Universal Stainless & Alloy Products Inc (USAP) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Universal Stainless Second Quarter 2017 Conference Call and Webcast. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference over to Ms. June Filingeri. Ma'am, you may begin.

Thank you, Andrew. Good morning, this is June Filingeri of Comm-Partners and I'm very pleased to welcome you to the Universal Stainless conference call and webcast. We are here to discuss the company's second quarter 2017 results reported this morning. With us from management are Denny Oates, Chairman, President and Chief Executive Officer; Larry Pollock, Executive Vice President and Chief Manufacturing Officer; Chris Zimmer, Executive Vice President and Chief Commercial Officer; Paul McGrath, Vice President of Administration and General Counsel; and Ross Wilkin, Vice President Finance, Chief Financial Officer and Treasurer.

Before I turn the call over to management, let me quickly review procedures. After management has made formal remarks, we will take your questions. Our conference coordinator, Andrew, 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.

Thanks, June. Good morning, everyone. Thanks for joining us here today. The broad-based recovery that began for Universal in the first quarter of 2017 continue to show traction in the second quarter with business and plant activity levels clearly improved. As a result, we saw a strong sequential and year-over-year growth in our top line, which included record premium alloy sales, combined with a significant improvement in our gross margin from the first quarter, leading to a decisive return to bottom line portability and noteworthy growth in our EBITDA.

Let me drill down our second quarter performance with some additional details. Second quarter sales totaled $52.6 million, an increase of 7.6% sequentially and up 28.2% compared with the second quarter of 2016. This brings year-to-date sales to $101.5 million, up 25.9% from the same period last year. Sales of premium alloys reached $6.8 million or 12.9% of sales, topping the previous quarterly record of $5.8 million or 11.9% of total sales, which were set in the first quarter of 2017. Order backlog before surcharges of $63.5 million grew 11% compared to March 2017 and stands at 65% greater than June 2016, which bodes well for a normally seasonally slow second half. Order entry, so far in July, has been stronger than normal seasonal expectations. Gross margin made a sizable move up in the second quarter to 13.6% of sales, the highest level obtained since 2014, as we benefited from the sell-through of products manufactured in higher activity months that started in January, coupled with manufacturing productivity savings and a more favorable product mix. We see opportunities for additional margin improvement in coming quarters, although obviously don't expect that dramatic move as a sequential improvement in the second quarter. With the recovery in our margin, net income in the second quarter swung to a positive $1.2 million or $0.17 per diluted share, from an equal-sized loss in the first quarter enabling us to reach breakeven for the first half. Another indicator of our much improved profitability, second quarter EBITDA was up 74% sequentially and up 69% from the second quarter of 2016. As a result, we are on track with our plan to deliver further progress in the second half of the year.

There are some additional factors supporting a positive outlook for the second half. Price increases announced in Q1, for stainless and low alloy products began to take effect this month. Commodity prices have been somewhat volatile but nothing like the experience of 2015 and 2016. While nickel did fall from $5 per pound to $4.05 per pound during the first half, other key commodities increased. Nickel has since rallied in July to about $4.50 per pound. Therefore, our surcharges will be modestly lower in July and August, probably recovering to June levels by September. We do not anticipate any meaningful distortion in buying patterns or misalignment of material costs and surcharges. Another positive is that we won a total of 5 more customer approvals in the second quarter; 4 from major aerospace OEMs and 1 from a major energy services company. There were also 2 additional premium products commercialized during the quarter. Our pipeline remains strong with 15 products currently under development. Plant activity levels continue to run high. We expect to run at a rate similar to the second quarter, which represents a 33% increase over 2016's third quarter production levels. As we noted last time, higher plant volumes not only generate favorable operating leverage on product cost, they also enable added variable cost savings from improvement initiatives, both completed and currently underway. Another potential positive for us was the final outcome of the Commerce Department Section 232 investigation and where the Commerce will find that U.S. national security is threatened by steel imports. How this will all play out is uncertain but we are confident that some actions will be taken this year to address the subject of unfair trade in steel and the chronic issue of excess global steel capacity.

