Universal Stainless & Alloy Products, Inc.
Q2 2020 Earnings Call Transcript

Published: 2 Aug 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Universal Stainless & Alloy Products Second Quarter 2020 Conference Call and Webcast. [Operator Instructions]. I would now like to hand the conference over to your speaker today, June Filingeri. Thank you. Please go ahead, ma'am.

[June Filingeri:]

Thank you, Christel. Good morning. This is June Filingeri of Comm-Partners, and I also would like to welcome you to the Universal Stainless conference call and webcast. We're here to discuss the company's second quarter 2020 results 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; John Arminas, Vice President of Administration and General Counsel; and Chris Scanlon, 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. Christel will instruct you on procedures at that time. Also please note that in this morning's call, management will make forward-looking statements. Under 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 the formalities complete, I would now like to turn the call over to Denny Oates. Denny, we are ready to begin.

[Dennis Oates:]

Thanks, June. Good morning, everyone. Thanks for joining us here today. As we reported in the morning's release -- in this morning's release, the coronavirus pandemic continues to cause serious dislocation in the metal supply chain, taking its toll on end-market demand, especially in aerospace and oil and gas. The rapidly deteriorating conditions in both these end markets have caused the supply chain to adjust quickly with substantial reductions in new mill orders and a drive to reduce inventory. For Universal, that has meant low order entry, the pushout of delivery dates and some cancellations, albeit mainly on long lead-time products not yet in production. Average monthly order entry declined from $15.3 million before surcharges in the first quarter to $7.1 million in the second quarter. Cancellations during the quarter totaled $10.5 million. All of our plants operated throughout the quarter working through our backlog. We ended the quarter with total backlog before surcharges of $71.8 million, down from $110.7 million at the end of the first quarter, which points to the challenges we will confront in the second half of 2020. We do, however, expect to see sequential quarterly improvement in business activity beginning in 2021. These negative trends were becoming evident at the time of our last call, but the magnitude and duration of the downturn were uncertain. We outlined a plan to reduce costs and increase liquidity during the second quarter. Specifically, we said we would reduce plant activity levels in line with market conditions, we would flex spending down on all fronts and we would cut capital spending to roughly $2 million per quarter on average for the remainder of the year. Let's take a look at what we actually did in the second quarter versus the first quarter. Plant activity levels will reduce 25% as measured by pounds processed. Melting activity was reduced 34%, contributing to a $12 million reduction in inventory and suggesting further reductions to come in the second half. Despite lower activity, I'm pleased to report our variable operating cost per pound was flat, validating the outstanding job our manufacturing team is doing, relentlessly controlling costs in a rapidly changing environment. SG&A expenses declined $1.1 million or 20% before including a $600,000 severance charge. Operating cash flow was a positive $7.4 million despite a $13 million drawdown in accounts payable. Capital spending was $2.7 million, and we are tracking towards our $9 million total for 2020. We generated $800,000 in cash through strategic scrap sales. And very importantly, plant-wide safety, as measured by our OSHA recordable rate, was within 1 decimal point of matching our company's record low. Our goal remains to flex spending and plant activity in line with market changes while still maintaining productivity, a safe work environment, servicing customers and positioning ourselves for growth and the ultimate recovery. The acute pressures on the commercial aerospace and oil and gas markets, 2 of our largest end markets, continued during the second quarter. Therefore, we have taken further difficult actions to respond to current market realities. These actions include

[Christopher Scanlon:]

