Universal Stainless & Alloy Products Inc (USAP) 2007 Q4 法說會逐字稿

Good morning. My name is Jennifer and I will be your conference operator today. At this time I would like to welcome everyone to the Universal Stainless fourth-quarter 2007 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 session. (OPERATOR INSTRUCTIONS). Thank you. Ms. Filingeri, you may begin your conference call.

Thank you. Good morning. This is June Filingeri of Comm-Partners, and I'd also like to welcome you to the Universal Stainless & Alloy Products conference call. We're here to discuss the Company's fourth-quarter 2007 results and first-quarter 2008 outlook, which were reported this morning.

With us from management are Mac McAninch, Chairman; Dennis Oates, President and Chief Executive Officer; Paul McGrath, Vice President of Administration; 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 as well.

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 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. It is my pleasure this morning to introduce Denny Oates, our new President and Chief Executive Officer of Universal Stainless & Alloy Products. I'm extremely pleased, both personally and as Chairman of the Board, to have Denny take over the leadership of this Company. His record of accomplishments and industry experience make him well-prepared and exceptionally well-suited to take us to the next level of growth.

Denny is well acquainted with most of our customers. He and I have personally visited two of our largest customers and I had the opportunity to view him in action. He is, without question, a professional.

You can expect a very smooth transition. My new role will be to work very closely with Denny, the senior management team, and the Board to refine Universal's future strategic direction and to assist in business development. Beyond these specific areas, Denny understands that I will be as involved in the transition as he deems necessary.

At this time, it is now my pleasure to turn this call over to Denny, who, along with Rick Ubinger, our CFO, will take you through the operational and financial review this morning. Denny?

Thanks, Mac. Good morning, everyone. It's a pleasure to be here this morning and I want to thank everyone for joining us.

I'm clearly the new kid on the block here at Universal, but many of you know I've been in the steel industry for over 30 years. While that isn't all that long compared to some people sitting next to me, it is long enough to give me the background to form some early impressions of Universal. There can be no doubt that Mac and his team have done a truly outstanding job in positioning Universal in profitable and growing segments of the specialty metals marketplace.

We have a nucleus of very strong customer relationships, complemented by a very competitive cost structure. The quality of our products is excellent, according to recent customer feedback. Our balance sheet is in very good shape. The real challenge, in fact the real opportunity, is to build on this foundation and accelerate profitable growth to build stockholder value, and that's exactly what we intend to do. The employees I've met to date are up for this challenge and they are eager to get moving.

Let's take a minute and just talk about how we're going to do it. We're moving forward quickly on a number of fronts. We are initiating programs to significantly improve customer service levels. We're targeting shorter leadtimes through reduced manufacturing cycle times and best in class on-time delivery. We are pursuing the market niches, including international partnerships and further penetration of existing markets, such as aerospace, power generation, and petrochemical. Adding an experienced vice president of sales is essential. And filling that post is one of my immediate priorities.

So is getting our new high temperature annealing equipment up and running in Dunkirk, which is scheduled for the second quarter of this year. We will continue to prudently spend capital on equipment and technology to provide the capabilities necessary to meet the needs of our customers.

We are also exploring new product opportunities. We will be relentless in eliminating waste in our manufacturing process. We see particular opportunities in yield improvement, streamlining product flow, and first-pass quality.

Lastly, acquisitions will continue to be part of our game plan as we seek to meet our customer needs, penetrate new markets, and develop new capabilities. As you know, Universal has a successful track record in this regard and we will continue to adhere to a very disciplined approach.

I hope you can get a sense of my excitement about what this Company is today, and more importantly what it can be in the future. I'm looking forward to working with all of the employees of Universal, our customers and our suppliers to make that future a reality.

Now let me turn to the fourth-quarter and the full-year 2007 performance. As we reported this morning, our sales for the fourth quarter of 2007 were $50 million with diluted earnings per share of $0.65. Our full-year 2007 sales were $230 million, generating diluted earnings per share of $3.32, both of which are Company records. Our 2007 cash flow from operations was $33.6 million, and free cash flow rose to $24.8 million or $3.67 per diluted share. The record cash flow enabled us to retire the $7.5 million outstanding balance on our PNC term loan.

As I noted in today's release, these results are within our forecasted range. The forecast we developed for the 2007 fourth quarter reflected volatile raw material costs and economic uncertainty as well as normal conservative year-end ordering patterns. There were a few surprises, with the exception of the sudden drop in nickel prices in December, which Rick will discuss in greater detail in a few moments.

Now, let's take a look at our key end-use markets. While our sales to aerospace were up 16% for the full year, they were down 19% from the fourth quarter of 2006 and 25% from the 2007 third quarter. As Mac said in past calls, service centers stopped ordering for inventory replenishment in the second quarter due to the rapid and volatile decline in nickel and focused instead on selling their higher surcharge products and reducing all inventory levels.

