Universal Stainless & Alloy Products, Inc.

Q3 2021 Earnings Conference Call

10/20/2021

spk00: Good day, everyone. Thank you for standing by and welcome to the Universal Stainless Third Quarter 2021 conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the Q&A, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. And now, I would like to hand the conference over to your speaker today, June Filingeri. Thank you. Please go ahead.
spk01: Thank you. Good morning. This is June Filingeri of ComPartners, and I also would like to welcome you to the Universal Stainless Conference call and webcast. We are here to discuss the company's third quarter 2021 results reported this morning. With us for management are Denny Oates, Chairman, President, and Chief Executive Officer. Chris Zimmer, Executive Vice President and Chief Commercial Officer, and John Arminas, Vice President, General Counsel, and Corporate Secretary. 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 the formalities complete, I would now like to turn the call over to Denny Oates. Denny, we are ready to begin.
spk02: Okay. Thanks, June. Good morning, everyone. Thanks for joining us this morning. Positive business momentum continued to build during the third quarter. Our backlog of $125.1 million increased 27% from the second quarter, reaching the highest level since early 2019 on a continued strong order entry. That 27% increase was on top of a 74% increase in the second quarter. Gross bookings remained high at $58 million, and September had the second highest order entry of the year. Bookings are being driven by aerospace, our largest market. Demand has begun to ratchet up, and more is expected in 2022 and 2023 with a planned step-up of commercial airplane build rates, travel growth, and expanding freight traffic. Our sales momentum moderated in the third quarter. In total, net sales of $37.2 million were off 3.5% from the second quarter. This was not the normal seasonality we commonly see during summer months. Like every industrial business I know, we wrestled with chronic supply chain issues, particularly trucking, coupled with labor shortages. These factors negatively impacted our third quarter revenues by about $2 to $2.5 million. Our gross margin expanded to 6.2% in the third quarter due to four factors, higher activity levels and correspondingly lower fixed charges, reduced variable operating costs per pound processed, surcharges offset increasing raw material costs, and lastly, proactive pricing actions. Our overall plant activity level in the third quarter, as measured by pounds processed, was up 6% from the second quarter and up 53% from the recent cyclical low in the third quarter of 2020. However, plant production remains almost 40% below pre-pandemic levels. We also received forgiveness of our $10 million term note from the Payback Protection Program, and we recorded the gain in debt reduction this quarter. Our balance sheet remains strong to support our strategic initiatives and the ramp in our business. Let's take a closer look at the third quarter results. Net sales of $37.2 million in the third quarter compared to $38.5 million in the second quarter and $37.4 million in the third quarter of 2020. We shipped 12.3 million pounds versus 14.5 million pounds in the second quarter and 12.1 million pounds in the 2020 third quarter. Third quarter premium alloy sales totaled $5.9 million or 16% of sales, virtually unchanged from the second quarter of 2021. With the recovery in aerospace demand beginning to gain traction, we expect to resume growth in our premium alloys starting in the first quarter of 2022. Gross margin in the third quarter increased to $2.3 million or 6.2% of sales from $2.2 million or 5.6% of sales in the second quarter and a loss of $4.4 million or 11.8% of sales in the third quarter of 2021. Gross margin amounts included fixed cost absorption charges of $1.5 million, $2.1 million, and $4.3 million in each of the respective periods. While activity levels have improved in recent quarters, they remain at historically low levels, hence the fixed cost charges. Our goal is to maximize operating leverage as we ramp up operations to meet growing demand while mitigating the negative impact of upward spiraling raw material costs and general inflationary trends on labor and major operating supplies. To be more specific, depending upon grade, third quarter surcharges rose 20% to 30%. largely offsetting sharply higher commodity prices and increasing melt material costs. We've announced four base price increases this year to stay ahead of double-digit percentage increases in parts and consumable operating supplies like lubricants and refractories. The increase announced in March is benefiting shipments now, while the other three increases will begin to impact results as we move into 2022. Variable operating costs per pound processed around 15% to 18% lower than 2020's third quarter, reflecting higher throughput and process improvements. Controllable overhead spending is being