Universal Stainless & Alloy Products, Inc.
Q1 2019 Earnings Call Transcript

Published: 24 Apr 2019

[Operator:]

Good day, ladies and gentlemen, and welcome to the Universal Stainless First Quarter 2019 Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference June Filingeri. You may begin.

[June Filingeri:]

Thank you, excuse me. 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 are here to discuss the company’s first quarter 2019 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; Paul McGrath, 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. The conference operator will instruct you on procedures at that time. Also please note, in this morning's call, management will make forward- looking statements under the Private Securities Litigation Reform Act of 1994. 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.

[Denny Oates:]

Thanks, June. Good morning, everyone. Thanks for joining us today. We continue to make progress in the first quarter albeit at a slower pace than originally planned. Sales increased 5.6% from the fourth quarter 2018, fueled by aerospace sales of $42.6 million, which is a new company record. Our premium product sales also increased by 15.6% sequentially. Although first quarter 2019 gross margin of 12.2% improved from the 2018 fourth quarter, our margins were somewhat below the 13% to 14% range discussed on our last conference call. The shortfall was due to three issues

[Chris Scanlon:]

Thank you, Denny, and good morning, everyone. Let’s start with the P&L. As Denny noted, first quarter 2019 sales of $60.3 million were up 5.6% or 3.2 million compared with the 2018 fourth quarter and down 5.4% of $3.5 million from the 2018 first quarter. First quarter revenues were led by aerospace sales, which increased $7.5 million from the 20187 fourth quarter and $6.4 million from the first quarter of 2018. First quarter oil and gas, heavy equipment and general industrial sales declined both sequentially and compared to the prior year first quarter. first quarter gross margin totaled $7.4 million or 12.2% of sales up nearly 1% from the 2018 fourth quarter and down 2.3% from the prior year first quarter. As Denny noted, in the 2019 first quarter, our gross margin was negatively impacted by the continued melt cost misalignment as the recovery in surcharges was delayed by approximately one month compared to our original expectations. Additionally, we experienced lower-than- forecasted shipment volumes and unfavorable product mix. Looking now at selling, general and administrative costs. First quarter SG&A was $5 million or 8.2% of sales, a decrease of approximately $600,000 compared with the 2018 fourth quarter and a $240,000 decrease compared to the 2018 first quarter. Employee-related costs drove the SG&A change between periods as employee recruiting fees and incentive accrual activity decreased compared to the fourth quarter of 2018 and the prior year first quarter. Our tax rate for the current quarter was 16.9% and was favorably impacted by federal research and development tax credit. Net income in the first quarter was 1.2 million or $0.14 per diluted share. Fourth quarter 2018 net income totaled $582,000 or $0.07 per diluted share and 2018 first quarter net income totaled $2.1 million or $0.28 per diluted share. Lastly, the first quarter and fourth quarter – first quarter of 2019 and fourth quarter of 2018 weighted average shares outstanding included an additional 1.4 million shares outstanding due to the second quarter of 2018 equity issuance. First quarter EBITDA totaled $7 million an increase of $1.6 million or 29% sequentially and a decrease of $1.8 million or 21% compared to the first quarter of 2018. Adjusting for noncash share compensation expense, 2019 first quarter adjusted EBITDA totaled $7.4 million. The EBITDA and adjusted EBITDA calculations are provided in the tables to the press release. Turning now to the balance sheet. At March 31, 2019, managed working capital totaled $140 million and increased by $17 million compared with the fourth quarter of 2018. Accounts receivable increased by $2 million, and inventory increased by $12.4 million while accounts payable decreased by $2.6 million. Our increased inventory levels supported our higher backlog, which grew by nearly $4 million during the quarter, up to a record $130 million. Capital expenditures for the first quarter were $5.6 million with prior year fourth quarter CapEx totaling $2.2 million and prior year first quarter capital spending totaling $2.5 million. Our first quarter capital expenditures were primarily strategic with continued spend on our new midsized bar cell unit at our Dunkirk facility. As Denny previously discussed, our bar cell commissioning continued throughout the quarter. The company's total debt at March 31 stood at $65.4 million, an increase of $18.7 million from the prior quarter. Our first quarter debt increase was primarily driven by working capital changes. Lastly, in the current quarter, we made a $2 million payment on our outstanding notes, which were part of the purchase of our North Jackson facility. The balance outstanding on this debt is $17 million as of March 31, 2019. The outstanding balance is comprised of $2 million recorded from the current portion of our long-term debt and $15 million recorded as long-term debt. This concludes the financial update. And Denny, I'll turn the call back to you.