While you might expect the negative headlines about the U.S. economy to affect the current tone of business in our marketplace, our customers in aerospace and elsewhere tell us they are seeing a disconnect between the extreme negative headlines and their order books. Nevertheless, we expect them to be conservative until the economic outlook becomes clearer.

As to the further delay in the 787, we do not see a significant impact on our business. The story in the aerospace market is that Boeing and Airbus continue to book new orders at record levels. Backlogs remain strong. While we expect periodic adjustments in the metal supply chain in the future, the outlook for aerospace remains exceedingly positive from our standpoint through 2012. In short, the demand fundamentals in the aerospace market remain very strong.

Our sales to the power generation market for the year approximated 2006 results, but were down 32% from the record fourth quarter last year and 30% from the prior third quarter. We expect the growth trend to be quite different in 2008. As we noted in our release, we have already seen an uptick in orders for our ESR products since the beginning of the year. Customers are indicating they are getting new orders from General Electric, mostly destined for the turbines they are building for China. In fact, GE shipped 56 turbines in the fourth quarter, up from 40 last year, and they continue to forecast strong growth in their infrastructure segment in 2008. In their earnings call on Friday, they noted that their infrastructure order entry increased 40% in the fourth quarter.

Our sales to the petrochemical market were 30% lower than in the fourth quarter of 2006 and down 21% sequentially. While this market, which includes oil and gas at Universal Stainless, can fluctuate normally, I think there are more opportunities we can pursue and I plan to focus on them early on.

A bright spot in the fourth quarter was tool steel, which increased 54% year over year and was in line with a very strong third quarter. As Mac has discussed before, the worldwide trends and prospects for the heavy equipment market remain positive. With the exception of the strong domestic agriculture market, the growth in heavy equipment has been taking place mainly in markets outside the U.S., and that's expected to be the case in 2008 as well. Worldwide infrastructure, mining and energy markets are continuing to drive growth. From our vantage point, order entry for tools still continues to be very strong.

Let me now turn the call over to Rick for a closer look at our financial performance in the fourth quarter.

Thanks, Denny. As we reported in our earnings release, sales for fourth quarter of 2007 were $50 million. Net income was $4.4 million and diluted earnings per share was $0.65.

Our sales, which were in line with our expectations, were down 11% from the 2006 fourth quarter. That was mainly due to a 19% decrease in total pounds shipped. If you look at sales in comparison to the fourth quarter of 2006 by customer category, you will see increases in all cases with the exception of forgers and redrawers. Let me highlight a few items.

The increase in service center sales reflect a very strong increase in tool steel plate shipments, which Denny touched on. That increase offset lower shipments of vacuum [mark] remelted and other bar products to service centers. Sales to forgers echoed the overall trends we have been talking about in reference to service center buying behavior. Rod and wire sales at Dunkirk were lower in all customer categories because we elected to not pursue certain products that no longer met our profitability threshold.

Our gross margin as a percentage of sales was 17.1% in the fourth quarter versus 18% in the third quarter of 2007 and 21.2% in the fourth quarter last year. The decline in the latest quarter was the result of lower shipments in the quarter as well as the absence of a FIFO benefit in the Dunkirk Specialty Steel segment results. In the prior five quarters, we estimated that that impact from the rise in nickel prices on Dunkirk's gross margin generated a $1.5 million benefit in the second quarter half of 2006 and an additional $4 million benefit in the first three quarters of 2007. The monthly average price of nickel on the LME has declined from $23.67 in May of 2007 to $11.79 in December. Therefore, the estimated FIFO impact in the 2007 fourth quarter was actually a charge of $53,000. Our gross margin as a percentage of sales, net of material costs, was 26.3% in the fourth quarter of 2007 versus 26.9% in the same period of 2006.

In addition, the decline in nickel prices which began in June of 2007 resulted in our recognizing additional inventory reserves of $1 million at June 30th and an additional $1.4 million at September 30th under lower of cost or market accounting rules. In formulating our forecast for the fourth quarter, we had anticipated that a significant portion of the inventory associated with the additional reserves would ship during the fourth quarter and would generate a substantial reduction in our reserve balance at December 31st. However, the $2 drop in the average LME nickel price for the month of December generated a net increase of $400,000 to our inventory reserves for the month, offsetting somewhat the $1.2 million of reserves we were able to liquidate in the first two months of the quarter.

Our selling and administrative expenses for the quarter increased $468,000 in comparison to the fourth quarter of 2006. This increase primarily related to higher employment costs, including the recognition of stock-based compensation expense in accordance with FAS 123R. I would like to point out that we expect this expense to increase to approximately $1 million in 2008 from the $427,000 we are recognizing for the full year in 2007.

