Universal Stainless & Alloy Products Inc (USAP) 2021 Q4 法說會逐字稿

Good day, and thank you for standing by. Welcome to the Universal Stainless Fourth Quarter 2021 Conference Call and Webcast. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions) I would now like to hand the conference over to your host, June Filingeri -- Filingeri, I'm sorry. Please go ahead.

Thank you, Carmen. Good morning. This is June Filingeri of CommPartners and I'd also like to welcome you to the Universal Stainless call and webcast.

We are here to discuss the company's fourth quarter 2021 results reported this morning. With us from management are Denny Oates, President and Chief Executive Officer; Chris Zimmer, Executive Vice President and Chief Commercial Officer; John Arminas, our 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. The conference operator will instruct you on procedures at that time. Also please note that in this morning's call, management will make forward-looking statements under the Private Securities Litigation Reform Act of 1995. I would like to remind you of the risks related to these statements, which are more fully described in today's press release and in the company's filings with the Securities and Exchange Commission.

With these formalities complete, 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 today. Before we talk about fourth quarter results, I'd like to take a moment to simply state the obvious. Our progress in the fourth quarter and in all of 2021 would not have been possible without the tireless efforts of every one of our employees and the support of their families and friends. 2021 was a very challenging year with our business recovering from the pandemic, while also dealing with many unprecedented issues, including new COVID variants, critical shortages, uncertain schedules, just to name a few.

Nonetheless, our employees were up for the challenge all year long. Because of their continued commitment, we expect to make further progress this year, and we are planning for sequential improvement in each quarter of 2022 as our markets continue to recover.

So let's talk about our results. Business momentum continued to accelerate during the quarter based upon a couple of different things. Sales of $43.2 million were up 16% sequentially. Premium alloy sales of $7 million, up 19% sequentially. We achieved record-breaking vacuum melting production during the quarter. And perhaps most importantly, as we sit here looking at 2022, our order backlog before surcharges reached a new company record high of $134.5 million before surcharges. The main driver behind this performance was strengthening aerospace demand, which continues today and is consistent with expectations of recovery in aerospace in 2022, 2023 and beyond.

Taking a deeper dive into the numbers. The net sales of $43.2 million for the fourth quarter compared to $37.2 million in the 2021 third quarter, and included quarter-over-quarter growth in each of our end markets. Net sales increased 38% from the fourth quarter of 2020. Premium alloy sales of $7 million or 16% of sales compared favorably to $5.9 million in the third quarter. Our record order backlog in the fourth quarter of $134.5 million reflected solid order entry of $44 million. More than 20% of the total backlog at the end of the fourth quarter consisted of premium alloy products.

Gross profit improved for the third consecutive quarter to $3.7 million or 8.7% of sales. Third quarter gross profit was $2.3 million or 6.2% of sales while 2020's fourth quarter was a loss of $5.1 million. There were no special fixed cost absorption charges recorded given our production levels. Q3 2021 and Q4 2020 gross profit included fixed cost absorption charges of $1.5 million and $3.8 million, respectively.

Our progress in the most recent quarter reflects a number of benefits, number of positive things that occurred. Generally higher production levels, positive product mix management, including more premium melted products, targeted pricing actions to offset inflation, record-breaking production in our North Jackson premium melting facility and process improvements initiated over the last 2 years.

These positive factors were partially offset by 3 things: first, the ongoing labor shortage impacting all manufacturers continued and was compounded by a spike in absences related to COVID. Specifically, since Thanksgiving, we've experienced 10% to 15% call-offs daily due to Omicron. Fortunately, it does appear the situation is slowly improving.

Secondly, supply chain issues challenged a range of functions within the company, all transportation and freight, critical MRO parts delivery reliability, timely raw material receipts, capital project completion and basic planning and scheduling of operations. And lastly, we experienced unplanned outages in our Bridgeville melt shop, hot mill and a transformer, which services the entire plant. These 3 outages alone reduced gross profit in the fourth quarter by $750,000 or 1.7% of sales.

