Universal Stainless & Alloy Products Inc (USAP) 2007 Q2 法說會逐字稿

Good morning. My name is Tashanta, and I will be your conference operator today. At this time I would like to welcome everyone to the Universal Stainless second quarter conference call. (OPERATOR INSTRUCTIONS). Ms. Filingeri, you may begin your conference.

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 second quarter 2007 results and third quarter outlook, which were reported this morning.

With us from management are Mac McAninch, Chairman and Chief Executive Officer; Ken Matz, President; Paul McGrath, Vice President of Administration; and Rich 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 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.

What these formalities out of the way, I would like to turn the call over to Mac McAninch.

Good morning. Thank you for joining us this morning. As reported in today's press release we achieved very strong results for the second quarter of 2007. Sales rose 29% to a record $62.1 million, which was above our forecast.

Net income for the second quarter rose 27% to $5.9 million, or $0.87 per diluted share, in line with our forecast. Included in our net income were charges totaling $0.18 per share for a legal settlement and inventory adjustments. Before giving effect to those changes, we exceeded the high end of our forecasts by $0.15. We estimate that $0.12 of that amount was a FIFO benefit due to the effect of nickel prices. Nickel prices were higher than expected until the end of the quarter when they experienced a sharp decline to the low point of $14.42, which occurred on July 17. Yesterday it was $15.66 a pound.

The market price for nickel has continued to move since the quarter's end. We have developed our forecast for the third quarter accordingly. Our earnings release has substantial defect -- detail on the effect of changing nickel prices on our business. For the balance of this morning's formal remarks, Ken Matz and I will focus on end markets and on operating factors that are in our control, as well as our latest growth initiatives.

Looking at our second quarter performance by end markets, aerospace remains our largest end market and a primary driver of our sales. Approximately 40% -- 46% of our total sales in the second quarter were aerospace-related. Our sales to aerospace rose 40% from the second quarter of 2006, and were 13% higher than the first quarter.

As you know, the commercial aircraft market is experiencing a very strong growth cycle, which will extend well into the next decade based on actual delivery schedules. Unlike past cycles, this one is being led by Asia, especially China, as well as by startup carriers and freight growth worldwide.

I have noted before that the commercial aircraft orders to date do not yet include the domestic fleet replacement. At its recent investor conference, Boeing noted that we are now at the point that the replacement cycle worldwide is likely to accelerate due to record fuel costs and the increasing importance of environmental issues.

Boeing's product strategy has enabled it to win the race for world market share in this cycle. And their deliveries, orders and backlog are at record levels. Not surprisingly, we believe that Boeing is the main end customer for our aerospace grades of steel.

We're continuing to work with Boeing directly in our effort to win additional conversion business from them as part -- as our overall OEM strategy. Based on recent conversations with Boeing's engineers, the special shape project has taken a back seat. Their emphasis is on the 787 Dreamliner in their deliveries.

Despite Boeing's success, Airbus remains a major producer of commercial aircraft. To capture more of the Airbus opportunity, we are conducting a search through SMR, the leading stainless steel market research consulting firm in Europe, to find a sales rep or sales partner in Europe. Of course, we want the scope of that partner's activities to go beyond aerospace to include power generation and other niche market opportunities that we may be able to participate in.

We have concluded that to sustain our growth initiative we must participate in the export markets. Our total sales to the power generation market where in line with the first quarter and 4% below the second quarter of 2006. However, our sales to forgers doubled over last year and were up 9% from the first quarter, mainly for billet products for the forging of turbine blades. We see many reasons for optimism about the power generation market going forward.

GE just reported that their gas turbine shipments rose to 41 units from 27 last year, and that they received orders for 64 new turbines versus 47 at this time last year. They also reported that their nuclear orders were up more than 100%. We continue to view the renewed opportunity in nuclear as a major new growth driver for the industry and for our Company. In fact, GE and Hitachi recently formed an alliance to pursue nuclear business they see being created by climate change and energy security concerns. The company they formed, GE Hitachi Nuclear Energy, has already submitted its reactor design to government regulators in London. The UK is considering whether to build a new fleet of reactors to help meet its energy and emissions reduction requirements. A single reactor project costs several billion dollars, so the potential market opportunity for nuclear power is enormous.

