Universal Stainless & Alloy Products Inc (USAP) 2009 Q4 法說會逐字稿

Good afternoon. My name is Angelia, and I will be your conference operator today. At this time I would like to welcome everyone to the Universal Stainless fourth-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, today's call is being recorded.

I would now like to turn the call over to Ms. June Filingeri of Comm-Partners.

Thank you, good morning. This is June Filingeri, and I'd also like to welcome you to the Universal Stainless & Alloy Products conference call. We are here to discuss the company's fourth-quarter 2009 results which were reported this morning.

With us from management are Denny 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 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 again 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.

Formalities out of the way, I'd now like to turn the call over to Denny Oates. Denny, we are ready to begin.

Good morning everyone, thanks for joining us today. The financial results we reported this morning showed sequential improvement in the fourth quarter amid signs of early-stage recovery in market demand. Even before the benefit of import duties in the quarter, our net income rose 74% over the third quarter on a 5.5% increase in sales and an 11% increase in tons shipped.

Order entry improved each month in the quarter, resulting in a welcomed increase in backlog, the first and five quarters. Because of the improving order entry and backlog, the rate of our managed working capital reductions slowed in the quarter. As a result, our cash flow was lower sequentially and year-over-year, although it was a solid $2.5 million.

The main driver of our sequential sales growth was a 50% increase in tons shipped to service centers, in line with indications they have generally finished destocking. While the increased volume included 13% higher shipments of aerospace products compared with the third quarter, the main driver of shipment growth was a tripling of our sales of tooled steel plate. The momentum in tool steel replenishment shows how fast orders can pick up with any inflection in demand after a period of heavy destocking by service centers.

To take advantage of this increasing demand, we have been working very hard to reduce cycle times, improve customer service and lower our costs. These initiatives are the major drivers behind our recent capital projects to upgrade the melt shop and cellularize bar finishing at Dunkirk. The melt shop project has entered the next phase, which is installing automation and control systems. These investments, coupled with higher shipments and process improvements in the fourth quarter, led to the continued recovery in our profitability.

Looking at our fourth-quarter performance by end market, let me start with aerospace.

Aerospace remained our largest market share in 32% of sales, which is nearly unchanged from the 33% in the 2009 third quarter and 34% in the fourth quarter of 2008. While our aerospace sales were down 56% year-over-year, they were slightly better than the third quarter, and we are continuing to see an uptick in our aerospace order entry and backlog.

From an industry standpoint the successful first flight of the Boeing 787 on December 15, followed by 14 more successes, took away one major uncertainty overhanging the market. More specifically positive for Universal, Boeing reported that the next-generation 737 topped its commercial airplane order book for the fourth quarter with 197 gross orders. The 737 is the major aircraft for our products, and build schedules currently remains strong.

While some of the news from Boeing and from Airbus has been improving, it is important to keep things in perspective. Boeing doesn't expect the airline industry to recover enough to see increased demand for new planes until 2012. And Airbus, after reporting deliveries for two thousand and -- record deliveries for 2009 and their plan to maintain 2008 and 2009 production levels in 2010, noted that they need to remain prudent and flexible because they are not out of the woods yet. Therefore, we have to assume that service centers will continue to be cautious in managing their aerospace inventories.

Power generation was our second largest market in the fourth quarter, representing 23% of sales, up from 18% of sales in the year-ago period but down 32% of sales in the third quarter. It was also the only end market where our sales declined both year-over-year and sequentially. Specifically our power gen sales were down 41% from the fourth quarter of 2008 and 25% from the 2009 third quarter.

As I said on the last call, our customers don't expect recovery in the market until the middle of 2010, so directionally our power generation sales trend was in line with our expectations. It was also in line with GE's report on the fourth quarter call. Their orders for gas turbines declined to 40 in the fourth quarter 2009 from 70 in the same quarter of 2008. GE's plan for 2010 calls for 117 gas turbines compared with 134 shipped in 2009. Few of those orders are destined for the US market. However GE is bullish that demand will resume in the domestic market over the long term.

Let me add a side note that our main customers for power generation products are forgers. Despite the decline in power generation, we achieved a 9% sequential increase in our sales to forgers because of the expansion of our product portfolio and increased international sales.