Thank you, Denny, and good morning, everyone. Let's get started with the income statement. As Denny discussed, second quarter 2020 sales of $52.5 million were down 10.3% or $6 million from the 2020 first quarter and down 26% compared with the 2019 second quarter. Our general industrial sales improved 27.7% or $700,000 from the 2020 first quarter and were also $700,000 or 30% higher than second quarter 2019. Sales for the balance of our end markets declined sequentially and year-over-year. Second quarter 2020 gross margin totaled $1.9 million or 3.7% of sales, down from 8.4% of sales in the first quarter 2020 and 12.8% of sales in the 2019 second quarter. In the second quarter, we generated $800,000 of cash receipts from the sale of excess scrap. Our Q2 gross margin was unfavorably impacted by $350,000 related to this sale. Additionally, our gross margin was negatively impacted by fixed cost absorption direct charges of $200,000 related to reduced plant operating levels. Gross margin as adjusted for these 2 items totaled 4.8%. The $200,000 fixed cost absorption direct charge was a result of reduced second quarter operating levels. Due to the reduced production levels, there is an amount of our fixed cost that was not absorbed into inventory and taken as a charge in the second quarter. We anticipate these absorption charges to continue in the second half of 2020 on lower activity levels. Selling, general and administrative costs in the second quarter totaled $5.4 million or 10.3% of sales a decrease of $511,000 compared with the 2020 first quarter and $207,000 lower compared to the 2019 second quarter. As Denny noted, second quarter 2020 selling, general and administrative expenses include severance expense of $620,000. Our SG&A costs, excluding severance expense, totaled $4.8 million, which represented a nearly 20% decline from our first quarter SG&A expense of $5.9 million. SG&A in each of the third and fourth quarters is expected to be below our adjusted $4.8 million second quarter amount. SG&A also includes increased property and business insurance-related costs totaling $300,000 as compared to the 2019 second quarter. Specific to the second quarter, our income tax benefit was $939,000, and we expect our full year 2020 effective tax rate to approximate 25%. Net loss in the second quarter was $3.3 million or $0.38 per diluted share. Second quarter net loss, as adjusted for the loss on the sale of excess scrap, the fixed cost absorption direct charge and severance costs, totals $2.4 million or $0.27 per share. First quarter 2020 net loss totaled $1.4 million or $0.16 per diluted share, and 2019 second quarter net income totaled $2.1 million or $0.24 per diluted share. Q2 EBITDA, as adjusted for noncash share compensation, the loss on sales of excess scrap, fixed cost absorption direct charge and severance, totaled $2.9 million. The EBITDA and adjusted EBITDA calculations are provided in the tables to the press release. Second quarter cash flow provided from operations was $7.4 million compared to our first quarter cash flow used in operations of $7.8 million and second quarter 2019 cash flow provided by operations of $2.2 million. Related to the balance sheet, managed working capital totaled $151.8 million and decreased by $1.7 million compared with the first quarter of 2020. Managed working capital was a source of cash. As activity declines, managed working capital has been a source of cash, and we expect to see greater cash benefit from working capital for the rest of the year. Within the components of managed working capital, accounts receivable decreased by $3.4 million and inventory decreased by $11.7 million, while accounts payable decreased by $13.4 million. The decline in inventory is primarily due to Q2 sales levels and reduced production activity as we maintain an inventory level commensurate with our order backlog. The decline in accounts payable was driven by decreased AOD and VIM melt activity and a corresponding decline in production-related spending. Also contributing to the decline in accounts payable was a reduction in capital expenditure activity. Second quarter 2020 backlog totaled $71.8 million and is down $38.9 million or 35.1% from the 2020 first quarter. Year-over-year, second quarter 2020 backlog decreased $45 million or 38.5% compared to the 2019 second quarter. Capital expenditures for the second quarter were $3.2 million, $860,000 lower than first quarter 2020 and $660,000 lower than second quarter 2019. Capital expenditures for the first half of 2020 totaled $7.2 million, $2.2 million lower than first half 2019. Capital expenditures are expected to approximate $9 million for full year 2020. The company's total debt at June 30, 2020, was $72.5 million, a decrease of $3.8 million from the prior quarter. Company's debt is primarily comprised of our revolving credit facility and term loan, which collectively totaled $47.6 million as of June 30 and our notes, which were issued in connection with the acquisition of our North Jackson facility in 2011. These notes totaled $15 million at June 30. We continue to include this $15 million in current debt as these notes are due and payable in March 2021. Our long-term debt also includes a $10 million term note pursuant to funds received under the Paycheck Protection Program. As of June 30, 2020, we maintained revolver borrowing availability of $46.6 million. We believe that our current liquidity position, coupled with the solid creditworthiness of our customer base, provides us the ability to continue to endure future uncertainties. As I noted earlier, anticipated declines in managed working capital levels are expected to be a source of cash, and we expect to see continued reduction in our debt levels throughout the second half of 2020. I will summarize our Paycheck Protection Program loan next. On April 17, we received $10 million of PPP funds. These funds were used for eligible employee payroll and utility costs during the 8-week measurement period, which began on April 17 and ended on June 11. Paycheck Protection Program loans can be forgiven based on usage of the funds for eligible payroll and utility expenses. The PPP forgiveness calculation also includes adjustments related to reductions in full-time employee equivalents and salary and hourly wage reductions. We have complied with the PPP loan requirements and had eligible payroll and utility costs during the 8-week forgiveness period in excess of our $10 million of PPP proceeds. During the third quarter, we will submit our loan forgiveness application for full forgiveness of the total $10 million loan amount. This concludes the financial update. And Denny, I'll hand the call back to you.

