Universal Stainless & Alloy Products Inc (USAP) 2014 Q4 法說會逐字稿

Good day ladies and gentlemen and welcome to the Universal Stainless fourth-quarter 2014 conference call and webcast. At this time, all participants are in a listen-only mode. (Operator Instructions). As a reminder, this conference call is being recorded.

I would now like to turn the conference over to June Filingeri of Comm-Partners. Please begin.

Thank you, Latoya. Good morning. This is June Filingeri of Comm-Partners, and I also would like to welcome you to the Universal Stainless conference call. As Latoya said, we are here to discuss the Company's fourth-quarter 2014 results which we reported this morning. With us from management are Denny Oates, Chairman, President, and Chief Executive Officer; Chris Zimmer, Executive Vice President and Chief Commercial Officer; Mike Bornak, Vice President of Finance and Chief Financial Officer; and Paul McGrath, Vice president of Administration and General Counsel.

Before I turn the call over to management, let me quickly review procedures. After management has made formal remarks, we will take your questions. Latoya 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 complete, I would now like to turn the call over to Denny Oates. Denny, we are ready to begin.

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

As we reported this morning, the fourth quarter of 2014 was a very solid quarter and capped a year of recovery for Universal Stainless. Our team overcame the typical year-end slow down to produce fourth-quarter net sales of $53 million, which were up 31% from the fourth quarter of 2013 and nearly matched the strong 2014 third quarter. In fact, our fourth-quarter sales were the second highest in nine quarters.

Full-year sales rose 14% from 2013. Excluding the loss of a major customer late in 2013, our full-year 2014 sales increased 24%.

Another fourth-quarter highlight was our progress in moving to a higher value sales mix reflected in our sales dollars per pound in the fourth quarter, which were our highest ever despite the fall in surcharges associated with lower raw material prices.

We reported increased sales of our vacuum induction melted products, which were up 8% sequentially, 26% from the fourth quarter of 2013 and up 30% for the full year. It also included a richer mix in our core products. We are targeting core more growth in our higher value product sales in 2015, consistent with our long-term strategy.

Our fourth-quarter sales mix, along with improved cost performance and yields, contributed to our gross margin for the quarter of 16.8% of sales, the highest since the second quarter of 2012. Margin improvement has been a major priority for us all year and the step up in the fourth quarter was achieved in the face of lower surcharges as nickel prices and other commodities have declined.

Net income for the fourth quarter of 2014 was $0.21 per diluted share, excluding a tax benefit of $0.03 per share relating mainly to the reinstatement of the research and development tax credit. Earnings per share for the full year was $0.66, excluding the fourth-quarter tax benefit as well as a tax charge of $0.12 per share in the first quarter due to legislative changes for certain state income taxes.

Cash flow from operations increased $8.5 million in the fourth quarter, the highest level in 2014. We reduced total debt by $3 million for the year while funding increased working capital requirements to support sales growth and higher capital spending. Our debt to total capitalization was 29.9%, the lowest level since 2011, the year we acquired North Jackson.

From an operational standpoint, progress was made on a number of fronts in 2014. A high performance culture is essential to our strategy for growth. Over the past year, we have deepened our management team with a continued emphasis on building the core competencies and leadership skills necessary to design, produce, and reliably deliver increasingly sophisticated products to a very demanding marketplace.

New product introductions are essential to our move to a higher value product mix. We added 11 new products in 2014. That is in addition to the 11 new products introduced in 2013.

One of our top priorities has been earning customer certifications, and we added two in 2014 that are critical to our focus on aerospace. We were recognized by Pratt & Whitney with LCS approval in March and S400 and S1000 approvals from GE Aviation in July. Added to our previous certification from Rolls-Royce, that gave us certifications from three of the largest aircraft engine manufacturers.

Additionally, we have earned numerous source approvals from other mostly aerospace OEMs and developed methods of manufacturing which meet industry specifications on a range of other products to be introduced this year.

Our $11.2 million in capital expenditures in 2014 featured capital projects to add automation on our hot rolling mill in Bridgeville, debottleneck constrained operations, expand internal testing capabilities for new and core products, and streamline product flow. Our Dunkirk operations posted record shipments during the fourth quarter, another sign of growing value added products.

I was also pleased with our team's effort to reduce scrap rates and improve yields by refining manufacturing processes and working collaboratively to reduce variation in manufacturing execution.

