Universal Stainless & Alloy Products Inc (USAP) 2010 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Universal Stainless fourth-quarter 2010 earnings call and webcast. (Operator Instructions). As a reminder, today's conference call is being recorded. I would now like to turn the conference over to your host, Ms. June Filingeri. Please go ahead.

Thank you. Good morning. This is June Filingeri of Comm-Partners, and I would also like to welcome you to the Universal Stainless conference call. We are here to discuss the Company's fourth-quarter 2010 results which were reported this morning. With us from management are Denny Oates, Chairman, President and Chief Executive Officer; 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, and Ali 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.

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

Our fourth-quarter sales of $51.6 million were essentially the same as the third quarter as we expected. Some customers did delay deliveries until after year-end as part of their inventory planning, which is not all that unusual for this time of year.

Sales also reflected a mix shift towards more semi-finished products, which modestly reduced our operating margin of 11% as compared to recent quarters. The mix shift also matched some of our other further progress in operational improvement during the quarter. For example, with the completion of our [M-Plus] melt shop project, including the new automation packages, our melt shop operated at the second highest quarterly production level on record, second only to the first quarter of 2005. Costs, productivity and yields are all trending positively.

On the other hand, our progress in reducing lead times and reaching best-in-class on time performance was more directly visible in our record level of Power Generation sales and a 22% sequential increase in volume in the fourth quarter. This business was mainly captured through new quick turnaround programs and expanding nuclear activity. The schedule for material buys for new power generation turbines still points to the second half of 2011.

Looking at shipment volumes for the balance of our end markets, the 7% sequential increase in petrochemical volume in the fourth quarter was in line with growing momentum in the oil and gas markets. Demand in aerospace also has good momentum. However, our volume was 6% lower than the third quarter, due mainly to customer-requested pushouts to the first quarter of 2011.

In addition, we had a fire in December in the heat treating area of our Dunkirk facility. Repairs and incremental cost of operations are largely covered by insurance, but the furnaces are not expected to return to service until March. Our Dunkirk management team has done a great job executing a recovery plan, and we anticipate minimal impact on shipments in the first quarter.

The 54% decrease in our shipments of service center plate compared to the third quarter was due to customer inventory management and easing demand mainly in the automotive sector. Demand for tool steel was whipsawed again by destocking after near record volume earlier in 2010.

On the plus side, order entry across all markets continued to build in the fourth quarter, including tool steel plate. We find our customers increasingly optimistic about business levels over the next few quarters. In total, our backlog increased another 18% in the quarter, following a 27% increase in the third quarter to reach $69 million at year-end, the highest level since the fourth quarter of 2008.

To support the strong sales activity and backlog, we invested in managed working capital during the quarter, which resulted in a negative cash flow from operations of $3.6 million.

Let me turn to some of our end markets. Aerospace remained our largest market at 36% of sales in the fourth quarter compared with 37% in the 2010 third quarter and 31% in the fourth quarter of 2009. Our Aerospace sales were 4% lower sequentially, but 124% higher than in the fourth quarter of 2009.

The momentum in commercial aircraft demand is evident throughout the supply chain from the manufacturers right to our backlog. Earlier this month Boeing reported 530 net commercial orders in 2010, which they describe as the year commercial carriers moved from "economic recovery to expansion."

In addition to the production rate increases for the 737 discussed on our last call, Boeing announced a production increase in December for the 777 to 100 per year with the first ramp-up slated for mid-2011. They also announced a new delivery date for the first 787, which was well received by the market.

And just last week in conjunction with President Hu Jintao's visit, Boeing reported getting final approval on contracts for 200 Chinese aircraft orders comprised of 737s and 777s.

The news from Airbus further confirms the momentum, and in fact, new orders in Airbus in 2010 topped Boeing's, and they, too, announced a production schedule ramp-up during the year for the A320.

Our petrochemical sales represented 22% of sales in the fourth quarter, about even with both the third quarter of 2010 and the fourth quarter of 2009. Petrochemical sales rose 9% sequentially and were double the level of the fourth quarter of 2009. Oil and gas exploration has picked up considerably over the past year. On their earnings call last week, Schlumberger said the demand increase for oil in 2010 was the second largest in the last 30 years. The current oil price levels are encouraging exploration and that the consensus forecast is for further healthy increases in oil demand in 2011.

While natural gas did not recover as quickly, exploration around shale gas has been a positive factor in the US as Schlumberger sees the potential for that to extend to other parts of the world.

As to channel inventories, we feel excess inventory has been consumed, and the market is now on balance.

Our sales to the Power Generation market also represented 22% of sales in the fourth quarter compared with 17% in the 2010 third quarter and 23% in the fourth quarter of 2009. Our record Power Generation sales reflect a 28% growth from the 2010 third quarter and an 88% increase from the fourth quarter of 2009.