[Dennis Oates:]

Thanks, Chris. In closing, on our last call, I offered a snapshot of where we saw things at that time. And to summarize, we said our industry was highly stressed, and uncertainty was running high. Our customers were being conservative in ordering and buying only on a need basis and not on speculation, and we were anticipating headwinds from lower activity levels and higher cost and inefficiencies from ongoing disruptions through the virus. Each of those conditions played out and continues to be the case today. What has become clearer is that the difficult situation will last through the end of the year and impact our financial performance with a step-down in quarterly sales and operating activity expected for the next 2 quarters. As Chris explained, the disposition of our PPP loan should occur before the end of the year. I also said last time that to mitigate the challenging conditions and remain in a strong position for the eventual recovery, we would focus on liquidity and on aggressively reducing cost. We made tangible progress on both counts in the second quarter. Let me reiterate that we are executing a proactive operating strategy, similar in principle to past cyclical downturns, and look forward to the beginning of recovery in early 2021. Let me also say that we have some heavy lifting to do over the next few quarters. Even so, I remain extremely confident that we have the right plan, a great team of employees, the support of our stakeholders, and we will power through the current situation and position our company for further growth and success in the next upturn. I'm sincerely grateful to everyone for their support. That concludes our formal remarks. Operator, we'll take questions at this point.

[Operator:]

[Operator Instructions]. Your first question comes from the line of Tyler Kenyon with Cowen.

[Tyler Kenyon:]

Denny, I wonder if you could just walk us through just some of the sequential gross margin impacts in the quarter. You did call out a few items, but just excluding those pieces, so surcharges, kind of lower production and perhaps some mix impacts. And is there a good way to think about kind of the progression from here as we move into the second half?

[Dennis Oates:]

Okay. Let's talk about the second quarter. You saw we reported gross margin of about 3.7%. And if you look at the detail, some -- there were some adders in expense over the course of the quarter. We had some heavy scrap activity, which was about 1.6% margin. So in other words, we would add about $900,000 negative. That's equivalent to 1.6% margin. We did write off some inventory, some older inventory. And again, we're seeing a situation where we have inventory which is for sale, it's slow moving. In decent times, customers will take that on a regular basis. In the current environment, they will not. And as we look at just the time phasing of cash flows, we're in a situation where it makes sense for us to basically write some of this off and scrap it out and defer buying new scrap because that all goes back into our melt shop. We had a loss on the sale of some 316L scrap that we discussed during our prepared comments. That was 0.7%. The slow moving, by the way, was 1.2 -- was 0.8%. We had an acceleration of fixed cost of $200,000, which is 0.4%. And although I don't have a specific number for you here, there are several percentage points just as to the base level of absorption. When you cut your operations in a capital-intensive business by the magnitude we did during the second quarter, you're going to have unabsorbed cost that's going to kick out as a volume variance. So you're seeing that embedded in our margins as well. So roughly, if you adjust for that, you get up to the 7.5%. If you add the unabsorbed fixed cost in the base, you're starting to push 9.5%, 10% margins. As you look at the third and the fourth quarter, we're going to see a fall in sales. If you look at the margin percent itself, we will have larger acceleration of fixed cost. So that $200,000 number is going to grow. Our focus is to maintain a positive gross profit margin as we go through the second half of the year in this environment. And what you will see is a generation of cash as working capital will unwind at a much higher rate than it did during the second quarter, and capital spending in the third and the fourth quarter will be lower than what you saw in the first 2 quarters. Does that give you a sense for where we're at?

[Tyler Kenyon:]

Yes.

