Universal Stainless & Alloy Products Inc (USAP) 2008 Q3 法說會逐字稿

Good morning. My name is [DeShonta], and I will be your conference operator today. At this time I would like to welcome everyone to the Universal Stainless third quarter 2008 conference call. As a reminder, ladies and gentlemen, this call is being recorded. 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.

Thank you, DeShonta. 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 third quarter 2008 results and fourth quarter outlook, which were reported this morning.

With us from Management are Dennis Oates, President and Chief Executive Officer; Chris Zimmer, Vice President of Sales and Marketing; Paul McGrath, Vice President of Administration; and Rick Ubinger, Vice President 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 remind you of 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 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.

Our third-quarter sales were $57.6 million, and diluted earnings per share was $0.40, in line with our revised guidance. As we discussed on October 8, two events impeded our sales in the third quarter. The first was the prolonged strike at Boeing. This was compounded by the acute economic turmoil in September, as well as the substantial drop in commodity prices in the quarter, which made service centers very conservative in their purchase decisions. As a result, Dunkirk sales were $2 million lower than we originally expected.

Service center cautiousness and minimal purchasing in advance of expected surcharge reductions are continuing with full force in the current quarter, when service centers normally tend to be very conservative.

The second event impacting our third-quarter sales was the expiration of the Bridgeville contract on August 31. Although our employees stayed on the job as negotiations proceeded, productivity was reduced, and Bridgeville shipments lagged projected levels. With a new five-year contract with our Bridgeville employees now in effect, we're rapidly getting back on track with customer shipments.

The resulting lower shipment volume in the third quarter combined with a 20% decline in raw material prices that reduced margins on finished products shipped, reduced our earnings for the period. I would add that raw material prices have continued to decline since the end of the quarter.

On the October 8 call, I reviewed our end-market sales. This morning I'll also discuss what we're seeing and hearing today from our customers and from the major end-market players.

But before I do, let me turn the call over to Rick Ubinger for a closer look at our financial results for the quarter.

Thanks, Denny. Sales for the third quarter of 2008 were $57.6 million, and net income was $2.7 million, resulting in diluted earnings per share of $0.40. As Denny said and we previously reported, our sales did not meet our initial expectations for the quarter because of lower-than-expected aerospace product shipments and production inefficiencies at the Bridgeville facility during labor negotiations.

We estimate lost sales due to the production inefficiencies at Bridgeville approximated $6 million, and the earnings-per-share impact was $0.16 per share in the quarter.

Year-over-year, sales decreased 7%, based on an overall 5% decrease in total tons shipped to customers. Lower shipments of VAR product were partially offset by increased shipments of tool steel and ESR products used for power-generation applications.

Our sales were down 9% sequentially, primarily due to lower shipments in Dunkirk and the fact that Bridgeville generated other revenue of $1.1 million in the second quarter, due to the sale of excess scrap.

If you look at sales in comparison to the third quarter of 2007 by customer category, you will see a decrease in sales to service center, OEM, and reroll customers due to the reduced sales of aerospace products, offset by higher sales to forgers and redrawers. Our sales also benefited from an increase in tool steel plate shipments to service centers.

The Universal Stainless segment sales were down 7% from the third quarter of 2007, primarily due to a 6% decline in tons shipped. Dunkirk sales declined 20%, based on a 16% decrease in tons shipped in comparison to the third quarter of 2007.

Our gross margin, excluding the $586,000 charge recognized in the quarter for the relocation of the round bar finishing line from Bridgeville to Dunkirk, was 12.5% of sales in the 2008 third quarter versus 18% in the third quarter last year and 16.5% in the 2008 second quarter. The decline in the latest quarter in comparison to both prior periods primarily resulted from reduced shipments of VAR products and the effect of lower raw material prices on surcharges.

Despite falling commodity prices, our material costs as a percentage of sales, before the impact of LCM reserve changes, increased for both Universal Stainless and Dunkirk segments compared to the 2007 third quarter and the second quarter of 2008, due to the production inefficiencies at Bridgeville and the normal production cycle at Dunkirk. The combination of these factors led to a decrease in consolidated operating income for the third quarter of 2008 to 6.5% of sales, from 13.1% in the year-ago quarter and from 12.3% sequentially.