As most of you know, commodity prices have been on a bull run all year. Compared to 2020's fourth quarter, nickel was up 19% at $9.10 per pound on December 31 and has increased another 15% so far in '22, reaching $10.42 as of this morning. Molly and chrome more than doubled during 2020 -- 2021, excuse me, at $18.96 and $2.20 per pound, respectively.

Vanadium increased in 2021 by 30% and reached $14.91 a pound. And lastly, scrap jumped almost 60% during the year. In addition to these material costs, inflationary pressures continue for other major consumable operating supplies, maintenance parts and plant services. We will address these issues through a combination of productivity improvements, base price increases and raw material surcharges.

Towards this end, we announced 4 price increases in 2021 and implemented an additional base price increase of 3% to 10% on selected products effective January 10. Fourth quarter 2021 selling, general and administrative expenses remained level with the third quarter at $5 million, but declined as a percent of sales to 11.6% versus 13.5% of sales in the third quarter. We expect SG&A expenses to remain at current levels for the next few quarters.

Our effective tax rate for 2021 was 81.3% reflecting a benefit of $3.3 million on a pretax loss of $4 million. The benefit includes a 21% statutory rate, a $2.1 million add back for the PPP loan forgiveness gain and research and development credits, partly offset by expense from stock option forfeitures. The fourth quarter effective tax rate is negative 29.2%, driven by our pretax loss, stock option forfeitures and the impact of changes in tax rates on deferred tax balances. That brings us down to a net loss for the fourth quarter of 2021 of $1.6 million or $0.18 per diluted share.

In the 2021 third quarter, we recorded net income of $7.9 million or $0.87 per diluted share, which included a gain of $10 million due to the forgiveness of the Payback Protection Program loan. Before the PPP gain, the third quarter net loss was $2.1 million or $0.23 per diluted share.

In the fourth quarter of 2020, the net loss was $7.3 million or $0.83 per diluted share. There were pretax fixed cost absorption charges in the 2021 third quarter and 2020 fourth quarter as previously mentioned. EBITDA for the fourth quarter of 2021 was $4.1 million and adjusted EBITDA was $4 million after adding $300,000 in stock-based compensation and deducting $4 million for an insurance claim settlement.

Moving on to our financial position. Managed working capital increased $12.6 million during the quarter, reaching $136.9 million, reflecting sales and production growth, along with rising commodity prices. More specifically, inventory increased by $5.1 million or 4% to $140.7 million during the quarter. The increase reflects an $8.2 million increase in work-in-process inventory, offset by a $2.5 million reduction in raw materials and a $0.5 million reduction in operating supplies.

The growth in work in process reflects our increasing backlog, particularly for premium products and a $3.5 million for test material involved in the commissioning of our new vacuum-arc remelt furnace and an 18-ton crucible. Virtually all of this test material has passed testing at this point and is now being applied to customer orders.

While the reduction in raw material inventory was caused mainly by heavy premium product production, we are still carrying about $1.5 million to $2 million in advanced raw material purchases to protect operations from potential supply chain failures. Fourth quarter receivables increased by $1.5 million or 7.5% from the third quarter due to sales growth during the quarter.

Days sales outstanding remained unchanged from prior quarters and receivables are in great shape. Accounts payable decreased $5.9 million or 20% from the third quarter to $24 million. Fourth quarter capital spending totaled $4.6 million, bringing the year-to-date capital spend to $11.1 million, exactly on the target we've discussed previously.

Depreciation and amortization totaled $19.3 million for all of 2021 and $4.8 million for the quarter. Most of the capital spend in 2021 was for 2 strategic projects. The addition of a state-of-the-art vacuum-arc remelt furnace to support growth in premium products and an 18-ton crucible for our vacuum induction melting facility to further reduce operating costs as we continue to ramp up. I'm very pleased to report that the vacuum-arc remelt furnace is now fully installed, commissioned and being integrated into our operations. The 18-ton crucible is in the final stage of commissioning after a very smooth first campaign.

We're also pleased to announce today that our board has authorized the acquisition of 2 additional vacuum-arc remelt furnaces, which are slated to begin operations in the second quarter of 2023. This initiative is part of our strategic plan for 2022 and will support our growth in technically advanced premium alloys.

