Universal Stainless & Alloy Products Inc (USAP) 2006 Q4 法說會逐字稿

Good morning. My name is Lynn and I will be your conference facilitator today. At this time I would like to welcome everyone to the Universal Stainless & Alloy Products fourth-quarter 2006 conference call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period. As a reminder, today's conference is being recorded. Thank you. 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 are here to discuss the Company's fourth-quarter 2006 results and first-quarter 2007 outlook, which were reported this morning.

With us from management are Mac McAninch, Ken Matz, Paul McGrath, Rick Hack, and Rick Ubinger. 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 those statements, which are more fully described in today's press release and in the Company's filings with the Securities and Exchange Commission.

With these formalities out of the way, I would like to turn the call over to Mac McAninch. Mac, you may begin.

Thanks June. Good morning. Thank you for joining us today. I would like to begin today's call by introducing Ken Matz to you. I am pleased to introduce Ken as the new President of Universal Stainless & Alloy Products, which we had announced on Tuesday of this week. The Board and I have been conducting a search for a new President for the past year and Ken had the experience, leadership qualities, and proven track record of achieving profitable growth that we were looking for.

Before I provide you with my report on 2006 fourth quarter and the full year, I have asked Ken to spend a few minutes discussing his decision to join Universal Stainless. Ken, you are on.

Thank you Mac. I am very pleased to be here today. It is exciting to join a company with the impressive management team, performance, and growth potential of Universal Stainless. This company has a very broad range of stainless and specialty steel products that are in high demand in the marketplace today and should continue to be for the foreseeable future based on the prospects of the markets we serve.

Its commitment to pursue that opportunity combined with what I believe I can offer Universal Stainless based on my background and experience led me to my decision to join the Company as its President. Regarding my priorities, I have spent a good portion of my 25 years in the metals industry focused on product quality, operational excellence, and customer satisfaction. I plan to continue that focus here at Universal Stainless.

My first order of business is to get up to speed on the operations of our three facilities, the capabilities of each, the strategic opportunities that they offer, and what is needed to capitalize on those opportunities. I also will focus on our technical services to ensure that we are the -- we are developing the practices necessary to produce the highest quality products, further improve our efficiency and on-time delivery, and create effective solutions for the complex applications and special chemistries required by our customers.

I know that Universal Stainless has always emphasized the pursuit of profitable growth as the best way to serve the long-term interest of customers, employees, and shareholders. I fully share that philosophy and look forward to further implementing it along with Mac and the entire universal team. Mac, thanks again for carving out some time this morning for my introduction and let me turn the call back to you for the quarterly review.

Thanks Ken. As we reported this morning, we achieved record fourth-quarter and full-year results for 2006. Fourth-quarter sales rose 33% to $55.8 million and were above forecast. That brought the full-year 2006 sales to $203.9 million, which is 20% ahead of 2005. It is also the first time we have crossed the $200 million mark.

Both of our operating segments set new sales records for the year -- with total sales of $179 million for the Universal Stainless segment, while Dunkirk sales reached a record $70 million. Net income for the fourth quarter of 2006 rose 80% to a record $6.5 million, or $0.97 per diluted share, including $0.09 from import duties and a reduction in the full-year tax rate. Even before including those items, we exceeded our forecast for EPS of $0.70 to $0.75. As a result, our full-year 2006 net income reached $20.6 million, or $3.12 per share, both crossing new thresholds.

The continuous shift in our sales to higher-value products was the main driver of our growth. However as I mentioned last quarter, spiking nickel prices in the second half of 2006 increased our selling prices companywide because of the effect of the surcharge mechanism that we have in place, and thereby accelerated our sales growth.

I just might add that nickel hit $16.50 yesterday and moly is on its way north. So it looks like as we go into 2007 we are going to continue to experience the volatile raw materials costs that go into our product.

Dunkirk, with an average production cycle of three to six months, benefited from the timing of feedstock procurement and achieved an operating margin of 20% in the 2006 fourth quarter. If nickel stays at the current levels, that benefit will diminish in the first quarter of 2007 and Dunkirk's operating margins should return to a more-normal level.

Our Universal Stainless segment, which produces semifinished as well as finished products, saw the opposite effect on its profitability from nickel pricing because semifinished products, with their shorter production cycle, are more likely to be impacted by the lag effect of the surcharge mechanism in a period of rapidly accelerating material cost. As a result, the operating margin for the Universal segment in the fourth quarter of 2006 was 10% versus 12% in the same quarter last year.

