Universal Stainless & Alloy Products Inc (USAP) 2009 Q3 法說會逐字稿

Good morning. My name is Cassandra and I will be your conference operator today. At this time I would like to welcome everyone to the Universal Stainless third quarter 2009 conference call and webcast. 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, this call is being recorded. Thank you. And now I would like to turn the conference over to June Filingeri.

Good morning, everyone. This is June Filingeri of Comm-Partners, and I would like to welcome you to the Universal Stainless & Alloy Products conference call as well. We are here to discuss the Company's third-quarter 2009 results which were reported this morning. With us from management are Denny Oates, President and Chief Executive Officer; Bill Beible, Senior Vice President of Operations; Paul McGrath, Vice President of Administration; Rick Ubinger, Vice President of Finance and Chief Financial Officer; and Chris Zimmer, Vice President of Sales and Marketing.

Before I turn the call over to management, let me quickly review procedures. After management has made formal remarks, we will take your questions. The conference operator will instruct you on procedures at that time.

Also, please note that in this morning's call management will make forward-looking statements under the Private Securities Litigation Reform Act of 1995. We 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 the formalities out of the way, I would like to turn the call over to Denny Oates. Denny, we are ready to begin.

Thank you, June. Good morning, everyone. Thanks for joining us today.

This morning we announced earnings of $0.05 per diluted share on sales of $25 million in the third quarter. Cash flow from operations was a strong $10 million. Our performance reflects tight controls on costs, aggressive working capital management and upward-based pricing actions. We have also continued to invest for the long term. Our major capital project, the melt shop upgrade, remains on schedule and on budget. We're beginning to see early payback from improved yields on our semi-finished products. With most of the hard assets for the project in place, we are now training employees, commissioning equipment, developing practices and beginning to move towards our operational and quality benchmarks.

Installation of automation and control packages is the next step with completion slated for mid-2010. That timing may be optimal, based upon what we are hearing from today from our customers about an expected recovery time line.

While business remained very challenging in the metal sector during the third quarter, there were some signs of stabilization. Our order entry increased 30% sequentially. While not enough to replenish our backlog, which was $33 million at the end of the third quarter versus $38 million at the end of June, there were several positive indicators. First, our backlog of aerospace products increased for the first time since 2008. It appears destocking by service centers is finally subsiding. However, we see little evidence of significant restocking at this time.

Second, our backlog of service-center plate also increased, mainly due to increased automotive production and model changeover.

Third, on a year-to-date basis international sales increased more than 50% over last year and now represent 11% of sales versus 4% of year-to-date sales in 2008.

Looking at our third-quarter performance by end market, let's start with aerospace. Aerospace remained our largest market at 33% of sales, about the same percentage as the third quarter of 2008 but below the 40% recorded in the 2009 second quarter. Our aerospace sales were down 55% year-over-year and 31% sequentially. Most service centers, which are our main customer in aerospace, are remaining cautious, especially going into the seasonally uncertain fourth quarter.

While recovery will take time, the recent uptick in our aerospace backlog is a positive sign. The recent news from Boeing also sounded more positive. In the second quarter Boeing reported adding 57 gross orders to their books but removed 52 others. Last week they said they booked 96 gross commercial jet orders in the third quarter while removing just 17. Boeing also noted that the capital markets are gradually opening up for aircraft financing.

Currently, the aircraft of greatest importance to us is the 737, and Boeing reconfirmed their 737 production plans again this quarter.

I mentioned in our last call that we have achieved AS9100 certification for the Bridgeville and Dunkirk facilities. With the certification we are now pursuing new opportunities in the global aerospace market.

Our sales to the power generation market increased to 32% of our total sales from 29% in the second quarter and 15% in the year-ago period. Even so, our power generation sales were down 7% year-over-year and 8% sequentially. Our forging customers are expecting power generation demand to recover until mid-2010. That timing seems consistent with GE's third-quarter report. GE said they received orders for 23 gas turbines in the third quarter versus 33 last year and 26 in the second quarter. Their third-quarter orders included 15 turbines of a 40-unit order from Iraq. They expect the remaining 25 turbines for that order to move into 2010.

Our sales to the petrochemical market represented 20% of sales in the third quarter versus 19% in the second quarter and 25% in the year-ago period. Our petrochemical sales, which are mainly to the oil and gas market, were down 66% year-over-year and 13% sequentially because of the continued low rate of oil and gas exploration.