Total debt at December 31 was $69.2 million, an increase of $17.7 million from September 30. The $12.6 million increase in managed working capital and capital spending of $4.6 million accounted for most of the increase. Total gross availability under the revolver stood at $24 million at year-end, providing more than ample liquidity for the ongoing ramp-in activity.

Now let's take a look at end markets, beginning with aerospace, our largest market. Our aerospace sales increased 16% to $26 million or 60% of sales in the fourth quarter. up from $22.3 million and 60% of sales in the third quarter of 2021. Aerospace sales jumped 50% from the fourth quarter of 2020. Full year 2021 aerospace sales were $91.5 million or 59% of total sales compared with $121.9 million in 2020 and $170.4 million in 2019. So while our market is improving, we are not back to 2019 and early 2020 levels. However, the recovery in aerospace is gaining traction based upon improving travel activity, increased deliveries a return of bookings for commercial and the freight sectors, single-digit increases in already healthy defense spending and growing activity in general aviation.

A couple of data points for everyone to consider. TSA traffic increased 219% versus 2020, fueling aftermarket demand. Boeing delivered a better-than-expected 99 planes in the fourth quarter, ending in 2021 with 340 deliveries versus 157 in 2020. Airbus similarly reported increase in deliveries of 611 planes. Gross new plane orders are increasing with Boeing at 909 and Airbus at 771. China issued an airworthiness directive for the 737 MAX, a critical step in the return to service process and the increase in future build rates. Backlogs remained strong with Boeing at 5,136 planes and Airbus at 7,082. Airfreight grew 20% in 2021 and the outlook for the freighter market is increasingly positive based on expanding e-commerce and express cargo markets. Defense spending is expected to increase 5.5%. Business jet takeoffs and landings were up 40% in 2021 and inventory of used planes is very low.

Major airlines are highlighting strong spring and summer travel bookings and pent up demand for consumer and business travel. And finally, the metal supply chain for aerospace is in good shape, perhaps even on the lean side in some areas. We feel these positive trends will more than offset potential headwinds from 787 Rework, Omicron trends, high aircraft retirements and related parting out and any supply chain issues. We still see an accelerating metal pull as we move through 2022 into 2023. Certainly, our growing backlog and the near doubling of our sales to forgers in the fourth quarter supports our outlook.

The heavy equipment market remained our second largest market in the fourth quarter with strong growth in sales versus prior periods. Specifically, heavy equipment sales were $9 million or 21% of sales which is 19% higher than the third quarter sales of $7.6 million and 50% higher than the fourth quarter of 2020. Full year 2021 heavy equipment sales totaled $34 million, or 22% of sales and were 52% higher than 2020.

Metal fabrication demand drives our sales to the heavy equipment market. The 52% increase in our 2021 sales reflects continued pickup in industrial manufacturing, increased off-road vehicle production and a high level of automotive retooling and new model development. Based on our bookings and forecast from customers, we expect our heavy equipment market sales to remain strong in 2022 even with some typical quarterly lumpiness.

The oil and gas end market was our third largest market in the fourth quarter with sales of $4.1 million, which is slightly ahead of the third quarter and represents 9.4% of total fourth quarter sales. Oil and gas sales were up 78% from the fourth quarter of 2020 as oil prices soared and rig counts rose. Full year 2021 oil and gas sales were up 16% from 2020. Oil prices remain at 7-year highs and natural gas prices rose another 25% in the fourth quarter, bringing the full year increase to 82%. And both are setting the stage for continued recovery in drilling activity.

Last week, Schlumberger reported strengthening activity in international markets, along with strong sequential growth in North America driven in part by offshore and land-based drilling activity. Schlumberger expects a step-up in industry capital spending in 2022 and described industry macro fundamentals is very favorable due to the combination of steady demand recovery, an increasingly tight supply market and supportive oil prices.

Baker Hughes agrees with that assessment citing an increase of 228 rotary drilling rigs in the U.S. over the past year, while international rig counts were up by 169 over the same period. Taking a closer look at the U.S., oil rig counts were up by 205% or 71% year-over-year, while gas rig counts were up 24%, up 24% or 28%. For the oil and gas supply chain, more production equals more parts equals more demand for our metal. While there continues to be some excess inventory in the channel, we expect a pickup in our oil and gas market sales as we move through 2022 and we actually booked some very nice orders earlier this week.