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

Finally, we lowered our estimated effective income tax rate for 2008 from 33% to 32% during the third quarter. The lower rate, which generated a $0.03 per diluted share benefit, is primarily based on lowering our annualized income estimate.

In total, we reported net income of $2.7 million, or $0.40 per diluted share, which was in line with the high end of our revised forecast.

During the quarter, we generated free cash flow of $2.7 million. Our cash flow from operations was $6.9 million for the third quarter of 2008, a $2.2 million increase from the 2008 second quarter.

During the quarter we reduced our working capital from $95 million at June 30 to $94 million at September 30. This reduction was primarily achieved by reducing the quantity of raw materials on hand in our Bridgeville melt shop by 9%.

Capital expenditures during the quarter were -- of $4.2 million were primarily focused on our expansion activities in Dunkirk.

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

Thanks, Rick. Let me start with what we're hearing from customers. I don't need to tell anyone that the last two weeks, since our last call, stock market volatility has been extreme, and much more doubt has been cast on the global economic outlook, at least for the next few quarters.

While our customers may not fully agree with all the negative headlines about the economy, there is definitely a new level of uncertainty and hesitancy in the marketplace, with the result that our order entry is down from its level back in September. Our backlog, however, remains solid. And our receivables remain in good shape. We're not seeing any cancellations. And the fallout from the stresses in the credit markets do not seem to be affecting our customers, as far as we know, or any of their customers.

Looking beyond the current uncertainty, the news from our end markets is mainly encouraging. One obvious exception is short-term demand in aerospace. As I mentioned on the last call, our sales to aerospace, which represented 32% of total third-quarter sales, were down 8% from the second quarter and 32% from last year.

Aerospace demand is expected to remain weak until the Boeing strike is settled. However, the long-term prospects for aerospace remain very positive. Yesterday, Boeing reported that its contractual backlog for commercial airplanes rose to a record $276 billion, which approximates eight times their annual revenues for these products.

Of course, reductions in credit availability for aircraft financing and/or a deep worldwide recession could clearly change things, but absent dire conditions, the long-term drivers of commercial aircraft demand remain intact. In fact, on October 16 American Airlines announced their new purchase agreement for 42 Boeing 787-9 Dreamliners. They will be delivered between 2012 and 2018, and there is a right to purchase an additional 58 787s.

Their stated reasons for making this decision despite the current economic environment included reduction in fuel and maintenance costs, and a lessening in their environmental impact.

As we've said before, many of us in the industry have been waiting for the domestic carriers to begin replacing their aging, inefficient fleets, which would be a good addition for the Boeing and Airbus backlogs that up to now have come mainly from Mideast and emerging Asian economies.

Our wait has probably been extended because of economic uncertainty, but it's good to see a first move by American. Now we just need to have the Boeing strike be settled, and hopefully they are back at the bargaining table as we speak.

Our sales to the power-generation market, which represented 13% of third-quarter sales, were 11% lower sequentially and down 7% from the third quarter of 2007, mainly due to the issues that arose in Bridgeville. The demand prospects for the power-generation market remain strong, both now and for the long-term.

As we touched on briefly in the last call, power-generation projects are normally long-cycle infrastructure projects. Most of those driving market demand today are funded by foreign governments or sovereign wealth.

On their earnings call, GE reported that they received orders for another 33 gas turbines in the third quarter, with seven of those for projects in the US, which is a positive sign as well.

Our sales to the petrochemical market increased 5% from the second quarter, and rose 39% from last year. Petrochemical was our second-largest end market in the third quarter at 20% of sales. We definitely -- we are definitely benefiting from our new focus on the oil and gas segment.