[Denny Oates:]

Okay. Thanks, Chris. In summary then, we made progress in the first quarter of 2019 but not as much as we had planned, and we are far from satisfied. While sales grew sequentially, margins did not meet our target due to the lower-than-expected shipment volume, particularly for tool steel, less favorable product mix and a continued misalignment issue. On the plus side, aerospace sales were a record level in the first quarter, which helped drive strong premium alloy sales. Our backlog at quarter's end reached a record level of $130 million before surcharge. Surcharges for non-tool steel products are rising in April and May. While full year 2019 will have its challenges as every year does, we are fully focused on improving our operations and execution. We are even more excited about ramping up our new bar cell after processing some meaningful volumes in the first quarter. The new bar cell in Dunkirk is key to our plan, and commissioning is accelerating. In terms of organizational development, we announced on Monday that Wendel Crosby is being promoted to Vice President of Manufacturing from his current roles as General Manager of our Dunkirk facility and our Titusville facility. Additionally, Rick Secola, who started with Universal as an intern nine years ago, has been promoted to Supply Chain Director. Both gentlemen have bright futures and will play key roles in executing our strategy. Overall, we believe 2019 will be another positive year for Universal with sales growth, margin improvement and positive cash flows expected to begin as soon as the second quarter. Before I close, I want to thank all of our employees for their continued hard work and dedication, which is reflected in the record production across our four facilities. That concludes our formal remarks. Operator, we're ready to take any questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Lucy Guo with Cowen and Company. Your line is now open.

[Lucy Guo:]

Good morning. Thank you for taking my questions.

[Denny Oates:]

Hi Lucy. How are you?

[Lucy Guo:]

Hi. First, can you maybe just help us update your margins, thoughts in terms of the 13% to 14% range that you provided before?

[Denny Oates:]

Well, as you recall, last quarter, we had a margin in 11.3% range. And we talked about the misalignment at that point of about 180 basis points. We had some melt shop issues, which is another 100 basis points, and some physical inventories of 120. As we look at this first quarter's gross profit margin at 12.2%, we had felt that the misalignment would shrink. It would still be there but not be as big as it was in the fourth quarter, which happened, but it did not shrink as much as we thought. So I would estimate that the – our base margin was 12.2%. The misalignment would be roughly 125 basis points in there. And as we look down the road, we expect in the second quarter continued improvement in the margins. We've got – as I mentioned, we've got surcharges up in April and May. We'll see how June plays out based upon what happens here over the next week with commodities. It looks today like surcharges will flatten out in month of June. And we expect shipment volume – yes.

[Lucy Guo:]

Okay. So that's still a good reference point of range for 2019?

[Denny Oates:]

Yes.

[Lucy Guo:]

Got you. So sorry to cut you off, but maybe a high-level question just given the positive comments around aerospace. And clearly, it is an important end market for premium melt products and others. Can you just – I know that you participate in a lot of the conversations with the industry and participated in trade associations and such. Is there any chatter as to potentially any long-term market share impact? And this kind of goes to the current outlook for the supply chain, which is no change in schedule, but I just wonder whether there’s another shoe to drop.

[Denny Oates:]

There’s no chatter about any long-term changes in market share. I think fundamentally, there’s a lot of chatter about the subject of the 730 MAX and what it means. It largely comes down to a timing issue. The feeling is that this will get resolved this year, and it gets resolved this year. From a metal supply chain standpoint, you should not see much of an impact. There is a school of thought that would suggest that this is actually could be a good thing because frankly, the metal supply chain in general has been struggling to keep up, and this will give a little window of opportunity for people to get caught up in the supply chain as things come back together. But I’ve not heard any chatter about any long- term share loss or anything like that.