General industrial market sales of $2.5 million or 6% of sales were up 18% from the third quarter of 2021, but 43% lower than the fourth quarter last year. Full year sales totaled $9 million, which is 30% lower than in 2020. Our general industrial market includes sales to the semiconductor, medical and general manufacturing markets. The semiconductor industry is coming off another strong year with ramped up production by chip makers, leading to record sales and unit shipments through November. Major investments are being made in chip manufacturing in the U.S., which should benefit our customers. Overall, we expect reasonable volume opportunities in the general industrial markets in 2022.

Power generation market sales increased to $1.2 million or 3% of sales, an increase of 39% from $800,000 or 2% of sales in the third quarter and up 24% from the fourth quarter a year ago. Full year sales were $4.6 million, which is 33% lower than 2020 sales. Maintenance demand has accounted for most of our power gen sales in recent years and was the main driver of our fourth quarter sales. We expect that to be the case in 2022 as well. although we continue to anticipate some benefit from increased gas turbine backlogs at major OEMs. Longer term, while there's abundant discussion on what effect net-zero emissions in the latter part of the century will have on the industrial gas turbine market, recent reports tag industry growth through 2028 and at least the mid-single digits.

So let me summarize. Business continued to come back in the fourth quarter, and we see sequential sales growth of 16%, including 19% higher premium alloy sales as well as a record backlog of $134.5 million and a gross margin of 8.7%. We also continue to narrow our bottom line loss.

Recovering aerospace demand was the main driver of our top line growth with Aerospace sales up 16% from the third quarter and nearly 50% from the fourth quarter of 2020. The latest reports on deliveries, orders and build schedules at Boeing and Airbus combined with growth trends in the freight world, business jets and travel fueled aftermarkets point to further recovery in demand in 2022. Our sequential sales growth in the fourth quarter also included increases in the balance of our end markets and the outlook for each is positive in the coming year. While there is no doubt that we will continue to be presented with challenges in our supply chain and from labor shortages and related issues, we plan to achieve sequential improvement in each quarter of 2022.

In looking to the future, our strategic investments in 2021 and an additional VAR -- vacuum-arc remelt furnace and 18-ton crucible will begin lowering costs and expanding capability immediately. Our Board has now approved the acquisition of 2 additional vacuum-arc remelt furnaces, which will further expand our product portfolio based on recent customer approvals. Our balance sheet remains strong as we ramp up operations and invest in the future. Our liquidity position is adequate to fund working capital needs as activity levels rise, consistent with our record-breaking backlog, growing sales and target investments in the future.

I just want to repeat that none of our accomplishments will be possible without the dedication and resilience of our employees and add the support of our Board, customers and shareholders. I remain sincerely grateful to all of them. That concludes my formal remarks. Carmen, we're ready to take some questions.

(Operator Instructions) Our first question comes from the line of Phil Gibbs from KeyBanc Capital.

Just want to talk first about the raw material cost to surcharge spread and how that impacted you one way or the other in the fourth quarter and what you're anticipating in the first quarter with seemingly fares deflating, but nickel and other things staying strong.

There was some positive misalignment, but it wasn't big enough to call out in the fourth quarter. So as we've talked the last couple of quarters, our material costs are kind of catching up to the real market.

As we look at the first quarter, you're right, we've got kind of mixed signals depending upon what you're looking at. Some of the commodities like nickel continue to go up yet scrap is trending down. So our expectation is we'll see surcharges continue to increase. Certainly, we know they will for January and February already and will probably increase modestly in March. From there, we're expecting stabilization in raw material costs and commodities. But as you know, that's a wildcard.

So does that help you and all is equal in Q1 versus Q4? Should we anticipate that's going to help your margins given what you're seeing already?

That should give us a modest plus in the first quarter.

And then on the side of net working capital and CapEx, what's your outlook for 2022?

We would look -- as we look at 2022, we expect each quarter to reflect higher sales. As I outlined in my comments, we have some unusual things happening in the fourth quarter because we have a fair amount of test material which is now past test, so we can now use that material for customer orders, which is another way of saying we wanted to melt that material in the first quarter. So as you look at managed working capital over the course of this year, I would expect some modest increase. I'll use the modest word again, tracking with our sales.