Our petrochemical sales, which primarily go to the oil and gas markets, represented 21% of fourth-quarter sales compared with 20% in the third quarter and 23% in the year-ago period. Petrochemical sales were down 57% in the fourth quarter compared to the fourth quarter of 2008 but rose 13% sequentially.

Our steel is typically used in equipment for oil and gas exploration, and both Schlumberger and Halliburton reported sequential increases in rec. activity in North America in the fourth quarter, with Halliburton noting a 14% increase in the US rig count over the third quarter. Both companies also expressed some level of optimism that 2010 will be a better year than 2009, although Schlumberger remains cautious about gas market, and Halliburton expects spending by drilling operators to remain weighted to the second half of the year. That timetable is consistent with what we are hearing from our customers.

Our service center plate sales were 13% of total fourth-quarter sales, well above the 5% of sales they represented in the third quarter and in line with 14% of sales in the year-ago period. They were 55% lower than the fourth quarter last year but rose 186% over the third quarter. As I already highlighted, the jump in our tool steel sales accounts for this increase.

Our tool steel is primarily used in the automotive industry, which seems to have moved from model changeover to actual production in the fourth quarter. At the beginning of January Ford report reported that December was the highest sales month since May 2008, while GM reported that retail deliveries by their dealers in December increased 7% from last year and 50% from November and that dealer inventory was at the lowest year-end level on record.

Also Polk is forecasting that US light vehicle sales will increase 12% in 2010 to 11.5 million units. To put that in perspective, the 10.3 million US light vehicles sold in 2009 was the lowest level in 27 years, also according to Polk. Therefore the automotive industry in the US is a long way from historic production levels, but at least the trend seems to be going in the right direction at this point.

As I said last quarter, we expect 2010 to be a better year overall for service center plate than 2009.

Let's take a minute and turn the call over to Rick to review the financial part of the company.

Sales for the fourth quarter of 2009 or $26.7 million compared with $57.1 million in the 2008 fourth quarter and $25.3 million in the 2009 third quarter. The decline in sales in comparison to the year-ago period is attributed -- attributable to a 47% decrease in shipments and lower surcharges, partially offset by base price increases in 2009. The sequential increase in sales is attributable to an 11% increase in shipments, most of which relates to tool steel, as Denny has discussed.

Operating income for the fourth quarter of 2009 was $736,000 in comparison to $524,000 in the 2009 fourth quarter (sic - see press release) and $457,000 in the 2009 third quarter. The 2008 fourth-quarter results included an $807,000 increased to inventory reserves in response to the sharp decline in market values of nickel and other commodities during that period, and a $248,000 charge for the relocation of the round bar finishing line from Bridgeville to Dunkirk. Before including those items, operating income in the fourth quarter of 2008 was $1.6 million.

The decline in our operating income from the year-ago period was due to the reduction in shipments and higher costs created by lower manufacturing volumes. Sequentially, the improved results were due to increased shipments and operating cost reductions resulting from completed capital expenditure projects.

The Universal Stainless segment sales were down 57% from the fourth quarter of 2008, primarily due to a 48% decline in shipments and lower surcharge revenues. Sales increased 7% sequentially on an 11% increase in shipments. Increased shipments of billet product to rerollers and plate product to service centers were partially offset by lower shipments of products to OEMs.

The gross margin for this segment in the 2009 fourth quarter was $2.2 million, or 9.5% of sales, versus 6.6% in the fourth quarter last year and 7.4% in the third quarter of 2009. The year-over-year improvement was due to the decline in material costs as a percentage of sales to 42.8% from 60.7% in the year-ago period. This 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 product. Material costs were about level with the 2009 third quarter as a percentage of sales.

Our operation cost of sales per ton shipped continued to be higher in 2009 versus 2008 due to the lower production volumes, although it did improve sequentially.

Dunkirk segment sales were down 25% from the fourth quarter of 2008 and were level with the third quarter of 2009. The year-over-year decline was also due to reduced shipment volumes and lower surcharges.

