Universal Stainless & Alloy Products Inc (USAP) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Universal Stainless First Quarter 2013 Conference Call and Webcast.

At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. (Operator Instructions)

As a reminder, this conference call is being recorded.

At this time, I would like to hand the conference over to Ms. June Filingeri. Ma'am, you may begin.

I thank you. Good morning. This is June Filingeri of Comm-Partners, and I also would like to welcome you to the Universal Stainless Conference Call. We are here to discuss the Company's first quarter 2013 results 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. The conference coordinator 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 these formalities out of the way, I would now like to turn the call over to Denny Oates. Denny, we are ready to begin.

Thank you, June.

Good morning, everyone. Thanks for joining us this morning.

As expected first quarter sales were $49.1 million, up 4% sequentially on 8% higher volume, but sales were down 34% on 31% fewer tons shipped compared with our record first quarter of last year.

The increased shipment volume in the first quarter versus the fourth quarter of 2012 came in every customer category except conversion services and in nearly every major end market. There was also a 39% increase in order entry in the quarter compared to the fourth quarter [trial]. The increase in incoming business was not sufficient to reload our backlog, which declined $5 million, or 10%, to $46.6 million.

We continued to see inventory correction within the supply channel during the quarter, especially in oil and gas, and inventory control remained tight throughout, with purchases being made on an as-needed basis.

Record-level lead times at all the mills and volatile raw material costs are further encouraging the hand-to-mouth buying strategy on the part of our service center and forger customers.

The difference between the sequential increase in our sales and volume in the first quarter was due mainly to a lower price mix characterized by proportionally more semi-finished products and less remelted and vacuum-induction melted produced product.

Our operating income in the first quarter was essentially at breakeven, as was our net income at $0.01 a share. The decline in margins compared to Q4 of 2012 was directly attributable to four factors --

First, higher depreciation expense on mainly North Jackson assets placed in service, approximately $0.05 a share;

Second, our strategic decision to continue our focus on refining manufacturing processes for new products and achieving industry and customer approvals, which would include costs such as process and product experiments, lower-than-normal yields, audits, equipment surveys, consulting, extensive product testing and outside labs, and inefficient equipment utilization;

Third, dispositioning test material which is out of spec; and

Fourth, the combined effect of the continued low level of plant activity and a lower-priced, lower-margin shipment mix.

Cash flow from operations was positive at $4.4 million due to a reduction of $2.8 million in managed working capital and $3.8 million in depreciation, partially offset by $3.6 million in capital spending.

We finished the quarter with total debt of $104.7 million, or 34.5%, debt to total capital.

With the commissioning of most North Jackson equipment now successfully behind us and its integration [in] Universal substantially completed, we have literally become a single manufacturing system, consisting of four closely linked facilities. As a result, we moved to single-segment reporting with this first quarter report to reflect the way we now capture information and manage the business.

We have also added a new metric starting this quarter that looks at our sales of premium alloys versus specialty alloys. Premium alloys are any products that are vacuum induction melted, so this is a new window into our business and another way to assess our progress going forward.

In the first quarter, premium alloys represented approximately 5% of sales. Our strategy is to grow that percentage to 25% to 30% by 2015, with major approvals being achieved in 2013 and volume ramping in 2014.

We reached a major milestone in our plan with the winning of our first contract with Rolls Royce, as was announced last week. Qualifying our products and [then] production with major OEMs in our key end markets has been the foremost priority, which you've heard me talk about many times. The qualification process is lengthy, it's intense, and it involves all of our facilities, not just North Jackson.

Rolls Royce is among the most demanding OEMs out there, so our success with them in getting a five-year contract was a major accomplishment.

We've also received product qualifications from a few additional OEMs, as well, showing that our effort is gaining traction.

Just to complete my update on North Jackson, our vacuum induction melting furnace produced 41 heats in the first quarter. Our four vacuum-arc remelt furnaces processed 172 heats. Forged production remained low, with about 8.9 million pounds processed across the dies, including stainless, nickel alloys, tool steel, and titanium grades.

Nadcap heat-treat certification was awarded in February, a critically important foundation for other approvals. These heat treat operations processed about 5.8 million pounds during the quarter.

In turning to our sales by end market, let me mention first that we have renamed two of them. Petrochemical is now oil and gas, and service center plate is now heavy equipment.

Let me start with aerospace. Aerospace remained our largest market in the first quarter and represented 52% of sales versus 54% of sales in the fourth quarter of 2012 and 50% of sales in the first quarter of 2012.

Our sales to aerospace were up slightly on a 5% increase in volume from the 2012 fourth quarter, while sales and volume were down approximately 31% from the first quarter of 2012.