While it is anticipated that economic uncertainty, especially in North America, and the fall in oil prices will have a short-term impact on new drilling in these markets, the longer-term outlook remains very strong. There is general agreement that the inadequacy of the current supply base and a decrease in reserve replacement ratios will drive exploration and production for the foreseeable future. We see additional opportunities to increase our participation in oil and gas, and have added sales support in Texas, which is an essential step in building that business now and for the long term.

Our tool steel sales were down 11% sequentially but up 43% from the same period of 2007, and represent an 18% of third-quarter sales. The Bridgeville issues held back our sequential performance. Demand for tool steel plate is holding up very well. While the heavy-equipment market in the US is expected to face tough conditions at least through the first half of 2009, most of the growth in the market over the past two years has come mainly from mining and energy outside the US.

On its earnings call this week, Caterpillar mentioned that it has a three-year backlog for large mining machinery and large engines and turbines for both new and replacement applications in mining and energy.

While mindful that the strengthening of the dollar may open the door to more imports, we plan to build upon our strong market position, our customer relationships, and the quality of our product.

On balance, our end markets continue to hold substantial opportunities for us despite short-term uncertainty and challenges. Our immediate focus is on getting Bridgeville fully ramped up, and on improving our efficiency and customer service levels company-wide. These are essential at any time, but even more so in uncertain economic times.

Looking at the fourth quarter, our forecast takes into account current conditions in aerospace and very conservative buying by service centers. However, due to the heightened economic and market uncertainty that we're experiencing, we have widened the range within our sales and earnings estimates, and want to underscore again that our forecast is based on current expectations.

Let me conclude by saying that we do not expect the fourth quarter to be an easy quarter. We do intend, however, to make further progress in implementing our strategies.

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

(Operator Instructions). Michael Gallo, CL King.

A couple of questions I have. First, I was wondering, with obviously a significant fall in nickel and other commodity prices, is base pricing still holding? Are customers asking for reductions in base price? Because I know, fairly recently you were still able to get base price increases. I was wondering if anything has changed on that front over the last month or so?

We have not announced any changes in base prices. As we negotiate new arrangements with customers, we're seeing some increased competition, but I would not say that we're seeing large-scale reductions in base prices at this time.

From a customer standpoint, they are seeing sizable reductions in the acquisition cost of our products due to the surcharge reductions.

Second question I have is, you noted, Denny, that over the last couple of weeks, order entry seemed like it had really fallen off. I think when you had the call in early -- earlier -- a few weeks ago -- you indicated that you were still seeing good order entry for tool steel plate and for power-gen products.

Have you seen a change in tool steel plate and power-gen product order entry? Or is it just -- obviously, aerospace has grounded to a halt, I would imagine. But I guess have you seen the other areas start to fall off, or are those still holding up okay?

Aerospace is the one that's down, Mike. If you look at our power-gen business and then you look at tool steel, they are still relatively strong. Power gen is a particularly strong spot. The tool steel business is good. It's down from where it was three to six months ago. But that's not what's accounting for what's gone on the last two weeks. It's mainly in the aerospace, and primarily service center business.

That's helpful. And then I guess final question for Rick. I guess as I look at the range for the fourth quarter, obviously it's a wide range, and it's a very uncertain environment. I was wondering, have you assumed anything in terms of resolution of the strike at Boeing? Do you pretty much assume that that continues through the quarter? I know it's something you have no control over. I just want to understand kind of how you came up with the range, given that?

Well, the forecast anticipates the lower shipments of product to the aerospace industry in the fourth quarter. A lot of that is due to the fact that most of that product does go through the service centers.

We didn't make any explicit assumption that the Boeing strike will be over at such and such a date during the fourth quarter, Mike. I think our view on that -- just to echo what Rick said -- is that we're seeing sharply lower order intake from service centers, largely with aerospace-related products. We see that continuing during the course of the fourth quarter.

Hopefully, they will get that thing settled, but even if they got it settled here in the next few weeks, it's still going to be down quarter.

All right. But I guess what I'm driving at is, what's the difference in your view between kind of the higher end and the lower end of the range, based on what you see today? Is the lower end what you're seeing to date, and the higher end assumes some improvement? There just kind of -- obviously, again, it's a much wider range than what you typically give.