Dunkirk's gross margin for the 2009 fourth quarter was $1.1 million for 12.9% of sales versus 1.4% of sales in the fourth quarter last year before the impact of the relocation expense and LCM charge noted earlier. It matched the third quarter of 2009 as a percentage of sales. Material costs of 58% of sales improved from 67% in the year-ago period.

Our operation cost of sales per ton shipped was lower in comparison to the year-ago period and sequentially due to the benefit of relocating the round bar finishing facility at the end of 2008.

During the quarter we generated cash flow from operations of $2.5 million. We reduced our managed working capital, consisting of accounts receivable and inventory minus accounts payable, by $1.1 million during the quarter, in spite of sequential shipment and order entry level increases.

Capital expenditures for the quarter were $2.1 million, of which $1.8 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. Just to summarize, our sales in the fourth quarter showed sequential improvement, in line with early-stage recovery in market demand. Our profitability improved because of increased shipment volume and also because of the investments we have made to reduce costs, to deliver unparalleled customer service, and to position ourselves for the recovery and for future growth. They included the investment in our melt shop in Bridgeville and our realigning of resources at Dunkirk.

Our financial position remains strong with $42 million in cash and only $13 million in total debt, enabling us to continue our strategic capital spending program.

Despite the operational progress we made over the past year, it's good to have 2009 behind us. If our customers are right, 2010 should be a better year, but let me underscore what we said in today's release, we believe market recovery will be gradual. However, our focus on executing our strategy in 2010 will continue to be relentless and intense.

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

(Operator Instructions). Michael Gallo, C.L. King.

Just a couple of questions. First just wanted to focus on inventory in the various supply chains. Aerospace seemed to flatten out, obviously you went through a lot of destocking in that end market in 2009. Do you think it's complete, the destocking on the aerospace side?

And then on the power gen side, obviously we're going through some destocking now. Any feel for whether that's a couple quarters of inventory? Or more than that? Obviously with the turbine builds down and the expectation at least coming out of the third quarter I think that inventories in that supply chain were pretty high, on a sequential basis should we expect power gen to be -- just continue to be down in the first half of the year?

Let me take aerospace. First of all, as far as the destocking in the aerospace products, yes, I think generally speaking the destocking is over. I still see a lot of caution out in the marketplace in terms of rebuilding inventories. We do hear occasionally little spots where there might be some excess inventory, but all in all I think that is behind us.

As far as the power gen market goes, you described it pretty well. We look at the first half of 2010 as being relatively slow, liquidating inventories, and a pickup as we get into the second half of 2010.

Great. My second question is just on the gross margin. You showed a nice improvement in the fourth quarter. I was wondering if you can break out for us on a sequential basis how much of that was from the beginnings of the benefit of the melt shop upgrade versus changes in mix or changes in nickel price? Thank you.

From the Universal Stainless segment perspective, most of it is going -- most of the change is going to be related to mix. There was a slight improvement in yields in the quarter, but it wasn't -- did not have a material impact on the results. So most of it is going to be mix-oriented.

On the Dunkirk side about $300,000 of cost improvements ran through the Dunkirk operate -- Dunkirk segment -- excuse me.

So would you say the mix though was -- you had a higher mix I think of tool steel Q4 to Q3, but would you say that that level of mix is sort of pretty typical from a margin perspective of what we should expect going forward? In other words, would you expect as you gradually build demand that you can build off of the gross margin level that you had in Q4? Or was there something about the mix as it occurred in Q4 that was more favorable than what you would expect to see going forward?

I guess in my view I would expect the mix to improve as we go through a cycle. You'll see more finished bar, which generally has higher margins than some of our ingot product, which we are currently shipping. So as this recovery matures, I would expect to see us have the opportunity to improve those margins. I would couple that with some of the cost improvements that we are making, and we will see more cost improvements as we go through the cycle again, get more volume and complete some of these capital projects.

Okay, great. Thanks a lot.

Edward Marshall, Sidoti & Company.

In the prepared remarks and in the press release you talked about service center shipments up 50%. Was that sequentially? I'm assuming it was.

Yes.

So sales were up 35% quarter-over-quarter to service centers? Was that -- so was that just a mix shift? Or why would sales be up less than the shipments? Was there a price decline?