Let me take a minute and note 2 developments on the corporate front during the second quarter. First, we were successful in achieving an early labor agreement at our Dunkirk facility. The new 5-year agreement maintains the flexible workflow terms and profit-sharing incentives contained in the prior agreement. Separately, as most of you know, we received an unsolicited offer from Synalloy Corporation for a proposed business combination. In response, we announced on June 29, that after deliberation and careful consultation with independent financial and legal advisers, our board unanimously rejected the offer as having no merit for the stockholders of Universal, either financial or strategic. And that there was not basis for further discussions. We sincerely appreciate the strong support we received from the many investors we spoke with about our decision.

Let me take a few minutes and turn to our end markets, starting with aerospace our largest market. Aerospace sales totaled $29 million in the second quarter of 2017, representing 55% of quarterly sales. Aerospace sales increased 8.6% sequentially and 10.3% from the second quarter of 2016. Our continued growth in aerospace reflects positive industry trends along with addition of the premium alloy products that we developed and won approval for over the past several years. Aerospace market fundamentals as well as supplier channel demand are being driven by the continued strong build rates and backlogs at Boeing and Airbus, currently estimated at 7 to 9 years of production depending on whose numbers you want to use. The market got an additional boost from Paris Air Show where orders were more robust than expected, and I personally must say the environment was much more positive than recent years. Boeing posted orders for 571 aircraft, including orders for a well-received launch of the 737 MAX 10, which drew 147 new orders along with 214 conversions. Airbus also booked an order of 326 airplanes. The engine manufacturers were also active at the Paris Air Show, for example, GE and its joint venture companies led by CFM, announced $31 billion in orders and commitments of the show, Rolls-Royce booked $15.1 million and Pratt continued to add to their backlog. The ongoing strength in demand for air travel is evidenced in the most recent release from IATA, the International Air Transport Association, for May that reported global traffic was up 7.7% year-over-year. The growth of revenue passengers miles continues to be above expectations this year, which is driving aftermarket demand. This is another source of good news for a metal supply chain and for Universal. It's also worth noting the IATA reported that air freight traffic increased 13% in May versus last year, another sign of the increase in economic activity and further aftermarket demand. We're also seeing building momentum in the defense sector. So we remain as positive as ever about the aerospace opportunity for Universal. Business has picked up, customer inventories are generally in balance and the market remains healthy overall.

The heavy equipment market remained our second largest market in the second quarter, representing 17% of total sales compared with 16% in the first quarter and 11% in the second quarter of 2016. Heavy equipment sales totaled $8.9 million in the second quarter and increased to 16% from the first quarter of 2017, and doubled their level in the second quarter of 2016. Our tool steel plate sales are the main component of this heavy equipment category and they are continuing to be driven by strong domestic demand resulting from solid vehicle production numbers, albeit 2% to 3% lower than 2016, and a very healthy clip of automotive model changeovers. Also driving demand growth is heightened activity for heavy off-road equipment makers, such as Caterpillar, which reported a second consecutive quarter of improving demand and an upbeat outlook for second half. In fact a recent survey of construction equipment makers by Wall Street analysts indicated that market supply conditions are tightening and lead times are extending because of that activity and low inventories. Universal is benefiting from this ramp coupled with the shorter lead times we can offer as a domestic supplier.

The oil and gas end market represented 9% of second quarter 2017 sales, compared with 10% in the first quarter and 7% a year ago second quarter. Our oil and gas sales totaled $4.8 million in the 2017 second quarter, essentially leveled with the first quarter and 70% ahead of the second quarter 2016. While demand was flat in the most recent quarter, there has been substantial improvement for us and for the market since last year with land-based drilling activity up, rig counts continue to increase and channel inventories continuing to be worked down. We expect slow but steady recovery in the market, along with greater acceptance of new products we've introduced in recent years.

The power generation market represented 9% of the second quarter sales in line with the first quarter of 2017, and compared with 8% in the 2016 second quarter. Our power generation sales totaled $4.8 million in the second quarter, up 13% sequentially and up 39% from the second quarter of 2016. Our Power gen sales, which picked up in the second quarter, continue to be largely driven by the maintenance business and as noted last quarter that business is benefiting from the continued move to natural gas as the fuel of choice over coal. On the new build front, on Friday GE reported receiving 9 orders for its HA gas turbine, bringing its backlog to 33 units. This class of turbines are the world's largest high-efficiency turbines. GE is also the world's largest supplier of gas turbines overall and how many of the new turbines they decide to build in the U.S. will be an important factor in the return of the new build market for metals community. In the meantime, we will focus on the maintenance market opportunity as installed turbines are continuing to work at higher activity levels.