As most of you know, gaining approvals of our vacuum induction melted production gives us a major new platform for growth in the aerospace category, which will benefit our results in a meaningful way beginning in 2014 and beyond.

There also continues to be favorable news from the aircraft manufacturers.

Boeing reported last month and confirmed on their earnings call last week that commercial airplane demand is strong, their backlog is healthy, and they plan to keep increasing production rates. They also underscored their confidence that the market will continue to be strong.

Backing that up, they have now rolled out their first next-generation 737 at the increased production rate of 38 airplanes per month and reiterated their plan to increase that rate to 42 airplanes per month in the first half of '14.

While they have slightly adjusted the rate of the 747-8 production to 1.75 aircraft from two per month, they were successful in ramping up the triple seven to a record 8.3 airplanes per month.

They also are continuing their plan to increase production of the 787 to 10 per month by year-end from its current rate of five per month. Now that they have FAA approval for their battery solution, Boeing said they intend to complete all planned 2013 deliveries by year-end.

Meanwhile, Airbus moved to the top spot for aircraft orders in the first quarter with 431 orders. All totaled, Airbus now has a backlog of 4,948 aircraft, which is an industry record and represents about seven years of production.

Earlier this month, Airbus reported that construction officially began on their manufacturing facility in Alabama.

Despite the continued strong outlook on commercial builds, demand for our aerospace [grades] in the first quarter was tempered by customer inventory concerns and flat to down demand in the aftermarket in defense segments.

Oil and gas market sales represented 13% of our first quarter sales compared with 16% of sales in the 2012 fourth quarter and 21% in the first quarter of 2012. Our oil and gas sales were down 17% sequentially on 23% lower volume, and sales were 60% lower than in the first quarter of 2012 on 62% lower volume.

As you have heard from others, there was inventory destocking in the supply channel during the quarter. That's against a backdrop of a 3% decline in the US onshore rig count, slow dry gas drilling activity, even with the drawdown of storage because of the cold winter, and recent weakness in oil prices.

Fortunately, drilling was active in Canada, the Gulf of Mexico, and many international markets for the various oil service majors in the quarter.

Baker-Hughes in a recent earnings report forecasted a modest increase in US rig count after several quarters of decline. Realistically, though, it may take a couple more quarters for channel inventory to come back in balance.

Power generation represented 12% of first quarter sales, which is in line with the 2012 fourth quarter but below the 15% of sales they represented in the first quarter of 2012.

Power generation market sales were down 2% sequentially on 17% higher shipments but down 49% on 50% lower volume than in the first quarter of 2012.

Market demand for us continues to come from the quick turn maintenance side of the power gen market as expectations for new gas turbine builds continue to get pushed out.

GE reported receiving only eight orders for new turbines in the first quarter. However, they did say they expect to get orders for 120 to 130 turbines for the year spread across Latin America and the Middle East.

At this point, we expect maintenance to be the main source of our power generation sales for the next few quarters.

Heavy equipment markets sales represented 11% of first quarter sales compared with 10% in the 2012 fourth quarter and 6% in the first quarter of 2012. Sales were up 15% sequentially on a 27% increase in volume and up 28% from the 2012 first quarter on a 56% volume increase.

The automotive market continues to be the main demand driver for our tool steel products, and it remained a positive driver in the first quarter.

On April 2, GM reported their best March sales in the US in five years, and Ford said their US sales in March were the best since May of 2007, with truck sales especially strong for both companies, in tandem with the housing market recovery.

Caterpillar, on the other hand, told a different story for the off-road market for the first quarter and reduced their forecast for the full year, mainly due to their increased pessimism about mining. We expect stable activity over the next quarter.

We're including an additional market category in my report today, general industrial, which includes sales to a broad variety of industries, including semiconductor and medical.

General industrial represented 10% of first quarter sales compared with 4% in 2012's fourth quarter and 7% in the first quarter of 2012. General industrial sales increased 152% sequentially on a 124% increase in volume and were up 3% on 62% higher volume compared with the first quarter last year. That was driven mainly by semiconductor market sales.

At this point, let me turn the call over to Doug for the financial report.

Thank you, Denny.

As Denny said, our first quarter sales were $49.1 million. That's a decrease of $25.5 million, or 34.1%, from the first quarter of 2012 on a 31.4% decrease in shipments. Sequentially, sales increased by $2 million, or 4.2%, on an 8.4% increase in shipments.

Our gross margin in the first quarter was $4.6 million, a decrease of $9.6 million from the same quarter of 2012. Sequentially, it was lower by $1.3 million, or 22.1%, than the gross margin recorded in the fourth quarter of 2012.

As a percentage of sales, the gross margin was 9.5%, compared with 19.1% in the first quarter of 2012 and 12.7% in the 2012 fourth quarter.