As for the power generation market, recovery in petrochemical is currently expected in mid-2010. Schlumberger reported some encouraging news on Friday. They're expecting a modest recovery in North American gas drilling in the fourth quarter, although they did note that it was a fragile recovery. They also said overseas rig activity is stabilizing and they expect operators to maintain their spending levels, due to the strength of oil prices.

Our service center plate sales represented 5% of sales in the third quarter compared with 9% in the second quarter and 18% in the year-ago period. They declined 88% year-over-year and 54% sequentially. The global recession and auto industry implosion hit this product category head on, and service centers were caught with high levels of inventory. The increase in our order book for service center plate is a welcome sign of improvement. However, the ongoing level of automotive activity, which is one of the drivers of demand in this category, is less than certain.

On the other hand, Caterpillar said they are expecting to see some improvement in their sales in 2010. And, while they still expect 2010 to be more of a transition year, they have started to plan for an upturn with their dealers and suppliers.

We also expect 2010 to be a better year for service center plate than 2009.

Let me turn the call over to Rick at this point for his financial report.

Thanks, Denny. Sales for the third quarter of 2009 were $25.3 million compared with $57.6 million in the 2008 third quarter and $30.8 million in the 2009 second quarter. The decline in sales in comparison to the year-ago period was attributed to the 49% decrease in shipments and lower surcharges, partially offset by base price increases announced earlier in the year.

The sequential decline in sales was attributed to a 19% decrease in shipments, most of which relates to our service center customers.

Operating income for the third quarter of 2009 was $457,000 in comparison to $3.7 million in the 2008 third quarter and $565,000 in the 2009 second quarter. The 2008 third quarter results include a $586,000 charge for the relocation of the round bar finishing line from Bridgeville to Dunkirk and a $416,000 increase to the Dunkirk segment's lower of cost or market reserve.

The decline from the year-ago period is due to the reduction in shipments and lower manufacturing volumes. Sequentially, lower shipment volume was partially offset by the realization of higher base prices for stainless steel bar products, primarily produced in Dunkirk.

The Universal Stainless segment sales were down 59% from the third quarter of 2008 and 19% from the second quarter of 2009. These declines were primarily due to reduced shipment volumes of 51% and 24%, respectively, although I would note that shipments to OEMs increased substantially in both periods, due to the increased international sales. Lower surcharge revenues also impacted sales in comparison to prior-year results.

Segment gross margin for the 2009 third quarter was $1.6 million or 7% versus 10% in the third quarter last year and 9% in the second quarter of 2009. Material cost as a percentage of sales improved to 42% from 59% in the year-ago period. This improvement is directly related to a better alignment of material costs and related surcharges assessed, as well as yield improvements recognized on shipments of semi-finished products.

However, our operation cost of sales per ton shipped increased in the current quarter, due to the lower production volumes.

The Dunkirk segment sales were down 50% from the third quarter of 2008 and 17% from the second quarter of 2009, but Dunkirk did attain margin improvement in the quarter.

The year-over-year sales decline was also due to reduced shipment volumes and lower surcharges, while the sequential decline was due to reduced shipment volumes, partially offset by higher selling prices generated from the stainless steel bar-based price increases announced earlier this year.

Dunkirk's gross margin for the 2009 third quarter was $1.1 million or 13% of sales versus 10% in the third quarter last year, before the impact of the relocation expense and lower of cost or market charge noted earlier, and 4% in the second quarter of 2009. Material cost of 53% of sales improved from 64% in the year-ago period and from 62% in the 2009 second quarter. Our operation costs of sales per ton shipped were lower in comparison to the year-ago period, due to the benefits achieved from the relocation of our round bar finishing facility in 2008, but we did experience a modest cost increase in comparison to the 2009 second quarter, due to the lower production volumes.

Our selling and administrative expenses dropped as a result of our cost reduction initiatives to $2.1 million in the current quarter from $2.6 million in both the 2008 second quarter and the 2009 first quarter. Most of the reduction is related to the 20% reduction in salaried personnel in the first quarter.

We ended the quarter with cash of $42.2 million, working capital of $97.1 million and long-term debt of $11.5 million. We generated cash flow from operations of $10 million in the third quarter. We reduced our managed working capital, consisting of accounts receivable and inventory minus accounts payable, by $5.9 million and received a $1.5 million federal tax refund during the quarter.

