Universal Stainless & Alloy Products Inc (USAP) 2010 Q2 法說會逐字稿

Good morning. My name is Christie and I will be your conference operator today. At this time, I would like to welcome everyone to Universal Stainless & Alloy Products second-quarter 2010 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. I would now like to turn the call over to June Filingeri of Comm-Partners. Please go ahead, June.

Thank you, Christie. Good morning, everyone. This is June Filingeri of Comm-Partners, and I'd also like to welcome you to the Universal Stainless conference call. We're here to discuss the Company's second-quarter results, which were reported this morning. With us from management are Denny Oates, Chairman, President and Chief Executive Officer; Bill Beible, Senior Vice President of Operations; Paul McGrath, Vice President of Administration and General Counsel; Doug McSorley, 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. Christie 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, we are ready to begin.

Thanks, June. Good morning, everyone. Thanks for joining us today. Before getting started with this quarter's review, I want to take a minute to introduce our new Chief Financial Officer, Doug McSorley. Doug comes to Universal Stainless with extensive experience in financial management, an excellent track record in strategic planning and business development, and strong leaderships skills. He joined us after a 15-year career at PSC Metals, a metal recycling company with operations in the United States and Canada, which is now part of Icahn Enterprises. Before PSC, Doug worked with numerous industrial clients as a chartered accountant with Deloitte & Touche in Ontario, Canada. Since Doug has only been with us for a few days, we're going to let him off the hook fairly easily, but I know he has a few introductory comments he wants to make.

Thank you, Denny. It is a great pleasure to be here today and to be part of the Universal Stainless management team. From the very beginning of the interview process I was impressed by the level of the energy, the focus and the passion at Universal Stainless to move this Company forward. Now that I'm here I've discovered how pervasive that is throughout the whole Company. It is a very exciting time to be here. Let me add that I look forward to getting to know our analysts and our investors in the weeks ahead. I'm planning to keep the same open-door policy that this Company has always had.

With that, Denny, let me turn the call back to you.

Okay, Doug, thanks. Let's start with the second quarter of 2010. Sales of $51 million were 48% higher than the 2010 first quarter, and 67% higher than the second quarter of 2009. Volume shipped was up 40% sequentially and 72% from the year-ago period. So our robust sales growth was largely volume-driven. The increased volume combined with cost reductions from process and quality improvements and recently completed capital projects produced operating income of $6.4 million or 12.5% of sales, the highest quarterly operating margins since the third quarter of 2007.

Net income was $4.2 million or $0.61 per diluted share, compared to $1.4 million or $0.21 a share in the first quarter of 2010. Cash flow from operations was a use of $800,000 in the second quarter, which includes a $4.1 million tax refund. Cash flow has decreased in 2010 due to our investment in managed working capital to support the sharply higher sales activity. However, managed working capital per dollar of sales improved to 35% versus 42.5% in March 2010, and 46.7% in December 2009. Days sales outstanding and receivables improved by eight days during the quarter, and our FIFO-based inventory turns continued to improve reaching three turns, compared to 2.5 turns last quarter.

Capital expenditures were $2.3 million in the second quarter, including $1.2 million for the melt shop upgrade project, which will be substantially completed in September. At June 30, our balance sheet remained very strong with cash balances of $34.7 million and total debt of $12.2 million. The $600,000 per quarter principal payments on our $12 million PNC term loan began in May.

There were four drivers to the second-quarter sales improvement. First, end user demand in certain markets began to improve earlier this year. Second, supply chain restocking began to accelerate late in the first quarter and early in the second quarter.

Third, service levels are a critical determinant in the awarding of business from customers to remain fully focused on minimizing their own inventories. Our gains in on-time performance and shortened lead times enabled us to win additional business. Fourth, our progress in ongoing initiatives to penetrate new segments of our markets made a favorable contribution.

While sales increased 48% sequentially, operating income of $6.4 million nearly tripled over the 2010 first quarter of $2.3 million.

The process improvements on capital projects discussed in past calls, including the elimination of heat treating bottlenecks, the cellular rising of our bar finishing operations, and our melt shop upgrade all contributed significantly to margin expansion.