The combination of these factors led to a decrease in consolidated operating income to 10.9% of sales for the fourth quarter of 2007 from 16.5% in the year-ago quarter. The remaining items on the income statement had a positive effect on our fourth-quarter net income. We had other income of $740,000, including the receipt of $586,000 related to import duties. The balance represents interest income from excess cash invested during the quarter. We also recognized lower interest expense in the 2007 fourth quarter because we did not have to access our revolver.

Finally, we lowered our effective income tax rate for 2007 in the fourth quarter because of a favorable adjustment to the tax credits earned in the state of New York after discussions with the New York State Department of Taxation and Finance. In addition, our tax rate was further reduced by favorable shifts in the apportionment of taxable income for state income tax reporting purposes.

Turning to our balance sheet, our working capital December 31st, 2007 approximated $86 million versus $88 million at September 30th, 2007. A $12 million decrease in accounts receivable and a $2 million decrease in non-debt current liabilities, partially offset by a $3 million increase in inventory, generated sufficient cash flow to further increase our cash balance above $10 million as of year end. While the accounts receivable decrease corresponds to the decline in our sales during the fourth quarter, we also built up our inventory during the quarter to service the Dunkirk customer base as we entered 2008. That completes my review of the financials. I would now turn the call back to Denny.

Thanks, Rick. As noted in our earnings release, we expect sales for the first quarter of 2008 to range from $50 million to $55 million and diluted earnings per share to range from $0.60 to $0.65. Our cash flow from operations will continue to be strong in the first quarter.

Later this week, the Board of Directors will be meeting to discuss our capital and strategic plans. I tried to give you a general flavor this morning for the direction of that plan, and I look forward to updating you about it on our next call. That concludes our formal remarks. We would like to have your questions at this time.

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

Couple questions. First just wanted to kind of hone in on the aerospace market. Obviously there's been a lot of headline news, particularly around Boeing pushing out the 787 again. Obviously, aerospace sales were down in the fourth quarter and service centers have continued to restrain their order patterns. I was wondering whether, one, you'd seen any improvement from service centers here early in January. Obviously, many of them like to watch their year-end ordering patterns. And two, I was wondering, as you look at 2008 with the prospects of the 787, obviously, continues to be pushed out and you're looking at, you know, it seems like that some of the deliveries being pushed out to 2009 and 2010, whether you expect aerospace to still improve in the back half of the year or whether you expect on a year-over-year basis that there may be some softness?

Mike, let me take a couple of those. Let me talk about the 787 first. As I said, we don't see a big impact on our business due to the 787 postponement. What we've seen is basically an inventory adjustment in aerospace metal supply chain. A lot of that is centered at service centers. Some of that was made worse by the trends in nickel prices and service centers are in the process of working off that inventory. They're basically doing that during the second half of 2006. And our expectation is we will see improvements in that as we go through 2008.

Fundamentally, aerospace is still very strong. Airbus and Boeing are still making airplanes. Everyone we talk to in the supply chain is very busy. And I think you can make a pretty good argument that the postponement of the 787 in a strange way can be good for some manufacturers. That will give them a chance to get caught up. Because as you know, many of them have been behind.

More broadly, when you look at the overall mix of planes being produced, the 787 and the A380 get all the notoriety, but there are a heck of a lot of other airplanes being built and we'd still be in a pretty robust aerospace environment even without those two airplanes.

As far as the service centers go, just to amplify my comments there, I think the adjustment in inventory at the service centers began midyear. We saw during 2007; we saw it during the second half. As we look at the first quarter of this year, we are seeing some improvement. It's been somewhat -- I would call it a moderate improvement, and it's been mixed. Some service centers have started to order. Others are still on the sidelines.

That's very helpful. The second thing I wanted to just hone in on and I think one of the points you addressed in your prepared remarks was the opportunity to pursue international markets. I was wondering if you can give us any more color on some of the things -- some of the areas more specifically you might be focusing on there and then what your experience at Carpenter brings there in terms of how to approach those markets.

I guess from a strategic standpoint, the way we would intend to approach this -- the international markets is we want to be in those markets for the long haul. We're not interested in quoting on pieces of business on a spot basis. And in my mind, the way you do that is you hook up with an existing customer or a well-established company in the geography that you're targeting, and you stay committed to that through thick and thin. And you build a presence; you build a reputation just as Universal has done domestically. And that's what we attempt -- that's what we're going to do over the long pull.

In the two weeks I've been here, we've been very active in terms of quoting a variety of alloys, mostly aerospace related. The other thing we've been doing is looking for those long-term partners that we can work with in order to build a presence, both in Europe as well as Asia.

Okay thanks a lot. And I just wanted to congratulate Mac on great service to the Company over the last I guess 14 or 15 years.

Thanks. And if Denny has his way, I'm probably not completely finished yet.

He does nice work, Mike.

Timothy Hayes, Davenport & Company.

