Universal Stainless & Alloy Products, Inc.

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.

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.

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.