[Melt to ship] yields increased 1.5% during the quarter. Interestingly, our upgraded melt shop produced more pounds in the first half of 2010 with first-time true measures well up in the 90s than was produced in the entire year of 2009. Melting costs fell 5% during the quarter. Labor productivity, as measured by pounds shipped per labor hour, increased at double-digit rates versus the first quarter. These improvements are sustainable and there is more we can do.

Turning to our end markets, aerospace remained our largest market at 31% of second-quarter sales compared with 33% of sales in the first quarter, and 39% of sales in the second quarter of 2009. Our aerospace sales rose 41% sequentially and 35% over the year-ago period. Aerospace bookings have increased for three consecutive quarters due to our marketing initiatives, supply chain restocking, and end user demand improvement. Since our last call, positive momentum has continued to build. The Farnborough Air Show is described as a revival of commercial aerospace with over $28 billion in new orders.

The International Air Transport Association forecast of global airline profitability now projects solid earnings in 2010 and revenue passenger miles continued to rebound in May. Boeing has increased the build rate on several major programs. The production ramp-up of the 787 programs slated for 2011 will add to demand for our aerospace stainless materials. Airbus also said they expect to increase their build rates due to the growth in their order book.

Probability of lower defense spending in coming years is one of the few negatives in current aerospace trends. Despite the recent positive news, our customers continue to project gradual improvement in demand for the remainder of 2010 with accelerating growth in 2011. Customers are also being conservative in placing orders citing unstable raw material cost trends.

The petrochemical market was our next largest market in the second quarter, representing 20% of sales, compared with 23% in the first quarter of 2010 and 19% in the second quarter of 2009. Our petrochemical sales, which are primarily for oil and gas exploration, were up 34% from the first quarter of 2010 and up 78% from the second quarter of 2009. Halliburton and Schlumberger both reported strong growth in North America in the second quarter and recounts were up 13% for the period. However, both companies also reported reduced offshore activity in the Gulf of Mexico late in the quarter due to the drilling moratorium.

Despite the moratorium, it appears equipment and crews are being relocated to continue drilling. The majors and service companies along with our customers are generally positive about the second half. However, we remain somewhat cautious. The metal supply chain in this market still appears to have excess inventory and the lingering effects of the BP disaster in the Gulf remain to be seen.

Power generation represented 19% of second-quarter sales, compared with 17% in the first quarter of 2010 and 26% of sales in the second quarter of 2009. Our power generation sales were up 66% sequentially and up 22% from the second quarter of 2009.

We continue to benefit from maintenance activity in this market, which requires our short lead times and quick turnaround. There also appears to be some life in the new gas turbine business. We use General Electric as a bellwether for the power generation market.

For the 2010 second quarter, General Electric reported shipping 31 gas turbines versus 42 last year. However, GE orders improved to 46 new turbines compared to a total of 25 turbines in the year-ago quarter. I've said before that the market for new turbines is not expected to recover until 2011. My recent conversations with forging customers confirm this outlook despite what may be some promising signs at GE.

Our service center plate sales were 17% of second-quarter sales versus 18% of sales in the first quarter of 2010 or just 5% in the 2009 second quarter. We continue to see positive momentum in our service center plate sales, which rose 44% from the first quarter of 2010 and were up fivefold from the 2009 second quarter. This further ramp-up is being driven by the recovery in the domestic automotive industry, off-road equipment, and the general industrial sector. Last Friday, Ford reported that their second-quarter revenues rose 30% and they are expecting further improvement in 2011.

Earlier this week, Caterpillar reported better-than-expected results, with machinery and engine sales up 34%. Cat noted that their challenge has been to increase production rapidly enough to fill orders. This is obviously welcome news and helps explain why our business level and backlog in service center plate remain strong and why our customers remain optimistic about the second half of 2010.

So in summary, there was robust improvement in our sales and profitability in the second quarter of 2010, with levels attained that we have not seen since early 2008 and late 2007 respectively. Continued demand recovery and the success of market initiatives and product expansion drove the growth in sales. The accelerated profit growth was due to the substantial volume increase, disciplined pricing, further execution on process and quality improvement efforts, and increasing return on past capital investment projects.