In addition to our ability to win fast turnaround business, supply channel inventories in the Power Generation category remain lean, which is another positive.

As to current end-user demands, on their call last week, GE said they received 29 gas turbine orders in the fourth quarter, which is down 40 from the fourth quarter of 2009, but ahead of the 15 new orders they received in the third quarter. In total, they ended the year with 103 turbines in their backlog and said they their book-to-bill ratio in 2011 may be above 1.

In 2010 they delivered 114 new gas turbines. GE also said they expect their backlog to continue to improve in 2012. With roughly 50% heavy-duty gas turbine market by their own estimates, they are a major business indicator for this industry.

Service center plate sales represented 7% of our fourth-quarter sales versus 14% in the third quarter of 2010 and 13% in the 2009 fourth quarter. Our service center plate sales were 50% lower sequentially, but 12% above the fourth quarter a year ago. The improvement in our order entry I mentioned earlier suggests that demand for tool steel in the supply chain has stabilized and has begun to improve.

From an end user standpoint, the news from GM and Ford is generally positive. GM reported that December was their best month in 2010 with a 16% increase in sales, and they are adding a third shift to their Flint assembly plant due to demand for heavy-duty pickup trucks. Meanwhile, Ford sales were up 17% in December, and they see potential for more growth in worldwide industry sales in 2011. Caterpillar reports year-end results tomorrow, but their news about off-road demand is also expected to be positive.

Let me take a moment and turn the call over to Doug for a review of our fourth-quarter financial performance.

Thank you, Denny. Sales in the fourth quarter were $51.6 million. This was nearly double the $26.7 million in sales recorded in the fourth quarter of 2009 and primarily driven by an 84% increase in our volume. Sequentially sales for the fourth quarter were in line with the $51.9 million recorded in the prior quarter on 3% lower volume. The full-year sales for 2010 totaled $189.4 million, which was 52% better than our prior year sales of $124.9 million. Full-year volume increased 54% over 2009.

The gross margin in the fourth quarter was 17.1% of sales as compared with 12.4% in the fourth quarter of 2009. Sequentially the fourth quarter compares to 19.9% in the prior quarter. As we reported in the third quarter, we recorded a favorable adjustment of $1 million for the metal recovered as a result of the capital project in streamlining our scrap loading area. Excluding this adjustment, our third-quarter gross margin was 17.9%. The gross margin for the full year was 17.8% as compared to 5.6% in 2009.

SG&A expense for the fourth quarter was 6.6% of sales as compared to 9.6% in the prior year of fourth quarter and 7.7% in the 2010 third quarter. SG&A in the fourth quarter was $700,000 lower than the third quarter, primarily due to an adjustment for increased stock option compensation expense recorded last quarter as noted in our last call. Other income in the fourth quarter was $72,000 compared to $559,000 last quarter year, which reflects the closeout of a dumping subsidy offset act, which contributed $551,000 to the fourth quarter of 2009 and $32,000 to the fourth quarter of 2010.

The Company's cash position at the close of 2010 was $34.9 million as compared to $42.3 million at the end of year-end 2009. Our managed working capital for the fourth quarter, which includes receivables, inventory less Accounts Payable, was 38% of sales compared to 46.7% in the fourth quarter last year. This percentage was 33.1% at the close of 2010's third quarter.

The decrease in cash from the third quarter reflects an overall use of $6.2 million, primarily due to an increase in our inventory levels. As Denny mentioned, we have seen a significant increase in our order activity, and our operating plans are scheduled to support that. With the completion of the upgrade project, our melt shop production in the fourth quarter was at peak levels for the year with an increase over our third quarter of 24%. Capital expenditures for the fourth quarter were $2.3 million, bringing our year-to-date spend to $7.5 million.

The total debt is $10.8 million. This data includes our term loan with PNC against which we are making quarterly principal payments of $600,000. We ended 2010 with a debt to total capitalization of 6.3%.

This concludes my report. Denny, I will turn the call back to you for concluding remarks.

Thanks, Doug. In summary then, our fourth-quarter sales were level with the third quarter, but the momentum in order entry and backlog increased as the quarter progressed, and we ended the year with a backlog of $69 million. Operating improvements continue to produce tangible results in the fourth quarter, especially in yield improvement and in our ability to capture fast turnaround orders. The capital project to improve our remelting facilities is now underway and should prove to be timely given the positive news from our end markets as we enter 2011. We will remain focused this year on pursuing profitable growth by seizing market opportunities and relentlessly pursuing operational improvements.

That concludes our formal remarks. We will now open the call up for your questions.

(Operator Instructions). Michael Gallo, CL King.