Our customers continue to pay consistently, and we reduced our pounds of work-in-process inventory by another 10% during the quarter. Capital expenditures during the quarter were $2.7 million, of which $2.1 million related to the Bridgeville melt shop upgrade.

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

Thanks, Rick. Our cost control and working capital actions enabled us to generate earnings and very strong cash flow in the third quarter despite low sales activity. While managing through this cycle, we also continued to execute on our plan to position Universal for the eventual recovery. This has included relentless focus on improving operational performance and customer service levels including reliable on-time delivering and shorter lead times.

Our investment in the melt shop upgrade is essential to this effort and to increasing quality and yields. We are working aggressively to expand our market share. Despite recent signs of stabilization, we expect the fourth quarter to remain challenging because of typical year-end inventory control practices in the supply channel. However, there is increasing optimism in our end markets that recovery will begin to take hold in 2010. We will continue to strengthen our position to take advantage of opportunities as the market does recover.

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

(Operator instructions) Michael Gallo, CL King.

My question is on the melt shop upgrade. Do you expect to start to see the benefit of that here in Q4? How much of a benefit do you expect to get? I was also wondering if you had -- maybe I missed it in the prepared remarks -- what the impact of nickel was in the third quarter. Thank you.

As far as the benefits from the capital improvement, we have essentially got most of the fixed assets in place. So that's a piece of the pie, and we are starting to see some benefits from that as we speak. And those benefits will continue to build. The next step is to put in the automation and control packages. That will also generate additional savings.

Mike, if you remember, we indicated that, using 2008 volumes, we would expect it to generate somewhere in the range of $7 million in pre-tax cost reductions from this capital project. With its completion in the middle of 2010 we would expect to start to see the full boat of cost savings as we move through the second half of 2010, albeit somewhat lower because I expect our volumes to be lower than 2008 volumes.

If you look at the third quarter itself, we would estimate that our benefits on the improved yields were in the range of $0.01 to $0.02 a share.

And you would expect probably incrementally a little better than that on a sequential basis each quarter?

Yes.

And then, probably a question for Rick. Did you have what the impact of nickel was in the quarter?

Not nickel specifically, Michael; but, again, if you look at the material cost, especially in Dunkirk, from the material cost as a percentage of sales, that would be the benefit of not only nickel, but also there was improvement in chrome, iron. So all of the materials increased in value during the third quarter, which helped our profitability.

Could I have just what the dollar impact of all that stuff was sequentially?

Well, some of that -- we don't have that specifically identified because some of this include base price increases as well.

Okay, that's fine; I can follow up with you off-line. I'm just trying to get a feel for how much of the improvement was from the improvement yields versus how much was from increase in base-priced metals. But I'll give you a call off-line.

Edward Marshall, Sidoti & Company.

I'm looking at the sales from Bridgeville facility. And you look in the other segment, there's about a $1.2 million sale, which is unusually high. I'm wondering if any of that is raw material that is sold back to the market.

No, this is largely sales of internal revert scrap and raw materials. So that's secondary prime product, if I'm understanding your question correctly.

Yes, that's what I was asking.

No.

Is it scrap and raw material? Is that what it is?

It's scrap and raw material. It's not finished product that we're putting back in the market.

What's the operating profit benefit as well as the maybe after-tax benefit, if you have either of those?

It was less than $0.01 a share.

So the steel plate pickup that you saw obviously related to the automotive sales. Tool steel orders usually go to the service centers. I'm assuming that hasn't been recorded as sales, that pickup that you've seen so far?

We saw an increase in our incoming business for tool steel plate, largely driven by the recovery in automotive, during the third quarter. And those sales dollars will start rolling out in the fourth quarter.

So it was an order increase and not a sales increase?

Right.

And then, you had mentioned that the petrochem market, kind of mid-2010 and as well as the power generation -- you expressed improvements in 2010. If the demand comes back, what does the supply channel look like? Is there inventory in the channel that needs to be worked through? And even if we pick up mid-2010, will your demand coincide with that, or your pickup in sales?

If you look in the oil and gas business that we serve, I would say there still is some de-stocking going on, so there is some excess inventory in that system.

So even if we see the pickup in the second half of '10, would you coincide with that same pickup? Or is that what you are referring to?