[Dennis Oates:]

And it's all against a backdrop of a very uncertain environment. As I look at -- as I was looking at the numbers this morning, we had about 2.5 million pounds sitting on the dock ready to go on June 30 that customers didn't take. So a lot of that depends upon timing and when customers take things. And we're still in a mode -- although it's quieted down somewhat, customers cancellations are down, bookings continue to be relatively weak. But customers are managing very carefully when they take delivery of product, so you see some small pull-aheads, but most of what we're seeing is pushouts.

[Tyler Kenyon:]

Got it. Okay. I appreciate all of that. Just on SG&A, curious if that's at the right level relative to kind of how you anticipate the second half to play out. It sounds like you are taking additional action here in response to a more challenging environment, so curious as to where we'll see some of that cost come out and how to specifically think about the SG&A line.

[Dennis Oates:]

In the low $4 million range. So we're basically running at a 4.8 run rate in the second quarter. And we did announce some changes to our salary payroll. As you saw, that's not all SG&A. There's a fair amount of salaried folks that are in the gross profit number. The other thing I would comment on SG&A for us is about 40% of our SG&A is what I would call people cost. It's also where we book our business insurance. That's our next largest item there.

[Tyler Kenyon:]

Got it. Okay. And then just lastly for me, and then I'll turn it over. But with respect to the free cash flow in the second half, I mean, how should we be thinking about that in 3Q versus 4Q and maybe how exactly to think about the progression of the working capital piece?

[Christopher Scanlon:]

Sure. We will have improved working capital levels, i.e., reductions, in Q3 and Q4. As Denny noted, those will favorably impact our debt levels. We anticipate much improved reduction in inventory compared to second quarter levels and a similar situation on debt reduction. Current forecast, we do anticipate, probably call it -- and Denny, you can chime in here. We're looking at approximate debt reductions north of $20 million in the second half of the year. On the managed working capital, we're looking at reductions north of $30 million for the second half of the year.

[Operator:]

Our next question comes from the line of Phil Gibbs with KeyBanc Capital Markets.

[Philip Gibbs:]

Denny, you had the backlog down about 35% versus the first quarter. Is that roughly the change we should see in revenues in the upcoming quarter relative to 2Q in terms of the magnitude of the drop-off you're expecting?

[Dennis Oates:]

No. No. It's not going to be that significant in the third quarter. We still have opportunity to book business into the fourth quarter. So you're looking at about another 20% reduction, somewhere in that range, as we look at the third quarter from where we stand today. So I would still expect to see a 4 in front of that number in the third quarter. Getting out of the third quarter, it gets a little dicier. Our expectation, as we get into the fourth quarter, we'll start to see some bookings coming in for the first quarter of 2021. And by that point in time, you should see the destocking. The liquidation of inventory that's occurring as we speak should be over. So the whiplash effect that mills have to suffer through should be behind us. And you should start to see bookings pick up and activity levels pick up a little bit as we go through the end of the year.

[Philip Gibbs:]

Okay. Got it. And then you gave some color on the gross profit side. Are those absorption impacts, Denny, going to be basically acute in the back half and then the assumption is that, that starts to improve next year?

[Dennis Oates:]

Yes. We will be accelerating fixed cost write-offs in the third and the fourth quarter. It'll be much larger than what you saw in the second quarter. And that's reflective of the fact that we -- as you look at our facilities, we ran the entire second quarter. For all intents and purposes, we took 3 of our larger plants down during the first week of July. And we have, depending upon the plant, 3 or 4 weeks scheduled down during the second half of the year. In addition, we've got rolling outages at different work centers. So as those activity levels come down, you will start to spin out the requirement to accelerate fixed cost write-offs. So those numbers will get bigger in the third and fourth quarter. That's all noncash, by the way.

[Philip Gibbs:]

Okay. And then, Chris, on the revolver availability, what's that number today? And then reiterate what you said in terms of second half net working capital reduction, did you say $30 million plus is your goal?

[Christopher Scanlon:]

Yes. On the managed working capital, you're correct. From a liquidity standpoint and an availability standpoint, in the second quarter, we had $86 million of borrowing base. We had outstanding drawings on our revolver of $40 million. That left us with a remaining revolver availability of $46 million. That remaining availability, we anticipate, should be fairly consistent as we approach and go through the third and fourth quarters. And that is commensurate with reduction in borrowings, along with the reduction in our borrowing base, as we wind down manage working capital levels. Specific to the revolving credit facility, the managed working capital impacts are the accounts receivable and inventory lines.