Rounding up my end market review, our general industrial markets sales were 9% of sales versus 10% in the 2017 first quarter and 7% of sales in the second quarter of 2016. Second quarter general industrial sales totaled $4.6 million, which was slightly lower than the first quarter, but up 56% from the second quarter last year. As mentioned last time, we've developed several new products to increase our participation in infrastructure-related projects and business development activities for domestic manufacturing. We continue to expect growth in this market to continue in the 2018, subject to normal project seasonality. Any federal infrastructure bill will be an added plus.

Let's take a few minutes to look at the financials. Ross?

Thank you, Denny. As Denny already noted, second quarter 2017 sales of $52.6 million were up 7.6% sequentially and up 28.2% compared with the second quarter of 2016.

For the first 6 months of 2017, sales of $101.5 million were up 25.9% compared with the first half of 2016. The increase was broad based with all end markets contributing to the increase versus prior year, both for the second quarter and for the first half as a whole.

Gross margin in the second quarter was $7.2 million or 13.6% of sales, up almost 500 basis points from the first quarter of 2017, and up 300 basis points from the second quarter of 2016. It is the highest level achieved in the past 10 quarters. The improvement in gross margin was driven primarily by the realization of manufacturing productivity initiatives, improved operating leverage and a more favorable product mix.

Looking at selling, general and administrative costs. For the second quarter, SG&A was $4.5 million or 8.6% of sales and a reduction of $200,000 compared with the first quarter of 2017, and a $100,000 lower compared to the second quarter of 2016.

Our year-to-date tax rate is high at 92.5%, reflecting the impact of an $85,000 income tax expense associated with adopting the new accounting rules related to stock-based compensation. Under the previous rules, this amount would have gone to the balance sheet. We expect our full year income tax rate to be approximately 30%.

Bottom line net income in the second quarter was $1.2 million or $0.17 per diluted share, a $0.34 per diluted share improvement compared with the $1.2 million loss or $0.17 per diluted share in the first quarter of 2017. Year-to-date 2017, we are breakeven at net income, significantly improved from a loss of $3.2 million or $0.45 per diluted share in the first half of 2016.

Looking at EBITDA, second quarter EBITDA was $7.3 million, an increase of $3.1 million or 74% sequentially and an increase of $3 million or 69% compared with the second quarter of 2016. Adjusting from noncash share comp expense, EBITDA was $7.7 million for the second quarter. EBITDA and adjusted EBITDA calculations are provided in the tables to the press release.

Turning our attention to the balance sheet. During the second quarter, managed working capital of $100 million increased by $7.9 million compared with the first quarter of 2017 and is consistent with business activity. Accounts receivable increased by $3 million and inventory increased by $4.8 million. Accounts Payable were flat. The increase in inventory is in direct support of higher backlog, which grew by $6.4 million during the quarter. And the increase in the accounts receivable is directly attributable to the higher sales activity in the second quarter. Despite the increase in working capital, overall managed working capital efficiency, as measured by taking working capital as a percent of annualized second quarter sales, was 47.5% and that's maintained the improvement realized in the first quarter. It continues to be the best it has been in the last 5 years.

Capital expenditures for the second quarter were $1.7 million, marginally higher than the $1.4 million in the first quarter of 2017, and up from the prior year's second quarter level which was $900,000. For full year 2017, we expect CapEx to be in the $7 million to $9 million range, down from the previous range of $8 million to $10 million reflecting more selective capital spending across the business as a whole. As you will note, capital expenditures continue to be less than our ongoing depreciation and amortization expense, which is $18.5 million annualized, reflecting the fact that we largely have the assets in place from investments previously made to support the growth in the business.

Total debt was $77.7 million as of March 31, 2017, an increase of $3.2 million compared with the end of the first quarter, driven primarily by working capital increases noted earlier. Despite the higher debt, borrowing availability under our credit facility at the end of the second quarter expanded to $28 million, a record high since entering the credit facility 18 months ago. Included in the increased availability is $5 million that our bank group released to us during the second quarter based upon our improved financial results since entering into the credit agreement. From an interest rate standpoint, with the company's higher profitability in the second quarter, our senior debt leverage ratio improved to 2.7x, thus qualifying us for a 25 basis point reduction in its interest rate effective immediately. This is the second such interest rate reduction in the last 6 months and applies to all senior debt.