tightly controlled, with third quarter spend down 9% sequentially and remains 40% below pre-pandemic levels. Looking more closely at the headline grabbing increases in commodity prices, Nickel prices increased another 8% sequentially and are up 31% from the third quarter last year. Chrome, manganese, and tungsten were up more than 30% during the quarter. On a year-over-year basis, moly, manganese, ferro, titanium more than doubled, while chrome rose more than 90%. Scrap prices also more than doubled from the third quarter last year, but appear to have stabilized at a high level with expectation of sideways movement over the near term. The positive misalignment between the timing of surcharges and increasing melt costs continued to narrow as we expected and amounted to less than $200,000 during the quarter. Power outages and related capacity reductions primarily in China are adding to the volatile outlook for commodities this quarter and into 2022. Selling general and administrative expenses of $5 million, or 13.5% of sales, were essentially unchanged from the second quarter, and we expect little change for the remainder of the year. SG&A expenses remain 26 percent below pre-COVID levels. Our effective tax rate for the third quarter was at negative 17 percent due to the impact of our tax-free gain on the PPP loan forgiveness. We recorded net income for the third quarter of $7.9 million, or 87 cents per diluted share, which included the $10 million gain on the PPP loan forgiveness. Before the gain, the net loss for the third quarter narrowed to $2.1 million, or 23 cents per diluted share, from a net loss of $2.5 million, or 28 cents per diluted share in the second quarter, and a net loss of $7 million, or 79 cents per diluted share in the third quarter last year. Third quarter EBITDA was $12.1 million, including the $10 million gain. Adjusted EBITDA was $3.8 million versus $4.1 million in the 2021 second quarter, and $635,000 in the third quarter of 2020. Looking at our financial position, managed working capital at September 30 was $124.4 million versus $116 million at June 30, and $133 million at the end of the third quarter of 2020. More specifically, inventory increased $14.8 million, or 12%, to $135.6 million from the end of the second quarter. Of the $14.8 million sequential increase, raw materials account for $5.4 million, with $3.6 million of the increase due to higher commodity prices and $1.8 million due to increased melt volume and advanced buying of certain difficult-to-get items. Work and process and supply inventory increased $9.4 million as our growing backlog entered production. Third quarter receivables decreased by $1.6 million, or 7.5% from the second quarter, and we're down 6.7 million or 25 percent from the third quarter last year as DSOs continue to improve. Accounts payable increased 4.8 million or 19 percent from the second quarter of 29 to 29.9 million due primarily to higher melt activity and $1.3 million in capital spending-related payables. Capital spending in the third quarter totaled $2 million, bringing the year-to-date capital spend to $6.5 million. Third quarter depreciation and amortization totaled $4.8 million. Most of the capital spent this year has been for two strategic projects, the addition of a state-of-the-art vacuum mark 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 scale up. Both capital projects are generally on time and within budget. We continue to expect capital expenditures to approximate $11 million in 2021. Total debt at September 30 was $51.5 million, down $1.4 million or 2.7% from the second quarter. Excluding the $10 million note forgiveness, total debt in the third quarter was up $8.6 million or 20% sequentially on higher capital spending and working capital. Total gross availability under the revolvers stood at $39 million on September 30, providing more than ample liquidity for the expected ramp in activity. Now let's take a look at end markets beginning with aerospace, our largest market. Aerospace sales increased 4.4% to $22.3 million or 60% of sales in the third quarter of 2021. Up from 21.3 million or 55% of sales in the second quarter of 2021. In the third quarter of 2020, aerospace sales were $25.1 million or 67% of sales. Year to date, 2021 aerospace sales are 65.8 million, or 58% of total sales. We continue to expect recovery in commercial aerospace demand to gain traction as we move through the fourth quarter. Our current backlog in bookings reinforce the expectation that demand recovery will accelerate as we move into 2022 and 2023. And other positive signs, supply chain inventories have been worked down and are running generally lean in most instances, which is also reflected in our order entry. Lastly, we have begun to hear rumblings of pull-ins for engine parts, which contributes to our confidence. The recovery in demand is supported by the latest forecast for commercial airplane build rates and travel trends. 