Universal Stainless & Alloy Products Inc (USAP) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Universal Stainless fourth-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 is being recorded. I would like to hand the conference over to June Filingeri. Ma'am, please go ahead.

Thank you, Karen. Good morning, everyone. This is June Filingeri of Comm-Partners. I'd also like to welcome you to the Universal Stainless conference call. We are here to discuss the Company's fourth-quarter 2013 results reported this morning.

With us from management are Denny Oates, Chairman, President and Chief Executive Officer; Mike Bornak, Vice President of Finance and Chief Financial Officer; Paul McGrath, Vice President of Administration and General Counsel; 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. Karen will instruct you on procedures again 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.

Thanks, June. Good morning, everyone. Thanks for joining us here today. The fourth quarter was our weakest sales quarter of 2013 and concluded a very challenging year for the metals industry and for Universal. The fourth quarter also was a period in which Universal reported a 42% increase in bookings over the fourth quarter of 2012 and a 26% sequential increase in bookings despite the loss of a major customer during the quarter.

Our fourth-quarter net sales were $40.3 million, a decrease of $6.6 million from the fourth quarter of 2012, on 5% lower volume. Sequentially, sales were down $8.2 million on 14% lower shipments. While our sales level was in line with our expectations, the sales mix remained weighted towards semi-finished products. Low shipment and plant activity levels, the mismatch of surcharge and raw material costs and expenses associated with customer approvals and new product development combined to limit profitability. As a result, our gross margin slipped to 3.7% of sales.

The net loss per share was $0.41 for the quarter, including a $0.14 writedown of a deferred tax asset. Before the deferred tax asset writedown, the loss was $0.27 per share, about the same as in the 2013 third quarter. Cash flow from operations remained positive and strong in the fourth quarter at $7.5 million. We aggressively managed inventories, controlled capital spending and reduced debt. For all of 2013, we reduced inventories by $13.2 million. There was approximately $11 million of vacuum-induction melted product in work in process at year-end. That was reduced by $16.9 million for the year. As a result, our debt to total capitalization fell to 31.4% at the end of 2013 versus 35.1% at the end of 2012.

There were additional accomplishments in 2013. The award of our first contract with Rolls-Royce is among the top items on the list. The five-year contract required an extensive effort to meet their demanding requirements for qualifying our entire manufacturing system, including vacuum-induction melting and forge production in North Jackson. Our fourth-quarter sales included forger shipments tied to that contract, which didn't officially begin until January 1 of this year.

Our agreement with Haynes International is another major achievement, which leverages both our vacuum-induction melted capacity and hot working capabilities of our radial forge. Haynes has become an important melting and conversion customer for Universal. Our technical and operating teams have also begun technology exchanges with mutual benefits for each company.

There were additional customer approvals and new products developed for major customers in the aircraft, power generation and oil and gas markets. We are continuing to keep those names confidential for contractual and competitive reasons. Our plan to move to more technologically-advanced higher-margin products that we launched with the acquisition of North Jackson has required us to earn additional industry certification for all our facilities. We have obtained nine such certifications since 2012, four in 2013. While our main certification objectives have mostly been accomplished, there remains much to do in 2014 and 2015 regarding further customer approvals. We introduced more than 50 new products in 2013 defined by grade and shape.

In addition to our focus on winning customer approvals and certifications, we continued refining operating processes companywide, commissioning new finishing and testing equipment and cross-training our workforce. We have maintained a productive relationship with our workforce as reflected in the early renewal of the Bridgeville contract, which runs for the next five years.

Taken together, our accomplishments in 2013 have positioned us to capture broader opportunities as the metal industry recovers. As I mentioned earlier, the notable increase in our order entry in the fourth quarter, which is up 26% sequentially and 42% higher than the fourth quarter of 2012, is indicative that some level of recovery is beginning. Our order entry remained strong in January. Customers are expressing more optimism, although they remain cautious. While the direction is clearly more positive than recent quarters, we expect some level of volatility will undoubtedly continue.