Lastly, we remain in compliance with all her covenants under the bank credit facility at the end of the second quarter and we anticipate remaining in compliance going forward for the foreseeable future.

This concludes my financial report. Denny, I'll turn the call back to you.

Thanks, Ross. Let me summarize. Recovery that began for Universal in the first quarter of '17 continued in the second quarter and reflected in strong sequential and year-over-year sales growth, including record premium alloy sales along with a sizable move up in our gross margin, all leading to a decisive return to bottom line profitability and substantial growth in our EBITDA. We've ended the third quarter with 11% higher backlog, price increases taking effect, added customer approvals, more commercialized products and high plant activity levels that are adding to operating leverage and variable cost savings. Our end markets are generally moving forward, including our largest: aerospace. To reiterate my statement in today's earnings release, as we entered the third quarter and second half of the year, business conditions and demand remain positive with continued strength in our order entry and backlog.

That concludes our formal remarks. Andrew, let's take some calls from our -- take some questions from our callers rather.

(Operator Instructions) And our first question comes from Michael Gallo with CL King.

A couple of questions. I guess, just to sort of characterize your remarks, it seems like your business momentum has continued -- you're going to get the benefit of the price increases you're starting to come through in the third quarter. You'll have a little bit less surcharge. I'm just trying to parse all of that together. Would you expect, on a sequential basis, that Q2 and Q3 will look like Q2? Or would you still expect the gross margins to improve sequentially as you get the benefit of pricing?

I would expect a modest improvement in margin, mid-teens kind of number. And as far as the sales, I think this year will be a bit of an anomaly. The normal seasonal trend is the third quarter. The second half usually is slower than the first half and usually to parse that by quarter, the fourth quarter is the weakest from the sales standpoint, third quarter is second weakest. And from a bookings standpoint, you start to see orders trail off mid-third quarter anticipating a slower fourth quarter. Now if you look at our backlog and the trend in bookings I suspect that the third quarter sales number is going to be at or slightly above where we are in the second quarter. So a modest improvement in mid-teen kind of margin would be my best estimate right now.

So you still think you'll be able to increase the sales sequentially even though you'll have less surcharge?

Yes.

All right. Okay. And in terms of what you have planned in terms of further CapEx opportunities, I know you've been thinking about an automation project at Dunkirk. Update us on some of the other initiatives and how you think you can get more efficient from a manufacturing standpoint?

Well, the 1 capital you mentioned up at Dunkirk is something that was essentially approved by our Board contingent fund, getting the labor contract in place. We now have the labor contract in place. So that's a transaction -- it's about an $8 million investment -- $8 million to $9 million. That would begin in the fourth quarter, so you won't see much of that capital in Ross' numbers, that he quoted earlier, that will be mostly a 2018 investment with the benefits starting to flow in the latter part of '18 and '19. So that would be a significant improvement to our quality, our cost and our throughput on finished bar products. There are other opportunities for capital that we're looking at. We're coming out of the period where we were very tight with capital, our focus was on generating cash and paying down debt. So I think on the next call, we'll have more to say on this subject, but there are opportunities to make significant improvements in our melt shops. The whole subject of the digital world and getting better control of our facilities is something that will become a bigger part of our investments over the next couple of years. Being able to get access to how equipment is operating and have equipment talking to equipment will give us a tighter control over things, less variability on our manufacturing shop which will lead to higher quality, better yields and lower cost. So that's kind of the direction where we're headed. But I'm not -- we're not prepared to announce any larger investments beyond the Dunkirk thing.

(Operator Instructions) Our next question comes from Phil Gibbs with KeyBanc Capital Markets.

Had a question on the net working capital. I think you said managed working capital is 47.5% of sales in the quarter. Do you have any tactical targets in terms of where you think that could be over the next 12 months? And do you also have strategic targets in terms of where you think you want to get that over the next 3 to 5 years?

If you look at the work-in-process inventory itself, excluding raw materials, you look at the next couple of quarters, you should see those numbers come down. If you look at the next quarter, somewhere in the range of $2 million to $4 million.

