Universal Stainless & Alloy Products Inc (USAP) 2008 Q1 法說會逐字稿

At this time I would like to welcome everyone to the Universal Stainless first-quarter 2008 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). As a reminder, ladies and gentlemen, today's conference is being recorded. Thank you. Mr. Filingeri, you may begin your conference call.

Good morning. This is June Filingeri of Comm-Partners, and I'd also like to welcome everyone to the Universal Stainless & Alloy Products conference call. We're here to discuss the Company's first-quarter 2000 results and second-quarter outlook which we reported this morning.

With us from management are 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 again 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 these formalities out of the way, I would like to turn the call over to Denny Oates. Denny, you may begin.

Thanks, June, good morning, everyone. Thanks for joining us today. As we reported this morning, our sales for the first quarter of 2008 were $57 million, yielding $4.7 million of net earnings or $0.70 per share. Sales and earnings were higher than our forecast, mainly due to higher-than-expected shipment volumes of our power generation and tool steel products. Our backlog increased by 3.5% to $88 million. Rick will more fully review our financial results shortly.

In the meantime, let me take a couple minutes to expand on the progress we have made against these strategic priorities discussed on our last call. These priorities are part of our overall plan for accelerating growth and building stockholder value at Universal. Accelerating sales is key, and leadership of our sales and marketing efforts has been a high priority for us. We're very pleased that Chris Zimmer will be joining the Universal team as Vice President of Sales and Marketing next Monday. Chris has the right combination of industry and business experience to move our sales effort forward. He understands our markets and our products. He is well-known and highly respected by many our customers. He has the right blend of domestic and international experience. In short, he's a great fit for this organization.

We're pursuing sales opportunities on three fronts -- through further penetration of existing end markets, entering new market niches and establishing ourselves in international markets. We've had some early successes including a recent $3.7 million order for power generation product destined for Europe. However, we are realistic about the time it takes for the sales effort to produce substantive results. It involves establishing relationships, getting comfortable with each other, running trial orders and in some cases obtaining approvals.

We have been especially active in our international outreach over the past three months. We have been visited by potential customers, representatives and partners from the UK, Germany, Italy, Sweden, Russia, the Ukraine, India, Mexico, Brazil and Argentina. We have several product trials underway as a result, including some for new products.

On the domestic side we're solidifying our position with existing customers and actively pursuing opportunities with new customers. Our new state-of-the-art high-temperature annealing system has been installed at our Dunkirk facility. This $3.5 million project will eliminate a production bottleneck and increase our sales potential for finished products. This system is moving through the qualifying stage, and we expect our first production runs to begin in the latter part of May.

In tandem with our sales effort, we are deeply focused on significantly improving customer service levels and our operational efficiency. We're working to shorten our lead times to reduce manufacturing cycle times and best-in-class on-time delivery. All of our employees are heavily involved in every aspect of this effort. Together we have developed new performance metrics that are being standardized throughout our operations and we've assembled a number of multifunctional teams who are driving the operational improvement and eliminating waste in our manufacturing process.

We're also investing capital to support this effort. Today we announced plans to move the round bar finishing operation from Bridgeville to Dunkirk. This project will lower costs, improve yields and reduce cycle time. Inefficient multi-step finishing lines at Dunkirk will be replaced with continuous process equipment. We expect cycle times for bar products will be cut by two weeks. Bridgeville will benefit by being able to more fully focus on its core competency, which is the manufacture of semi-finished products, including tool steel plate.

We're also investing in improvements in our melt shop including a new state-of-the-art furnace shell, a new capacitor bank and control systems. We're investing in environmental and equipment controls and also rearranging our plant layout to authorize product flow through our finishing operations. Again, all these actions are targeted at enhancing productivity and eliminating waste.

We're still planning on a capital spending budget in the $8 million to $10 million range for 2008.

Let me turn to our operating performance in the first quarter of 2008 and review our key end use markets. Our sales to aerospace represented 38% of our total first quarter sales and increased 5% from the fourth quarter, but they were down 15% from the first quarter of 2007. The aerospace cycle remains very strong, notwithstanding the further delay in the 787. Aircraft manufacturers have impressive backlogs extending through 2012. In fact, Boeing reported yesterday that its contractual backlog for commercial aircraft reached a record $271 billion, which is more than seven times its projected 2008 revenues for that unit.