Let's talk a little bit about the end markets. Aerospace remained our largest market in the fourth quarter of 2014, increasing to 61% of total sales compared with 60% of sales in the 2014 third quarter and 57% of sales in the fourth quarter of 2013. While our aerospace sales were up less than 1% sequentially, they reached $32.1 million, the highest level in nine quarters. Aerospace sales jumped 40% from the fourth quarter of 2013, while shipments increased 22%, showing a much richer mix of products we shipped in the most recent quarter.

We've heard some comments of late on destocking in the aerospace channel. Frankly, we are not seeing much of it.

The news from the airframe and engine manufacturers remains positive. Boeing reported record commercial aircraft deliveries for 2014 along with record bookings which totaled 1,432 net orders and brought their backlog to a record 5,789 airplanes. Boeing noted that the next generation 737 and 737 Max accounted for 1,100 of those new orders followed by the 777 and 777X at nearly 300 orders.

While Boeing laid claim to record deliveries in 2014, Airbus won the category of new aircraft orders, booking 1,456 net orders in 2014. That included 1,321 single aisle airplanes and 135 widebodies. In total, Airbus has a backlog of 6,386 aircraft.

Last Friday, GE reported that their aviation equipment orders were up 8% at year end, including a 23% increase in orders for the GEnx engine with large orders from American and Air France. GE also noted that the LEAP engine is now in 79% of narrowbody aircraft, and their orders for commercial spare parts were up 37%.

The decline in oil prices has led to much discussion of its impact on future aircraft orders. In Boeing's recent comment, they saw the glass as half full. They noted that the plus side of the cheaper oil is that it is, and I'll quote, a tailwind for profitability of their customers as well as giving a boost to economies that would sustain jet demand.

In the meantime, one of the drivers of our aerospace business now and for the foreseeable future is the build rates of aircraft. Current production rates and the roll-in of higher production levels over the next few years appear to be firmly on track. The aftermarket is active, as evidenced by the GE spares orders up 37%. Therefore, oil related discussions notwithstanding, we see our aerospace business on the right growth trajectory for 2015 and beyond.

Power generation remained our second largest market in the fourth quarter of 2014 at 11% of sales, in line with the 2014 third quarter and compared with 12% of sales in the fourth quarter of 2013. Our power generation sales increased 2% sequentially and were up 16% from the fourth quarter of 2013 on 7% and 3% lower volume respectively.

At the risk of sounding like a broken record, new turbines are not yet a factor in our market. Our growth in power generation is driven by our maintenance business, which is reasonably healthy. The message from GE in their fourth quarter is in line with what we are seeing. They booked orders for 41 gas turbines in the fourth quarter, which was flat with the fourth quarter of 2013 before the large order we received from Algeria late last year. Their service orders are up 9%, and they expect service orders to grow in 2015.

Oil and gas sales were at 9% of fourth-quarter sales compared with 10% of sales in the third quarter of 2014 and 8% sales in the fourth quarter of 2013. Our oil and gas sales were 8% lower sequentially on 3% lower volume. However, they were up 53% from the fourth quarter of 2013 on 6% higher volume.

If anyone needed reminding that the oil and gas industry can be cyclical, I guess we got that message loudly and clearly over the past few months. There's no doubt that the significant drop in oil is only beginning to play itself out.

We heard a fairly consistent message from the oil service majors on their recent earnings calls. Their customers are ratcheting down capital budgets in tandem with falling oil prices. Conditions are expected to be in flux for the next several quarters until a new equilibrium is reached. Land rigs in North America are been especially hard-hit. On the other hand, drilling in the Gulf of Mexico where our products are used is faring somewhat better. In fact, Baker Hughes made the point that, of the three key deepwater basins, they think the Gulf of Mexico could be the most stable.

Each of the oil service majors has successfully ridden through past cycles. Schlumberger said they are confident in their ability to outperform in any part of the cycle, including current market conditions. For our part, we are focused on doing the same by staying close to our historical and new customers and by continuing to advance our portfolio of products.

Heavy equipment market sales increased to 11% of sales in the fourth quarter of 2014 compared with 9% of sales in 2014 third quarter and 11% of sales in the fourth quarter of 2013. Heavy equipment sales in the 2014 fourth quarter were up 25% sequentially on a similar increase in volume. They increased 27% from the year-ago fourth quarter on a 29% volume increase.

The automakers all reported higher vehicle sales in the US in December contributing to their best year since 2006. GM expects industry sales of light vehicles in 2015 to range from 16.5 million, their level in 2014, up to 17 million. If they should hit 17 million, it would be the first time since 2001.