I will devote the balance of my comments about 2006 and our outlook for 2007 and beyond to the fundamental and sustainable drivers of our business and growth, namely the strength of our niche markets and the investments we have made in capital equipment, workforce additions, process improvements, to take advantage of this opportunity.

Aerospace demand has been a major driver behind our growth in the fourth quarter of 2006, as it has been all year. The sixth vacuum-arc remelt furnace that we added at the end of 2005 and the two milling machines, plus the lab equipment that we added in 2006 enabled us to take advantage of that market opportunity.

For the fourth quarter of 2006 our sales to the aerospace market rose 68% from the 2005 fourth quarter and matched our very strong third-quarter. We have expanded our capability to produce the remelted steels required for the aerospace applications with the additions of a seventh vacuum-arc remelt furnace which we installed in Bridgeville in August. And we will recognize a full quarter of sales from it in the current first-quarter of 2007.

I've previously discussed the effort Dunkirk has been making directly with Boeing to roll the special shapes in titanium for the 787 Dreamliner. I am pleased to report that after lengthy testing, we received our first purchase order and shipped that product to Boeing earlier this month. I will be visiting Boeing in the very near future to finalize the process and hopefully get more shapes for our Dunkirk facility to produce.

With the peak in commercial aircraft deliveries from Boeing and Airbus not expected until 2009, they are forecasted to deliver a total of 985 aircraft. Aerospace should remain a very strong market for us for some time. And that does not include any additional orders from emerging markets or for fleet replacement that may be added.

Our sales to the petrochemical market rose 41% from the fourth quarter of 2005, but were 6% lower than in the 2006 third quarter. That kind of fluctuation can be typical depending on when the oil patch or the fertilizer makers need their products. The drop in oil prices will undoubtedly add to that fluctuation over the short-term. However with the longer-term energy consumption forecasted to continue to grow, market demand will ultimately benefit.

In contrast, we expect to see increasing strength in power generation throughout 2007 and 2008. In the fourth quarter of 2006 our sales to the power generation market increased 16% from the 2005 fourth quarter and were 15% higher than in the 2006 third quarter. Our sales included a significant shipment of forging billet that will be used to produce forged turbine blades.

The order came from one of our major forging customers which had won a significant contract with a power turbine manufacturer in China. We are the approved supplier of the forging billet for our customer under that contract. In addition, as I mentioned last quarter, we booked 1 million pounds of steel for GE Turbines for the first half of 2007. Overall, 2007 is shaping up nicely for us in the power generation market.

Our tool steel sales, which go to the automotive and heavy equipment manufacturing markets and others, declined 15% from the fourth quarter of 2005 and 12% sequentially. The problems of the U.S. automakers continue to impact that market, but the outlook for heavy industrial manufacturers is more positive. Putting aside Caterpillar's forecast for slower growth in 2007, the outlook is more positive for the agricultural equipment due to higher crop prices, and for mining equipment makers as their cycles continue to gain strength.

Despite the fact that analysts are forecasting a tough -- heavy -- a tough year for heavy truck manufacturing in 2007, Dunkirk had a substantial shipment of wire rod in the fourth quarter that will end up in the engines of diesel trucks and in the refractory composite material in reheat furnaces. And PACCAR just announced plans to build a $400 million plant in Southeast U.S. to build engines for its Kenworth and Peterbilt trucks, with completion slated over the next two years. On balance, the heavy equipment market should continue to offer us opportunity.

Turning to our forecast for the first quarter of 2007, we expect to report another strong quarter based on the factors I just discussed. I also remain very optimistic about the balance of the year. We expect the aerospace, power generation markets to be the main drivers of our growth this year, complemented by opportunities we are pursuing in the rest of our niche markets.

Our growth also will come from our continued shift to value-added products. We made headway in improving our operational efficiency in 2006 and will focus on furthering progress in 2007. That improvement combined with our investments in capital equipment and personnel has enabled to improve our on-time deliveries, although we have more to do. As always, our main objective for 2007 is to meet the needs of our customers and thereby build shareholder value. That concludes my formal remarks. We are now ready to take your questions.

(OPERATOR INSTRUCTIONS). Chris Olin, Cleveland Research.