No, that is a shift. It's the shift between tool steel plate and finished bar product.

Okay.

As far as pricing goes, there's been no real deterioration in pricing.

Okay. Your power generation. Is that mostly domestic?

No. If you take a look at our power generation market and some of our international sales growth that we've had, a portion of that is going to be power gen. As far as a specific breakdown of how much power gen is going overseas, it's -- probably as a percentage basis it's probably in the mid teens. Our overall percentage is 10%. So if we look at just power gen, probably 15%, 20%.

Okay. And then could you quantify the benefits of the melt shop savings in the quarter?

Well, we -- that was just -- I think we answered that with Mike's question. The benefits in the fourth quarter were not material to the Universal Stainless segment.

Right. And then you said I think $300 million in the --

$300,000.

$300,000. Okay.

I wish it were $300 million.

(laughter) Me too. And finally, with the improvement in tool steel shipments in the quarter, I would've thought we would've seen a bigger follow-through on the backlog. Is that a quick ship business? Or is that kind of an anomaly as we come off the increased production to automotive that maybe just in this particular quarter we saw the benefit but we'll mute down over the next couple of quarters?

Let me ask Chris to answer that one. Chris?

The tool steel plate product is typically turned around in about a two-month period, so it is relatively a quick hit from a lead time standpoint. So what we are booking, and we were able to ship most of that activity in the third quarter, where the uptick began in the fourth quarter, carrying over into the first. So that tends to flow through our system relatively fast, about a two-month turnaround.

Okay, thank you.

Nat Kellogg, Next Generation Equity.

Denny, did you say international sales for the quarter were 10% of the total? Or is that just power gen you were talking about?

No, the other were -- all international sales for 2009 were 10% of our sales. 2008 they were a hair over 4%. As you know, one of our ambitions is to grow our international sales. So we're making progress along those lines, albeit in a lousy market.

Absolutely. And what was the number for just Q4?

9%.

Okay. And that's down a little bit from the third quarter; correct?

Third quarter was 11%, as I recall.

Yes. Okay. And that's just -- I assume that will sort of fluctuate from quarter to quarter, but the idea is the trend should be up towards?

Yes.

Okay. As far as CapEx goes, where are you guys as far as spending for the melt shop upgrade? And any guidance or what you might expect for CapEx in 2010?

CapEx for the melt shop program in 2009 was $10 million, is how much we've spent to date. So we still have $3 million to go. Now, I'll tell you $7 million of that $10 million has been placed in service as of the end of 2009. So those will start to generate the benefits going forward.

CapEx guidance for 2010, we are looking to be pretty close to what we expended in 2009, so around $12 million.

Okay. And obviously you're going to have most of that melt shop upgrade behind you, so is there a new project that you guys are undergoing? Or is this just -- obviously this sounds like a little bit more than maintenance, so I just -- a little bit curious on sort of what the projects are that that might be focused on.

Our intent in 2011 is to spend in the same range as we spent -- or, excuse me, 2010 is to spend in the same range as 2009. In those numbers are some -- what I will characterize as longer-term strategic investments. Unfortunately I got to get my Board to approve those yet, so we are not ready to announce what they are.

But it's focused -- our overall strategy is to look at our facilities, and where we can bring facilities to state-of-the-art condition, to streamline our operations so we can get faster and faster cycle times so we can be quicker to market, and we can take costs out, operating costs as well as yield improvements and continue to improve those margins. So that's the driver.

We started in the melt shop, that's where the biggest hit is obviously. We're going to walk right through the production process. So we've got -- we have opportunities in remelting, we have opportunities in hot working that we are looking at, and we will be announcing those as we go through 2010.

As far as downtime to do these upgrades and stuff, you guys feel -- I guess obviously the melt shop, that's mostly behind you, and going forward you'll announce it as it comes?

The melt shop, we still have some work to do in terms of automation and controls. Most of the physical changes to the melt shop are completed.

As far as outages go, 2009, the only positive I can think up when you look back on the year is the fact that activity was relatively low --

[You're right.]

-- and that made some of it -- it was good planning on our part to arrange that downturn so that we could get some of these capital projects behind us.