They also forecast delivering up to 480 planes this year, 505 planes in 2009, which includes about 25 787's, and even more in 2010. Therefore, what we are experiencing is not lower end-use demand, but rather residual inventory issues in the metal supply chain. Service centers and forgers are continuing to be very conservative in their ordering patterns. Based on extensive conversations with our customers, we continue to expect to return to more normal demand conditions in the second half of the year, by necessity.

We experienced a favorable trend in our sales to the power generation market in the 2008 first quarter with a 35% increase from the fourth quarter and a 15% increase year over year. We expect this trend to continue, fueled by global energy requirements. Our view was further supported by a potential Indian partner who visited us recently. They spoke very enthusiastically about the growth of power plants in India and what they are seeing throughout the developing world.

We reported a 30% sequential uptick in our sales to the petrochemical market in the first quarter, which were essentially equal to the first quarter of 2007. As I mentioned on our last conference call, we're increasing our emphasis on this market, especially oil and gas. Our key customers expect that drilling demand will strengthen as the year progresses. More importantly, they are forecasting that the current cycle of exploration and production will continue well into the future.

Our sales of tool steel plate were stronger than we expected in the first quarter and increased 28% year over year and 25% from a very strong fourth quarter. Demand remained strong in the heavy equipment market because of the machinery being built to support the growth in infrastructure in emerging markets. For example, Caterpillar reported record fourth quarter results last Friday. They also forecast a robust demand for their products in the global mining and energy industries. The recent exchange rate of the dollar is also having a positive effect on domestic tool steel consuming industries. From our vantage point, we're not seeing much of impact from the much reported weakness in the US economy.

Let me close here to turn the call over to Rick for a closer look at our financial results for the first quarter.

Thanks, Denny. As Denny mentioned, our sales for the first quarter of 2008 were $57 million, and net income was $4.7 million, resulting in diluted earnings per share of $0.70. Our sales, which exceeded our forecast, were up 1% from the 2007 first quarter. That was mainly due to a 5% increase in total pounds shipped, partially offset by the mix of products shipped and lower surcharges assessed. Sales at both our Universal Stainless and Dunkirk segments essentially matched the first quarter of 2007, while operating margins were lower on a year-over-year basis. In the case of the Universal Stainless segment, that was due to a shift in product mix while the swing in the FIFO effect accounts for the change in operating margin at Dunkirk.

Both segments realized growth in sales and pounds shipped over the fourth quarter of 2007, which resulted in the sequential improvement in our operating margins. If you look at sales in comparison to the first quarter of 2007 by customer category, you'll see a significant increase in sales to rerollers. This increase was offset by lower sales to forgers and redrawers. As we discussed in our last conference call, the expected decline in sales to forgers was a result of excess inventory in the supply chain, while the reduction in sales to the redrawer market is related to our decision not to pursue certain products that no longer meet our profitability threshold.

Sales to service centers were level between the two periods with increased shipments of tool steel plate products more than offsetting lower shipments of aerospace-related bar products. As Denny mentioned, service centers are maintaining conservative buying practices as they continue to address pockets of excess inventory.

Our gross margin as a percentage of sales was 17.7% in the 2008 first quarter versus 17.1% in the 2007 fourth quarter and 23.5% in the first quarter last year. The decline in the latest quarter in comparison to the year-ago period resulted from the mix of products shipped and the absence of a FIFO benefit in the Dunkirk Specialty Steel segment results. We estimated that the impact of surcharges on Dunkirk shipments resulting from the rise in nickel prices through the first half of last year generated a $1.2 million benefit in the 2007 first quarter.

In comparison, our estimate of the impact of surcharges from the subsequent decline in nickel prices generated a charge of $53,000 in the 2007 fourth quarter and an additional $157,000 charge in the 2008 first quarter.