Congratulations on the results. Just a couple of questions, Denny. If I look at your commentary toward some of the momentum building into 2011, it sounded like Power Gen was maybe a little bit stronger in the fourth quarter than you had expected, but that on the other segment should all be picking up on a sequential basis Q1 versus Q4. Sales have kind of plateaued over the last three quarters at the $51 million to $52 million level. Should we expect those to start to pick up here in the first quarter, or will Power Gen sales maybe coming down a little bit in the first quarter offset some of the improvements in the other areas, and should we expect it to stay relatively flat?

From an overall standpoint, I would expect sales increase given the momentum across the board in all of our markets. As far as the Power Gen business goes on some of the quick turnaround business that we are doing, our visibility there is fairly limited, so you may see a small decrease in Power Gen. We are not necessarily anticipating one, but clearly the momentum in the other markets will more than offset any change there.

Okay. Great. The second question I have just on the margins. Obviously you did some additional reroll business in the fourth quarter. The mix hurt your margins a little bit. You have recently taken some additional base price increases that obviously are going to impact here in the first quarter. Certainly nickel and scrap pricing has been moving up. Would you expect to be able to improve your margin, your gross margins in the first quarter from the levels they were at in the fourth quarter?

Yes, I would.

Okay. And then just final question, you mentioned that you expect a minimal impact from the fire. I was wondering just dollar amount wise, how much you would expect the cost is going to be for the repairs and also what you expect in lost shipments and whether you expect to be covered from business interruption insurance on that?

If you look at our current estimates for the repair, it is in the neighborhood of $0.75 million. We expect our liability there to be about $100,000, which we recorded in the fourth quarter.

As far as the impact on the first-quarter shipments, based upon our recovery plan, we expect that number to be minimal. So I don't have a hard number there. It's an issue we still have to execute, but we have increased activity at other heat treating facilities we have at Dunkirk. We have transferred some material down to Bridgeville where we have some heat treating capability, and we have also started using some third-party heat traders to assist us here to get over the hump. When we put all that together, we think we can maintain our shipping levels as we had planned.

Just in terms of the incremental cost of moving all that stuff around, I mean should we expect in the first quarter?

I don't expect it to be material.

Tim Hayes, Davenport & Co.

Just two questions. On the margins, since the margin improvement has been quite good recently, looking further out in terms of long-term margin targets for the two segments, we have long thought about 30% gross margin as a percent of value-added sales for USAP segment and then 40% for Dunkirk. Do we have reason maybe that those targets you can exceed those, perhaps get mid-30% at Universal and maybe low 40% at Dunkirk?

We are striving to get those levels from a margin standpoint so on a consolidated basis we can move up into the midteens. So that is certainly our targets. That is not going to happen in the next quarter or so. That is going to take a combination of ongoing process improvements and returns from capital projects that we are currently in the process of executing on.

Right. Okay. And then secondly, we noticed that -- was there a restatement in the Dunkirk segment on the intersegment sales and then material costs, and if so, what did that relate to?

There was a minor re-class with regard to scrap sales where it is treated as a credit to material cost. The comparative numbers are classified -- are compared on a similar basis.

(Operator Instructions). Mark Parr, KeyBanc Capital.

Nice quarter, not as good as you guys though, dang. But it looks like you are sharing some of the glory today with ATI. They had a good quarter as well. Good outlook. I mean not as good a quarter as you guys had, but --. Hey, I wanted to talk a little bit about financial metrics. You are clearly solidly in the black, and do you have a sense of what your free cash flow number is going to look like for 2011?

We generally don't put out a number. I will tell you we expect it to be positive.

Okay. Because -- (multiple speakers)

We don't see the same rate of buildup in working capital, and we expect to make ongoing improvements in our working capital performance in terms of turns DSO and percentage of sales.

Alright. Did you give any outlook or guidance commentary as far as CapEx for 2011?

I would use $8 million to $10 million.

Okay. Another thing I wanted to just get an update on is your non-US initiatives, and what percentage of your business in 2010 was non-US and how you see that unfolding in 2011? Also, if you could share what percentage of your backlog is non-US, that would be helpful as well.

Let me ask Chris Zimmer to handle that one.

Our international business was at about 4.7% of sales in 2010. It is an important part of our ongoing initiatives moving forward. Next year we expect to grow at a faster pace internationally with the number of initiatives that we have focused into the Far East and into Europe. So I would expect that percentage to go up next year.

You mean next year, you mean you are talking in terms of 2011?

In 2011.

Okay. And is your current backlog, does it have more than 5% international built into it right now?

It is in a range of 7% for international stuff if you look at a percentage and the backlog.