I guess the first question that comes to the top of my mind, and maybe Rick can help me with this, is any sense for exactly how much of the earnings benefited from the nickel or the FIFO inventory counting?

Chris, I would have to say that given the estimate that we provided at the beginning of the quarter where we did not anticipate what nickel would do, if you take our $0.97 that we reported, subtract the two special items of nine, the balance of the difference between our estimate and that number I think we could say is as a result of the value of nickel.

So it's something in the neighborhood of $0.15 is it?

Not quite $0.15.

Not quite. It's a little less.

Somewhere between $0.10 and $0.15, but we still beat the forecast even with that nickel benefit.

My next question kind of revolves around the issues that I have mentioned you in the past regarding the fourth quarter. Can you give us, maybe, a feel for what you saw in terms of order activity from your customers, be it on the specialty stainless and/or nickel-based alloy side, and what you are seeing for early 2007?

Well number one, I cannot address the nickel-based alloy side because we are not really -- we are a small player in that business. I was pleasantly surprised with the order entry and the inquiry activity, especially in the month of December. You know, that is typically the time of the year when we all take a nap and think about Santa Claus and things like that, but I was pleasantly surprised. And for us to end up the year with a $120 million backlog, I would say we are pretty well-positioned going into the first quarter. And we have had some pretty interesting activity starting out this first quarter.

So there wasn't really a, call it, supply-driven slowdown in the December timeframe?

It was not as robust as the third quarter was, but it -- very seldom in the last few years that I have been in this business is it ever. I was pleasantly surprised at the momentum that it did have.

Great. And then I guess I am curious on your outlook for 2007 in terms of the supply/demand balance. There has been a lot of capacity coming online. It looks like it is good capacity. I am just wondering what your thoughts are in terms of if the market will be oversupplied and maybe a pricing outlook?

Number one, I think what you are referring to is the capacity in the vacuum-arc remelt area that has come on stream, primarily in 2006. If you take a look at the demand that has been placed on both Boeing and Airbus, as far as plane orders are concerned, we may just be in a position to keep up with the demand that I would expect that we are going to see out of the aerospace market.

I would certainly expect to see with this kind of growth and with the forecast for energy prices and stuff like this, I would expect that you are going to see some sales price escalation in 2007. And hopefully Rick Hack, who is our VP of Sales and Marketing -- I would expect that we are going to be a leader in that area, as we did in 2006.

That's all the questions I have. Thanks a lot.

Tom Cochran, Lake Road Partners.

Great quarter, but more than that it has been a great dozen years. I don't think anybody could have led this company better than you.

Well thank you for blowing smoke. I had a hell of a lot of help. I can tell you that.

That's all I've got.

Thank you.

Mark Parr, KeyBanc Capital Markets.

Hi, this is [Phillip Gibbs]. I'm calling in for Mark Parr here today. Good morning. I know you guys had commented on nickel pricing and moly, but what are your assumptions going into '07 regarding other key inputs, like ferrous scrap and nonferrous scrap, etc.?

Well, you know, and -- with the, and I happen to be a believer, that the domestic automotive industry is going to come back a little stronger in 2007 than they really were in the second half of 2006. I would expect that as the automotive comes back and it looks like the housing market has turned around a little bit, I would expect the demand for carbon scrap for the carbon steel producers will probably solidify the selling prices for carbon scrap in 2007.

I know there has been substantial fluctuation in the prices of carbon scrap coming out of the automotive industry over the last couple of months. I don't think -- from my perspective, I don't see a drastic reduction in scrap prices taking place here in the first half of the year. And assuming that the nickel prices are going to stay somewhere around the levels that they are -- and I will give you a wide range. Now that nickel went up over $16.50, if it stays $10-$16, you know, that is going to drive the price on stainless scrap.

So I feel pretty confident, and thank God for the surcharge mechanism, that we are not going to see a lot of relief in our scrap prices this year.

So that is heading north as well?

Yes.

Thank you. That's helpful. I had just one additional question. Where is your budget in '07 as far as CapEx, and do you plan on adding more capacity in '07?

I don't know that I would necessarily call adding capacity. But I will say this, we are going to have a Board of Directors meeting next week and that is when our capital budget will be formally approved for 2007.