As Denny noted, we placed assets in service throughout the end of 2012, resulting in an increase in depreciation of $600,000 from the fourth quarter of 2012, primarily related to North Jackson, where project capital came into service related to the vacuum-induction melting furnace and new VARs commissioned in the fourth quarter.

Selling, general, and administrative expense for the first quarter was $4.5 million, a decrease of $100,000, or 2.3%, from the first quarter of 2012, with $260,000, or 6%, above the 2012 fourth quarter. As a percentage of sales, SG&A expense was 9.1% in the 2012 first quarter versus 6.1% in the same quarter last year and 8.9% in the fourth quarter of 2012.

Operating income was $167,000 in the first quarter of 2013, a decrease of $9.5 million from the first quarter of 2012 and down $1.6 million from the 2012 fourth quarter.

Our effective tax rate for 2013 is 33.7%. In the first quarter of 2013, we recorded research and development tax credit benefits booked as a component of tax expense. These tax credits are recognized in the first quarter of 2013 due to the American Taxpayer Relief Act of 2012 that was passed in early 2013 that reinstated the research and development credit retroactively to 2012.

Under the provisions of the act, eligible research and development expenditures incurred in 2012 generate credits on our 2012 tax return; however, the tax benefit of those credits are recorded in the first quarter of 2013.

Our net income for the first quarter of 2013 was $40,000, or $0.01 per diluted share. This includes the benefit of the tax benefit recorded in the first quarter of 2013 of $368,000, or $0.05 a share. In the first quarter of 2012, net income was $6.3 million, or $0.86 per diluted share, and in the fourth quarter of 2012, net income was $1.1 million, or $0.16 per diluted share.

As we noted in the release, with the North Jackson acquisition, the Company's operating facilities have become more integrated, resulting in management increasingly viewing the Company as one unit. Given the progress of integrating our manufacturing operations and this change in management's view, we have moved to a single reportable segment beginning with this quarter.

It should also be pointed out that as we drive our strategic focus on developing higher-value products, we have introduced a table reporting our sales in premium alloys and specialty alloys that's intended to help in understanding and assessing our progress.

Turning to the balance sheet, our managed working capital as of the end of 2012 first quarter, which includes receivables and inventory less accounts payable, was $106.6 million, a reduction of $2.8 million, or 2.6%, from the fourth quarter of 2012 levels.

The value of the [end] product and inventory increased to $14.3 million, or $960,000, from the fourth quarter of 2012. Capital expenditures for the first quarter were $3.6 million.

During the quarter, the Company amended its credit agreement. We did this to provide additional flexibility within the agreement as we operate in these cyclical markets. At the end of the quarter, our total debt was $104.7 million, and our debt to total capitalization improved to 34.5% from 35% at the end of 2012.

This concludes my report. Denny, I'll turn that back to you for final comments.

Thanks, Doug.

In summary then, our sales, shipment volume, and order entry improved sequentially in the first quarter of 2013, but we were well below the first quarter of last year. And market trends were mixed in the quarter, but inventory control was uniformly tight throughout the supply chain.

Our lower production activity, coupled with higher depreciation expense and costs associated with pursuing strategic product approvals, resulted in marginal profitability during the quarter.

From a strategic standpoint, however, the first quarter was a quarter of significant advancement. After a full year of effort, we started to attain qualification of our vacuum induction-melted production from major OEMs, including a hard-earned five-year contract from Rolls Royce.

We and our customers expect improvement in demand to be gradual during the balance of 2013. Our focus is on seizing the opportunities our markets present while advancing steadfastly and rapidly on our strategic plan.

I'll turn the call over now for your questions.

Thank you. (Operator Instructions)

Dan Whalen, Topeka Capital Markets.

I apologize if you touched on this; I got on the call a little bit late here. But can you just talk a little bit in terms of how April looked and in terms of the market and also maybe just touch upon just maybe some of the conversations you're having in terms of price negotiations and how competitive that is and the implications of the added pressure from imports?

Good morning, Dan.

Good morning.

All right. Three questions in there.

I guess, first of all, as you look at our bookings for April -- we just wrapped up April yesterday -- and April was about an average month compared to the typical month in the first quarter. So specifically, our bookings will be about 15, $16 million. All right? We'd normally publish that number, so we came into this year with about just under $18 million in January, went down to just under $12 million in February, and we're about 15 in March, 14, 15 -- I'm doing this by memory --

Okay.

-- and it's tough for an old guy. All right? And then in April, it's about the average of the first quarter.

So what does that tell you? I guess where we're at is the market is giving us opportunities better than we saw in the second half of last year. That's certain. But it's nowhere near where it was a year ago.