Low interest rates, higher employment recovery and home prices and lower gasoline prices are all positive factors supporting auto demand. To keep their sales momentum going, they are introducing what one Detroit reporter called "a flood" of new models. New models and changeovers require new tooling for manufacturers, which as you know is good for tool steel demand. We are continuing to see that in our backlog.

Now let's have Mike give us a financial review for the quarter and the whole year of 2014. Mike?

Thanks, Denny. We continued to see an increase in demand for our products during the fourth quarter of 2014 as we posted the second-highest quarterly sales level of $53 million despite normal year-end seasonality. Our fourth-quarter sales were in line with the previous two quarters of 2014 and 31% higher than the fourth quarter of 2013.

Excluding our conversion sales and conversion pounds shipped, we saw our average product selling price increase to $3.02 for the fourth quarter of 2014 compared to $2.48 in the fourth quarter of 2013, an increase of 21%. This increase in average selling price was primarily driven by a more favorable value added product mix.

For the full year of 2014, net sales increased approximately 14% to $205.6 million with premium products comprising approximately 7% of net sales. Our sales of premium products were 30% higher in 2014 than in 2013.

Now, looking at our gross margin, as Denny mentioned, our gross margin in the fourth quarter of 2014 was $8.9 million, or 16.8% of net sales, the best performance of 2014. This compares with a gross margin of $8.6 million, or 16.1% of sales, in the 2014 third quarter and a gross margin of $1.5 million, or just 3% of net sales, in the fourth quarter of 2013. The strong improvement was primarily driven by a favorable product mix, improved yields, higher operating levels, and our management team's cost control efforts.

For the full year of 2014, our gross margin was 15.6% of sales, or more than double our gross margin of 7.7% of net sales reported in 2013. Again, higher shipment volumes and production levels, a better product mix sold, improved yields and controlled spending all contributed to this major recovery in our gross margin during the year.

Our selling, general, and administrative costs for the fourth quarter of 2014 were $5.8 million, or 11% of net sales, compared to $5.5 million, or 10.3% of net sales, in the third quarter of 2014. Our SG&A costs for the full year of 2014 were $21.1 million, or 10.3% of net sales, which is $3.2 million higher than the same period last year. The increase is primarily related to accrued costs associated with our variable incentive compensation plan based on increased profitability levels compared to 2013 and administrative costs associated with our self-insurance medical plan as we switch from a full premium plan to being self-insured this year.

With our solid Q4 sales level, improved gross margins, the slightly higher SG&A costs, we posted operating income of $3.1 million in the fourth quarter of 2014, or approximately the same level of operating income as the prior two quarters but substantially improved from the $2.6 million operating loss posted in the fourth quarter of 2013.

For the full year of 2014, we posted an operating profit of $10.9 million versus an operating loss of $4 million last year. That is an improvement of nearly $15 million in one year.

Our effective tax rate decreased to 24.5% for the fourth quarter of 2014 primarily due to the positive impact of the recently passed legislation extending R&D tax credits retroactively back to January 1. R&D tax credits have been a normal part of our quarterly tax provision for years. However, we called it out in the fourth quarter because of the impact it had in our effective tax rate for the quarter. While it is discrete for Q4, it is normal for the full year of 2014. For the full year, our effective tax rate was approximately 44% and included tax charges of $0.9 million or $0.12 per diluted share that occurred in the first quarter of this year.

Now, if I turn to the balance sheet and our managed working capital, at the end of the fourth quarter of 2014, our managed working capital, defined as trade accounts receivable plus net inventory minus accounts payable, decreased by $1.4 million to $104 million compared to $105.4 million at September 30. Our net accounts receivable decreased approximately $4.5 million primarily due to strong collection efforts throughout the quarter and especially at year end.

Our fourth-quarter 2014 total inventory levels increased by $7.2 million compared to the third quarter due to anticipated higher sales levels in the first quarter of 2015. Our accounts payable for the fourth quarter of 2014 increased by $4.2 million for the third quarter of 2014 to $25 million primarily due to the timing of vendor payments between periods and increased fourth-quarter capital spending.

Our capital expenditures for 2014 were $11.2 million with $5.1 million incurred in the fourth quarter, which was in the range that we outlined in our last call. In 2013, we spent $11.8 million on capital expenditures. We anticipate total 2015 capital spending to be in the range of $11 million to $15 million as our capital spending is discretionary in nature.

Our depreciation expense in 2014 was $14.6 million, and we anticipate depreciation expense in 2015 to be in the range of $15 million to $16 million.