[Lucy Guo:]

Thanks for the comment. And then third question is probably for Chris and Denny. Just in terms of how working capital and inventory levels may be worked down later on this year. And if there is any – it sounds like there may be some pull-forwards on CapEx. Help us with the seasonality on free cash here.

[Denny Oates:]

As far as inventory goes, we are in the process of positioning some more inventory up at Dunkirk, so that we can take full advantage of the bar cell, which we’re becoming increasingly excited about based upon what we’ve seen in the first quarter. So as far as working capital goes, as you look at the next couple of quarters, you should expect to see increases in receivables because we expect higher sales. You should expect to see decreases in inventory and a flattish level from accounts payable standpoint when the three major components are working capital.

[Lucy Guo:]

And how about CapEx?

[Denny Oates:]

Hi Lucy, CapEx will be declined from the first quarter levels. As we discussed in prior calls, year – full year CapEx probably will land around the $17 million mark. But we will not have CapEx levels in the second quarter as we did in the first quarter.

[Lucy Guo:]

Sounds great. I will pass it on. Appreciate the time.

[Denny Oates:]

You’re welcome Lucy.

[Operator:]

Thank you. Our next question comes from the line of Phil Gibbs with KeyBanc Capital. Your line is now open.

[Phil Gibbs:]

Hi, good morning.

[Denny Oates:]

Hey Phil.

[Phil Gibbs:]

Hi Denny, just in terms of the sales in Q1, what was the bigger surprise? Was it the tool steel business? Or was it the energy piece? And within your second quarter view because you do have some sales under your belt at this point, are you expecting the oil and gas sales to rebound versus the Q1 level?

[Denny Oates:]

I would say the bigger surprise was clearly tool steel. Let me turn it over to Chris Zimmer, and he can answer the rest of your question. Chris?

[Chris Scanlon:]

I think for the oil and gas business and the tool steel business, what we found was – and where the surprise was, the amount of buying ahead that we saw from our customer base in 2018. I think there was a level of anxiety about what the tariffs would mean as people shifted some of their supplies. So there are opportunities for us to be able to pick up business that was historically purchased offshore. And I think as the oil and gas and tool steel industry shifted those supply chains, they leaned into their inventories. So we saw buying patterns that were really ahead of those demand levels. We’re experiencing right now an adjustment of their inventories. I think the fundamental demand profile in both markets is still very good, but our customer bases just got too much inventory that they’ve been adjusting and working through. So we expect them to be largely through that year in the first, second quarter and then returning back up to those healthy demand levels in the second half of the year. So it was really those buying patterns and a level of caution that they took layering in inventory. We’ll see that play itself out here as they adjust those inventories in the first half of the year and get back to those healthy levels by the second half of 2019.

[Phil Gibbs:]

What about oil and gas specifically, Chris, in terms of the tax share of the sales or shipments in Q2? Or should we look at the Q1 as a little bit of a one-off? Or do we have more inventory to bleed there before sales pick up in oil and gas? Because the rig count’s still pretty healthy. Completion activity’s strong. Offshore’s strong, stronger. International is stronger. Prices are rising. So I think it would be temporary, but curious what you’re seeing.

[Chris Scanlon:]

I do think it was a bit of a one- off. The demand keep – continues to flow in. It’s reflected in our backlog. Customers have layered in orders for this year. Some of them are already reaching out to the first quarter of 2020. So the activity levels are still robust. Plans to continue to drill are ongoing, and the supply chain right now is now that they’ve gotten ahead of where they wanted to be from an inventory standpoint, they’re really just trying to balance the flow of everything. So we saw that adjustment in the first quarter, but I’d expect to get back to those robust levels. So the feedback that we have about it at the marketplace is still very strong.

[Phil Gibbs:]

That’s good. And then, Denny, I’d just want to qualify your comments. So I think you had said double-digit revenue growth. Was that sequentially? Or was that year-over-year?