As a company, and I know you haven't participated in too many of our conference calls, but we -- every year, we continue to upgrade equipment, install new equipment where it will add to our portfolio that we take to the marketplace to try to capture more of the value-added business. I don't see that changing. And hopefully, Ken Matz is going to come up with some new ideas and will become a bigger pain for our Board of Directors in approving capital spending.

Well thank you. I really appreciate the insight and congratulations on a great quarter.

Thank you.

[Lawrence Southam], Detweiler Mitchell.

Obviously delighted with the numbers. And I think the weather helped you also in the quarter.

Anytime there is no snow in Picksburgh it helps.

It may even help some energy costs for a while. Also, obviously very pleased to see Ken coming on board and he'll strengthen the team. I guess my question on CapEx will have to wait a week or so until we see what happens there. And I suspect that, although the question has come up occasionally of the dividend, that right now your inventory -- the higher metal costs are keeping cash pretty well used.

It sure is. But that subject may come up again when we have our Board meeting.

It is certainly one that I continue to feel something might be warranted more as a sign of the maturity of the -- maturing of the Company.

Thanks Larry. Thanks I need help like that.

I didn't say management.

No, no. I mean for suggesting -- you know, my primary driver is growing this company and it has cost us a hell of a lot of money over the last soon-to-be 13 years to reinvest the kind of capital dollars. And I would like to think that those stockholders out there would be in favor of us continuing to grow this company that is going to be a very strong, financially-sound company for the next 20, 30 years.

Now, Mac is not going to be around to see that. But I would sure as hell hope to think that that is what our stockholders would want us to do.

I think that is very much true. But there is also a lot -- a class of potential stockholders who -- with some kind of a dividend is an indicator to them that here is something to put on our radar screen. I have a question here. With the rising nickel prices, etc., the way you your adders work -- we get the added revenues, what is the effect on operating margin? Should it move proportionately or not?

No, in theory it's a pass-through (multiple speakers) and that is the idea of a surcharge mechanism. I would hate like hell to think that our customers would believe that our operating margins are being supplemented or complemented by the higher nickel and chrome and moly surcharges that are being in the marketplace. That is a direct pass-through, Larry.

That was my understanding, I just wanted to confirm it. Excellent. That's all of my questions. I just continue to watch as I have been for the last 12 plus years and --

Thanks Larry.

Michael Gallo, CL King.

A question I have is can you give us any update, Mac, on some of your efforts in international markets? I know that that has been an area you have been looking at the -- or starting to look at the last 12 or 18 months.

As I had mentioned within my presentation there, that one of our forging customers won a significant order out of China that's going -- the product is going to end up in turbine blades over there. I most recently had a phone conversation that pertained to my trip to India. And the kind of selling prices that they indicated that they were paying for the material that they were using to produce turbine blades certainly didn't match what I would be interested in selling product into India. That hasn't changed.

But Michael, as you pretty well know, we are patient. Do I have confidence that eventually we will crack that market and other markets? The answer to that is yes. And I would expect that as we go into 2007 we are going to continue to focus on some foreign markets for us to ship product into.

Great. And then, second question I have is just, and you mentioned in your formal remarks that you got the -- received the first purchase order and shipped, I guess, the initial shapes of titanium product to Boeing for the Dreamliner. I was wondering if you could -- it is probably too early, but any sense for how big the potential relationship there is? Is it you are doing one shape now and ultimately that can grow to five or six or eight or just a sense for -- obviously you have to execute out the initial shapes or shape, but any sense for how much potential there is, one.

Two, obviously Boeing is a new OE customer. Would there be opportunities potentially to sell them other parts directly. And three, is the titanium market a market that you might look to pursue more aggressively now that you have started to roll those products successfully?

I think that I would feel a whole lot more comfortable in being more specific of addressing the number of shapes that they might be interested in after my meeting with -- face-to-face meeting with Boeing. I know that when I go back to the initial conversation that we had with the Boeing representatives five months ago or whenever it was, they were, they had five different shapes of product that they could possibly be interested in.

So I really don't have a feel for ultimately where this could lead. But I can tell you we are going to pursue this with vigor because I think we are kind of in a unique position with our rolling capability at our Dunkirk facility. And we are certainly going to pursue it and hopefully it is going to be good for our company as well as good for Boeing. We are going to try to reduce their cost of producing the products and at the same time give us an opportunity to make additional money.

