can tell you that.

Okay, great. Final question is for Rick. Rick, obviously you have continued to have very robust sales and backlog, and that has attributed to growth in accounts receivable and inventory. I was wondering at what point we should start to look for you to convert a lot of that working capital into cash. I think you had over $100 million at the end of the quarter in those two areas.

Well, Michael, from an inventory perspective, if I look at just the pounds that are in our inventory at September 30 versus any of the quarters in the past year, our weight is actually down. The increase in inventory that you have seen is strictly the result of nickel prices going to -- up as high as $15 a pound.

On the receivables side, I really do not want to see the receivables drop, because that means our sales keep going up. But we are going to see some positive cash flow from operations and we saw that in the third quarter.

Okay, great. Final question on the capital expenditure plans for 2007, or is it too early to say?

It is too early to say. We have a Board meeting first part of December, and that will be the first blush at looking at our wish list for 2007. We will finalize that in January, and then I would feel more comfortable in talking about capital expenditures for 2007.

Okay, thanks a lot.

[Kevin Money], [Cleveland Research].

You mentioned a lag in the surcharge mechanism. I was wondering what is sort of the timeframe on that lag?

It is fairly consistent throughout the industry. When you establish a price out in the marketplace for the alloy surcharges, it is about a 20-day, 20- to 25-day lag.

Okay. My next question is there any impact to your volumes from the Airbus delays account for in your 4Q outlook?

None. I think -- at least the news media makes a big thing out of Airbus delays on the A380. As a mentioned in the conference call, they have a backlog of about 2000 aircraft. They're still going to build all of the other aircraft. Now, it is unfortunate for them that they are experiencing the problems that they are experiencing with the A380, but they are going to still build a lot of aircraft.

I feel very good about the future of the aerospace industry. And I might add, I did have a flight the other day and I did ride on a 737 300. It is not going to bother me whenever they put those off into retirement.

My last question is, you mentioned customer inventory estimates going forward. I was wondering if you could go into more detail and kind of talk about industrywide inventory levels and break out between stainless and nickel.

Well, I think we have all heard the comments out in the industry about inventory levels starting to climb and things like this. I will give you Mac's perspective on this. I personally think that the increase in inventories is more directed towards the carbon flatroll side of the business because of the drop-off on automotive, because of some softening in the residential builds. So maybe they are not building as many washing machines as they once did.

From the people that I talk to, we are not having -- and everything that I have heard -- they are not having an inventory build problem on specialty steel long products, whether it is stainless steel or whether it is nickel-based alloys, because of the demand that is out there and the simple fact that the lead times have gone out as far as they have for most of those value-added products that we're taking to the marketplace.

I think it is more related to carbon steels than it is to specialty steels.

That's what I was thinking. Thanks a lot. That's all from me.

(OPERATOR INSTRUCTIONS) Mike Churchill, Churchill Research.

I was trying to think about the gross margins. It is a little confusing -- it seems like there's a couple different things going on at the same time. There is the surcharges, but I was also wondering if there is any FIFO gains in here. You sort of mentioned something that sounded like it might be FIFO gains at Dunkirk. So for Q3, gross margin was 22.1. I don't know. How should I be thinking about that going forward?

I'm going to have Rick Ubinger answer that one.

Mike, the way to think about this is first off, let's understand and appreciate that a significant percentage of the feedstock of Dunkirk is coming from Bridgeville. So it takes approximately two months for Bridgeville to melt and ship billet to Dunkirk. And then it is another two to three months for Dunkirk to accept that billet, produce it into a product, and ship to a customer.

So in periods of time where you have rising material costs, Dunkirk is going to benefit from the surcharge mechanism based on the cost of the billet that they are using to produce that product. Obviously, as the material prices start to drop, Dunkirk is going to be hurt by that same phenomenon because of the timing.

Is that offset somewhere at Universal Stainless, the Bridgeville division? Or just it's a FIFO gain for the Company as a whole that reverses?

No, the exact opposite occurs in Bridgeville. Because the orders are quoted with the surcharge in place and then the material is purchased. So as the orders are entered, the material is purchased after the fact, in rising material costs, which is what happened in the third quarter for the Universal Stainless segment. Their profitability was hurt by the substantial increase in nickel.

Okay. Well, that actually sort of maybe is halfway through my next question, which is that I think when you and I talked a couple of months ago, you mentioned that nickel was half of your cost of goods sold. I could have totally butchered that, but --

Total material costs are half of our --

Nickel is half your total material cost?

No -- total material, so nickel, molly, chrome, iron. All of the material cost represents about 50% of our sales price.

Nickel is half -- okay. So I guess that might be the answer to this question. But I calculate that your dollars per ton sold went from $37.69 in Q2 to $40.42 in Q3, which is like 7% and change. But nickel went up hugely from Q2 to Q3.

It just seemed to me that the increase in the selling price -- I guess I would have thought it would be a little more, but I don't really have any firm way to calculate it. So I would also assume that Q4 ought to go up, because if you look at the average nickel price for Q3, we are way over that already in Q4.

It all depends. Nickel is a very volatile element when it comes to pricing. We have seen episodes where that price can jump $1 per pound in a day or more.

Or in hours.

Or in hours. The way we look at that, Mike, is we tend to look at our sales net of material cost.

Yes, I understand that. I guess it is just hard for me -- because I can't really model that. But it has to be numbers as you present them in the quarters.

Sure, but because of the lag in the surcharge mechanism versus the timing in which we actually buy the material that goes into the product, you are still going to have a disconnect in a period where the volatility in nickel is substantial.

Okay, I still (multiple speakers).

You can feel free to call Rick.