737 max build rate is moving towards 31 per month and will move even higher pending Chinese recertification. Although nagging short-term quality issues are holding back 787 production, we expect a return to 5 per month during 2022, along with gradual 777 production increases. Airbus recently confirmed its ambitious build rate plan first announced last May, which calls for an average production rate of the A320 of 45 aircraft per month in the fourth quarter of 2021, increasing to 64 by the second quarter of 2023, as many as 75 when you look out to 2025. IATA currently projects global revenue passenger miles in 2021 will improve by 18% over 2020 and rise 51% in 2022. reaching 61% of pre-crisis levels. Global trade is expected to strengthen in 2022 and support growing air cargo volumes. Looking at the big picture for a minute, Boeing's mid-September annual forecast projected the total addressable airspace market over the next 10 years at $9 trillion versus $8.5 trillion projected last year and $8.7 million in pre-pandemic 2019. Boeing also projects 10-year global demand for 19,000 commercial airplanes and up their 20-year commercial forecast through 2040 to more than 43,500 new airplanes, an increase of about 500 planes over the 2020 forecast. Significant growth is also expected for dedicated freighters, including new and convergent models, due to expanding e-commerce and air freight speed and reliability. Business jet flight hours in 2021 are expected to be almost 50% higher than a year ago and above pre-pandemic levels. Current projections call for up to 7,400 new business jet deliveries over the next decade, valued at $238 billion. Financial recovery among the airlines is essential to their willingness to order new planes. That recovery continued for Delta, which reported last week that revenue recovery in the September quarter reached 66% of 2019 levels. compared with 51% in the June quarter and just 25% at the start of the year, mainly due to strong consumer demand and growing improvement in business and international travel. Meanwhile, the aerospace aftermarket continues to improve, and defense spending should continue at current levels in 2022. Our service center and forging customers continue to expect a stronger metal pull in the supply chain to accelerate for building new planes and aftermarket strength in the fourth quarter and well into next year. The heavy equipment market remained our second largest market in the third quarter with sales of 7.6 million or 20% of total sales versus sales of 9.3 million or 24% of sales in the 2021 second quarter. Year-to-date 2021 sales totaled 25 million or 22% of sales and were 53% higher than the same period of 2020. Metal fabrication markets drive plate sales. The continued pickup in industrial manufacturing as well as high automotive retooling and new model development drove the 53% growth in our heavy equipment market sales year-to-date in 2021, while lower sales in the third quarter demonstrated the typical lumpiness in plate shipments as supply chain inventories adjust. We expect plate sales to get back on track as bookings pick up in the fourth quarter and sales pick up in the first quarter based on conversations with our customers. The oil and gas end market was our third largest market in the third quarter, with sales of 4 million or 11% of total sales, an increase of 2.6% from the second quarter, and up 47% from the 2020 third quarter. Oil prices are at a seven-year high, trading north of $80 per barrel, and natural gas prices were up 50% in the third quarter alone, pointing to further recovery in drilling activity. As noted in a recent release, Baker used Reported 264 drilling rigs were added in the U.S. over the past year, while international rig counts were up by 85 just last week. The bottom line for the oil and gas supply chain is that more production equals more parts equals more demand for metal. While there has been some excess inventory in the channel, we see our bookings picking up and continue to expect moderate growth in the fourth quarter and further recovery in 2022. General industrial market sales of 2.2 million, or 6% of sales, were down 4% from the second quarter of 2021 and 25% lower than the third quarter a year ago. Our general industrial market includes sales to the semiconductor, medical, and general manufacturing markets. Quarterly sales to these markets have been at record highs and near lows over the last year. Although consistent sales growth has been elusive, we expect reasonable volume opportunities in 2022 as labor and supply chain challenges recede. PowerGen market declined to $800,000 or 2% of sales compared with 1.4 million or 4% of sales in the second quarter and 1.6 million or 4% of sales in the third quarter of 2020. Maintenance demand has accounted for most of our PowerGen sales in recent years. Normal third quarter seasonality was exceptionally strong this year. We expect maintenance activity to improve, coupled with some benefit from increased gas turbine backlogs and major OEMs. In summary, then, during the third quarter, we