Let me turn to our end markets to give more context for 2014 with the overall comment that if customers simply buy based on their demand and destocking slows or stops, shipment volumes at the mills will demonstrate measurable improvement. With that said, aerospace remained our largest market in the fourth quarter of 2013 at 57% of total sales. We shipped 6% more tons to the aerospace market compared with the fourth quarter of 2012, but sales were down 11% due to lower surcharges and mix. Sequentially, our aerospace sales were down 20% on 14% lower shipments consistent with customer year-end inventory management and supply chain, our backlog going into the quarter and sales mix.

The majority of our increased order entry since December has been for aerospace products. There is growing commentary in the marketplace that aerospace inventories have stabilized after the misalignments caused by delays in the rollout of new aircraft models a few years back and inventory adjustments in the aftermarket. From our perspective, fewer of our customers are talking about further destocking.

Let's look at some of the demand trends. Airline passenger traffic remains healthy. The International Air Transport Association reported a 5% increase in global passenger traffic year to date in 2013 through November. Freight traffic also showed improvement. There has been more activity in the aftermarket with GE reporting that their commercial spares orders were up 16% in the fourth quarter. GE attributed the increase to three factors -- increased flying hours, aging fleets and some restocking after a period when airlines cut back on their spare parts inventory.

The news and scheduled production rampup at the aircraft makers also remained positive. Boeing reported a record 5080 airplanes in their backlog at year-end 2013, including 1355 net orders won last year. Cumulative orders for the 737 MAX reached 1800 and the reported record orders and commitments for the recently launched 777X and the 787-10. In terms of production levels, they have now achieved 10 per month for the 787 and recently announced plans to increase that rate to 12 per month in 2016 and 14 per month by 2020. Meanwhile, the 737 MAX is scheduled to move to 42 per month in the next few months and 47 per month in 2017.

Airbus ended 2013 with even more airplanes in their backlog then Boeing, a total of 5,559. Airbus says it is exploring additional production rampups for both the A320 and the A350. As I mentioned last time, the A350 XWB will be powered by the Rolls-Royce Trent engine.

Power generation was our second-largest market in the fourth quarter representing 12% of sales in line with both the fourth quarter of 2012 and 2013's third quarter. Volume increased 8% from the fourth quarter of 2012 although sales were down 15%. Sequentially, sales were down 22% on 33% lower shipments. It was an especially weak year in the power generation market where demand was mainly confined to maintenance projects. There may be some improvement on the horizon. GE reported that quoting activity picked up in the fourth quarter with most of that strength in the US, as well as in China. While they were not calling a significant turn in gas turbine demand, they did say quoting activity has made them much more positive. Our customers remain cautious planning around more maintenance business in 2014 with new turbine opportunities late in the year.

Oil and gas market sales represent 8% of fourth-quarter sales versus 10% in the third quarter of 2013 and 16% of sales in the fourth quarter of 2012. Our oil and gas sales are 39% lower sequentially on a similar decline in volume. They were down 60% from the fourth quarter last year on 51% lower volume. We have seen an ebb and flow in oil and gas all year, but the fourth quarter was especially slow. The oil service majors have some positive observations about the prospects for 2014. Schlumberger expects to increase their E&P spending this year in part due to ongoing strength in deepwater activities in the Gulf of Mexico. Baker Hughes is projecting a 5% increase in well count and plans to increase its investment in new products. Halliburton had some weather disruptions in North America in the fourth quarter, but expects growth in North America in 2014 also partly due to strength in the Gulf. We expect some further destocking in the first half with improved sales activity in the second half.

Heavy equipment market sales represented 11% of fourth-quarter sales, up from 9% in the third quarter of 2013 and 10% of sales in the fourth quarter of 2012. As expected, we saw a sequential improvement in this category with sales up 10% on a 9% increase in volume. Sales in volume were down slightly from 2012 fourth quarter by 4% and 2% respectively. Automotive model changeovers are a major driver for our tool steel sales to this market. Ford plans to launch 16 new or refreshed vehicles in North America in 2014, which is triple the level they launched in 2013. General Motors will introduce 15 new or upgraded models in the US in 2014. So the year is setting up well, although imports can always be an offsetting factor in this market. With my end-market review complete, let me turn the call over to Mike for his financial review.