Fourth quarter flat, and I'm saying flat because it really is a function of how business is. If you look at the first quarter, normally it starts to ramp up a little bit of inventory towards the tail end of the year. But fundamentally from a financial standpoint, our inventories are around $2 million, so strategically our long-term growth -- our long-term plan is to get that number up towards $3 million, which is a challenging target, but that's our long-term strategic goal there.

So that ...

Right now we're running around $2.1 million.

So the work-in-process inventory is really the biggest driver to getting that percentage down over the long term. Is that fair way to think about it?

I think we do a decent job managing our payables and our receivables. There is no real big issues there in terms of pulling those in a significant amount. The real issue is going to be getting things manufactured, getting a higher percentage done the first time and getting things moving through the shop and I would just remind you that we're still in development mode on a lot of these alloys, so we're still carrying somewhere in the range of $6 million plus of material that I would characterize as experimental test type R&D material, that is kind of there. It's good material, it'll sell at some point in time, but we need some approvals and further work before we can move that into the marketplace. And that stands, if you recall from a couple of years ago, roughly around $13 million on that number.

Okay. The heavy equipment piece, I think, you said 17% of sales, is that largely the tool steel plate business?

Majority of it's tool steel plate, yes.

And you mentioned that the off-road piece is getting better and clearly we're seeing that with some of the results from the Lexicon. How big in relation to that heavy equipment side is the auto piece versus the off-road piece?

It's one of those numbers, it's hard for me to give you a real specific answer because every pound that we sell goes through distribution, they don't exact -- so we can't give the visibility. So when I'm quoting the -- when I look at what drives that business, it's primarily automotive, followed by the off-road, followed by cavalry and things like that but basic metal fabrication anywhere you need to cut metal, so to speak, you're going to see that use. So as a manufacturing sector and the economy picks up, you should see growth there. But I can't give you a specific percent on automotive. Generically -- I don’t think anybody can quite frankly, but generically studies I've seen over the years generally say that 2/3 of tool steel produced in the U.S. goes in the automotive market or is driven by the automotive market.

Well, that's helpful, makes sense too because auto is a bigger market, broadly speaking. On the side of electrodes, there's a lot of talk that electrodes are poised to go up right now a lot. They're really tight globally given what we're seeing out of China and the increased in the EAS production this year, in general. How big is that normally in terms of your, call it, cost, cost of sales or cost of production?

If you take a look at the situation of electrodes, for those of you who don't know is -- there's some issues where right now, we have trouble getting price quotes out in the 2018. Due to the new batteries that are being produced demand for some of the raw materials that go into the electrodes is up. Therefore pricing has gotten tight. We are covered in terms of what we require in the price to the first quarter of 2018, but beyond that there's a lot of churn in the marketplace. So I honestly can't tell you what that price would be. The price has been $1, $1.50 per pound. You hear numbers floating around $2 to $3 a pound. So I cannot -- that's the best I can tell you, Phil. I can't give you any hard numbers on that. Obviously, that's a big number. If that were to go up, that would probably hit us, the tone is about $500,000 a year somewhere in that range. So it's a significant number, something that we're watching very carefully. We're working with our suppliers to make sure that we've got a supply, the hard supply, and the latest I have as of this morning is that we'll get some price quotes in the month of August, but right now we're not quoting out beyond the first quarter.

That's really helpful. And last question from me for now is on the SG&A. Obviously a lot of good work there in terms of maintaining on an absolute basis that OpEx level sequentially and year-on-year, but your business is getting better, profits are getting better. Are you expecting some upward migration or a little bit creep to that SG&A number just as the incentives improve? Or are you able to hold this line?

If the year continues as projected, you'll see some increase in SG&A. It won't be people, it will be variable compensation and there may be some additional legal fees related to the whole trade issue as we go through the second half of the year.

So between $4.5 million and $5 million is good in terms of a base?

Yes.

(Operator Instructions) And I'm showing no further question at this time. I would now like to turn the call back to Mr. Oates for any further remarks.

Thank Andrew. Once again, let me thank you for joining us this morning. We sincerely appreciate your support and your interest in Universal Stainless. We look forward to updating you on our progress on our next call, which will be in October. Have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.