Universal Stainless & Alloy Products Inc (USAP) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Universal second quarter 2011 conference call and webcast. (Operator instructions) As a reminder, today's conference is being recorded. I would now like to turn the conference over to your host for today, Miss June Filingeri. Ma'am, you may begin.

Thank you, Mary. Good morning. This is June Filingeri of Comm-Partners and I also would like to welcome you to the Universal conference call. We are here to discuss the Company's second quarter 2011 results, 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 McSoreley, Vice President of Finance and Chief Financial Officer; and Chris Zimmer, Vice President of Sales and Marketing.

Before I turn the call over to management, let me quickly review procedures. After management has made formal remarks, we will take your questions. The conference operator will instruct you on procedures at that time. Also, please note that, in this morning's call, management will make forward-looking statements. Under the Private Securities Litigation Reform Act of 1995, 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 the formalities out of the way, I would now 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.

This morning we reported that our second quarter sales were $63.4 million, an increase of 23% from last year's second quarter and an increase of 6.0% sequentially. Sales for the aerospace and petrochemical markets were the major drivers of topline growth, increasing 57% and 47%, respectively, compared to the second quarter of 2010.

For a second consecutive quarter, our Dunkirk Specialty Steel segment posted record sales, which reached $25.6 million, nearly double the same quarter of 2010 and up 16%, sequentially. In total, Dunkirk sales represented 40% of our total consolidated sales versus 26% in the 2010 second quarter, in line with our plans to improve profitability through product mix management. The upgrade of our Bridgeville melt shop and recent capital projects and process improvements completed in Dunkirk are supporting this growth.

Net income increased 33% over last year and 24% sequentially, reaching $5.5 million or $0.79 per diluted share, on the high side of the $0.75 to $0.80 per share guidance we provided on June 15th. Excluding costs related to our pending Patriot Special Metals acquisition, net income was $5.8 million or $0.83 per diluted share, which is up 40% from the second quarter last year.

With the continued shift to higher value products, additional cost reductions, and pricing actions, operating margins continue to expand and bottom line profitability grew in the second quarter. Our consolidated operating margin of 13.4% was the highest in four years. Excluding onetime acquisition expenses, operating margins were 14.1% versus 12.5% in the 2010 second quarter.

We invested 6.2 million and managed working capital to support the growth in longer lead time, higher margin products. Capital spending totaled $2.4 million during the quarter and we ended the quarter with $28 million of cash on the balance sheet versus total debt of $9.4 million.

Overall business activity remained at strong levels in the second quarter despite some slowing in order entry in June. With declining nickel prices lowering surcharges, some customers are choosing to lower inventories and defer purchasing. Nevertheless, end use demand at all our major markets is reasonably healthy. At June 30, our backlog remained solid at $90 million versus $46.1 million a year ago and $69.3 million at December 31, 2010.

Taking a closer look at our end markets, Aerospace remained our largest market in the second quarter at 40% of total sales, which is in line with the first quarter and up from 32% of sales in the second quarter of 2010. Our sales to Aerospace increased 57% from the same quarter last year and we're up 5.0% from the first quarter. Volume, however, was down 6.0% sequentially, with the divergence due to a higher sales mix and higher base prices partially offset by lower surcharges.

The positive momentum in commercial aircraft demand continues to build. At the Paris airshow in June, Airbus and Boeing came away with a total of 870 orders for new airplanes. Last week U.S. domestic airlines made a move when American Airlines announced the largest single airplane order in history, with an order for 460 narrow body, single aisle aircraft, including 260 Airbus A320s and 200 Boeing 737s.

High jet fuel prices seem finally to be spurring domestic carriers to make long awaited investments in new fuel efficient aircraft. We expect some other domestic carriers to follow suit. To support growing demand over the past year, both Airbus and Boeing continue to ratchet up build rates. That's all positive news for Universal and our customers.

Petrochemical sales represented 24% of total sales in the second quarter, also in line with the first quarter and up from 20% in the second quarter last year. Petrochemical sales increased 14% sequentially and 47% from the second quarter of 2010. Our initiative a few years ago to focus on the oil and gas market is enabling us to take advantage of the positive trend line in oil and gas exploration.

In their earnings report last week, Halliburton reaffirmed its confidence in the North American market, based on strong crude prices, operator's cash flow and access to capital and the increasing focus on liquids-rich basins. In their better-than-expected quarter, Schlumberger noted an increase in the deep water recount globally, along with renewed interest in deep water activities in the Gulf of Mexico. From our standpoint, demand is strong and channel inventories remain in balance.