Our selling and administrative expenses for the quarter increased $521,000 in comparison to the first quarter of 2007, although they were level with the fourth quarter. The increased cost year over year primarily related to an increase in stock-based compensation expense in accordance with FAS 123R, additional audit fees incurred as a result of complying with the Sarbanes-Oxley Section 404 requirements for the first time, higher legal fees resulting from the Company's defense of a contractor litigation matter and the recognition of a reserve for a product claim matter. The combination of these factors led to a decrease in consolidated operating margin for the first quarter of 2008 to 12.3% of sales from 19% in the year-ago quarter, although our operating margin improved from 10.9% in the 2007 fourth quarter.

The remaining items on the income statement had a positive effect on our first-quarter net income. We recognized lower interest expense in the 2008 first quarter as a result of retiring our PNC term loan in December. In addition, we did not have to access our revolver in quarter and generated interest income from the excess cash balance we were able to maintain throughout the quarter. We had $10.8 million of cash at the end of the quarter.

Finally, we lower estimated effective income tax rate for 2008 to 33%, based on additional New York State income tax credits we expect to recognize from capital equipment additions at our Dunkirk facility as well as certain favorable state tax law changes that became effective in 2008. In total, we reported net income of $4.7 million or $0.70 per diluted share, which was $0.05 ahead of the high end of our forecast.

Turning to our balance sheet, our working capital at March 31, 2007 approximated $89 million versus $86 million at the end of 2007, a $7.2 million increase in accounts receivable and the payment of $2.4 million in profit-sharing earned by our employees in 2007 partially offset increases in accounts payable and accrued income taxes payable at March 31. As expected, our accounts receivable balance increased directly in relation with our increased sales activity in comparison to the fourth quarter.

That completes my review of the financials. I will now turn the call back to Denny.

As noted in our earnings release, we expect sales for the second quarter of 2008 to range from $55 million to $60 million and diluted earnings per share to range from $0.70 to $0.75, representing incremental improvement over our first-quarter performance. With the operational improvements we have completed or have underway and the positive outlook for the second half of the year, we should see further improvements in the balance of 2008.

That concludes our formal remarks. We are now looking forward to taking your questions.

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

First, just one thing on the power generation market, obviously we've had some fits and starts over the last couple of years in that market. It was nice to see the pickup sequentially as well as this nice order that you booked in the quarter. Should we expect to see some sustainable momentum in that market, or is there anything unusual where you booked an order this quarter and we shouldn't expect that kind of activity going forward?

I would view it as sustainable from everything we're hearing from our customers and our plans for the rest of the year. As they look at the globe and the energy requirements around the globe, Mike, it's pretty much a consistent story that we should expect bigger and better things as we go through this year and into the next couple of years, quite frankly.

I actually missed it in your prepared remarks, but I didn't hear you talk about the high-temperature Neely equipment at Dunkirk that had been originally talked about a couple quarters ago and was originally supposed to come online in the second quarter. Is that still planned, or did I miss that?

I did comment on it. We did complete that project and equipment is there; it's up and running. We fired the furnace up earlier this week. It's now going through its qualifying stages, and we would expect production runs to begin there toward the third or fourth week of May.

So would you expect to be in full operation on that, then, in the third quarter?

Yes.

Is it still fair to assume $20 million in annual revenues off of that?

We're not backing away from that initial estimate, no. So $20 million is still our target for that facility on an annual basis.

[Kevin Miney], Cleveland Research.

I'm wanting to try to get some more color on the 787 delay. Just what impact you guys may see there, and also just what gives you the confidence that you are going to see service centers returning to more normal buying patterns in the second half.

As far as the 787, it's almost impossible for me to give you a specific impact on Universal. I would tell you it's relatively small. Since over half of our sales go through service centers, we can't track it right to -- our product right to individual models at each one of the major producers of commercial airplanes.

As to what gives us confidence, it's our conversations with our largest customers and our understanding of where they stand from an inventory position and what their plans are as they go through the rest of calendar year 2008 coupled with what we view as (inaudible) demand for the product. These planes are still being built, even though the 787 has been pushed off a couple times now, take that out of the equation, there still is an all-time record number of airplanes being built, and that process has not stopped. So inevitably, the metal supply chain will be drained of excess inventories and service centers and other members of the supply chain will have to begin buying again.

And the mix shift during the quarter -- how do you expect that to trend moving forward? Do you see any deviation from that?