Right.

There is not a strong positive momentum here at this point in time. Customers are pretty much hand to mouth. They're managing inventory very carefully. Raw material prices are not increasing, so there's no incentive there to make longer-term commitments. And from a lead-time standpoint, as I said in my comments, they're at record lows. So there's no incentive really to pace longer-term commitments. So hence in the early part of my comments, if you didn't hear, Dan, is just that pretty much hand to mouth. That's what we see our customers doing, and that's pretty much in all the markets that we're dealing with at this point in time.

As far as pricing goes out there, every month, it gets tougher. We are very disciplined about that subject because we recognize the impact on profitability. We have walked from some business based upon pricing, but it is getting more competitive out there. All the mills are hungry. Every order is a battle. So you're seeing more and more price competition out there.

Does that answer the three? I think I covered the three.

Yes, and then imports are probably not helping. And then just -- I mean a lot of people, I think, in just the general space, first half is kind of, I think, written off, so to speak. People are hopeful for second-half recovery. But just given your transformation that's -- you're really a 2014 story, I mean even in a flat or low-single-digit revenue growth environment, can you give it a little color in terms of what your real leverage is there and once we get a lot of these production ramp costs out of the way, we get more of a normalized fixed cost absorption environment. And any kind of color you can add on that in terms of kind of getting over the hump here in terms of this ramped process.

Well, our expectation is activity and the markets are going to improve gradually each quarter, so you'll see some higher -- some greater market activity out there. We're not anticipating any tremendous red-hot marketplace out there, so we would expect to see some improvement on the top line. These approvals, we're working on them very diligently. As I talked, we'll get approvals in each quarter, and as we get those, we'll be transitioning those into additional sales over and above normal market demand. And we would expect to see improvement in our premium melted product as we move through each quarter of the year.

Now, if we look at the first quarter, that did not happen compared to the fourth quarter, but our expectation is you'll start to see improvement in that each quarter as you go through.

Initially when you start out, you're not going to get the normal margins you would get on those products because you're going to have a learning curve going in there until you get all these processes tied down, and basically, we're experimenting with customer product, so you're going to have some unusual yields, like we saw in the first quarter.

But as those higher-value products come in the stream, you will see our margins go up, and as you look at the general trend and these approvals [who] are working on them, when they all come together, they pretty much come together as we move through the summer timeframe, and they're all focused on first-half 2014 in terms of meaningful volume.

So even almost in a flat revenue environment, not that this may be the case or not, but even in a flat 2014 revenue environment, there's significant room for margin improvement, as a lot of the learning curve's been paid for, so to speak.

If you look at North Jackson itself and even the other plants, we have new people, new equipment, new products, and new processes that we're -- they're working on. Every month, we get better as we come up that learning curve, which would suggest you should see lower cost and higher margins as we go down the road.

Okay, great.

But right now, we're right at the peak level of all the extraneous costs from an approval standpoint.

That I appreciate. That's very helpful. All right. Thanks a lot, guys.

You're welcome, Dan. Have a good one.

Thanks, Dan.

Thank you. (Operator Instructions)

Lloyd O'Carroll, Davenport & Company.

Good morning, Denny.

Hey, Lloyd. How're you doing?

All right. Of the customers that you're going through qualification on or expect to go through qualification on, what percentage of the volume that you expect to have in '14 at the end of this process are already done, as opposed to what's remaining? I'm thinking of the qualification process and how far along are you in trying to quantify it.

Are you talking about the percentage of the number of customers we're talking about or the volume (inaudible)?

Both. I mean it may help to give it both ways.

I think we're talking about -- we're kind of in the second inning, third inning. There's a lot of intensity around, for example, Rolls Royce we announced. Rolls Royce allowed us, basically, to announce that. The other customers we do not have the authorization to announce who we're dealing with, all right?

Rolls Royce is a very intense -- has a very intense program to get approved, a very high-cost program to get approved, and it's very expansive when you look at the number of alloys you're talking about. So I would say it's the most expensive, but if I look at all the customers we're talking about and all the products we're talking about developing here over a relatively short year-and-a-half timeframe, I would say we're about in the second inning.

Okay, yes, I think that helps give a little feel for where we are in the process and really just getting started.

Yes.

Okay, thank you.

You're welcome.

(Operator Instructions)

I'm showing no one in queue at this time. I would like to hand the conference over to Mr. Dennis Oates for any closing remarks.

Okay, so thank you. Thanks again for joining us today. We know that 2013 will continue to present challenges in our market but also opportunities. We're focused on seizing on those opportunities while moving aggressively forward with our plan. We'll look forward to talking to you in July to update you on our progress. Have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all disconnect, and have a wonderful day.