Our sales to the power generation market represented 16% of the second quarter, compared with 18% in the first quarter and 19% in the first quarter of 2010. Our power generation sales were down 7.0% sequentially and up 2.0% from the second quarter of 2010.

We expect to see improvement in after-market sales during the second half as scheduled turban maintenance outages begin, following the summer cooling season. We also expect some positive upside as new turban orders increase. GE recently reported receiving 46 gas turban orders in the second quarter, compared to 27 in the first quarter and while their gas turban unit volume was down 11% in the first half of 2011, the volume is forecasted to rise by 33% in the second half of the year.

Service center plate sales represented 12% of second quarter sales with improved product mix, versus 9.0% in the first quarter and 17% in the second quarter of 2010. Our service center plate sales were 36% higher sequentially, although 16% below the second quarter a year ago, which was a period of heavy restocking of tool steel in the channel.

Despite fluctuations in the supply chain demand over the past couple of years, our order entry has been strengthening for the last third quarters, consistent with continued positive end user news. Auto production continues to be positive. For the first six months of 2011, GM dealers in the U.S. sold 18% more units that the same period of 2010, while Ford sold 12% more vehicles in the U.S. over the 2010 first half.

Other drivers of plate demand, like Caterpillar, continue to expect moderate economic expansion in the U.S., along with stronger growth in emerging markets and they've raised their sales forecast for the year. Off road demand remains strong.

Before I turn the call over to Doug for his financial report, let me give an update on our pending acquisition of Patriot Special Metals, which was announced on June 14th. Just to recap, Patriot Special Metals is a substantially completed greenfield facility in North Jackson, Ohio, which is about 80 miles from both our Bridgeville and Dunkirk facilities. It includes a state of the art radial forge, an 18-ton vacuum induction melting furnace, two vacuum-arc remelt furnaces and related equipment for heat treating and finishing long products.

Adding these assets to Universal broaden our production capabilities, expand the breadth of our product range at higher value, higher margin products and facilitate our entry into new markets segments on a global basis. From a transaction standpoint, we have now gotten early regulatory clearance and our financing is we'll on track.

Simultaneously, we've been working with the team at Patriot and key vendors on construction and installation of the equipment. Here's a progress report.

The radial forge commissioning continues. Almost two million pounds of material has been forged to date, including a full range of round products, sharp corner flats as wide two-inch by twelve-inch, sharp corner squares as large as eight inch and forgings as long as forty-one feet. Difficult to forge grades such as 718 and 60, 8286 and M4 high speed steel have been processed successfully. As of today, additional tuning and refining of the control systems will be required.

Related forge shop equipment, including the rotary reheat furnace, inline hot saw, the straightening press, the bar peeler, two clamshell furnaces and wooder and polymer quench systems have all been installed and tested.

The erection of the vacuum-induction melting furnace is underway. The roof assembly and casting chamber are in position, vacuum pumps are rough-set and the chem lab fit out is progressing. We have an ambitious target of melting our first heat in December of this year. The two new vacuum-arc remelting furnaces are on schedule for delivery in September, as planned.

As a result, we are on track with our plan to have the facility fully operational by the end of the first quarter of 2012. However, commissioning of the forge is taking somewhat longer than originally anticipated.

Meanwhile, Hart-Scott-Rodino approval is behind us. Our financing arrangements, led by PNC, are also in good shape. As we noted in today's release, the closing of the transaction is expected during the third quarter. We are still estimating approximately $0.30 per share in dilution in the third quarter and $0.10 in the fourth quarter associated with deal expenses, startup costs and interest expense. Accretive results will begin in the first quarter of 2012, as the facility comes on stream.

Let me turn the call over to Doug now for his financial report.

Thank you, Denny.

Sales for the second quarter were $63.3 million, an increase of $12 million or 23.4% from the same period last year. The increase was due to improved pricing and mix management and a 6.8% increase in shipments.

Sequentially, sales for the second quarter were 5.9% better than our first quarter, despite 3.0% lower shipments due to improved pricing and mix management. Our YTD sales were $123.1 million, an increase of $37.2 million or 43.2% from the first half of 2010.

Our gross margin in the second quarter was $12.2 million, an increase of $2.5 million or 25.5% from the same period last year. As a percentage of sales, the margin for the quarter improved to 19.2% from 18.7% last year. Sequentially, the improvement in gross margin is $1.4 million or 12.7% better than in the first quarter.