Thanks, Denny. As Denny indicated, our fourth-quarter (technical difficulty) were $40.3 million, which is a decrease of approximately $6.9 million, or 15% when compared to the fourth quarter of 2012 net sales of $47.2 million. For the full-year 2013, our net sales were $180.8 million, which is down approximately $70 million, or 28% from full-year 2012 on a 24% lower shipment volume.

Our net sales for both the fourth quarter and full year were primarily impacted by soft market conditions in most of our end markets. On a positive note, we are encouraged that market conditions may be improving as reflected in the more than 17% increase in our backlog from the end of the third quarter on stronger fourth-quarter 2013 bookings. The increase in bookings has carried over into 2014 thus far as Denny mentioned.

Our gross margin in the fourth quarter of 2013 was $1.5 million, or 3.7% of net sales, compared to $6 million, or 12.7% of net sales of 2012. The decrease from the prior-year period is primarily due to lower shipment volume, operating activities, a lower product margin mix and a mismatch of surcharges to raw material costs. For the full year, our gross margin was $13.9 million, or 7.7% of net sales, compared to $41.1 million, or 16.4% of net sales in 2012. Our full-year 2013 margins were primarily impacted by the following factors compared to 2012 levels. One, a 24% increase in shipment volume and less favorable product mix; two, lower operating levels throughout the year, which hampered our ability to absorb fixed costs as we would have under normal operating conditions; three, higher fixed costs and depreciation expenses with the full integration of North Jackson; and four, lower raw material surcharges, which were mismatched with higher cost inventory melted in prior periods being shipped over the year, in particular, the second half of 2013.

Our selling, general and administrative costs for the fourth quarter of 2013 and the full-year 2013 were approximately level with the same 2012 periods. As a result, our fourth-quarter 2013 and full-year 2013 operating losses were $2.6 million and $4 million respectively compared to our operating profit of $1.8 million in the fourth quarter of 2012 and $23.4 million for the full year of 2012.

In the fourth quarter of 2013, we also took a valuation allowance or a write-down of a state deferred tax asset of approximately $1 million as the future tax benefits of this asset, which were tied to direct sales to end customers in the state of New York, are unlikely to be realized in the foreseeable future. This valuation allowance had no impact on our bank covenants, but it did reduce our fourth-quarter 2013 diluted earnings per share by $0.14. That brought our net loss for the fourth quarter of 2013 to $2.9 million, or $0.41 per diluted share, on approximately 7 million diluted shares outstanding. In comparison, in the fourth quarter of 2012, we posted net income of $1.1 million, or $0.16 per diluted share on approximately 7.5 million diluted shares outstanding.

For the full year, our net loss was $4.1 million, or $0.58 per diluted share, compared to net income of $14.6 million, or $2.02 per diluted share. As I indicated last quarter, we have responded to industry conditions by making a concerted effort to reduce our inventory levels throughout the second half of 2013 and flexed down our capital spending programs to help generate cash and repay a portion of our long-term obligations.

During the fourth quarter, we generated cash from operating activities of approximately $7.5 million. For the full year, we generated cash from operating activities of $28.6 million, primarily as a result of reducing our inventory levels by $13.2 million and reducing our accounts receivable balances by $3.3 million. With the cash generated, we repaid $4.8 million of bank debt in the fourth quarter of 2013 and $16.9 million for the full year. Our total debt to capitalization at the end of 2013 improved to 31.4% compared to 35.1% at the end of 2012 and we are in compliance with all of our bank covenants.

Our capital expenditures in the fourth quarter of 2013 totaled $1.4 million compared to $4.3 million in the fourth quarter of 2012. For the full-year 2013, our capital expenditures were $11.8 million compared to $35.1 million in 2012. The lower capital spending when compared to the prior year is primarily due to the completion of assets placed in service during the latter half of 2012 and early 2013 related to our North Jackson facility, as well as delaying certain capital projects until market conditions fully improve.