had positive market momentum. Our backlog increased to 25.1 million, the highest level since the first quarter of 2019. Gross bookings were healthy at 58 million. Sales did moderate somewhat in the third quarter as we wrestled with the same supply chain challenges and labor shortages confronting virtually all industrial businesses. Our third quarter gross margin increased to 6.2% of sales due to higher activity levels and correspondingly lower fixed charges, controlled spending, and prudent pricing and surcharge management. We received forgiveness on our $10 million PPP term loan and recorded the gain and debt reduction during the quarter. Excluding the gain, the net loss for the quarter narrowed to $2.1 million or 23% per diluted share, while adjusted EBITDA was $3.8 million. We continue to move forward with our growth initiatives, including the addition of the new VAR furnace as well as an 18-ton crucible. While we expect the current supply chain and labor challenges to persist through the rest of the year, we are determined to make further progress in the fourth quarter and take full advantage of our recovering markets, especially aerospace, as we move into 2022. In closing, I want to recognize and thank each of our employees. We've wrestled together with many unprecedented challenges over the past 15 months, and I remain in awe of how each of you is powering through to overcome each of those challenges. With markets recovering and your continued commitment, I remain extremely confident in Universal's future. That concludes my formal remarks. Lovely, we're ready to take some questions.
spk00: As a reminder, to ask a question, you will need to press star and then the number one on your telephone keypad. If your question has been answered and you'd like to remove yourself from the queue, press the pound key. Again, that would be star and then the number one on your telephone. Our first question comes from the line of Mike Hughes with SGF Capital. Your line is now open.
spk04: Good morning. Thanks for taking my questions. How are you doing, Mike? Good, good. Thank you. First question just is on the inventory days. I know this is partially a function of the revenue falling off so significantly over the past year, but they've really drifted up over the past few years. I think they're
spk02: north of 300 days now can you just address that issue and where you see them falling out over the next few quarters uh if you look at the next few quarters you will see those numbers improve and the reason for that will be you'll see higher sales volume is the number one contributor to that the other point i would make is you look at our uniquely look at our inventory levels uh x the the growth and backlog which has been you know our backlog has basically doubled here in the last six months nine months is the fact we carry about $5 or $6 million of what I'll call R&D inventory as we work on approvals at our North Jackson facility, primarily for what we call premium melted products, vacuum induction melted products. The other issue that I would call out this morning is, and I mentioned it in some of my script, is we have had a spike in commodity prices. which has caused a fairly sizable increase in our inventory carrying costs as well. From a P&L standpoint, that is a pass-through to the supply chain via our surcharge mechanism, but to cash out the door up front as we purchase those raw materials and increase our melt schedules is pretty significant.
spk04: Okay. And then just thinking about the backlog, I think it's roughly $125 million now. And if you go back to on a quarterly basis back to 2007, you've historically converted 75% of your backlog into revenue in the following quarter. That's obviously not happening in this environment. And just over the last three years, that number, the conversion is 50%. I'm assuming that's not going to happen in the December quarter. So could you just give us maybe a way to think about the December quarter
spk02: revenue and gross margins i'm not sure you give guidance but maybe just some uh rough parameters we don't give guidance but i can tell you that 66 of the 125 million dollars is scheduled to ship next year and 34 is scheduled to ship before the end of this year 34 of the 125 yes okay So we don't give guidance, but I assume you can figure that one out.
spk04: Yep, yep, appreciate that. And then just the gross margins on a go-forward basis, it seems like there's a number of things that should drive them higher. Number one, the fact that year-to-date there's $6 million that you directly charged to rather than capitalizing into inventories, that's going to be a nice boost to gross margins on a go-forward basis, right? Because it hasn't been capitalized in the inventory. Your costs are lower in the inventory, right?
spk02: That's correct.
spk04: Okay. Yes. And then the second thing, can you help quantify how much the three price increases that are going to start to flow through gross margins will help gross margin sales?