As Denny mentioned, we continue to report record sales from the Dunkirk facility. The increase in our consolidated gross margin reflects the increasing strategic shift towards higher value products. Our YTD gross margin in $23 million, an $8.4 million improvement from last year, or 57.2%.

The selling, general and administration expenses were $3.7 million for the second quarter, or 5.8% of sales, compared to $3.3 million last year, or 6.4% of sales. The difference is largely due to $496,000 in costs in the quarter related to the pending Patriot acquisition. Sequentially, the quarter is level with last quarter and on a YTD basis, SG&A was $7.5 million, or 6.1% of sales compared to $6.0 million, or 6.9% last year.

Operating income was $8.5 million for the second quarter, an increase of $2.1 million or 33% from the second quarter of 2010 and up $1.5 million or 22% from the 2011 first quarter. As a percentage of sales, our operating margin increased to 13.4% versus 12.5% in the second quarter of 2010 and 11.7% in the first quarter. We continue to record at a 35% tax rate. Net income for the second quarter of 2011 totaled $5.5 million, or $0.79 per diluted share, and we would have been at $0.83 per share, excluding the impact of the expenses related to the Patriot acquisition. The Company's cash position at the end of the quarter was $28 million, compared to $29.8 million last quarter. Our managed working capital for the second quarter, which included receivables, inventory less accounts payable, was 37% of annualized sales, which is level with the first quarter and improved from 38% as of the end of 2010.

Capital expenditures for the quarter were $2.4 million, bringing the YTD total to $4.6 million. Our total debt is $9.4 million. This includes our term loan with PNC against which we make quarterly principle payments of $600,000. Our debt to total capitalization is 5.2%.

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

Thanks, Doug. In summary, then, our second quarter was marked by very solid sales growth and further margin expansion as we pushed ahead with initiatives to increase sales of higher value products and reduce costs. Despite some moderation in order flow due to declining nickel prices and surcharges, business activity remained healthy and we closed the quarter with a backlog of $90 million.

The highlight that capped the second quarter was our agreement to acquire the assets of Patriot Special Metals. We are moving towards closing the deal in the third quarter and our financing agreement is progressing well. We're working closely with the team at Patriot to construct and commission equipment and are on schedule the have the facility fully operational by the end of the first quarter of 2012.

At the time of our announcement, we said this acquisition will enable us to fast-track our strategy to accelerate growth and will transform our position in the specialty steel industry. Our conviction about those outcomes has only increased since that time.

With that, I'll close. That's the end of our final remarks and we're ready to take your questions.

(Operator instructions) Michael Gallo, CL King & Associates

Hi, good morning.

How are you doing, Mike.

Hi Mike.

Denny, can you comment at all on the order entry over the last 30 days? Obviously, as nickel prices came down, there were some customers waiting for surcharges to be reset. Nickel prices certainly moved back up here over the last thirty days ago, so I was wondering if you can comment at all on order entry patterns or what you're seeing so far, through July.

Yes. Well, if you look at the months of the second quarter - the month of June was the low month in terms of bookings - we start to see a down trend the latter part of May and we attribute that to what's happening with nickel prices and surcharges. As we've come through the month of July, we would expect that when we finish July today our bookings will be slightly higher than June, which I interpret as the bottoming out of that process when you consider seasonal factors for a typical July. Normally that is a down month relative to June.

So the fact that we expect that to be up tells me that things have bottomed out. We do not see a decrease in end use demand among our customers, so this is purely a phenomenon of inventory and eventually customers have to buy product to continue operations.

Right. Any impact just in the supply chain from the slight reduction, call it a month of build rates on the 74 and 780 about Boeing, or channel inventory on the aerospace side, if you feel where it needs to be?

I would say it's pretty much in balance. There's nothing that we can perceive as a significant change in the last couple months on that score. I mean aerospace channel has been very buoyant and continues to be very buoyant and is in the process of ramping up gradually, from where we sit.

Okay, great and then a question for Doug. Obviously, from the economic stimulus bill, there should be some meaningful tax benefits to you on the transaction and on a cash tax basis. So I was wondering if you can give us an update? Obviously you've been booking a full tax rate, but where do you think your federal cash tax rate will be for the year, what kind of refunds you think you might get, if any, and what we should expect on that score next year? Thank you.

We are anticipating moving through the rest of the year at the same tax rate for our effective tax rate on the income statement, Mike. We do expect to have a significant impact from the stimulus as it relates to our ability to recognize bonus depreciation for assets that we would be able to apply to our taxable income for tax reporting purposes. So we are not anticipating a significant cash tax from here through the end of the year.