Two issues I guess for the expansion in there as I look at the lower end, and that is -- typically in the fourth quarter, you get a lot of customers that are looking at year-end inventories, and they take a hard look at December receipts. So one of the things that concerns us is what happens as we go out of this year, as people are looking at their inventory this year, of all years. And what we see, the demand in the month of December that we typically -- that we're expecting in this forecast. So based upon that, we thought it was appropriate to expand that range.

The other subject is what's going to happen with raw material costs? We noted that some of the raw material costs have gone down since the end the quarter. And where will they end up here as we move through the rest of this quarter?

Okay. That's very helpful. Thanks a lot.

Kevin Money, Cleveland Research.

Just wondering, with the outlook of kind of sluggish demand in the near term here, what are your thoughts on industry-wide supply in the products you serve?

And sort of related to that is, how is the competitive landscape in some of the key markets that you guys serve?

Well, I think everybody in industry is wrestling with a very sudden reduction in demand, and also wrestling with a very volatile -- and I know we've used the word volatile an awful lot in raw materials, but I mean really volatile trends in the key inputs to making our product. I don't see any significant -- so everyone is wrestling with those two issues.

I don't see any significant change in the competitive landscape in terms of new entrants or people leaving the market. Even though the value of the dollar has strengthened, I don't see a great influx of imports into the domestic markets. So I don't see any big change in the competitive fundamentals, other than each company that competes in our space is wrestling with those two issues.

Larry Southam, My Broker LLC.

A couple of things caught that my attention here. You mentioned with regard to the increased petrochemical sales, you added sales support in Texas. Is that a salesperson, or is it in a support, or inside, outside?

That's sales people. That's a person on the street in Texas. That's part of our longer-term strategy to grow in that sector.

Excellent. The other area I'm seeing reports of a definite slowdown, an anticipated slowdown in steel worldwide, especially China, India, etc. Are you -- is there any -- most of their steel has not been competing with your grades of stainless, but are you seeing any of their stainless reaching over to that area?

You mean coming into the States, or exporting into those areas?

(multiple speakers) or produced in those areas. Are you seeing them improving their quality capabilities?

You're sure seeing slow improvement in the quality of the products in those parts of the world, yes. But the vast majority of the products that we specialize in are still made in North America.

I'm not seeing -- we're not seeing any significant increase, as I said earlier, in any imports coming into this country. And at the same time, if you look at our plan to export from this country, we're still -- we're running about 4% to 5% of our sales would be direct exports, and that is a target of opportunity for us to grow our international presence.

Luke Folta, Longbow Research.

We -- I had a question regarding your aerospace business. You said that most of it goes through the service center. Do you have any of that business on contract?

Virtually all through service centers. No long-term contracts to speak up.

Okay. So you probably wouldn't have a really great feel on how maybe the non-Boeing aerospace business would be doing?

Only insofar as that business goes through service centers. We don't have the direct visibility or direct contact with the end-use customer.

And a question on the cost side. If we do get into a prolonged downturn in 2009, can you maybe talk about some of the ways you could lower costs? I don't know if that means you cut production or lower costs in other ways. Can you maybe (multiple speakers)

Bob, if there's a prolonged reduction in demand in the marketplace, I think one of the things the entire industry learned the hard way over the past couple of decades is, you've got to adjust your production levels. It doesn't make sense for anybody to compete and just drive prices into the ground. So we will manage very aggressively what our production plans are. That's one.

Second thing, there are opportunities to significantly reduce costs in our facilities, as there are in most facilities. One key area would be yield improvement that we will be focusing on as we go down the road.

They would be the two large areas. And obviously, the production reductions implies that we would be controlling labor costs and all of the variable costs that go along with that.

Hello?

Do you think there's enough discipline in that market to where other producers would also take the option of curtailing production?

Yes, I do. That's why I made the comment -- I think the industry has learned over the last couple of decades -- both the carbon, stainless, and specialty side -- what the success factors are in the business.

Any other questions?