Our sales to the petrochemical market essentially matched the second quarter of 2006, but were 8% lower than in the first quarter, reflecting the normal fluctuation patterns. There is no doubt that the petrochemical market should remain a good one for us. In fact, on Friday Schlumberger reported that their oilfield services revenue rose 21% from last year and 5% sequentially, driven they said by the increasing pace of the international activity.

After a very strong first quarter, our tool steel sales in the second quarter came in at a slightly lower level both sequentially and year-over-year. On our last call I told you that we did a much better job of shipping tool steel product to our customers in the first quarter. Our backlog in tool steel remains strong. And we continue to see positive worldwide trends in the heavy equipment market, especially in mining, oil and gas and agriculture. Even Caterpillar, which saw North American sales soften in the second quarter, sees substantial growth in the rest of the world as being robust.

Let me turn to the capital project we announced in today's release. We have decided to add high temperature annealing equipment, capable of oil, water and air quenching, at our Dunkirk facility. Almost every grade of steel that we produce at Dunkirk requires high temperature annealing and quenching. Annealing is heat treatment process that brings the metal to an elevated temperature. It is than cooled, quenched either by water or more slowly by oil to achieve the specific structure and grade size -- grain size requirement for each grade of steel and application.

Dunkirk's current high temperature annealing capacity is approaching full utilization. The cost of this project is approximately $3.5 million. It has the potential to expand Dunkirk's annual sales revenue by as much as $20 million. Installation is scheduled for completion in the fourth quarter.

We based our decision on the same priorities that we always have. One, improving our ability to take advantage of our market opportunity. Two, continuing to shift our sales mix to higher value-added products. Three, reinvesting our capital to better serve our customers and build value for our employees and our shareholders.

We are also in the process of installing our seventh large milling machine that will add to our current aerospace and power generation product finishing capability in Bridgeville. Our existing milling machines have been running 24/7 for the last couple of years.

I will now turn the call over to our President, Ken Matz, for a closer look at our operating progress in the second quarter.

In making our CapEx spending decisions there are operational benefits that we look to achieve, in addition to the broader objectives Mac just mentioned. Among them is ensuring the reliability of our equipment, improving our processes and efficiency, and reducing our cost. Two projects underway reflect those objectives. First is rebuilding the cranes in our melt shop, which will be completed in August. By improving their efficiency and reliability we will be able to increase the productivity of our melt shop.

The second is the addition of emerging immersion sonic testing equipment, both in Bridgeville and in Dunkirk. By adding this capability we are lowering cost of immersion sonic testing by eliminating the need for outside convergence sources on more sophisticated products within our niche markets, as well as improving our efficiencies and on-time delivery.

As we discussed on the last call, improving our on-time delivery performance is an ongoing priority. It is essential for customer satisfaction and for quoting shorter lead times, which is a competitive advantage in our market, especially when it comes to service centers.

We made further progress in the second quarter, both because of our past capital investment and because of better production planning, scheduling and material handling. Another area of focus is sales and marketing. Unfortunately Rick Hack has decided not to move his family to Pittsburgh, and will be departing Universal Stainless shortly. We wish him well.

We're working with the executive search firm, Korn/Ferry, to find a new Vice President of Sales and Marketing. We have also been successful in hiring a sales rep organization to cover the western United States to help us take advantage of the strong new business opportunities we see in that region.

Before turning the call back to Mac, I will briefly recap the performance of our Universal and Dunkirk segments, both of which achieved record sales in the second quarter. Sales at our Universal segment grew 21% to $55.1 million. Mac already mentioned the doubling of our sales to forgers in the second quarter which contributed to that growth. Our sales of bar products to service centers also increased over the same quarter last year, as well as over the first quarter. These sales offset lower sales of tool steel, as Mac also mentioned.

Sales at our Dunkirk segment totaled $21.3 million, which is an increase of 32% from the second quarter of 2006, reflecting higher sales of bar products to service centers and OEMs, most of which were aerospace-related.

