Universal Stainless & Alloy Products Inc (USAP) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the USAP third quarter 2010 earnings call and webcast. At this time, all participants are in a listen-only mode. Later, we'll have a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, today's conference may be recorded.

I'd now like to turn the conference over to your host for today, Ms. June Filingeri of Comm-Partners. Ma'am, you may begin.

Thank you, Mary. Good morning, this is June Filingeri and I also would like to welcome you to the Universal Stainless & Alloy Products conference call. We are here to discuss the Company's third-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; and Doug McSorley, Vice President of Finance and Chief Financial Officer.

Before I turn the call over to management, let me quickly review procedures. As Mary said, after management will -- makes their 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. I'd 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'd now like to turn the call over to Denny Oates. Denny, we are ready to begin.

Okay, June. Thank you very much. Good morning, everyone. Thanks for joining us today. Our third-quarter performance reflects modest sales growth, solid profit margins, positive cash flows and the 28% increase in our backlog.

Third-quarter sales were $51.9 million, double those of the same quarter last year and about 1% ahead of the second quarter. With supply chain restocking mostly completed in the first half of the year, third-quarter sales mainly reflected end-use demand as well as our progress in market and product expansion initiatives. From an end-market standpoint, positive momentum in aerospace is the major positive driver of our sales in the third quarter.

Our operating margin remained above 12% of sales in the third quarter despite the recent price fluctuations in nickel and other raw materials. We continue to drive improvements in operating performance. The increase in inventory turns achieved thus far has lessened the impact of nickel volatility. The melt shop upgrade and other recently completed capital projects along with process improvements are reducing costs and increasing yields.

By way of update on our melt shop project, daily melt productivity has increased 33%, material yields are up more than 2% and work-in-process inventory turns are 50% higher. In total, our melt shop production in the first nine months of 2010 was 50% greater than its production for all of 2009. As I said on our last call, the operational improvements achieved to date are sustainable and there is still more we can do. Cash flow from operations was a positive $8.8 million in the third quarter and managed working capital per dollar of sales has consistently improved all year. Let me turn to our end markets.

Aerospace remained our largest market, growing at 37% of sales in the third quarter compared to 32% of sales in the second quarter of this year and 31% in the third quarter of 2009. Our aerospace sales rose 20% sequentially and were 150% greater than the 2009 third quarter. Boeing's earnings report last week shows the positive momentum in the market.

For the third quarter, Boeing reported booking a net 221 commercial airplane orders compared with 68 net orders in the 2010 second quarter and 79 in the third quarter of last year. They also have raised the production level for the 737 for the third time, citing a resurgence in air travel and strong demand from their customers. Their current backlog includes over 2,000 737s and they are optimistic that number is going to increase based on existing customer options and their sales efforts.

Boeing also has said the demand for the 777, 787 and the Stretch 8s -- Dash 8s rather supports their current production schedule and they anticipate prolonged market recovery overall.

The petrochemical market was our second largest market in the third quarter, representing 21% of sales, essentially even with the second quarter of 2010 and the same period last year. Our petrochemical sales, which are primarily for the oil and gas exploration market, were up 2% sequentially, while being nearly double the level of the third quarter of 2009. As noted on the last call, some excess inventory remains in the distribution supply chain, which we expect to come into balance by year-end.

For their third quarter, Halliburton and Schlumberger both reported sequentially flat international sales, with strong growth in North America with a shift to more land-based fields from offshore drilling. Both companies are forecasting further recovery in 2011. The good news from our standpoint is that our customers have started adding to payroll and our quoting activity has picked up in recent weeks.

Power generation represented 17% of third-quarter sales compared with 19% in the second quarter of 2010 and 32% of sales in the third quarter of 2009. Our power generation sales were down 10% sequentially, but up 9% from the third quarter of 2009. Our customers continue to expect significant market recovery in 2012, which implies a pickup in power gen business for us as we move through 2011. Their expectation seemed to be in sync with what we are hearing on the end market.

On their third-quarter call, GE reported a total of 15 new orders for turbines in the quarter compared with 23 in the third quarter of 2009. It was good to see the announcement earlier this week that GE won a large deal for natural gas and steam turbines from Reliance Power of India.