Just a couple of questions on the stainless billet, what are your leadtimes right now and how has that changed over the last quarter or two? And then also, how are base prices for that product?

Well the base prices -- we have not moved on base prices. The effective price of the customers is coming down somewhat as nickel prices come down, obviously, with surcharges. I mentioned leadtimes and cycle times in my prepared comments. One of our objectives is to compete based upon our leadtimes, so our intention is to pull those in. They haven't changed much over the last three months from what I have seen. And we are in about threes.

And then on your comments about the service centers, what is your expectations on when the service centers will have their inventory destocking completed for the aerospace supply chain?

Well, I think they're going to -- as I said, I think it's been a moderate improvement. I've seen over the last couple of weeks it's been mixed. Some service centers seem to be in and buying again. Others are still on the sidelines. My personal opinion is by the time we get to midyear, they will have eaten through the inventory levels and given the end-use demands for these products, they're going to have to start buying again.

Very good. Thank you.

Mark Parr, Keybanc Capital.

Welcome to USAP.

Thank you.

I was wondering if you could provide some additional color on the potential for your high-temp annealing capability at Dunkirk. And how much incremental capacity will this release internally and how quickly do you expect to be able to apply that to the market?

Well, we are expecting to have that piece of equipment fired up early in the second quarter. That's our current plan. I think we have announced before we would expect roughly $20 million of additional sales volume. Based upon that [first], I see nothing to dissuade me from that number. That's an annual number. We will start to see the benefits of that as we exit the second quarter and move into the second half of this calendar year.

So from our perspective on the financial side, would we look for a gradual shift in the mix, say away from Bridgeville into Dunkirk or will we look for overall improvement in volume shipments?

You will see the lion's share of that going through Dunkirk. So that is where you will see the numbers manifested from a financial perspective.

Okay. So we will see more -- we will see less semi-finished and more finished product?

Well, you will see more finished product, but I would not say we're going to see less semi-finished.

I guess, so the question, there's additional incremental capacity at Bridgeville to be able to feed Dunkirk to produce the incremental --

Absolutely.

$20 million in sales?

Absolutely. It's not going to be a trade-off where we are walking away from certain pieces of business in order to go up scale from a value standpoint.

Okay. Is there -- based on the end markets, I realize that your long and storied career at Universal Stainless, you've got incredible detail on this, but --

I know where the men's room is right now. Yes.

Congratulations. Good job. But how long do you think it will take -- what are your people telling you at this point in terms of how quickly you might be able to effectively utilize that incremental capacity?

We're going to jump on that very quick. It's at the top of my priority list and everyone else's priority list here, so as we get into the second half of this calendar year, we will be going full bore.

Okay.

I don't see it as a little incremental ramp-up.

Okay. So we would -- it would expect to see that coming on sooner as opposed to later? And I guess the last question I had, if you could give us a little more color as far as the process for hiring a VP of sales, how far along are you there? Is this a three-month project, a six-month project? Or -- and what sort of qualifications and capabilities are you looking for?

As far as the process itself goes, we've got a half dozen candidates. I'll be in the interviewing process here the next couple weeks. This thing isn't going to go on three to six months. It's a very high priority.

As far as the qualifications, we are looking for someone with experience in this industry that understands our products, knows our customers, and has international background.

Okay. Any sense of where you think the international mix of universal ought to be in two to three years or where you would like to see it?

I know where I would like to see it and it's a big part of our strategic planning discussion with the Board. Can we hold that question until our next conference call?

Absolutely.

The way I see this playing out is you can't do everything at once. Given our alloys and the products we make, Europe would be the likely first start. That doesn't say we're going to do these things all sequentially. But I see it being double-digit percentages on the Company's sales in the not too distant future. That's my objective, but I've got to review a lot of that with the Board here and make sure we are all aligned around that.

All right, terrific. Denny, thanks for your commentary and welcome to Universal.

Thanks, Mark.

(OPERATOR INSTRUCTIONS). Wayne Atwell, Pontis Capital Management.

Thank you. Without being specific, are there any acquisition opportunities you are excited about in your area? Is there much available for you?

As far as acquisitions go, that's part of the plan that we are looking at. We do have ideas along that line of thinking. If you look at valuations, valuations have obviously been very steep over the last couple of years. I think some of those valuations are coming in line where things can be done more effectively. And that's going to be something. As I said, that will be part of our strategic plan. Obviously, I can't give you a list of who they are, but they are philosophies that go after companies with a very disciplined approach, not overpay, and look at companies where we know there are good, hard cost synergies to generate the returns we want.

Thank you.

(OPERATOR INSTRUCTIONS). At this time there are no further questions. Mr. Oates, do you have any closing remarks?

Yes, I'd just like to thank everybody once again for joining us. Look forward to talking to you on our next conference call at the end of the first quarter. Have a good day.

This does conclude today's conference call. You may now disconnect.