spk02: In terms of putting an exact dollar figure on it, that's a challenging thing to do. What I would say is if you look at the March increase, we're already benefiting from that. If you look at the grades that we had price increases in and the timing of shipments of those products, those other three price increases will start to hit late this year and into next year. But keep in mind, in the back of your mind, what's transpiring here. We are seeing inflation on parts and consumables. And our goal is to grow our gross profit margins. To do that, we need to stay ahead of the inflationary trends, not only in those categories, but also in labor. So that's essentially what we're doing. So as things go down the road into 2022, you should see higher activity levels. That will improve the fixed cost absorption issues we've been wrestling with. We've got process improvements. which will continue to work to improve our productivity and offset some of the inflationary trends. We've got price-based price increases to also offset, and then we've got surcharges as a pass-through for the raw materials. So you put that all together, and we would expect to see continuous improvement. By that, I mean increases in our gross profit in each quarter going forward.
spk04: Okay. Okay.
spk02: I'm not trying to be evasive on the selling price thing. The problem is there's some variables in there that are difficult to quantify. We know we've got significant inflationary items already that we're buying, so it really depends upon the amount of inflation as we go through 2022 as to what the impact is going to be on the gross profit of the selling prices on a net basis.
spk04: Understood. Just one more question. I think on the last call you indicated a desire to hire maybe 100 people over the next few quarters. Where does that stand? And if you're short of that number, how much of a gating factor is it on revenue growth?
spk02: It is a definite issue in terms of revenue growth. It has been to date. I would say that we have seen very modest improvements in terms of applications and hiring over the last two or three weeks. It's a relatively short period of time, but we have seen a noticeable improvement there. We are supplementing our hourly workforce with outside contractors as best we can, but there's no doubt there's a challenge there. As far as the absolute number of people we need, that moves around a little bit based upon the backlog. The backlog has continued to grow, so arguably we need a little bit more than that 100 number as I sit here today.
spk04: Have you made any progress? Have you hired on a net basis since the last call?
spk02: Yes, but it's relatively nominal. It's not something I'm jumping up and down and saying the problem is over. All I'm saying is directionally, if you're an optimist as I am, we have seen some improvement in applications and in hiring, and our net headcount is up, but it's nowhere near where it needs to be. So that continues to be one of the major issues we're wrestling with, as is everybody that I know in manufacturing these days.
spk04: Okay, my last question. This came up on the last call, but any additional thoughts on hiring a CFO?
spk02: We're continuing to work our internal plan, which is to evaluate our internal candidates and compare to outside options. And as I think I said on the last call also, we're going to take this year to do that.
spk04: Okay, thank you very much. Appreciate it.
spk02: Okay.
spk00: Our next question comes from the line of Phil Gibbs with KeyPack Capital. Your line is now open.
spk03: Hey, Danny. Good morning. Bill, how are you doing? Good. Can you elaborate a little bit on the comment that you made during your script on engine pull-ins and what that means or suggests or, you know, maybe – maybe related to other cycles, just in terms of what that signifies?
spk02: Well, we've been looking at demand and inventory levels, right? So we've gone through multiple quarters of destocking. So the next step in aerospace recycling is to start to replenish inventories. And if you look at that little checklist of what normally happens in recoveries, you're going to start to see some of the OEMs start to pull in requests through forgers and then into us. So we're beginning to hear some rumblings is the term I think I used. So I'm not saying that any of our backlog is due to that, but we're beginning to hear some talk about can you, in the supply chain, about can you accelerate some things. And normally pull-ins like that, in other words, we need the metal and the forging is faster than we told you before, suggests that things are starting to heat up a little quicker than people anticipated, which from our standpoint, continues to support our view that we'll see continued improvement in aerospace demand.
spk03: Thank you. And then on the oil and gas side, sales picked up marginally, but obviously rig counts, sequentially I'm talking about, obviously rig counts are starting to move up and there's a lot of thoughts for greater spending next year. Maybe talk a little bit about what you're seeing in that supply chain and what you're customers are telling you?