Recent economic uncertainty in raw material pricing have caused customers to remain cautious as evident in our backlog, which fell from $53 million on March 31 to $46 million on June 30, although it remains well above last year. Therefore, sequential sales growth should continue in the second half of 2010. However, at this point, it is expected to be modest. Our effort to achieve higher service levels, further process improvement in cost reduction, and to derive more benefit from the melt shop upgrade will continue relentlessly.

Lastly, let me close by saying again we are pleased to have Doug McSorley on board to fill the important role of Chief Financial Officer on our management team.

And with that, I'll close my formal remarks and open up to your questions.

Thank you. (Operator Instructions) And your first question comes from Michael Gallo of C.L. King.

Hi. Good morning. Congratulations on the good quarter.

Good morning, Mike. Thank you.

Question I have just is, I know you noted the -- you expect some of the sales growth obviously really sequentially to flatten out or be up modestly in the back half. Was there anything unusual that you saw in the gross margins in the quarter in terms of mix of business, or would that be a reasonable gross margin expectation for the back half of the year as well?

That would be a reasonable number, Mike. There is nothing unusual in the second quarter, stronger volume and solid improvement from a cost performance standpoint.

All right, okay.

And we expect that to continue.

And you would expect -- I think from your commentary obviously you've had very good maintenance business on the power gen side, you'd expect that portion of it to moderate somewhat, but that that power gen business would start to pick up more meaningfully in 2011. Is it a fair characterization?

Yes. As we look at our bookings, we would expect sales to decrease in the third quarter in the power gen area. And the only caveat I would put on that is this maintenance business requires quick lead times and fast turnaround, so you won't see it in our backlog at the end of June, come in in July or August, then we'll turn it around and get it back out the door before the quarter ends.

All right.

So we expect that -- with our lead times, right now, we would expect to continue to see that maintenance business, but the true underlying growth in that market, which as you well know is very cyclical. From all we can see, the only real positive that we've seen in new turbines has been that GE incoming business. All of our customers universally feel that this will be something they'll hit in the fourth quarter, the first quarter of next year.

Okay, great. And then just final question that the -- what was the -- I don't know, maybe I missed it in the prepared remarks, but what was international as a percentage of the sales in the quarter?

International was 7% in the second quarter.

Okay.

So we're down somewhat. We were up to 10% if you remember last year. It was one of our initiatives and that has to do not so much with the loss of international sales at the more rapid growth of domestic sales over the last two quarters.

All right. And then I guess one more final question. The melt shop, it sounds like that that will be substantially complete in September. Should we start to see more of the benefit of that in the fourth quarter, or probably you won't get much of it until 2011?

Well, a lot of the savings you're seeing already are attributed to that capital project. I mean basically the equipment has been in place for a while, and we've been refining our practices. What we're talking about completing in September are the control systems. So you're already seeing some of the savings, I would say you're probably seeing two-thirds of the savings.

Okay.

Maybe you'll start to see in the fourth quarter.

Right, okay, great. Thanks a lot.

You're welcome.

Your next question comes from Tim Hayes of Davenport & Company.

Hey, good morning.

Good morning.

Just to further the question on the margins in the second quarter. We're calculating that gross margins as a percent of the value-added sales for the USAP segment was 35% for Q2. Now you're -- you've had a stated goal long term of that being 30%. Should we be taking that long-term goal higher based on this Q2 performance or what?

We have not upped our goal, but we've already achieved the goal. So I think, as I said to Mike a few minutes ago, I would look at our second-quarter margins and I don't see any reason for those to fluctuate going forward subject to any wild swings or raw material costs than we're not seeing today.

Right. I guess one thought was that maybe the margins got a little help in Q2 from nickel going up in price earlier in the quarter. Was there any of that FIFO gain that may have been in there at least a little bit?

I think the Company has changed a lot and with our cycle times as short as they've gotten over the last couple of years, I don't think you have that long lag time. We get a big pop, so there were some of that. If you ask me to quantify it, I'm not sure I could because it was so small.