Before I turn the report back to Denny, I did want to note that heading into the first quarter of 2014, we expect our gross margin to be negatively impacted by higher natural gas costs in the range of $500,000 to $600,000 resulting from severely cold weather conditions since the beginning of the year. That concludes my financial report. Denny, I'll turn the call back over to you.

Okay, thanks, Mike. As I said at the outset, the fourth quarter concluded a difficult year for the metals industry and for Universal. This is very much reflected in our sales activity and profitability for both the quarter and the full year. We took actions throughout the year to adjust operating levels, manage inventories, control capital spending and reduce debt. The resultant cash flow from operations was positive in each quarter of 2013 and increased 35% for the year.

The fourth quarter and full-year 2013 also included substantial progress at Universal as we executed our plan to move to higher-margin, more technologically advanced products. We achieved major customer approvals from such companies as Rolls and Haynes. We completed the heavy lifting on critical industry approvals and were successful gaining accreditations across the board. We introduced 15 new products. We strengthened our operations companywide and we trained, cross-trained and maintained our workforce for the next phase of growth.

As a result, we are in the best position we have ever been to capture broader opportunities as the metal industry recovers. We are starting 2014 with more wind at our back than we had entering 2013. However, let me be clear, the first quarter is still going to be a tough quarter for us even as the early positive momentum continues. All indications from the marketplace suggest 2014 will provide progressive demand improvement as the year proceeds with our development and integration of North Jackson adding to our opportunities. Customers remain cautious. Our strategy, therefore, is to keep laser-focused on executing our long-term plan so that as demand recovers, we will be ready to seize the opportunities. With that, I will end our formal remarks and turn it over to you for questions.

Michael Gallo, CL King.

Hi, Mike and Denny. Good morning.

How are you doing, Mike?

I am doing okay. Just a couple questions. I am trying to get my arms around the gross margins. Obviously, they bounced around quite a bit. So I was wondering -- you obviously had the headwind on natural gas in the first quarter, but you had a significant relative increase in reroll business as a percentage of mix in the fourth quarter. So what kind of gross margin levels should we think about going forward at least for the first quarter? Will it be improved from Q3, Q4? Can you get back to where you were kind of first half of 2013 or is that more second half to kind of get back to a double-digit rate?

I would characterize it as improved driven by a couple things. The major one being our activity levels in the first quarter will be higher than what we saw in the third and fourth quarters and we won't have the negative volume variance kicking out into our P&L. So that's one basic positive that really killed us in the third and fourth quarters. We expect sales to be stronger than we have seen in the last couple quarters. I don't see us getting back to the margins back in 2011 and 2012 in the first quarter. The one wild card in that is this whole weather situation.

It sounds like natural gas could be 100 basis point kind of headwind to gross margins in the first quarter.

That is a reasonable number. Mike called out $500,000 to $600,000. That is our best estimate based upon where we are today and as I am sitting here -- I mean it snowed last night. We are expecting more bad weather over the weekend. That is our best estimate. It could be a little bit higher than that. We just don't know. It depends upon how the weather plays out. And that is on natural gas and some delivery cost of electricity to our Dunkirk facility. That doesn't take into consideration some of the other issues we wrestle with just operationally in terms of getting product to customers, getting raw materials into our facilities and that kind of thing.

And in terms of just the backlog, how much of that is scheduled to ship kind of in Q1 or Q2? I guess how much is the improvement in Q1 predicated on continued improvement in order flow as we come through February and into March as opposed to what you already have in backlog? And then I was wondering, as a second part of that, how much of the backlog as it exists today is related to reroll business that I think rolls off, correct me if I'm wrong, in the March or April timeframe?

Let me have Chris Zimmer answer the first part and then I will take the second part.

I would characterize our first quarter as being about 85% to 90% on the books right now. We have a general idea of where that business is going to trend based upon bookings. For the reroll business, the loss of the Talley business will still have some carryover from 2014, some shipments in the first part of the first quarter. But in large part, that business is going to be roughly half of what it had been traditionally.