And then on CapEx relatively $11 million this year. I know you did complete some big projects, but you also have some VAR equipment that you're going to install over the course of the next several quarters. I was just trying to understand how much of that target accounted for?

Capital -- our best estimate right now would be to assume capital spending in 2022 at $20 million. And the reason why I say that with a little bit of qualification is the supply chain and when we can actually get some of these projects rolling and when we can expect actual receipt of equipment.

But directionally, everyone should understand that we would expect to spend more capital in 2022 than we did in 2021. We expect sales to be improving in each quarter, and we expect margins to be improving at the same time.

What's the breakout of the capital spending number that you're forecasting for 2022 in terms of maintenance versus other things that you're trying to augment the business with.

Broadly, I would say about $8 million, $9 million will be maintenance and the remainder would be the vacuum-arc remelt furnaces I just alluded to. And by maintenance, I mean, you know what I mean by that, right? There are some high return small projects in there. And by small, I mean, $0.5 million or less.

Okay. No, I was just surprised because I thought you all had excess in your capacity at North Jackson unless that's something that you had -- tapping or maybe you had space for bays that you're adding these and now I can't quite remember.

We're reviewing where we're going to install the vacuum-arc remelt furnaces. We've agreed to install 2. So we're looking at where we're going to do that. So that's another point of variability in the $20 million.

(Operator Instructions) We have a question from Bob Sales with LMK Capital.

Congratulations again to all of you on the nice performance. Can you hear me okay?

Yes.

Okay. It sounds like there were some headwinds on gross margins in the quarter with some test materials. I know you had talked in the past about shipping costs being higher. It sounds like there's some inefficiency. Can you -- would you be able to peel back what you think the total impact of that was on the quarter?

Well, we called out $750,000, which is specifically related to 3 incidents we had during the fourth quarter, which were unusual, unplanned outages. One was a melt shop crane failure which was a mechanical issue. And that required outside help. And in this day and age, it's very difficult to call up and get immediate outside help, so it caused us to be down for an unusual amount of time.

Same thing with the transformer and the same thing with our hot mill outage. So they were about $750,000 that I can specifically identify as unusual costs in the fourth quarter that won't recur.

The other one is a bit of a wildcard, and that is this whole subject of COVID. If you can imagine trying to schedule a facility and run operations as efficiently as possible when you've got 10% to 15% of your employees kind of walking -- going through the Omicron 5-day-off situation. We've been very fortunate that most folks have recovered from that very quickly, but it did cause a fair amount of disruption in the operation. And I suspect, as you hear calls from other manufacturers you're going to hear the same thing because everyone is wrestling with production over the last couple of months.

And you already have a labor shortage in the country. And on top of that, having your existing employees have a relatively high call off rate. So I -- it's difficult for me to put a number on that. But it's in the hundreds of thousands of dollars, clearly.

Did you absorb any gross margin hit on any of the test materials that you were running for some of the specialty products or an impact on freight that you think reverses at some point?

We tend to be pretty conservative on that. So I would -- if you look at total fixed costs and forget direct, we had $7.1 million of fixed cost to hit the P&L in the fourth quarter. We had $7.1 million hit the P&L in the third quarter. So some of those factors in Bridgeville didn't affect and some under absorption.

As far as the test orders specifically, as you go into -- you're trying to commission a new furnace an 18-ton crucible, you can't just turn those on and apply those orders -- pounds to customer orders. Being in the aerospace business, we have to validate that the equipment is working well and producing quality product, which means we have to make the product, and we have to test it. So there was extra spending that $3.9 million I called out that's simply -- that's the variable cost of those products that's sitting in the work in process inventory.

And there is some percent of fixed cost on those as well, but they will be fully recovered because virtually every pound turned out to be good product, and that will all be applied to customer orders and be sold in due course over the first half of the year.

Okay. And then sticking with that thread on gross margins, it looks like premium alloy was 16%, and you sound pretty confident of that as you look forward with the capital expenditures.