Right and then next year obviously you'll have some of the assets being put in place next year as well?

That's right.

Okay, great. Thanks very much.

You're welcome.

Mark Parr, KeyBanc Capital

Great, thanks. Good morning.

How are you doing, Mark?

Good, doing okay. I guess our President is speaking momentarily, so (inaudible - multiple speakers).

Well, you're not going to interrupt me for him are you?

Hell no. I'll say that emphatically. A couple of questions and I saw the results and congratulations on the progress. The color on orders in July is also helpful. First of all, could you give us some more color on the commissioning delays that you'd mentioned, related to the rotary forge?

Yes. The rotary forge is a very complicated piece of equipment. It is all computer-controlled, very advanced control systems and it's a very tedious, long process to get that whole facility tuned up so it runs like a top. We had anticipated things would be moving a little bit quicker, but the process there is you process material and you basically try to break the machine and as you do that, you've got to make changes to code and refinements, which are commonly characterized as "tuning the machine". So we're just grinding our way through that process, Mark, and it's taking us a little longer than we anticipated.

Our transaction was predicated upon getting acceptance on the part of the current owner, from the mill builder, which has not happened yet. And also, the passing of a stress test that we designed by the way of Universal to make sure that the equipment would do everything it was advertised to do and what we expected it to do and we simply are not there yet.

You know us pretty well. We tend to be pretty conservative and very detail-oriented. We're going to make sure the machine is doing everything that it was designed to do before we closed the deal. That's pretty much where we're at and that's what's causing some of the slippage. I guess I was a little bit more optimistic we'd be farther along at this point.

I mean, can you put any sort of time parameters on how much incremental time that this may be? Is it a week? Is it a month? Is it six months?

I think now you're talking a week to months. You're not talking six months. So we think we're going to get everything wrapped up and be able to close in the third quarter, which would say to you months. We originally expected to close by the end of July. We now expect to close at some point in the third quarter.

Okay

I'll give you the analogy our engineers give me. You're at the airport and the plane is late. They tell you it's going to be a two-hour delay, but don't leave the gate because it might leave in a half an hour and that's kind of where we're at, at this point in time. It's very difficult to assess, as you work through the product mix, what kind of time is required to do that tuning.

Yes. No, I'm just trying to get a sense, so I appreciate that color. Thank you very much. I had one other question, if I could.

Sure.

Looking at the new melting capability you have now with the VIM furnace. Can you give us some color, in terms of what the -- putting that VIM together with your airmelt shop in Bridgeville, what's the increase in underlying capacity from electrode product standpoint?

Well, the VIM will give us, depending upon sizes, another 12,000 tons of vacuum induction melting in a year. I'm having a little trouble with the correlation with our air melt shop. I mean our air melt shop has production, probably has another 35% of capacity that underutilized at this point in time.

Yes. Okay.

And as we grow the business, our intent would be to be expanding with a bias towards more remelted product and our remelting facilities, we have sized -- the melt shop out there is sized for additional remelt, so we have two VARs coming in, another ESR that'll begin in the second quarter of next year and space for additional six remelt furnaces out there. You won't see any increase in our -- there's no increase in our air melt anticipated, so in terms of pure melt it's be the VIM furnace, if I'm understanding your question properly.

Yes, so that'd mean the VIM would add another 12,000 tons onto 100,000 tons that the airmelt capability has that you put together for that one right now. Is that fair?

Correct. Yes, except it's not 100,000. Its 120,000 tons.

Yes, 120,000, okay. Well, pardon me. You keep raising it on me. Alright and then lastly, if I could, with all this momentum, could you give us an update just on the prospect for base prices, maybe and update in terms of where you are now on bases prices compared to the previous peak? And where would you expect base price increases to unfold over the next, say, 60 to 90 days?

We're not currently, over the short-term, contemplating any base price increases, speaking from Universal's standpoint at this point in time. I would say we're still running, generally speaking, 10% to 15% under the last peak, from a base price standpoint.

Okay.

So there's more wind to go. If you look at demand levels, certainly demand versus supply is tightest in aerospace and petrochem. So, as we go through the second half of the year, to the degree that there's price increases, I think they're the markets and the products that you'll see those price increases occur. But we're not contemplating anything over the short-term.

Okay, is the mix you had in the second quarter, is that sustainable through the second half of the year?

Yes.

So, I mean that bodes well for margins, then, as shipments expand, so that's good.

Yes.

Okay. I'll get back in line. Thanks for all the color, though, and congratulations on a great quarter.