Until the market recovery gains traction, we are focusing on continuing to capture maintenance business as it becomes available based on our short lead-times and quick turnaround. We're also upgrading our re-melt facilities to meet our customers' needs in what we feel will be a very robust market in the future.

Our service center plate sales represented 14% of third-quarter sales versus 17% of sales in the second quarter of 2010 but just 5% in the 2009 third quarter. Our service center plate sales were 16% lower sequentially, but 6 times higher than in the same quarter a year ago.

Current sales levels seem stable, now that restocking has been completed in the channel. Domestic auto sales appear to be settling in at around 12 million units annually and the off-road equipment manufacturers continue to report healthy backlogs and strong bookings.

Let me turn the call to Doug at this point for a report on third-quarter financial results. Doug.

Thank you, Denny. Our third quarter sales of $51.9 million and volume shipped of 11,800 tons more than doubled from the same quarter in 2009, due to strong growth in shipments to all end markets. Sequentially, our sales increased 1.1% while our tons shipped were essentially flat. The sales increase was due to the improved shipments to aerospace and our pricing levels on those products that offset the volume variability in our other end markets.

For the first nine months of 2010, our sales of $137.8 million were up 40.3% from the same period of 2009, with an increase of 45.4% in our tons shipped. Our third-quarter gross margin of $10.3 million was 19.1% of sales compared to $10.7 million in the 2009 third quarter and $18.9 million in the 2010 second quarter.

Our cost of sales can include book to physical inventory adjustments. Our third quarter of 2010 included a favorable adjustment of $1 million for the additional metal recovery as a result of a capital project in streamlining our scrap loading area. Excluding this adjustment, our gross margin was 17.9% of sales for the quarter. For the first nine months of 2010, our gross margin of $24.9 million was 18.1% of sales compared to 3.8% in the same period of 2009.

Our selling, general and administration expense for the third quarter was $4 million or 7.7% of sales compared to 8.9% in the 2009 third quarter and 6.4% in the 2010 second quarter. There was a $700,000 increase in our SG&A from the 2010 second quarter. This increase was primarily due to an unfavorable adjustment for increased stock option compensation expense. The adjustment was a cumulative non-cash adjustment required to fully expense vested options and change the estimated forfeiture rates of current unvested options.

Our third-quarter operating income of $6.3 million was 12.2% of sales compared to 1.8% in the third quarter of 2009 and 12.5% in the 2010 second quarter. Our operating income for the first nine months of 2010 was $15 million or 10.9% of our sales.

The Company's cash position at the close of the 2010 third quarter was $41.2 million, an increase of $6.6 million from the second quarter. Our managed working capital, which includes receivables and inventory less accounts payables, includes a 33.1% -- improved rather to 33.1% of sales in the third quarter from the second-quarter level of 34.7% of sales. Capital expenditures for the third quarter was $1.7 million, bringing our year-to-date spending to $5.1 million.

Total debt at the end of the third quarter was $11.5 million. This debt includes our term loan with PNC against which we're making quarterly principal payments of $600,000.

That concludes my report. Denny, I'll turn the call back to you for final remarks.

Okay. Thanks, Doug. In summary then, sales remained at strong levels in the third quarter as the market shifted from restocking to end-user demand, and we continue to execute on market and product expansion initiatives.

Our backlog rose 28% and order entry increased in the quarter. Manufacturing improvements and targeted capital spending programs contributed to profitability, and our margins remained strong in the third quarter despite the fluctuations in nickel. Our balance sheet remains very strong.

For the balance of 2010 and beyond, we will continue to focus on high service levels, process improvements and lower costs, while investing in our operations, all of which are aimed at driving growth in profitability.

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

(Operator Instructions) And our first question comes from the line of Michael Gallo from CL King.

Hi, good morning, congratulations on the good result.

Thanks, Mike. How are you doing today?

Good. How are you doing? Just wanted to dig in a little bit on the SG&A question. I think Doug, was the whole increase Q2 to Q3, this stock option adjustment? The total increase over the prior quarter, I think was $700,000; $640,000 of that was the adjustment for stock options.

Right.