I'm sorry. I think I'm cutting out.

Edward Marshall, Sidoti & Company.

The guidance suggests a 30% to 40% decline in sales at Dunkirk. And my question -- and I know this is -- these two are kind of intertwined, but I want to know if you can quantify in any way what is attributable to the aerospace customer buying patterns, and how much is due to the falling surcharges on -- as nickel comes down?

The surcharges are estimated to drop about 20% from the third quarter. And then the rest of it would be volume. The volume is about -- I believe about a third.

Do you know how much -- is the business out of Dunkirk predominantly VAR product or aerospace-grade type product?

It has historically been heavily weighted to VAR product, yes.

And how fast do you feel -- or what's the lag time once Boeing gets back up to work? What type of -- and I know they're not going to go to 40 planes -- a 40 build rate planes a month right away, but what type of time line are you looking at as to when that aerospace business will start to pick back up?

You mean following the settlement of the strike?

Following the settlement of the strike.

We're guessing. But I don't know our Crystal ball is any better than anybody else's. About two months?

About two months?

Yes.

So based on what you're telling me today with -- or telling us today rather, the tool steel, the power gen, and the petrochemical showing strong order growth and strong demand in the end markets, once that aerospace business comes back on, I imagine that will be incremental to what you're seeing in the other end markets?

Yes. The other factor that plays into that is this trend in raw material costs, as well. Because -- but we haven't talked a lot -- we've mentioned it in our script, but nobody has asked the question. That is playing a heavy role in terms of how service centers, that represent almost half of our sales, basically buy their product.

So if you're sitting there today, and you looking at future -- or expecting to see future reductions in raw material costs, you're not going to be placing orders today. You're going to be putting off if at all possible those buys.

So I think a large portion of the service center community is kind of on the sidelines right now waiting to see when raw material costs stabilize. Once they see that coupled with the change in the aerospace environment, the labor situation specifically at Boeing, you will see a significant increase in their buying.

I think we saw on one of the calls last week that one of the service centers reported and said that they are looking at very conservative inventory patterns. I mean, that's what you're seeing, and I think that's what you're saying, isn't it?

Yes.

This is probably a little bit of a tougher question, but customer credit. And I know -- I'm not talking about the credit that you extend to your customers through your receivables. But are the orders at the same size in orders as they've been historically, or are we starting to see the orders get smaller and sort of spaced out, as they're worried about funding some of their projects?

I haven't seen a reduction over the short term in the size of incoming orders. Over the longer term, over the last couple of years, maybe in over just the last year, we have seen a slight reduction in average order size, which I attribute not to the credit issues out there, but more simply to efforts -- increasing efforts to reduce inventories. So you're seeing a general trend towards smaller orders.

So more of just adjusted-time type of order pattern?

Yes.

Rick, that charge of $0.06 -- that was through the Dunkirk facility. What line was that on?

It would be in cost of sales.

Thank you guys very much.

Nate Kellogg, Next Generation.

I just have a -- just a quick question to try and get my hands around sort of the effects of the lower costs from market inventory effects of the quarter. It sounded like actually there was a $300,000 that helped you -- the $300,000 on the Universal Stainless side -- but then obviously hurt to about $416,000 on the Dunkirk side. Is that the correct way of looking at it?

That's the correct way of looking at it, yes.

Okay. And can you just help me -- the favorable mix shift on the Universal Stainless side that led to that $300,000 benefit or credit or help or whatever? What -- is that a shift away from aerospace products towards other products, or what is driving that?

Well, what really drove that, Nate, was a large portion of our LCM reserve in Bridgeville at June 30 was tied to high-temperature grades of steel that we did ship in the third quarter. So that reserve basically was released. And the amount of reserve released as a result of those shipments was more than the amount of reserve created for new product that we melted.

Great. Okay. Great. Right, which obviously has that -- would have that cost in it. Okay. Yes, that's helpful.

And then just going forward, I know we sort of have to wait until at some point nickel stabilizes, and who knows how that all shakes out. And I realize it's more than just nickel that you guys have to deal with in making your product, but obviously that's one of the things that's most important and easy to get a handle on what the producing looks like.