I think you will see that work down over the course of the first half of 2010. The power gen supply chain is a little more mixed. There are some customers who are probably a little heavy from an inventory standpoint, but I think that's much more in line than what you'll see in the oil and gas side.

Finally, the challenging fourth quarter that you mentioned -- is that to assume that -- can we assume that you will be profitable in the fourth quarter, assuming that -- I know you guys don't give guidance any longer, quarter to quarter.

Safe assumption.

Nat Kellogg, Next Generation Equity.

Just a question on CapEx. This may have been in error, but I thought you guys had talked about spending $15 million or so for this year, and it looks like you're only a little over $10 million. So just curious about the fourth quarter, whether that is going to come in below that number and that's just maybe my number is in error. But I was just going to try and get a sense of where you guys expect to come in for the full year.

We anticipate spending about $2 million in the fourth quarter, which will get us to $12 million.

And with most of the equipment in place, is the bulk of the CapEx spending behind you guys for the melt shop upgrade? Or, is there still some to come, in 2010? Or is most of the additional spending going to flow through on the operating side?

There is still $2 million to $3 million to be spent in 2010.

Okay, all right, that's helpful. And just maybe a little bit, if you guys could talk about your uses of cash -- you've got a great cash balance now; your balance sheet is in great shape. I realize it probably pays to be a little conservative, just given the fact that operating rates are so low right now. But you guys clearly seem in good shape and just coming here towards the end of this CapEx cycle, I'm just curious about what you might be thinking about internally doing with that cash.

As far as the cash balance goes, you are right. We looked at cash as a safety valve, given the state of the economy. We feel very comfortable; we have a strong financial position which gives us a lot of flexibility going down the road. We are looking at additional strategic capital investments which we're not prepared to announce publicly at this point in time. And obviously, we are looking at investing not only internally but also externally.

And would you guys ever think about dividend or share buyback, or that's just low on the priority totem pole?

That's low on the priority pole. Our philosophy has been, we can achieve a higher return by reinvesting in the business, and that's been demonstrated over the 15 years of Universal's history.

Obviously, your operating cost of sales has come down quite a bit year-over-year and even the last couple of quarters. And just curious about how much of that is permanent and how much of that will sort of creep back up again as order rates increase.

Nat, let me understand your question. You're asking if -- it's coming down because of -- are you looking at just pure dollars of operating costs?

Yes. I'm just trying to get a sense of how much of that is just because volumes are lower and obviously there's some fixed costs in there, too, that I would think are somewhat leverageable. So just trying to get a sense of that mix.

You said something about creeping back up. I don't see anything that would cause the operating cost to creep back up unless there was a significant cycle up in raw material cost.

In terms of the non-material costs that we are incurring right now, we are investing strategically to continue lowering those costs. We are working very diligently to improve our practices, which will also continue to drive those costs down. That's somewhat mitigated by the fact that we are running somewhat inefficiently because of the low volume that's going through the plant today. That will only get better in the future, so you shouldn't look at us and expect to see higher operating cost in the non-material side.

Okay -- no, you guys have made a great improvement there, and obviously that, I would think, put you in great position for when things start to come back through again.

I had expected -- it sounds like we're starting to hear some sort of rumblings about inventory restocking at the service center level, even if it's modest. It doesn't look like we saw any of that in the third quarter. And I know you guys don't give guidance, but just given your order entry rates and stuff, would you expect that there will be some sort of inventory restocking at the service center level that we'll start to see in the fourth quarter numbers?

I frankly have not seen much evidence of that at all. If you take a look at our incoming business, it's a fact that in the month of September our backlog increased for the first time this year. As we mentioned in here and highlighted, a lot of that was driven by aerospace business, most of which was service center business. So we are seeing an improvement coming out of that group. But the general conversation with our service center customers is, there's still a great concern about overextending themselves from an inventory standpoint. And our view is, from a planning standpoint, is that will continue through the fourth quarter.

As we get into 2010 and we get two, three, four months of this more positive outlook, I think you'll start to see some bigger investments in inventory by our service center customers. We're not expecting that until early 2010.

That's helpful, all right, thanks, guys. And obviously, nice job on the quarter.

Mark Parr, KeyBanc Capital.

One thing, Denny, I don't know to what extent you've mentioned any update on the export program, but I would like to get your sense about where you are seeing export opportunities and how much of an impact incrementally that could be in 2010 versus '09.