[Philip Gibbs:]

Okay. So essentially -- I got the liquidity number. So essentially in the back half, as you flush out cash, that also goes as an increased block against your base. So your liquidity basically is going to stay similar to where it was in the second quarter. Is that the thought?

[Christopher Scanlon:]

Correct.

[Operator:]

[Operator Instructions]. Your next question comes from the line of John Deysher with Pinnacle.

[John Deysher:]

A couple of questions. One, you mentioned the fixed cost write-offs. To make sure I understand that, is that fixed asset write-offs? Or what exactly you're referring to there? And how big might those be in the back half of the second half of the year?

[Christopher Scanlon:]

Sure. John, I'll touch on the accounting exercise that is the fixed cost write-off. So this is required whenever we have production levels that are decreased. When production levels fall below normal operating levels, we're required to do a review of fixed cost absorption to see if any of the fixed overheads should be taken to the P&L versus capitalized in the inventory. This is done to make sure that we avoid any over absorption of fixed costs on the balance sheet. We did this review in the second quarter because our production levels fell outside of our normal operating levels. And this is what resulted in that $200,000 expense hit to the P&L... We do anticipate decreased production levels in the third and fourth quarters, commensurate with the reduction in backlog. Because of these reduced operating levels, the fixed charge for the absorption is anticipated to be much higher than the $200,000 in the third quarter -- or in the second quarter, correction.

[John Deysher:]

How much larger do you think it might be?

[Christopher Scanlon:]

The amounts in the third and fourth quarters could approach $1 million based on what we currently have forecasted within the production levels for Q3 and Q4.

[John Deysher:]

Okay. And that runs through the P&L, correct?

[Christopher Scanlon:]

Yes. That will run through our gross margin. It is a noncash charge. We will make sure we highlight it as these charges only come about whenever we have significantly reduced production levels.

[John Deysher:]

Got it. And on the CapEx side, $9 million for the year, $7.2 million year-to-date. That implies $900,000 or so per quarter. Is that the right way to think about this for the back half?

[Dennis Oates:]

Yes. We have finished virtually all of our capital work that we plan to do this year as of June 30. The risk there is that we have a major breakdown of a piece of equipment where we need to spend some capital to keep it going. This will be non-maintenance-type stuff, but we're not aware of anything like that. So that's where we're at.

[John Deysher:]

Okay. And this one's for you, Denny. Obviously, times are tough. You're struggling. And I would guess some of your competitors are struggling also. So I'm just wondering -- your focus is on debt and expense reduction, but is M&A at all on the radar screen at this point? Because historically, you've been opportunistic in downturns like this, and we always like companies that come out the back end of a downturn stronger than when they went in. And I'm just curious, are you seeing opportunities with -- amongst any of your competitors? Kind of what's that landscape look like at this point?

[Dennis Oates:]

I think M&A in our space is relatively muted right now. Normally, during a downturn, you get well into it and you start to see some opportunities start to pop before the next upturn. We're still -- I won't say we're at the beginning of this thing, but we're nowhere near the end of it. So there's nothing that's really hot. There's a couple of opportunities. We were always talking to people and looking at different things. But I think, to be honest with you, over the last 3, 4, 5 months, whether it's Universal or any of our competitors, the focus is all about adjusting to this current demand levels and the sharp drop we're seeing and how do you restructure your business so you can get out to the other end.

[John Deysher:]

So no one's waving the white flag at this point.

[Dennis Oates:]

No. But I think that will probably happen. But I think it's too early in the game right now. Later this year, early next year kind of time frame, in my opinion.

[John Deysher:]

All right. Well, keep your eyes open.

[Dennis Oates:]

We will.

[Operator:]

And there are no further questions. I would like to turn the call back to Mr. Dennis Oates for closing remarks.

[Dennis Oates:]

Thank you. Once again, I want to thank everybody for joining us this morning. We continue to deeply appreciate your ongoing support and interest in Universal Stainless, and we look forward to updating you on our next call, which will be out in October. So be well, stay safe, and have a great day.

[Operator:]

This concludes today's conference call. You may now disconnect.