Can you perhaps draw a figure in the sand for us on where you'd like to target gross margins given improvements with premium metals and other factors as you exit '22?

Well, we typically don't give guidance at that level of detail. What I would tell you is I would expect double-digit margins here as we move through the first half of the year in total.

Yes. Fair enough, fair enough.

And expect it to improve each quarter as we go through the year. You see the backlog. So we would expect -- as you look short term, we would expect sales to improve by roughly the same range as you saw in the fourth quarter versus the third.

So that's what we're looking at based upon the backlog. And with higher production and higher sales and the sweeter mix, we would expect to see higher margins. And our longer-term target as we've said many times, will be up in the mid to upper teens from a gross profit margin standpoint.

Okay. And with -- I can't remember where your premium products peaked in the last cycle. But at 16%, when you look out to sort of '22, '23, '24, what is your hope or expectation in terms of premium products as a percentage of revenue as we go forward?

Well, the percentage is one issue, so somewhere between 20% and 25%, I guess, generally speaking, but I look more at the absolute dollar amount. So with the -- in 2021, we were down around $26 million, $27 million. I would expect that number to be well up in the 40s in 2022. And that product line is expect -- that product grouping is expected to grow very rapidly as North Jackson goes up to speed in 2023 and 2024.

We have said publicly many times, we think there's $100 million of incremental revenue in premium melted products. So we're somewhere in the $40 million range in 2022, which I think is a reasonable number. We still have a way to go, which explains why we're making some of these investments we've announced.

And that's the same playbook of positioning yourselves as an alternative or secondary supplier to the OEMs in the same -- the supply chain and then the qualification process that goes along with it. Is that still the strategy that you're finding success with?

Yes. We're looking at areas of the premium melted market where we feel there is room for us to participate from a competitive standpoint, and we have the capability of making those products.

And I think if you look at the last 5 or 6 years, we've demonstrated the ability to make those products based upon the approvals we've gotten. We continue to get those approvals. We anticipate a few more later this year. So that's the same game plan that we've talked about before.

Perfect. And congratulations for continuing to just really move the ball on this.

Okay. Thank you.

(Operator Instructions) We have a follow-up from LMK Capital, Bob Sales.

Denny, I'll take the floor since you will have the benefit of this being transcribed. It will save you some calls with other people down the road. When you look at Aero, can you, again, give us a figure on -- I assume most of that growth now is in commercial as opposed to defense spending. Is that true?

Not necessarily. We do a fair amount of defense spending. Some of the new approvals of premium alloy products would go into applications like helicopters from the military standpoint. So it's not strictly commercial, we're talking about.

I have a hard time giving you a precise number because we don't -- we sell to forgers and we sell to service centers, we don't sell directly to the OEMs. So we don't have clear visibility, but we know where some of these grades of steel are used.

Yes. And -- when you look at your pull-through today and your visibility or your confidence on revenue growth as you go through '22, do you think the -- the majority of the poll is for sort of the ongoing maintenance and refurb of existing fleets? Or do you think you're seeing more pull-through for new orders as we look at the Boeing and Airbus backlogs.

There's a base load that is aftermarket related. I think a healthy portion of the backlog that we booked over the course of 2021 has to do with the outlook for aerospace build rates. So if we use Boeing as an example, there are about 26 planes a month, 737s a month now, expecting to go to 31 by the end of the year and continue to increase in 2023 and 2024.

I know they've got a call later today, so that might change, but that's what people were looking at. So if you think about that build rates are going to accelerate later this year and into 2023. If that's going to happen, the parts have to be ready -- the parts have to be ready at that time frame. People are going to have to be buying the metal in the first half of the year to make those parts, which means we would have -- we need to be making that metal now. And frankly, that's what -- that's a healthy chunk of what you see in our backlog.

And with that, we conclude the Q&A session. I will turn it back to Denny Oates for his final thoughts.

Thank you, Carmen. Once again, thank you for joining us this morning. We're beginning 2022 with a full focus on taking advantage of our market opportunities, and we'll continue to press forward on our growth initiatives.

We look forward to updating you on our progress on our next call in April. In the meantime, be well, stay safe, and have a great day.

And with that, this concludes today's conference. Thank you for participating, and you may now disconnect.