Okay, Mark. Good talking to you.

Yes, likewise you too.

(Operator instructions) Tim Hayes, Davenport & Co.

Good morning.

Hi Tim.

Good morning, Tim.

A few questions. Is the recent softness in orders -- I take it that's coming primarily from service centers?

Generally speaking, yes.

They're the ones that will focus -- have a greater tendency to focus on trends in nickel prices and try to outguess the market in their purchasing practices.

Right. Any -- you have a two-month surcharge. Is that current? Its two months, right?

We have a two-month surcharge, yes.

Any thoughts of shortening it up like some of the collateral folks have done?

Well, there's a very interesting article in the American Metal Market today, which would tell you that, no, we don't plan to change ours from two months to one months and the logic for that is pretty simple. If you look at the underlying reason for a surcharge, it's to try to match the surcharge to the production cost of the material. That's where the two months comes from and it's not perfect. But clearly, with long products, there is a longer lead time than with flat roll products. So we don't see any reason to shorten things up to a one-month versus a two-months. We don't know that's its going to -- it really defeats the fundamental purpose of a surcharge.

Okay. Alright and then within the -- back in the Q2, there was a drop to the re-rollers. What -- anything of note there or is that just lumpy?

I think that's largely inventory control. Some of those re-rollers have June fiscal years and people do window dressing at the end of the year.

That's right and then, for the forgers, sales flat there. I guess we were kind of assuming with the strength in aerospace and whatnot that that would have continued to show momentum. Any more color on the sales being flat to the forger, sequentially?

I think that flatness is largely reflective of what's going on in the power gen market. There's a pretty decent ongoing maintenance end to that market that we've been going after fairly aggressively, but it kind of is what it is. As I said in my prepared remarks, I do expect that to pick up here in the fall.

We've had a very hot summer season and I expect that there's a lot of turbines out there that have been working extra hard and there'll be a fair amount of maintenance that we'll see here as we go through the end of the third quarter and fourth quarter. And the new turbine business is still rather anemic, even though it's improving gradually, quarter-to-quarter. If you look at GE and Siemens and some of the OEMs that are in the business, it's nowhere near where it was in the last cycle. But, as advertised, we still expect that to improve as we go the second half of the year and into 2012.

That's good color there and then, finally, just wanted to get some trends in shipment, say for the two segments. How are shipments at USAP doing, sequentially and from a year ago and the same for Dunkirk?

Hang on. So you want to know what the shipments were in the second quarter for Dunkirk, the Dunkirk segment

Yes.

So, if you look at Dunkirk, second quarter of this year to second quarter of last year, shipments are up 67%, which is a 2.5 million pound increase. If you look at the Universal segment, shipments are up 13.3%, or 3.4 million pounds, second quarter this year to second quarter last year.

Okay and how did they do sequentially?

Okay. Dunkirk, up 11% sequentially and the Universal segment essentially flat, up 0.2% sequentially

Good. Thank you.

Okay, you're welcome.

Mark Parr, KeyBanc Capital

Thanks again.

Hi Mark.

If you're looking at the second quarter mix, Denny?

Yes.

Is that -- how would you characterize that versus the previous peak levels?

The peak levels for Universal, you mean?

Yes.

The prior peak level, in terms of absolute volume for Universal, was much, much more heavily weighted towards semi-finished product that finished product.

And can you give us some color in terms of the differential right now?

Well, the main differential is in two areas - more finished products, more of the Dunkirk products. So our strategy has been to preserve our semi-finished business and to continue to work at growing that, but to facilitate ourselves to be able to grow in the finished end of the business. So, if you recall, we went to Cellular Manufacturing up at Dunkirk, we did the melt shop improvements here and that's why you the record sales up at Dunkirk at this point in time. So that's one piece of it.

The other piece of it is a greater focus on remelted products. So, if you compare ourselves today to the last cycle back in '06 and '07, you would see a much higher percentage in terms of our total ship pounds and remelted at a much higher percentage in terms of finished products. I don't have those numbers in front of me here to give you the exact numbers, but, directionally, that's what you would see.

Okay, yes and that's clearly going to continue to unfold as Patriot is ramped up?

Yes.

So that's all good news. Okay. Alright, look, I was just looking for a little more color there. I appreciate it. Thanks again, Denny.

You're welcome.

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

Okay. Thanks, Mary. Thanks again for joining us today. We're entering a very exciting new phase in the development of Universal Stainless and we're all here looking forward to updating you on progress we'll have during the third quarter on our next call. Have a good day and a great weekend.

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. 5