During the fourth quarter of 2014, we generated cash from operations of $8.5 million, which was primarily used for capital expenditures and debt reduction. We ended the fourth quarter with total debt to capitalization of 29.9% compared to 31.4% at the end of 2013.

That concludes my financial report. And Denny, I'll turn to call back over to you.

Okay, Mike. Thank you. In summary then, our fourth quarter was a solid quarter capping a year of strong recovery for Universal Stainless. Our team was laser focused on execution and delivered a richer sales mix than ever before, improved cost performance, higher yields, lower scrapped rates, and as a result, higher gross margins. We also achieved several critical customer certifications and approvals primarily in aerospace, our largest market.

As we enter 2015, we have a solid background and improving end markets with the exception of oil and gas, which represents 8% to 10% of sales. We feel recently developed relationships and an expanding product offering will partially mitigate the effects of any downturn in oil and gas activity.

2015 is an important year for our company. We are looking forward to it and we'll continue to be relentless in pursuing our goal to move to higher value products, expand margins, and build value.

Thanks a lot for your attention. Now we are looking forward to taking your questions. Operator?

(Operator Instructions). Michael Gallo, CL King.

A couple of questions. Denny, it looks like the revenues have bounced around the $53 million area for the last few quarters. Obviously, backlog has also bounced around a steady level as well. Given the normal seasonality you see, usually Q4 comes down a little bit. Would you expect to see an increase in overall revenue in Q1, or would you expect it to continue to kind of be in that same range? I think it's been $53 million to $54 million the last few quarters.

As I look at where our bookings are and our backlog and if you take a look at our movement in inventory during the fourth quarter, I think what it tells you is we are expecting our first quarter to see some improvement in sales. So we are not looking for flat sales or a decrease in sales in the first quarter.

Do you expect them up?

Yes.

Would you expect them up meaningfully? Or do you expect them to kind of uptick? Okay.

The second question I have is on oil and gas. I know it was still up in the fourth quarter. It looked like it was about 9% of sales. I was wondering how much of the backlog is in oil and gas? And any rough frame or expectation for what we should expect to see out of oil and gas in 2015?

Let me kick that to Chris Zimmer. Chris, do you want to take that one?

Sure. Yes. Our backlog right now, I would consider it as moving sideways, so our expectation as we move through the first part of 2015 is stability in oil and gas, both with those existing customers and new opportunities that come on board as we expand our product offering. So the visibility into the first part of 2015, based upon our current backlog, is that we are looking to move sideways for oil and gas.

Okay. Great. And then final question. Obviously nickel has come down quite a bit here over the last couple of months. I was wondering if you can give us any context around what kind of bookings you saw in January.

Chris, do you want to take that one?

Yes. I think that while I think customers are vigilant about what's going on with nickel and the impact that it has on surcharges, large feedback, particularly from our service center customers, is that they are buying to demand. They do typically moderate inventory levels at the end of the year, which is one of the drivers for a strong first quarter. But when we look at how they buy based upon the nickel patterns, there is vigilance; there is concern about what's going to happen. But in general, we see them buying to demand, so we don't necessarily see any major change in buying habits due to what nickel has been doing recently.

And in terms of just any context around what you saw in terms of the bookings for January? Have you seen a sequential step on it? You normally see that coming out of the fourth quarter, but any context you can put around that?

Yes. I would say that we are still in the January bookings level, continuing to remain at those same strong fourth-quarter levels that we had, generally moving sideways with a modest uptick.

Okay. Thanks very much.

I would add to that a continuing improvement in mix.

Tyler Kenyon, KeyBanc Capital Markets.

So I guess just kind of assuming we are in a stable nickel price environment as we move forward here and maybe taking into account some obviously expected oil and gas weakness, where do you envision gross margins kind of as we progress throughout the course of the year?

As we look down the road, our focus is on continuing to drive improvement in margin through cost reduction, new products, and mix management. That's the core of our strategy. As we sit here today, we've seen a significant drop in nickel, as you know. As a result, with the surcharge mechanism, when that happens, you can get pinched on gross profit margins. So as we sit here today in January, we will struggle, frankly, to maintain those gross profit margins you saw in the fourth quarter and the early parts of the first quarter. And things will reset as we go through this quarter. So right now, we are going through a little bit of a dip. That's not a disaster but as we look into next year, I would look at sideways movement with a slight downward bias in the first quarter and continued expansion as we get into the second, third, and fourth quarters of 2015.