[Denny Oates:]

Sequentially was what I was specifically addressing there.

[Phil Gibbs:]

And is that uplift sequentially more of this oil and gas snapping back and the -- and just continued momentum in aerospace?

[Denny Oates:]

It’s primarily aerospace, oil and gas coming back and some of the general industrial markets improving, not the semiconductor part of it but the other markets.

[Phil Gibbs:]

And I was just also unclear about your margin parameters. So second quarter, are we getting back into that normalized 14% to 16% range or you’re not going to be there yet? And are you thinking that the automation investment is accretive to that range? Thanks.

[Denny Oates:]

As you look at the second quarter, we see improvement in margin. Basically, we're a quarter off from what we said last quarter in my mind. So we'll be in a lower range of that 14% to 16%, and then as we get into the third quarter, you'll start to see benefits, true benefits from the bar cell, which should give us further lift on that. The only headwind in that regard is what's going to happen with commodities here. As I said in my prepared comments, nickel, for example, is up 17%, 18% far this year. But in the last two or three weeks, things have tailed off. So if we were to close out the month of April, surcharges would probably be flat with a downward bias in June. That's the only wild card in some of the margins as we look out into the third quarter. Other than that, you should see continuous improvement the next two quarters.

[Phil Gibbs:]

Thank you.

[Denny Oates:]

You’re welcome.

[Operator:]

Thank you. [Operator Instructions] We do have a question from the line of Scott Blumenthal with Emerald Advisers. Your line is now open.

[Scott Blumenthal:]

Good morning, Denny and Chris.

[Denny Oates:]

Hey Scott, how are you doing?

[Chris Scanlon:]

Hey, Scott.

[Scott Blumenthal:]

Okay. Danny, can you maybe take a moment and reconcile the record production with the weak shipments? I know you mentioned tool steel destocking. And maybe you can go through some of the segments and talk about where kind of a mismatch between the production and the shipments was during the quarter?

[Denny Oates:]

There is two mismatches if you want to call them mismatches. One is we were candidly a bit surprised by the reduced level of shipment requirements in tool steel, and the other issue is we have been rebuilding and melting in anticipation of growing demand as we move through the year coming from the bar cell. So we are moving material up to our Dunkirk facility in anticipation of continuing that ramp. That's the two reasons for what you're seeing in terms of a build-in in inventory. There were some other one-offs in inventories as well. We had a large shipment of cobalt, which we received during the quarter, which is just under $1 million, which will last us well into the fourth quarter. But fundamentally, the two issues I mentioned earlier is what's driving the what you're characterizing as the mismatch of inventory. As you look at the rest of this year, you should expect to see that inventory come down as we begin processing and get caught up and the bar cell starts to pull material through our manufacturing process.

[Scott Blumenthal:]

Okay. That’s really helpful.

[Denny Oates:]

Hit me with the second part of your question again. Or did I answer both parts?

[Scott Blumenthal:]

No. I think you got everything there.

[Denny Oates:]

All right. Okay.

[Scott Blumenthal:]

And just specifically related to the current quarter, Phil mentioned that you do have a little bit of the quarter under your belt here. Have you noticed any rebound in tool steel orders yet at this point? Or is that something that you're just not expecting until the latter part of the quarter or early Q3?

[Denny Oates:]

We haven’t seen any big movement in tool steel orders at this point in time. And as I said in the prepared comments, we're not really expecting that until later in the second quarter based upon our conversations with customers.

[Scott Blumenthal:]

All right. That’s also very helpful. Thank you.

[Denny Oates:]

You’re welcome.

[Operator:]

Thank you. [Operator Instructions] And there are no further questions at this time. I would now like to turn the call back to Mr. Dennis Oates for further remarks.

[Denny Oates:]

Okay. Thank you very much. I want to thank everybody for joining us this morning. We do sincerely appreciate your ongoing support and interest in Universal Stainless, and we'll be looking forward to updating you on our progress at our next call in July. Have a nice day.

[Operator:]

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.