spk02: Earlier this year, I think I said on the call, what we were hearing in the marketplace was kind of sideways movement with an appreciable improvement in the second half of 2021. But we haven't seen an appreciable improvement. We basically have seen that mindset pushed into 2022. So as we talk to our customers today, they point to what's happening with the price of oil and natural gas and so forth. the increase in spending as anticipated next year, more activity. They would also point to the fact that they're working their inventories down, but they're still a little heavy in certain grades and sizes. So our expectation is we'll see. We saw a little bit of gradual improvement there in the third quarter, but that should accelerate as we go through 2022. That's what they're telling us.
spk03: Danny, you had the overhead charge. carrying charge in the third quarter as well. Is that something that's going to be with you in the fourth quarter too, or is that dissipation is largely done on that?
spk02: I can't say for certain it's done. I would say it's 50-50 at this point in time, to be honest with you. It depends upon how things play out here over the next month or so. We're having active discussions on that subject. It's going to be a function of what our activity levels end up being. generally our accounting practices have a very specific level of activity at each one of our plants. To the degree we exceed a base level based upon historical performance, then we would stop that practice.
spk03: And then my last one's a two-parter. I do appreciate it. You said the price to surcharge is pretty matched in the third quarter. What's the outlook for Q4 and then how should we be thinking about networking capital in Q4? Thanks.
spk02: As far as surcharges, obviously we know they're going to be up in October and November and probably up a little bit in December, but flat lines, kind of flattening out a little bit. So as you think that through, I would expect this to be basically in alignment. We're slightly positive in the third quarter, and we should be in balance in the fourth quarter. That said, I have to admit commodity markets are a little bit crazy right now. They always are, but they're especially volatile at this point in time in terms of getting a read on what the direction is going to be with some of the things that are going on in China with power, some of the capacity reductions. You know, the valet strike that's now over, but I know they're struggling to get capacity back up. It's caused a lot of disruptions in the supply chain. As far as working capital goes, as you look at the fourth quarter, I would expect working capital in general to be up, but not as much as the increase in the third quarter. We expect to have higher sales, so that should drive higher receivables. We're going to be melting at a comparable level, maybe slightly below in the AOD front, but more on the vacuum induction melting front in the fourth quarter. And if you think about that, you're going to see what we've been melting here over the third quarter moving through the rest of the operations as we continue to ramp those operations up. So I would think inventory is going to be up, but not nowhere near what it was in the third quarter in terms of increase. And the payables will track what we do from a melting standpoint. So I would think they'd be, you know, in the $30 million range. Thanks, Sonny. You're welcome.
spk00: Again, to ask a question, you will need to press star and then the number one on your telephone keypad. Okay, we have a follow-up question with Mike Hughes with SGF Capital. Your line is now open.
spk04: Thanks for taking my follow-up. Question on the tool steel plate market. I think you've said that historically the big driver is new auto models. Will that be the case for EVs? How does that business play out on a go-forward basis?
spk02: Yes, that would be positive for the plate market that we serve. Any kind of retooling that the automakers do, which requires new jigs and fixtures and so forth. There's a new EV plant going in. Where is that, in Tennessee? So those kinds of things will benefit us. It's difficult for me to say what percent or what volume it will be, but that would go into the same general category that we typically reference in terms of new model retooling work that gets done.
spk04: Are you one of the few tool steel plate manufacturers in the United States? Is that right? That's correct. Does that mean your margins for that business are a little bit higher than the rest of the business or not?
spk02: Our margins in that business are attractive.
spk04: What percent of revenue is from that business?
spk02: It has ranged over the years from Low double digits, 10%, 11%, up to high teens.
spk04: Okay. And then a last question. In past cycles, did you have the direct fixed cost under absorption charges? I don't remember that happening in the past. Is that wrong?
spk02: It happened for a couple quarters in 2016, but not to the magnitude we have today.
spk04: Okay, great. Thank you very much.
spk02: You're welcome.
spk00: If there are no further questions at this time, I'll hand back the call over to Mr. Dennis Oates for closing remarks.
spk02: Thank you. Once again, I want to thank everybody for joining us this morning. I look forward to updating you on our effort to take advantage of our market opportunities and to move forward on our growth initiatives on our next call in, believe it or not, January 2022. Be well, stay safe, enjoy your holidays, and have a good day.
spk00: This concludes today's conference call. Thank you for participating. You may now disconnect.
Disclaimer

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