And our last shipment to Carpenter Talley would be in February at this point, not March.

That's right.

Okay. So you will have -- how much revenue do you expect? Do you expect kind of a $2.5 million-ish number for the first quarter from Talley? Is that back of the envelope right?

So right now, it's about $1.1 million.

$1.1 million? Okay. So it is pretty much running down and that will be added in going forward. That will be out of the business. And then final question, how much of the backlog is in the premium alloys now?

That's tracking right around 5% to 10%. It's a growing number, but it is still in that upper single-digit range.

Right. I would think just the nature of the Talley business rolling off, that that is going to grow it as a percentage, but I assume the whole number is growing as well.

Yes, as a percentage of our business, we will continue to evolve in a positive direction, more re-melted products, more finished products that naturally have a higher margin associated with them. That mix will improve with these new approvals that we have, the new contracts that we are taking on and with the Talley business going away, that is semi-finished business that was towards the lower end of the margin side of our portfolio.

It helped it from a utilization standpoint?

If you look at the Talley business, the negative on that is it's a sizable amount of volume, 150 to 200 heats historically out of the Bridgeville facility. Two things to do there, Mike. One is to adjust your cost structure, which we have done, so it doesn't have a negative impact on the bottom line. The other one is to look for replacement business, which we are in the process of doing and some of that I think you see in the level of bookings we had in the fourth quarter. There is more to come there.

Right, okay. Thanks very much.

You are welcome.

Dan Whalen, Topeka Capital Management.

Great, thanks. Good morning, everyone.

Hey, Dan.

Just I guess circling back on similar issues. One, I guess just given your broader commentary regarding Q1, is it fair to assume that we will see additional inventory reductions and further debt paydown?

In the first quarter?

Yes.

I would not count on that, no. And the reason I wouldn't count on that is if you look at our bookings coming in in the fourth quarter, quite frankly right now we are producing at a higher level.

Okay.

So it is going to be a function of how fast we turn that in the first quarter. My expectation internally is that we will be basically flat.

Oh, great. Okay, so we have kind of normalized on that.

Flat with (inaudible) inventory. I don't see significant -- we don't see significant reductions in inventory or significant debt paydown in the first quarter.

Okay. So it sounds like inventory turns will be picking up and just kind of looking in the rearview mirror here, certainly first half of 2013, we just saw a continuous slide in nickel prices. The second half was kind of rangebound, more stable. Is a lot of this misalignment between surcharges and raw materials through the system or is it more a second-quarter event where it is kind of more normalized?

There is still some more to come and keep in mind some of the -- a good example of that would be where we are making product it is vacuum-induction melted. We made a lot of that product on an experimental basis as far ago as fourth quarter of 2012. It is good product. We didn't have the approvals. As the approvals come on and we are able to sell some of that product, that is going to come out of inventory. The inherent metal cost in some of that product is a lot higher than what it would be if we made it today. So we make money on it, but we don't make the same margin spread on it. So that is a typical example of what we are talking about there.

Okay.

But as you look each month going forward and you look at the trend in nickel, nickel has been down and bouncing around for the last six months in a relatively tight band. So that issue is becoming smaller and smaller with each passing quarter, but we still have product in our inventory that was produced prior to that drop-off that occurred really mid-second quarter 2013.

Okay. So first quarter --

You'll see a little bit -- you'll see some -- we still have more to go in the first quarter, but it will be less than the fourth quarter and that will continue to cycle until we flush that all through the system.

Okay, great. Okay, thanks a lot. I appreciate that.

(Operator Instructions). Phil Gibbs, KeyBanc Capital Markets.

Good morning.

Hey, Phil, how are you?

Doing okay. I am just curious, Denny, the last couple of weeks of the -- this last couple weeks here in 2014 as far as what you are seeing, I think a lot of the macro data has been fairly muted to just downright negative as far as the slowdown in some of the industrial indicators and the automotive indicators and some of the construction indicators. Some of that I think a lot of people want to pin on weather, but I am just sitting back kind of scratching my head wondering maybe it isn't and maybe we are slowing down. Is there anything that you can see in your business over the last couple weeks that would maybe say that you believe this is temporary or is it just too early to tell?