Okay. And just walk me through a little bit how that came up, it's something I presume shouldn't reoccur here. Wouldn't be expected to reoccur?

No, it shouldn't and won't reoccur. It's a change in our estimated forfeiture rates of the different pools of options that are currently vesting and it was a full expense of options that vested with an August anniversary date and some prior to that.

So just to change the way you did things. So going forward, you would expect that to be more in line with probably where it was in the second quarter.

I would.

Given the [positive] expectation for a level of sales that's similar.

Yes, what will happen is, some of the expense will be quoted a little earlier. It's a little more current with more appropriate rates. I would say compared to the second quarter, you would see an increase related to stock options of $100,000.

Okay, okay, that's fair enough. And then just a commentary, Denny, just on the overall supply chains for petrochemical and power gen. I know you had indicated you expect this to improve in 2011, but just if you can comment, I think on the supply chains in those two areas, that would be great. Thank you.

Okay. As far as the supply chains in the oil and gas area, which is most of our petrochem business, a lot of that business that we sell goes to distribution. We still see some excess inventory along the supply chain, which as I mentioned we expect to go in the balance.

On the power gen side, it's not the same case. I think inventories there, I would characterize as lean, which means the timing of any turn in the market is going to be critical. You've been around this market a long time, Mike, so you know it tends to turn very quickly, and I think when it does, there will be a mad rush to get metal. So they are two different markets, two different situations of the supply chain from an inventory standpoint, as I see it.

All right. Okay, great. Thanks a lot.

Thank you. Our next question comes from the line of David Woodyatt from Keeley Asset Management.

Yes, could you give us at least a rough estimate of where you think the overall Company operating rate stands at the moment?

Usually, the operating rate is based off your melt capacity and your utilization of your melt shop. Today, we are running at about 55% of capacity based upon that measure.

Okay. Thank you.

(Operator Instructions) Our next question comes from the line of Tim Hayes from Davenport & Company.

Good morning.

Good morning, Tim.

Two questions. The first is, could you give us a little more color on volume trends for the two segments?

If you look at the Dunkirk segment, most of that is finished bar product. And most of that is also aerospace related. So the backlogs and the order trends there, I would characterize as relatively strong. And as you look at aerospace, you should see Dunkirk follow that same basic pattern. Yes, it's a little more mixed when you get into the Bridgeville -- the Universal Stainless & Alloy Products segment, which is mostly the Bridgeville facility.

There, you have some more puts and takes when it comes to the movements in power gen, which were down and we expect to be flat. But with some improvements as I cited in 2011 and into 2012, and Tool Steel Plate is also relatively stable at this point in time. They would be the two drivers of the various volumes.

And during the Q3, is it -- did those segments see volumes flattish with Q2 or is one segment stronger than the other?

The Universal segment, Tim, was slightly below the second quarter volume at 3%. And the Dunkirk segment was slightly above.

Okay. And then the last question, given this recent rise in nickel prices, have you seen anything unusual from your customers during September-October time frame, just trying to get a gauge on what they're doing and how they're reacting to this recent rise in nickel prices?

There is always an anecdote that when nickel prices fluctuate like this, customers will try and outguess the market, and either advance order or postpone orders, and that is a reality. But it's very hard for me to pin a number on that. I don't personally see much of that at this point in time.

Okay. Thank you.

Thank you. Our next question comes from the line of Phil Gibbs from KeyBanc Capital Markets.

Denny, Doug, June, good morning. How are you?

Good Phil, how are you making out?

Good morning, Phil.

Doing okay. I was curious about the power gen markets, it seems like the outlook as we look toward the second half of '11 and '12 and '13, I think it continues to look fairly favorable. And have you seen a change in attitude from your customers as natural gas prices continue to, let's say, remain weak as they look for low-cost alternatives? Have a lot of them or have any of them increased expression of trying to pull forward orders, or has there been an increase in tone in the marketplace because of that?

I think the tone is turning more positive. If you recall the last call, I was commenting that the recovery in power gen, most of our customers, along with some of the big OEMs, seemed to be suggesting it was pushing out into 2012. I think over the last two or three months given where industrial production has been, credit situations in the world and a whole host of other reasons, there seems to be more optimism that that can get pulled closer in. That's why I think it's important for us to maintain our flexibility because as I mentioned with Mike Gallo's question, I think when the market does turn, it may be sooner than 2012, and we want to be ready for that because when it turns, it usually turns relatively quickly.