I would expect the -- consistent with our forecast for aerospace, which are generally higher-priced, higher-margin products, I would expect the mix to improve as we go through this year.

Luke Folta, Longbow Research.

Congratulations on the solid results this quarter. My first question deals with the reported excess inventory that you said you're seeing in the aerospace service center and forger channel. Can you give a little bit more color on just what those products are and what programs you're seeing them related to, if possible?

I can't pin it to exact programs at the commercial builders. All I can say to you is, fundamentally, if you look at the last two or three years and look at buying patterns on the part of the forging community as well as the service centers that supply into the aerospace supply chain, given the significant ramp up in demands coupled with the trends in raw material costs, there was a significant amount of overbuying that was done. And really, for the last -- it's going on a year now, there has been an effort to work those inventories down.

Is this mainly your high-temperature alloy segment?

All the aerospace alloys we are seeing it in, yes. High-temperature would be one of the issues. If you look at our mix, Rick commented on the deterioration of our mix in the first quarter, and that's a piece of it.

Can you talk about what you are seeing as far as the competitive environment in your stainless business? Are your competitors keeping base prices relatively firm? Maybe you can comment on what was going on there?

I would say, if you look at pricing and compare to where we were a year or two ago, base prices were moving up fairly rapidly and fairly regularly. We're not seeing that anymore. I would say the market has become much more competitive, but we have not seen significant deterioration in pricing.

What percentage of your quarterly sales were to international markets? Can you talk maybe more about what the opportunity is there and may be quantify that somewhat?

International is not a big part of our business. It runs around 4% of 5% of our sales. Given the value of the dollar and given the product offerings that Universal has, we feel that's an opportunity to grow the business. We have reached out to a number of geographic areas, and I went through what those areas were, basically. I won't recount them. And we found a very receptive market. The issue now is to get comfortable. The customers need to get comfortable with us, we need to get comfortable with them. In some cases, we need to get approvals. We are running trial orders for several of them, and in my view this is a long-term process. It's not something that next quarter, all of a sudden, that 5% is going to go to 30%. It's a gradual process where we establish the name of Universal in certain areas of the globe for the products that we make, and over time we build those relationships the same way that it has been done domestically over the last 14 years since Universal was incorporated. And we'll go from there.

If you asked what products we're talking about, most of these products are aerospace-related products.

Mark Parr, KeyBanc Capital.

First of all, I wanted to congratulate you on the quarter. I guess the result was very encouraging. The outlook is very encouraging. The composition of the first quarter was a little surprising to me. There was a stronger volume momentum than what we had anticipated, and I think where the disconnect might be is that I'm thinking that maybe more of your business is late cycle and noneconomically sensitive than what I thought.

Could you give me an update on how much of your business you view as economically sensitive?

I guess the way I look at that is, I go back to markets we've tried to position the Company in, and they are aerospace, petrochem and power gen. As you look at the fundamentals behind those three markets, they are pretty strong not only in 2008 but as you look down the road the next three to five years, all the experts would tell you that, barring some unusual event, they should be pretty healthy markets. So we sit here today and, like you, I see the same television newscasts and read the same newspapers about the economy and how horrible it is. All I can tell you is we're not seeing that. I've been to a number of recent conferences in the industry and hear the same thing throughout, which is, what are some of these folks talking about on the newscasts? We're not seeing it on the industrial side.

So I can't give you a specific percent, other than our strategy is to focus on markets that we feel are growing globally, that fit our facilities nicely, that will insulate us somewhat from the business cycle. But I don't know that I can say to you we are 100% insulated there.

The backlog momentum that you showed at the end of March, a pickup from the end of December -- that's the first time we've seen much increase in the backlog for awhile. Does that indicate a change in the totality of your business outlook, or is it a function of maybe your influence in terms of being -- or perhaps a more aggressive marketing orientation or new product applications? Could you talk a little bit about the change in the backlog momentum?

As far -- as I look at the backlog, what I see happening are a couple of things. One is some very strong tool steel demand, which, candidly, has surprised us. I think that relates to the value of the dollar, coupled with the fact that you've got some manufacturing that was previously sent out of this country and is quietly making its way back into the country that utilizes tool steel. So we have a great deal of interest in tool steel. I don't expect that to be a one-quarter phenomenon; I do see that building.