We achieved volume growth in each of our product categories mentioned. The high nickel prices in place for most of the quarter heightened our sales to cover the effect of the surcharge mechanism.

Dunkirk continued to benefit from the improved flow of VAR remelted feedstock from Bridgeville in the second quarter because of the investment we made at -- in VAR capacity over the past two years. The addition of high temperature annealing equipment should enable Dunkirk to reach the next level of volume in sales beginning in 2008.

I will now turn the call back to Mac.

As noted in our earnings release, we expect sales for the third quarter of 2007 to range from $52 million to $57 million, and diluted earnings per share to range from $0.77 to $0.82. Lower nickel prices will restrain both our sales revenue and the profitability of our Dunkirk segment. The effect on Dunkirk will diminish as nickel prices stabilize.

On the positive side, lower nickel prices should encourage the service centers to resume inventory replenishment which would benefit our volume and our sales, especially in Dunkirk. Lower nickel prices also will increase our working capital.

While we cannot control nickel prices, we can and will execute on our strategy and our growth plan. There is substantial and increasing opportunity in our marketplace. We're making the investment and the operational improvements to further capitalize on them.

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

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

A couple of questions. I was wondering if you could just put any numbers on what kind of effect the new milling capacity at Bridgeville might have, and when you expect that to be up and running?

We expect the milling machine to be up and running in four to six weeks. And as far as the dollar value of that -- I don't know, Rick, I can't give an honest answer on that. I don't know whether you can. I really haven't looked at what it could possibly contribute. I know that we have had substantial backlog behind our milling machines, as I have mentioned. They were running 24/7 for the last two years. And I think that there's more opportunity out in the marketplace for us to add additional product as we increase our capacity for supplying that product in the marketplace. Dollarwise, I can't give you an honest answer right now.

It sounds like you expect it to be meaningful once you get it up and (multiple speakers).

I certainly hope so.

The next question I have is for Rick. I was wondering as we start to look at -- obviously you have had a lot of quarter-to-quarter fluctuation in nickel prices, and it is anybody's guess as to where it is heading over the next couple of quarters. But I was wondering if we assume that nickel prices stabilize somewhere in this current range, whether it is $15 a pound, etc., what the balance sheet might look like at the end of the year as you cycle through the accounts receivable, and as you turn the existing inventory over would you expect that you would be in a debt free position by the end of the year?

I would think, depending on how much monies Mac spends on capital expenditures, but that is a possibility. I would anticipate our receivables to drop just because our sales prices will drop as a result of lower surcharges. I would expect our inventory to drop based on lower material costs. So cycling all of that through based on where we are at at June 30, I would think that we would have a significant increase in our cash flow from operations in the second half of 2007 under that scenario.

I just might add we're not going to be debt free because we have a little bit of debt out there that has some very, very attractive interest rates on. And I am not in a big hurry to pay off that debt.

I understand. I was looking at it on a net debt basis.

I understand.

That potential does exist.

Just I guess a final question. It doesn't seem like you have seen any real change in the robustness of the end market. I was wondering any change in what your plans are over the next 6 to 12 months in terms of any new VAR or ESR capacity that you plan to bring on as you look at obviously the Dreamliner ramping up, as well as what looks like some increasing turbine build?

The way I would like to respond to that question, number one, with our expectations that we're going to be successful in finding sales representation in Europe, if that materializes, and we are on the verge of running out of capacity on our VAR or ESR furnace, I guarantee you the Board will have a decision to make on the approval for additional capacity.

Having said that, with our new sales rep organization out on the West Coast, if they are successful in uncovering some additional business out there that requires remelting, and the capacity is needed, I would certainly be in favor of proposing additional either VAR or ESR. We have the space to accommodate additional capacity -- additional equipment, I should say.

It sounds like you can break it out relatively quickly as needed. Is that a good characterization?

Yes.

Chris Olin, Cleveland Research.