And then just the second part of my question, just on the titanium side. I mean, do you look at this as a one-off for Boeing or is the titanium business something that you plan to pursue more aggressively over the next couple of years?

I am going to make a sales pitch here. I would hope that there is someone out there that might produce titanium that is listening to this call, or producing titanium, and call us if you are interested in having us produce titanium shapes or rounds or plate or anything else.

Yes, I am very much interested in expanding our participation in that market. Now are we going to be in the sponge melting business? No. But we have a tremendous amount of equipment that is fully capable of rolling and shaping and turning and grinding titanium products.

As a lot of you know, we continue to roll titanium ingot into plate product on our big universal mill here at Breckenridge from some of our customers. Bridgeville, I'm sorry, I said Breckenridge. Bridgeville.

And then just following -- just a housekeeping question for Rick, the tax rate for the year I guess ended up at 35.2%. Is that what we should assume for '07 or what should we assume for the tax rate for '07?

Michael, I think you can assume 35% for now for 2007. Because -- and the main driver of that is the manufacturing exemption deduction for federal purposes is increasing for corporations in 2007. So our tax rate should go down.

Great. Thanks a lot.

(OPERATOR INSTRUCTIONS). Jon Evans, Wells Capital.

A couple quarters ago people were asking you about Airbus' pushback on the A380 and if that had caused any disruption in the marketplace. Could you give us a little update maybe just what you're seeing and if you are seeing any ramifications now from that, and if you have any insight into what is going on with Airbus and how that is affecting the supply and demand of your aerospace markets?

I can tell you I am not wired into Airbus, but I will give you my opinion and that is all it is. Is Airbus going to solve the problem that they had with the A380? I assume so. But I think, if you listened in on the last call, the A380 is having an impact, a slight impact on the titanium sheet producers and things like that. But if you take a look at the backlog of airplanes that Boeing and Airbus has for the A320, the A319, and whatever else they build and with Boeing on the 737s and the 747s and 777s, it is going to consume a tremendous amount of titanium sheet, strip, plate, anything else.

I don't think the Airbus A380 problem that they are experiencing is having that much off an impact on any of the producers. Have they seen a blip? I am sure they have, but I don't think it is something that they are getting a whole lot of heartburn over.

And with the order backlog that they have, I would expect that the demand for all of those products that not only titanium, but all of the products that we produce is going to continue to grow in 2007, '08, '09, and hopefully '10. Did that answer your question?

Lynn, did we lose our questioner?

No, ma'am. Their line is still established. There is no response from the line. We will continue to queue the roster.

Thank you.

(OPERATOR INSTRUCTIONS). Chris Olin, Cleveland Research.

I just wanted to focus on one more question real quick. In terms of the nickel influence on your earnings, let's say I was bearish on nickel and I thought the commodity cost was going to go down to $10 throughout 2007, what is your level of confidence that you can exceed 2006 earnings under that scenario?

Well that is a loaded question if ever I had one. I am going to answer it and I am going to answer it this way. We are going to continue to try to develop end-user business and businesses out there in anticipation of nickel prices coming down. And we are going to pursue those higher value-added products that we can take to the marketplace that hopefully will offset that drop in nickel prices.

Is it going to do it 100%? Probably not. But you know our charge as management of Universal Stainless & Alloy products is to continue to try to develop that value-added business. Because one day nickel prices are going to come down and we are not going to get the benefit that we achieved, and especially in the second half of 2006, where early in 2006 nickel prices were down.

The only thing that I pray for is that if nickel prices are going to drop to whatever level, they do it in the same manner that they reached $16 a pound. They use that same gradual slide down to $12 or $10, whatever the number is. Because each and every one of us in this industry, it will make our life a whole lot more easy to take if that happens.

I apologize if it came off like a loaded question, just trying to get the --

No, no. It wasn't loaded it was just an extremely difficult question to answer. But that is the approach that we are trying to take, Chris, is to try to develop a business or a number of businesses out there that is going to help us should a situation like that occur with nickel prices.

Great. Thanks a lot Mac.

There are no further questions at this time. I will turn the conference over to Mr. McAninch for closing remarks.

If there are no more questions then I would like to thank you for joining us today. Universal Stainless & Alloy Products made important strides in 2006. We plan to make further progress in 2007. I look forward to giving you an update on our next call. Thank you.

This concludes the Universal Stainless & Alloy Products conference call. You may now disconnect.