Where have you -- I'm sorry, where have you seen the preponderance of these new projects coming online? North America, we have better visibility into that market. But globally, where are they maybe looking to --?

The Far East and the Middle East are the two geographic regions where we're seeing more optimism -- we're hearing about more optimism.

Okay, perfect. And then, just a question regarding your lead-times and I know you've positioned yourself to capture more market share with the shorter lead-times, but can you comment on any products that may be somewhat longer lead-times just given the demand, where are you seeing demand? What products are you seeing demand the strongest?

But we've worked very hard to hold our lead-times and our lead-time for billet, it varies by grade, but is 8 to 12 weeks, which is roughly the same place it was in the second quarter. Ingot products will be two to four weeks. Our finished bar product, again varies a lot by grade, is three to ten weeks and our plate product line will be six to eight weeks. So we haven't -- we don't have a stretch out in our lead-times at this point in time.

And thanks a lot for that. Just, Doug, a quick question for you. You said, the -- was it a positive scrap settlement in the third quarter that benefited you $5 million, was that what you had commented on?

Yes, the situation there is, as a matter of course, we regularly take physical inventories. This year, we've been working to improve our melt shop in our scrap operations. One of those capital projects is revamping our scrap building. So as we do these physical inventories, we typically will zero out a bin. Since we're doing a capital project there and we're basically redesigning the whole place and we're taking bins replacing them and digging underneath it, there was additional positive adjustments made based upon material that we found under those bins. Just simple as that.

Okay. So we should be facing our forward expectations on more of an 18% gross margin then?

Yes, I would take a look at the $1 million as a one-time affair.

Okay. Thanks a lot, guys.

Okay.

Thank you. (Operator Instructions) And our next question comes from the line of Gregory Macosko of Lord Abbett.

Yes, thank you. Just wanted to ask a little bit about revenue growth versus volume growth in the various aero, petrochem, power gen and service center numbers you've talked about. It sounds as if the volumes were a little bit higher than the revenue. Does that imply more pricing or mix or give us some color on that?

Well, we surge our -- surcharge our products just like everyone else in the industry. So if you look at the trends in nickel, we have a two-month lag in our surcharge and nickel prices started to fall midway through the second quarter of 2010. So you had a negative effect there, where surcharges would come down. We have the inverse of that now where nickel prices are starting to firm over the last couple of months and you should expect to see higher surcharges each month of the fourth quarter.

Along with that, we monitor our pricing very carefully like everyone else does. So we have made selective pricing moves over the course of the year -- price increases, that would be. We've also worked our mix very hard and I would also add that we just put out an official announcement that we're increasing prices effective January 1, 2011.

Yes, I saw that. That looks good, but I guess the point is, it has been priced, but that will catch up as we move forward and the surcharges are implemented.

Yes.

Okay. Good. And just generally speaking with regard to the -- that the SG&A line and again that forfeiture rate, that is just in terms of relative to the stock price and what you expect employees to be taking your options, is that correct?

I would say it a little bit differently. As we have pools of stock options that are outstanding and vesting, you realize the expense and you offset that by what you estimate to be an assumed forfeiture rates. Our -- we've changed the rates that we're going to use going forward and there was a catch-up impact of that in this quarter.

I understand the catch-up, but the 100 going forward is, have you done any re-pricing of options or is this just the existing options that are in place?

It's just the existing one.

Okay.

We have not done any re-pricing.

Okay. Good. I'm glad to hear that. All right. Very good. And the order entry, I believe relative to the order entry rates, you said that those have been increasing, is that going into October as well?

Yes.

Okay. Good. Thank you very much, Denny.

Okay, you're welcome.

Thank you.

Thank you. I show no further questions in the queue. I would like to turn the conference back to Mr. Dennis Oates for closing remarks.

Okay. Thanks once again for joining us today. We're pleased to share our results for the third quarter and we look forward to talking to you in 2011 about our results for 2010 and our fourth quarter. Have a great day.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect at this time.