As you look at 2010, we are still not looking at running at capacity, so I think we can handle some additional capital projects and handle the related downtime without jeopardizing any customer service or shipment opportunities we may have.

Okay. All right, that's helpful. And then on the tax rate, any guidance for what tax rate might look like going forward? And I'm just sort of curious if you guys expect to get a refund here once you file your tax return.

Yes, we do expect to receive a refund when we file our tax return for the 2009 year. And our tax rate, what we're looking at right now for 2010 is about 34%.

That's great. And how big is the refund? Do you have a sense?

Right now we are expecting that to be in the $4 million range.

Okay. And as far as just the capital structure going forward, obviously if we get some growth this year there will be a little bit of cash sucked up from working capital, although I guess with the improvements hopefully not too, too much. So it seems like you guys have got some extra cash on the balance sheet. Just curious if you'd like to pay down that debt or whether you think that that's nice to sort of carry and want to just sort of keep the flexibly for now.

At this point our plan is to keep the flexibly.

Great. All right. Well, thanks for taking my questions, I'll hop back in queue. Thanks guys.

Lloyd O'Carroll, Davenport & Company.

Just a few small things. What was Dunkirk volume year-over-year? And sequential?

Hang on a second, Lloyd, we are getting it.

Okay. And then the next item -- unless you are ready.

I am ready.

Okay.

Dunkirk volume in fourth quarter of 2008 was 3.4 million pounds.

How does that compare with the --

Third quarter 2009 was 3.2 million, and fourth quarter 2009 was 3.3 million -- that's pounds.

Thank you. Looking forward, what is the status of the dumping duty benefit? Is that going away? Or is there some residual there?

Okay. Lloyd, the tariff monies, it basically relates to all tariffs collected through September of 2007. The amount that we received this year was -- a majority of it was related to the tariffs collected from one country's shipments. What we understand from our consultants is that the pot of money has been significantly shrink -- shrunk -- sorry. So we don't think the monies coming to us in the future are going to be that significant.

Okay. And then one guidance issue with D&A. What should we think about for this year?

$5.5 million at this point.

Okay, thank you.

(Operator Instructions). Gregory Macosko, Lord Abbett.

With regard to the service center, that significant increase in service center volumes, is it fair to say that those are -- are they -- how much of that do you feel is true restocking? And do you expect more sort of inventory build at the service center level as opposed to it selling through? You mentioned automotive, and I would guess that a modest amount of that would've sold through to the end market.

If I look at what we have seen over the first couple of weeks of January, I would say that the sales to the service centers will continue at that same pace. Essentially what you're seeing is the end of inventory liquidation, so their purchases across the board are going to be more in line with their end-use demand.

And I guess what you're asking me is, what's their end-use demand going? And we hear numbers like they expect increases in the mid single digits, 4% to 6%, in 2010 versus 2006.

Or 2009 you mean?

Yes. I'm sorry. 2010 and 2009. Sorry.

Okay. Good. Thank you. And then if I could just perhaps go back again to the Dunkirk situation, you mentioned that the margins were 2.7% in the fourth quarter and 4.7% in the third quarter. And the volumes, at least the sales volumes are about the same. Could you explain just the difference again? I didn't quite understand it.

The improved margin was the operating cost savings generated (multiple speakers)

Excuse me. Was it an improved margin? It said the operating margin was 2.7 in the fourth quarter of '09 and 4.7 in the third quarter.

Oh. I'm sorry. That's a result of the mix of shipments, so the material costs, if you look at material costs versus the selling prices, material costs were higher in the fourth quarter versus the third quarter.

Okay. And the mix itself was a little less as -- a little lower as well?

Yes.

Thank you very much.

Edward Marshall, Sidoti & Company.

Just a quick one. The import duty, that was in the other income segment that didn't flow through either of the two segments; right? That was on the other income line on the P&L?

That's correct. It's in other income.

Okay. Thank you.

There are no further questions at this time. I would now like to turn the call over to Mr. Oates for any closing remarks.

Thank you very much for joining us today. I'd like to take this opportunity to wish everybody a happy new year. We are looking forward to 2010, we think we have some exciting things that will be happening, and we look forward to updating you at our next review in April. Have a good day.

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