We have had some -- we were up pushing 8%, if you remember. Actually we were up 10% there for a while. So we have had some changes there. Some of it has to do with the percentage in big growth rates on the domestic sales as opposed to decreases there. But clearly the penetration of some of the foreign opportunities we are after has been a little slower than we wanted to see it.

All right. Any -- is that worth discussing in terms of what sort of headwinds you are seeing? I know that at one point, I think you had talked about potential currency issues as a headwind. Is there something else that you have encountered that is worth discussing here on the call?

It is not really that material. What is happening is currency has had an impact. We have had some previous customers who have elected to make product internally to increase their own activity levels. That has been the main driver where things have dropped off.

Okay. I just --

Chris and I have made some trips over to Asia to begin building the business over in Asia. Most of our foreign activity has been in Mexico and also in Europe to date, and we have begun to ship some product into China. (multiple speakers) We just visit their early in the fourth quarter.

Well, it is good. I mean it is certainly -- when you look at your other companies in the specialty arena, it's not unusual to be north of 30% from an international mix. So I mean it certainly would appear as if it's a nice growth opportunity for you guys, and I would just encourage you to keep working to execute against that.

We agree with you. Our Board has tasked management with getting that number to 25% over the next three to four years. So that is our internal target.

Yes, okay. I think that would make a lot of sense. Another question, you have really built a reputation as least early in the life of this Company, and a lot of it happened prior to you coming around, Denny, where you did a lot of semi-finished material for other producers. I'm just wondering if you could give us a sense of how the semi-finished mix, where it was in 2009 as a percentage, where it was in 2010, and how you would see that in 2011? I would just like to get some more color on that if I could.

I think what you saw in our fourth quarter was somewhat of an aberration in terms of the percentage of sales going to re-rollers and so forth. We had some customers who I think were very optimistic about 2011, felt they were under-inventoried, looked at last year and felt they missed opportunities because they were under-inventoried as they came into 2010, and gave us a fair amount of business with some fairly short lead times, which we delivered upon. That shot up our volume, but the margin on that product is not as great as some of our other finished products.

However, it is still a very meaningful part of the Company. So I would expect that percentage mix to change as you look at the early part of 2011. You will see more tool steel plate as a part of the mix as compared to the fourth quarter, and you will see a sizable increase in finished bar products, which is most of that is the aerospace business kicking in.

Yes, and so that really has positive implications for margins. I mean is there any color you can give on what sort of goals you have for margin recovery prospects or further margin recovery in 2011?

Our long-term target for operating margins is 15%, which given our product mix is a stretch if you look at some of the other competitors who had nickel alloys and titanium, which generally carry much higher margins. So that is our long-term margin. I would say with regard to 2011 to expect continuous steady improvement in margin.

Okay. And then last question, if we can just get an update on the new melt shop, how it is performing, and just updated -- your updated thoughts on the capacity of that operation, and maybe any new growth opportunities you have identified that could help to exploit some of that excess capacity that you have created?

Well, we are very pleased with the performance of the melt shop. We have completed the project. We have been debugging it over the course of the second half of 2010, and I think the fourth-quarter performance in terms of volumes that we got through there, the first time through quality we got through the melt shop, the cost performance I think speaks for itself. So we are very pleased with where the melt shop is at this point in time.

Capacity-wise we feel that shop can produce 120,000 tons a year. That was the stated capacity before, but we never were able to make more than 70,000 tons prior to 2010. If you look at our current run-rate in the fourth quarter, it is about 75,000. They are about 70,000 to 75,000 tons on an annualized basis. That gives you an idea of the capacity increase potential we have. We are working very diligently to see if we can accelerate the utilization of that melt shop. I don't have anything to announce at this point in time, but that is clearly an area of big opportunity for the Company.

Okay. Well, you are -- just last, just a final comment. Your upcoming presentation at, what is it, MSCI conference, it has got to be a great indication of your confidence in your organization and the industry's confidence in your Company's ongoing growth and improving prospects.

So congratulations, Denny. You are doing -- it just seems like this thing is really coming together nicely, and best of luck to you this year, and I look forward to next quarter.

Michael, CL King.

Just a follow-up question for Doug. Doug, the tax rate 34% pretty consistently over the last four quarters a little lower than it had been historically? Is that what we should expect for 2011, your best estimate at this time?

Our best estimate would be to use 35% as some of our state apportionments will shift.

I'm showing no further questions at this time and would like to turn the call back to Dennis Oates for any closing remarks.

Thank you very much. Let me thank everybody for joining us today. We have entered 2011 on a positive footing and with full focus on executing our strategy to accelerate profitable growth at Universal. We will look forward to updating you in April on how our first quarter turns out.

Have a good day.

Ladies and gentlemen, that does conclude today's conference. You may all disconnect, and have a wonderful day.