I can't point to anything in our business that would say that we are slowing down. If you look at our bookings in January, they have continued at or slightly above what we were in the fourth quarter. It hasn't declined in the last few weeks or anything along those lines. When I look at raw materials, we are seeing a phenomenon where we are not seeing spikes in raw materials going up, things aren't running away from a price standpoint, but we are seeing problems and I look at this as a positive, I think we got a little spoiled. We could call an order of raw materials and get delivery the next day. (inaudible) virtually all of 2013. The last two, three weeks, things have tightened up. We had to do a little more planning, advanced planning and we can't get stuff in the next day or two in terms of raw materials. I am talking about scrap here and things like that.

So to me, that is indicative -- the reason I say it is positive, that is indicative that activity levels are picking up. Some of that may be weather-related; it is hard to discern, but I don't think we are generating that much scrap due to the weather and so forth and as a result, we are seeing some tightness there from a supply standpoint.

So when I look at raw materials, I don't see it there. I don't see it on the sell side. The one place you'd think you'd see it would be automotive or general industrial type stuff and there, we continue to see our customers saying demand will be relatively healthy in 2014, not jumping significantly, but at relatively healthy levels where they were in 2013. And our other customers are generally positive, but you will note in my comments I used the word cautious probably five times, I believe and that is a reflection of I think what you are seeing out there, that people aren't seeing anything directly negative in the business. They are typically talking about growing their sales in the year 2014. The most common number I hear is 3% to 5% with much less destocking, which is good news from a metals standpoint, but people keep reading the same thing in the newspapers and getting a little concerned about that. So that is the reason why I say cautious so much. So I'm not saying I can't point to one thing in our business that is saying things are going to slow down or definitely nothing that would indicate things have slowed down based upon the last two or three weeks.

Okay. And just curious, in the cost-of-goods breakout, typically, we've been getting a material, a raw material cost and then the operating costs. Should we expect that in the filing or is there any breakout you could give us there because I know that is typically something we look for?

Yes, it will be in the filing, Phil.

Okay. And then just lastly, Denny, anything that, maybe aside from the cold weather or maybe the spike in energy costs, anything that really surprised you in the fourth quarter relative to what you were thinking at the end of the third-quarter call?

I think the incoming level of bookings were stronger than I anticipated at the third quarter. The level of --.

Anything related in the mix though in there that may have surprised you or were you looking for the mix to be more --?

I think some of the year-end push-outs occurred in products that typically carry a higher margin and we had the flushing out of the final Talley reroll billet that was a normal quarter of shipments in the fourth quarter. So when you put the numbers together, our mix came up less positive or more negative, however you want to characterize it than we anticipated going into the quarter, but that was largely -- we knew the reroll billet number was there. But when you look at what was pushed out, it was largely some of our more profitable margin products.

Okay, thank you.

You are welcome.

(Operator Instructions). Dan Whalen, Topeka Capital.

Great, thanks. Just more a modeling question and I may have missed this in your initial comments, but just with North Jackson, how should we be thinking depreciation and amortization as we progress through here in 2014?

I think it will be pretty steady, Dan. Full-year depreciation expense was about $14 million last year, so I would expect about a similar level for this year as well.

Steady sequentially through the quarter?

Yes.

Okay. Great, thank you.

Thank you and I see no additional questions at this time. I would like to turn the conference back to Mr. Oates for any concluding comments.

Okay, thanks again for joining us today. 2013 was a year of challenge and progress for Universal. We started 2014 with cautious optimism as evidenced by our bookings and our backlog, especially when we look at the second half of the year. We expect the year to be one of progressive improvement. In any event, we remain fully focused on building on our progress to date and executing our long-term strategic plan and look forward to updating you in April on our progress during the first quarter of 2014. I hope everybody has a good day and stay warm and out of the snow. Talk to you soon.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.