I am just a little bit curious about your outlook in terms of demand. I guess I'm surprised that you don't have a little more of a cautious outlook for the stainless steel business. I would be thinking that you would see a slowdown in demand, or call it a slowdown in new warders until the nickel surcharge shakes out. I'm just wondering if you think that nickel will actually have a near term influence on order activity?

You have to remember, the surcharge mechanism on most of your businesses coming out of the service center industry and things like that are based on the last 20 day average or 30-day average at the time of shipment. So from my impression, for as long as the service centers have held off in replacing their inventory, I don't see that as an issue. And on top of that, I am more optimistic about the strength of the overall marketplace that we participate in. And I'm betting that I'm probably a little bit conservative.

I think that the strength is going to exist for some time as we go into the balance of this year. And in several of our markets it is going to be there for at least the first half of 2008.

Fair enough. Rick, a quick question on -- some help with the FIFO. Can you talk a little bit in terms of what the change would be in the third quarter versus the second quarter?

Number one, we certainly do not anticipate a FIFO benefit in the third quarter, especially since we did take a lower cost of market adjustment at June 30 because of lower nickel prices. Nickel prices have declined further from the number that we used in coming up with our increase in the LCM reserve. Time will tell as to what happens to our LCM reserve as we progress through the third quarter.

I guess you probably don't have any visibility in terms of what the fourth quarter effect would be?

No.

(OPERATOR INSTRUCTIONS). Mark Parr, KeyBanc Capital Markets.

This is actually Michael Bartlett for Mark. I had a question regarding in your guidance commentary you mentioned that Dunkirk's volumes are expected to be level sequentially. Would you be willing to comment on how you see volume and pricing playing out in the third quarter for Universal Stainless and the Bridgeville facility, etc.?

I think -- let's take Dunkirk first. A lot of Dunkirk's sales come through the service center industry, and with the drop in the prices of nickel, their selling prices are going to come down. I don't see that exact same benefit on the Bridgeville product that they're taking to the marketplace simply because our leadtimes and the time of melting versus shipping are much shorter than the Dunkirk facility experiences. Rick, I don't know if you want to add anything to that or not.

In our forecast we believe that the volume will be about the same for the Universal Stainless segment. We believe that the sales number might be -- it is going to be relatively close. It is going to probably be a little bit less, again, because of the surcharges. Operating margins we think will be consistent with the first and second quarters. And when I say second quarter, I am referring to the margin pre-adjustment.

Got it. Okay. That was helpful. In regards to the backlog number, I guess I had two questions. I'm not sure if this comes out in the detailed Q or not. But do you break out Dunkirk's backlog as a percentage of that?

No, we do not.

Then last question. Is there, or has there, or was there any effect from nickel on the backlog number?

Oh, absolutely. Because a lot of our business, whether it is Bridgeville's bar product or Dunkirk's bar product, a lot of it goes through the service center industry, even though it ultimately ends up in the aerospace and/or power generation market. And those guys had been awful quiet for the last several months, maybe even longer than that, as far as replacing their inventories.

They were very much concerned about getting caught with some very, very high-priced, i.e. nickel inventories, sitting on the shelf waiting for an order if -- and this is exactly what happened -- the price of nickel dropped from $22 to $14, whatever the numbers were. So being a Monday morning quarterback, you would said, boy, they made the right decisions. Well, that also impacted our order entry and our backlog. And I -- with what is taking place on nickel pricing, I would expect that we're going to see some activity as we go into -- through the balance of the year coming out of the service center sector. They have to start buying because the market is not dead out there. There is a hell a lot of life out there.

I understand. Next, regarding that backlog question and nickel's effect that was helpful. I guess maybe asked a slightly different way. The sequential decline in backlog, was any of that related to repricing of orders due to nickel or anything along those lines?

No.

No.

(OPERATOR INSTRUCTIONS). At this time there are no further questions.

Mac, let's turn it back to you for any concluding remarks please.

If there are no more questions, then I would like to thank you for joining us today. I can assure you that we are continuing to execute on our strategy to take advantage of our substantial market opportunity. And I look forward to updating you on our progress in our next call. Thank you.

Thank you. This concludes today's conference call. You may now disconnect.