Okay, yes. One more question. I am looking for 58,000 tons next year, up from maybe 51 this year. Does that sound reasonable with that seventh furnace coming on, or is that too high?

You know what? When you start talking about tons, that is almost a foreign language to me. I talk about pounds. I sell by the pound, and --.

That would be in --

You know, it all depends. That number, the 58,000 tons, if -- (multiple speakers) if the 4G market takes off, if the power gen business takes off like I think that it is going to, we will have -- because we do sell some straight air-melted steels into the 4G market. We also sell a lot of rerolled billets out in the marketplace, that that business would take off. Who knows what that number could be in 2007.

All right. Well, thanks a lot.

(indiscernible)

Good quarter. I'm just trying to get a sense of the nickel price and has that affected your customer behavior? Do you see the delayed buy-in at all?

Thank goodness (multiple speakers) going back and I think the surcharge mechanism was put in place a year and a half to two years ago now. Our customers understand because we have tried to educate them that, hey, this is not something that the steel industry has any control over or any input on. We have educated them to where to look to see the volatility in the price of nickel, chrome, iron, molly, and things like this.

And I think they are better -- or they are more accustomed. I do not want to say they are better educated -- they are more accustomed to seeing the volatility in it. Are they happy about that? Hell no. Nor am I happy about it.

But it is just something that we have had to contend with for the last year or so, and I do not see it changing as we go forward.

Great, great. So you guys are saying '07 will be a good year. Does that imply that you do not really see a drop in nickel pricing, because pricing helped your earnings so much --?

Logic says -- or my logic says to me, that with the aerospace business being very strong for the foreseeable future -- and this is based on their backlog and the fact that the military spending on military aircraft and things is really just starting to kick in -- my expectation is -- and based on some comments that I've heard from a nickel producer, the expectations are that nickel prices are going to stay fairly high next year.

Okay, great. My final question, do you see -- well, there has been a lot of consolidation in the steel and [OTCG] market. Do you see the same thing happening in your space and how would you guys respond to that?

Number one, do I think that there is an opportunity for further consolidation in the steel industry and that encompasses both specialty steel and carbon steel? The answer to that is yes, I think there is -- the potential for that exists. How would we deal with that?

Well, number one, we are a public company. So there are a lot of options the people have to deal with looking at a public company. If someone would come in with an offer that would just make my hair stand on end, I would certainly be obligated to take that to our stockholders -- first to my Board of Directors and then to our stockholders. So I personally do not have a hell of a lot of options when it comes to something like that.

Okay, great. Good job, guys.

Larry (indiscernible), [Detweiler Mitchell].

Obviously pleased with the numbers.

So am I.

Two areas we have not talked much about. You mentioned Dunkirk's work on titanium shape. And wondering if you could give a little more flavor of that. And also, I noticed that Allegheny just announced a significant continuing contract to supply titanium to Boeing. I presume that that is a different ball game or that yours is sort of a supplement to that.

No. Allegheny is a full-line producer of titanium products -- flatrolled, ingot, billet, everything that you could make out of titanium. I think it was a very good move on their part. And Boeing, they have locked up a partnership with a Russian company. That is why I feel so confident in talking about the future of the aerospace business and the impact that that is going to have on Universal Stainless & Alloy Products.

We are working very hard to try to satisfy Boeing's requirements for these special shapes. Again, our feeling is that it gives us another niche. And once we perfect this and we get this issue off on the table and running and stuff like this, which I fully expect that that will happen -- some people don't move quite as fast as Universal Stainless does -- but I still expect it to happen.

And Rick Hack, I can guarantee you, is going to take some of the knowledge that we have learned over the last three or six months, whatever it has been, and we're going to try to take that and expand it into other product areas and other customer bases out there.

When I think of special shapes, I also think of Titusville. Was that a totally different approach and what is happening with Titusville and shapes?

Again, Titusville is very much involved in power generation and the aerospace side of the business. Titusville had a good quarter, and I would expect that as we go out into 2007, it is going to continue.

Okay. Then while we are covering the other niches, any further comments on the tool steel industry here?

As I mentioned in my comments on my presentation there, I think tool steel is going to be strong. And as we go into 2007, it may not be driven by the automotive market, but there are more automotive producers out there other than Ford, GM, and Chrysler. So it does not look that good right now for tool steel as it relates to the automotive sector. But the off-road heavy equipment manufacturers and the industrial manufacturers, we expect that that is going to be strong going into 2007. So I have not written off tool steel.

Okay. Thank you very much.

Ralph (indiscernible), First Manhattan Company.

Two questions. First, just a follow-up on the M&A question from before. Are you still looking at any acquisitions that you think might make, say, in the next 12 months?

Well, that is a long time for me to answer -- the next 12 months. Do we have anything on the plate right now? The answer to that is no. Would I be interested in looking at something on the plate right now? If it made good, sound business sense, yes, I would. And as well as the directors and the management team at Universal Stainless & Alloy Products. We are always open to take a look at what might be available and would it complement the core business that we are in.

Right. My second question is also a follow-up on the direct sales potential for the Company. You have often mentioned two of your biggest indirect customers, I believe, both GE and Boeing. Would you try to sell direct to them in some of your products or all of the products that you sell?

Anything that they -- that is why I was so pleased when GE Jet Aircraft division contacted us to start talking about their total requirements for that division. Yes, I love doing business directly with Boeings and GEs and Toshibas and any large end manufacturer of a product. And we try to expand that every time there is an opportunity for us.

Okay, thanks.

At this time, there are no further questions. Are there any closing remarks?

Yes. If there are no more questions, then I would like to thank you for joining us today. We remain focused on pursuing the enormous opportunities in the marketplace for Universal Stainless & Alloy Products. I look forward to giving you an update on our progress on our next call. Thank you very much.

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