Okay. Great. Very helpful. And then just a question on the VIM actually, any update you can provide us on kind of where some of the new capacity might be coming from within that particular market and the timing of these ramps?

Well, new capacity, our most recent stuff would be the equipment that we put in, which is three years old now. Carpenter is putting in their Athens facility and that's ramping up as we speak. They are working to get their certifications and approvals.

I can't give you any clarity. I know they have got a call later today on where they stand with theirs.

We continue to see improvement. We would like it to be faster. We are pushing like hell to make it faster, and we are just grinding through getting approvals and then translating those approvals into topline sales and profit dollars.

Okay. Great. That's it for me. Thanks for taking the questions.

Gautam Khanna, Cowen & Co.

I was hoping you could just expand on your comments on the -- you are not seeing jet engine channel destocking? Have you seen any change in order patterns by the various OEMs? You mentioned GE. It looks pretty strong there. Are you seeing any kind of differences you can point to or changes over the last six months?

Not really anything we can put our finger on. I would point out that we have a higher mix of distributor business compared to our peers. Clearly, you can look at our bookings and our sales trends and we are not seeing any. In our view, destocking in that channel basically ceased about a year ago and we've seen consistent continuous good activity there.

From the engine guys, we are looking at and we are starting to get into that end of the market in a bigger way. Our targets have all been met. Where we have had agreements and had some estimations of what our sales should be in 2014 -- I think we published for example on Rolls-Royce that we would expect to get $4 million to $6 million of incremental revenue from Rolls in 2014, and I believe we are at $4.3 million, so we are at our low end of the range. But fundamentally we are within the bracket that we felt we would get.

So we haven't had any cancellations. We haven't done any broadcasts that we are pushing things away or pushing things out. Everybody is always looking at their inventory so you hear chatter from time to time about inventory reduction programs, but we haven't seen it reflected in a big way in our order book.

Okay. And could you remind me again, when you sell to the major jet engine OEMs, do you sell to their forging intermediaries, or do you usually sell direct to the OEM?

It's normally to an intermediary.

Within the intermediaries, have you seen any -- you haven't seen any revised schedules down over the last couple of months? Have you seen any indications of any increases down the road? I'm just wondering if we are going to kind of truck along in line with underlying consumption or if there is any pick up that you are seeing perhaps because of inventory realignments?

I am not aware of anyone -- and Chris, you jump in here if you have seen anything recently, but I have not seeing any cancellations, push-outs, or any significant change in buying patterns from the forgers that we deal with. If we look at our bookings and our backlog, I would characterize it as slightly up as we look into 2015, stable with an upward bias.

Do you have anything to add, Chris?

Yes. I agree with what you are saying there, Denny. We experienced inventory corrections that began in 2012 and ran their course through 2013. We did see a return to normalcy in 2014 and all indications for 2015 are the same. Those forgers and intermediary suppliers to the engine manufacturers continue to lay in new blanket orders for 2015. The release schedules are consistent. If anything, we probably see more pull-ins than we see push-outs. So, our expectation is that 2015 should not bring an environment of destocking. That's largely behind us.

And the last one, to follow up on a question from earlier, with oil and gas softening, how protected are you in terms of kind of your sales to distributors on base prices? Do you anticipate any base price erosion as one of the more profitable end markets softens? Does that kind of exacerbate an oversupply condition? What protections do you have? If you could just relate to us your spot versus contracted mix and maybe any other color you can provide?

If you look at our business, we are largely transactional in the oil and gas world. We don't have a lot of long-term fixed-price type arrangements like some of the larger players in our space do. So any movement in price, obviously we are going to have some issues there.

As we are looking at the market, we have not seen any significant deterioration in pricing. I look at 2015 as -- this business is a tough business. You've got to be able to compete, and I would not be surprised to see some compression there. But I don't expect it to be dramatic, and we will just have to fight it out as we go through 2015.

Thanks a lot and good luck.

Thank you.

(Operator Instructions). There are no further questions in queue at this time. I'd like to turn the call back over to Mr. Oates for final remarks.

Okay. Thank you all again for joining us today, and I also want to thank you for your interest in Universal Stainless. After a year of recovery and progress, we've entered 2015 with encouraging levels of business in three out of four end markets, including aerospace, our largest market. We intend to pursue all of those market opportunities as we work towards our goal of moving our company into these higher value products. And we look forward to talking to you all in April and updating you on our progress after the first quarter. I hope everybody has a good day. Take care.

Thank you. Ladies and gentlemen, this concludes today's conference. You may now disconnect. Good day.