The other thing is power gen business, which had its ups and downs here over the last year and a half, but I think is pretty solid first quarter. I'm optimistic about the rest of this year. As I said earlier, I think it's more stable, a stable growth outlook for that business. The interesting element is the aerospace business, where, as we look at it and we talk to customers, there are some customers that have begun to buy again. There are other customers that still talk about excess inventories, but virtually everyone says by the end of the first half they should be worked through all the excesses and start to buy, again, according to normal patterns, based upon their end-use demand.

Do you know where the tool steel-related business is coming back from?

Asia, primarily.

Really? That's interesting. Thanks for that color and congratulations on the progress.

Tim Hayes, Davenport & Company.

On your guidance, the EPS guidance for Q2 -- does that include the $0.02 for moving equipment?

Yes.

And, should we think of the tax rate going forward as now 33%?

Yes.

Allegheny yesterday reported, and they cited some weakness in their nickel alloy business. I just wanted to compare that to your product mix. How much of that overlap might affect you? I see a category high-temperature alloy steel. Is that the same as a nickel alloy, or is that different?

It's essentially the same, but fundamentally you can't compare us to Allegheny. They have a much richer product mix than what we have here. The nickel alloys are generally in the higher end, so you're talking about Allegheny's and the Carpenter's of the world there. So I heard the same comments. You shouldn't interpret their comments about nickel alloy as being a reflection of what's going to happen here at Universal. Just different products.

They did say that the weakness in the nickel alloy was not in the jet engines, and that's why I was questioning maybe it would be in some markets that that would overlap with you all.

Nothing that we're seeing.

In the Dunkirk segment, the gross margins as a percentage of value-added sales was 45% in the quarter. It has been exceeding your target of 40% for several quarters now. Should we be thinking of that as maybe it has reached a new plateau, or should we be conservative and go back to 40% going forward?

I think the 40% is probably conservative, based on what we're seeing, especially in the last quarter. I still think that there's some -- one of the effects on Dunkirk's margins in the first quarter was the stability in nickel prices and the fact that we were able to reduce our lower [cluster] market reserve in Dunkirk because of that. So I would say somewhere in the mid point between the 40% and the 45% might be reasonable. We're still holding the benchmark at 40%.

(OPERATOR INSTRUCTIONS) Lawrence (inaudible), [My Broker], LLC.

I think this is the first time I've had a chance to speak with you, and glad to see the way you are taking hold and making some changes. Always good to have fresh eyes there.

One area that we haven't heard a lot about, I do say it's picking up, is the oil and gas/petrochemical area. I wonder if you could give a little more flavor on what sort of products you are supplying into there, what sort of end products that are going into it?

We are supplying high-end steel, which is into that market. It is largely a market that's serviced by distributors, which is in our sweet spot. So many of the customers that we have already dealt with over time are big players there. As you talk to the end-use folks down there, the Halliburton's and Schlumberger's of the world, if you take a look at their recent releases and so forth, you'll see the optimism that I alluded to in my prepared comments about the exploration budgets not only this year but as they move into the next coming years. As look at our product portfolio, I think there's a good fit there. We already know the markets, we know the customers. We just need to pay more attention to that specific end, that particular segment of the market.

I fully agree with the optimism being shown. One area that strikes me -- with the ultra-deep offshore work, ultra-deep water, and now the work that's being done to actually build facilities that sit on the ocean bottom, I would assume that the corrosion resistance and the rest of the needs would -- may be calling for stainless type alloys or special alloys. Is this true?

Absolutely. There has been some recent articles in the Journal, as a matter of fact, about some sites over in Saudi Arabia and so forth. But anywhere in the world where we're looking for oil and gas today, it's getting harder and harder to reach the depths. The environments are more harsh. So anywhere that you are seeing that, they are seeing more requirements for corrosion-resistant products, and that plays right into the sweet spot for stainlesses and high-end nickel alloys.

And you feel well positioned to get a piece of those?

Yes.

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

I just would like to say thank you very much for taking the time to join us. I'll look forward to updating everyone at the end of our next quarter. Have a good day.

This concludes today's Universal Stainless conference call. You may now disconnect.