Okay. Thank you.

And keep in mind also nickel has come down over the last month-and-a-half, it has actually peaked in April.

Your next question comes from Phil Gibbs of KeyBanc.

Hi, guys, good morning.

Hey, Phil, how are you doing?

Pretty good. I just had a question on how we should be viewing the pricing realizations in the third quarter. I know that typically depends a lot on mix and timing of surcharges, but should we be looking at that somewhat coming in and some better sequential volume [amounts carrying] through to the third quarter?

Our base pricing is essentially unchanged as we look at the third quarter versus the second quarter. However, you mentioned surcharges; surcharges are clearly coming down. We price based upon a two-month lag. So if you think about nickel prices as a proxy for surcharges in total, they peaked in April, came down in May and June. So as you get into July and August, you're going to start to see lower total pricing due to the lower surcharge, but not due to lower base prices.

Okay, great. And can you just give me a feel for how your customers are feeling in the aerospace channel and how much of the recent upside in volumes have we seen there, it's been due to just the lack of de-stocking that we saw in the second half of 2009 and just the catch-up. And do you expect aerospace volumes to tick up in the back half of the year with these new programs and are we seeing a pull-through from the new programs in your view at this point?

I think we saw somewhat of a spike in aerospace demand late in the first quarter and early in the fourth quarter. A lot of that was to restocking, okay? When people realized that the world had not come to an end in the aerospace world and they were seeing some demand. So there was clearly some restocking. I think now we've come back closer in the balance and customers are buying closer to what they perceive to be their end use demand. They are very cautious because of raw material pricing volatility for one thing and just the general economic climate.

That said, the general feeling on the part of the customers is we'll see a gradual improvement in aerospace in the third quarter and the fourth quarter in terms of underlying demand, but 2011 is really the year they expect to see growth accelerate and that's a function of some of these larger programs kicking in.

You think any of the new programs have kicked in thus far?

I think we're starting to see the beginning of it on some of their traditional planes. I think people are looking to 787; as that starts to go operational, it will get into late first quarter, second quarter of next year. I think that's what they're looking at as the real driver of growth in 2011. But there has already been an increase in build rates in some of the more common models.

Perfect. It's good to see all the progress you guys are making with your capital upgrades and I wish you the best going forward. It looks solid.

Thank you very much.

(Operator Instructions) Your next question comes from Gregory Mocosko of Lord Abbett.

Yes, thank you. Just a follow-up on Tim's conversation about the gross margin, et cetera. I think earlier you said that you've realized about two-thirds of the savings from the restructuring. Is that correct?

From the melt shop upgrade, yes.

Okay. So we still should be seeing some savings, which I would assume would flow through to the gross margin line, right?

Yes.

So perhaps, in other words, you said the gross margin, you see no reason for it to fluctuate from this current level. Does that not mean it couldn't go up from some of the more savings to be realized?

No, if I said that let me clarify. We would expect to see further cost savings as we move through the year 2010 and into 2011, okay? That would drive our margins up. The only caveat I would put on that is any wild swings in raw material costs that we're not currently projecting. Our view is that nickel for all intents and purposes is going to trade between $8 and $10 a pound for the remainder of the year. So that's the only caveat I would put on it, Greg.

Okay. But in terms of, I mean you've got other costs I assume, scrap and the like too that could fluctuate, that could have a more direct effect from the fluctuations in nickel?

Yes, but it's pretty well tied to nickel. My comments are kind of an umbrella comment about raw materials. I always use nickel as a proxy. Whether we get the nickel unit from virgin nickel or we get it from scrap, you get the same fundamental trends.

Okay. And I think I heard you just generally talking about the conversation over restocking. Do you feel like restocking is done in aerospace, people backed off so much? Is that kind of leveled off by the end of the second quarter or so?

Yes, I believe restocking has basically leveled off and our customers are buying more towards what they perceive to be end use demand coming down the pipe toward them.

Right, sounds right. Now, and then just with regard to restocking in petrochemical, power gen, and service centers, just generally can you -- how do you feel about those industries? Have they completed their restocking at this point or?