Well, as you know, last year we started to look very aggressively at how we might position ourselves to grow in the international market. So last year was a kind of get to know each other year -- a lot of technical exchanges, visits to our facilities by some potential overseas customers. And we visited their operations as well. As you look at -- and I indicated then this would be a slow and evolutionary process. And that's pretty much what's playing out, if you look at our 2009 numbers. I did indicate that international sales are up to about 11% of our mix as compared to 4% in 2008. So we have seen some nice percentage increases, albeit off a low base. And I would expect that to continue year-over-year, Mark, as we get a reputation overseas and start to establish ourselves with some of these customers.

In terms of locales, most of this improvement is coming out of Europe, some out of Mexico, not so much in the far east at this point in time. So we still have opportunities, areas that we have not really pursued only because we want to stay focused.

Does that answer your question, where we are at? We've done a lot more internationally this year as well, in terms of attending the Paris Air Show for the first time and having a booth over there, which gave us a lot of leads and a lot of visibility. Getting the additional certifications like AS9100 will particularly help us because the aerospace market is one of the targets of opportunity we see.

We are currently working on (inaudible) heat treating certification, which we would expect to have in the middle of the first quarter of 2010, which would give us additional credentials to go overseas and sell our products.

In terms of the melt shop upgrade, where you are really building the capability to almost double your semi-finished capability, do you have a sense of where that incremental volume will go, say, domestic versus non-domestic locations? You're talking about another, what, 60,000 tons, I think?

Well, the rate of production out of the shop would be about 120,000 tons. The most Universal has ever made in its 15-year history is 70,000 tons. So the investments we are making today obviously put us at a very low capacity utilization rate.

As we look to the future, we're looking at this pretty much by market. And as we look at where we would expect the production levels to be and where that product would go, we are looking at what markets generate the highest margins for us. And they would be in the higher-value finished products, going into the aerospace and power gen market, where we have opportunities to remelt the product.

So that's where our focus is, and those markets are largely global. So our thinking down the line is -- I don't have a specific number for you, but we said internally there's no reason not to expect us to get to 25% international direct sales, over a three- to five-year period.

Lastly, if I could, did you qualify the magnitude of order momentum in tool steel, or can you give any color in terms of how much of an upside that has represented in terms of your backlog, say 3Q versus 2Q?

The backlog at the end of the third quarter actually tripled compared to the end of the second quarter. It's up to like $2.1 million versus $750,000.

Thanks and congratulations on the progress.

(Operator instructions) Tim Hayes, Davenport & Co.

My questions are in regards to gross margins as a percent of the value-added sales. The Dunkirk segment had a nice increase sequentially, while the USAP segment was flat sequentially. I was kind of curious why those -- the two didn't move -- why there wasn't an increase in the USAP segment.

Well, Tim, most of the Universal segment is going to be more of the semi-finished product, where the surcharges are assessed at the time of order entry versus shipment. So the material costs pretty much stay in line with the selling prices, whereas in Dunkirk they have certainly benefited from not only the base price increases that we put in place earlier in the year but also from the increased market values that impacted the surcharge.

Okay, that's helpful. And then --

I would add to that, too, just keep in mind as you look at the Universal segment you are talking largely about the Bridgeville plan. And our major facility here and biggest cost item is our melt shop, which we are doing a major renovation to. And, as I said in my prepared comments, we're continuing to operate at a relatively low level, so we're absorbing a lot of fixed cost at these low levels. And on top of that, we're also training employees, commissioning new equipment, developing new practices with the new equipment. So we've got some learning curve we're going through at the same time.

Right, and then, longer-term on these margins, I think you had the goal of 30% for USAP, and then 40% on Dunkirk. To what extent do you need volumes to return to, say, north of like 40,000 tons, thereabouts, to achieve those? Or, could you achieve them with volumes under that amount?

With the cost reduction initiatives from the melt shop project, we believe that we'll be able to reduce the volume to achieve those goals or targets. But we have yet to quantify that, and we won't quantify that until we see more progress in terms of the [M-plus] program.

And then, lastly, just a clarification on a number. Aerospace was -- did you say it was 34% of sales during the quarter?

33%.

There are no further questions. Mr. Oates, do you have any closing remarks?

Yes. I just want to thank everybody again for joining us today. We feel Universal is a stronger Company today, despite the significant challenges presented to us thus far in 2009. We are all looking forward to updating you on our further progress at our next call. Have a good day. Thank you.

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