But I mean, do you guys -- let's say nickel stabilizes at say $5.00 a pound. You guys can still make double-digit operating margins in a decent environment with nickel that $5.00 a pound; correct? It's just dealing with it as it sort of falls in price until you get some stabilization that will pressure margins. But once it flattens out, you guys should be able to make a decent margin (multiple speakers)

Absolutely. You're right on point.

And then also, I guess I would assume that we should see, I would think, a fair amount of inventory tick down, all else being equal, just because as nickel and other things -- commodities prices fall, that means that to keep the same poundage or tonnage in inventory, you guys need to have those dollars tied up. Is that a good way of looking at it, going forward?

Yes.

It is, yes.

And if you guys wanted to take -- quantify, I mean is that like $5 million, $10 million? How much do you think we might see over the next six to nine months?

That would be a very difficult question to answer, Nate, and the primary reason for that would be, the mix of grades that we have in our inventory can change day-to-day based on customer demand. And the material costs of certain grades are far greater per pound than other grades. So the mix would have a significant impact on that answer.

All right. That's helpful.

And then just last but not least, did you guys say what you expect CapEx to be for the full year? I think a while ago I had it at about $10 million for the full year, and you're almost there. So I'm just curious if it's going to be a little higher than that, or whether spending is going to tick down in the fourth quarter?

Based on projects approved in our system right now, there's $3 million to be spent. However, I would say a half to two thirds of that will not be spent until 2009.

Okay. So it will be less than $3 million for the fourth quarter, and it sounds like -- okay (inaudible).

All right, guys. Thanks very much for the color. I appreciate it, as always. And that's all I got.

Mark Parr, KeyBanc.

This is Phil Gibbs for Mark. How are you guys? Had you said that there was a 9% sequential decline in raw material volumes? Is that correct? In inventory?

In terms of the quantity of raw materials on hand in Bridgeville, September 30 to June 30.

Weight. Not value.

Weight. Not value.

Yes. In volumes; correct?

Yes.

Okay. How much volume is there typically in raw material inventories at a given time on a month-on-hand basis in a normal environment? Meaning, four weeks, six weeks?

Oh, okay. I get it. We typically have between 20 to 25 days worth of raw materials on hand. That number has -- depending on cycles of material costs, that could go up to 30 days of inventory on hand. It can go down as low as 15. But the normal range seems to be between 20 and 25 days.

Then a question on the backlog side. I believe at the end the quarter it was around $100 million. Going forward, would you expect to see that reduce just on an absolute basis by the decline in the surcharge?

Based upon what we're seeing over the last couple of weeks, I would expect to see a decline in our backlog. It was $101 million at the end of the third quarter. That was up from $97 million at the end of the second quarter.

Keep in mind we had some interruptions in our operations, which precluded us from shipping product at the tail end of the third quarter, as well. So that kind of fell over into the fourth quarter.

But it's really going to depend upon how things shake out on the aerospace side, in my mind. If we get a break and the labor situation is resolved, service centers start to order for first-quarter delivery, you'll start to see that in our backlog.

But at this point in time I would say you'll probably see a modest decline in our backlog as we exit this year.

And then lastly on the power gen and kind of oil and gas side, how much of that business -- I know it's been a meaningful volume driver for you guys, particularly this year in light of kind of the subdued momentum in aerospace. How much of that typically goes to service centers, as well? -- that power gen and oil and gas business. Is a lot of that any direct OE shipments there?

The majority of that product is going to go through our forging customers -- call it roughly three-quarters of the business. We do have product that goes through Dunkirk. But again, we're at a level or two removed from the end user, so it's either going through forgers, then on to the user; or through our service center customers.

Okay. Perfect. Thanks, guys.

(Operator Instructions). There are no further questions. I will turn the call back over to Mr. Oates for closing remarks.

Okay. Thank you very much for joining us today. We'll be looking forward to updating you on our fourth-quarter and full-year results in January.

Have a good day.

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