No. If you look at the oil and gas business in particular, we still feel that there is excess inventory in the metal supply chain feeding the oil and gas business.

So it's the opposite. There's still excess there?

Some excess. I think last quarter on my call I said they are six to nine months behind the aerospace business in terms of de-stocking. I think they still have some de-stocking, another quarter or two to go, based upon current levels of demand and there's a wild card there with this whole situation in the Gulf, which all of our customers would indicate don't worry about it because the rigs and so forth are going to be moved around and cruiser being moved. So you'll see the same level of demand that we should be able to work our inventory down and get them in line with demand over the next quarter or two. But that's the current view from the oil and gas side.

From power gen, we've been able to pick up quick turnaround business. That's why you see our sales going up. But if you look at underlying demand for new power units, it's still rather anemic and our forging customers are looking at that and essentially their planning is for a strong 2011, but we should be expecting additional metal buys as we get into the fourth quarter of 2010 and first quarter of 2011.

But with regard to the non-maintenance side of that business, [the idea is that] that the inventories are in shape.

Right, yes.

And then service centers?

Service centers generally are saying that they feel comfortable with their inventories. There is different -- different service centers have different things to say, but in general that they're comfortable with inventories. Some of the largest service centers have made comments in their conference calls, if you're listening about reducing inventories in the second half of the year. I would just caution you that they're talking in broad terms. In our products, I don't know of any service centers that are looking towards liquidating inventories in the second half of the year.

Okay, very good. And then finally back to the restructuring in the melt shop, if we look at all of the things you're doing on the manufacturing side of the business and the melt shop is two-thirds done, you're saying. Just remind me are there other sort of activities or things that are in process, or that you're expecting to execute over, say, the next six to 12 months other than normal ongoing kind of things?

Well, I guess you recall process improvements normal and ongoing, but I think there is tremendous opportunity for us to continue to increase yield and reduce scrap rates by making just simple process improvements. Not that they're easy, but very straightforward. In terms of additional capital spending, we're looking very hard at our re-melt facility, and looking and incorporating some new technology in our re-melting. That would be the next place we look to spend some sizable capital dollars.

And what about forging, I know there's been sort of some back and forth discussion of that area. Is there the possibility of some greater involvement in the forging area?

In terms of investing in a new forge ourselves, our valuation is that at this point in time is we are better off to work with partners to do our forging work for us rather than spend the capital to install our own forge. So that's the best what we've basically undertaken over the last few years to get closer relationships with our forging partners, so they can work with us to get the quicker turnaround we need to service the market.

Right. Acquisition or anything like that is kind of not considered?

Well, we always consider those things, but at this point in time, nothing would be imminent.

Okay. Thank you very much for all your answers.

Okay, Greg.

Your next question comes from [Ralph Marish] of First Manhattan Company.

Good morning.

Hi, Ralph. How are you doing?

Okay. How are you?

Good.

Good. On the -- starting with gross margin and moving down the P&L, you've said a lot about gross margin, but would it be fair to assume that the progression down the P&L with the other margins would also carry through?

Yes. Maybe a little bit additional amount of leverage depending upon the volume.

Okay. And on your segments, this is one of your smaller segments, but the wire redrawers segment is down quite a bit this quarter. Could you comment on that?

It's a small part of our business, relatively small part of the business. Chris, you have any comments on that? I'm turning it over to Chris, our VP of Sales.

Yes. The purchasing in that segment does tend to be a little bit more cyclical than others. So I attribute that more to a timing issue of shipments falling into one quarter or another. We see the business there continuing to move forward to stable.

Is that mainly from medical?

That would be one of the major markets.

Okay. So it's nothing more really than just timing at this stage?

I believe so, yes.

Okay. Thanks.

You're welcome.

(Operator Instructions) Again, at this time, there are no further questions. I'll turn the call back over to Mr. Oates for concluding remarks.

Okay. Thanks again for joining us today. We're pleased to see the level of recovery in the second quarter of 2010 and we expect to make further progress in the balance of the year. I'll look forward to updating each of you on our next call. Have a good day.

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