Universal Stainless & Alloy Products, Inc.

Good day, and thank you for standing by. Welcome to the Universal Stainless fourth quarter 2023 conference call and webcast. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today. June Fillingeri, please go ahead.

Good morning. Thank you for joining us. This is June Fillingeri of ComPartners, and I'd also like to welcome you to the Universal Stainless Conference call-in webcast. We are here to discuss the company's fourth quarter results reported this morning. With us for management are Chris Simmer, President and Chief Executive Officer, John Arminas, Vice President and General Counsel, and Steve DiTomaso, Vice President and Chief Financial Officer. 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 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 Chris Zimmer. Chris, we are ready to begin.

Thank you, June. Good morning, and thank you for joining us. Our 2023 financial audit is now complete. The 10-K will be filed tomorrow, and I'm pleased to report that our financial results show our strategy to accelerate profitable growth is gaining traction. Here are some highlights. Fourth quarter sales were up 12% sequentially to a record $80 million. That's the fifth consecutive quarter of sales growth. Full year sales were up 42% to a record $286 million. Premium alloy sales also reached record levels, climbing to $21 million in the fourth quarter and jumping 74% for the full year to $68 million, or 24% of sales. Gross margin has improved each quarter in 2023, reaching 16.4% in the fourth quarter, the highest level since 2018, despite a $1.6 million raw material misalignment headwind. Sixteen base price increases over the last three years, including the latest on February 12th, continue to benefit sales and gross margin while offsetting negative surcharge misalignment on commodity prices that have been falling. We expect to realize more of these price increase benefits as we move through 2024. Commodities have stabilized over the past few months, which should ease the raw material misalignment by the end of the second quarter. Operating income rose 9% sequentially to $4.8 million in the fourth quarter, despite higher SG&A expense on employee-related and insurance costs. Net income reached 27 cents per diluted share in the fourth quarter and 53 cents per share for the year, representing a marked turnaround from losses in 2022. Backlog remained strong at $318 million at year end, and order entry continues to be healthy. Premium alloys constitute 36% of our backlog. Our debt was reduced by $13 million in 2023, even with our strategic spend, which has added two new vacuum-marked remelt furnaces in North Jackson. We plan to continue to reduce that in 2024. The new VAR furnaces were released into production last month. This new capacity, in combination with capacity expansion of our VIM furnace, will accelerate our premium alloys ramp, which is key to our strategy of accelerating profitable growth. Turning to our end markets, starting with aerospace, fourth quarter sales rose 15% sequentially to a record $62 million. Full year aerospace sales increased 57% to a record $216 million or 76% of sales. As I said in January, aerospace demand was robust in the fourth quarter and that continues today. The dynamics of that demand remain the same. global recovery and air traffic, the demand from airlines for new, more fuel-efficient planes amid capacity constraints due to resilient demand and to replacing aging aircraft. Huge order backlogs at Airbus and Boeing extending into the next decade, even with Boeing's current challenges. Since our call in January, Boeing's challenges which were precipitated by the plug door blowout on an Alaska Air MAX 9 have continued, including investigations by the FAA, NTSB, and Justice Department into the accident and also into Boeing's production procedures. The FAA has capped production of the MAX airplanes at 38 per month, and they've set a 90-day period for the company to develop a plan to address quality control issues. At a conference last week, Boeing CFO underscored their objective to increase quality and to drive supplier stability. The airlines have been pressing for changes given how critical Boeing is to their fleet expansion plans. Ultimately though, the airlines are holding their slots for Boeing aircraft because their growth plans require it. In fact, Boeing recently described Demand is robust, noting new 737 orders from American Airlines, a Thai Airlines order for 787s, and an Ethiopian order for the 777X. At the end of February, Boeing's gross backlog of the 737 MAX airplanes totaled 4,752. Wide-body demand has increased with recovery and international travel. Boeing has reached a build rate of five Dreamliners per month and is working towards 10 per month by 2016. Their 787 backlog stood at almost 800 at the end of February, while total backlog was 5,900 planes or nearly nine years of production. For Airbus, the main challenge to reaching their build rate goals has been the supply chain. Despite that, Airbus expects the A320 build rate to reach 56 per month in 2024 and recently reported progress well towards their goal of 75 aircraft per month in 2026. Airbus' backlog of A320s at year end totaled nearly 7,200 aircraft. As to widebodies, Airbus is working towards a monthly rate of four aircraft for the A330 in 2024 and a rate of 10 in 2026 for the A350. Total year-end backlog at Airbus was 8,600 aircraft. The sustained recovery in air traffic is a major factor driving aircraft demand. IATA estimates global air traffic will grow more than 3% per year over the next 20 years, even with the constraints of infrastructure, delays in aircraft delivery, and supply chain issues. Heavy air traffic and the delivery delays of new aircraft are also fueling demand in the MRO market. In the defense sector, worsening world conflicts, increasing threats from Russia, China, and North Korea, and the step-up in military spend by NATO countries are driving increased market demand on a global basis. In the US, the DOD budget for 2024 prioritizes modernization of the fighter force and air defense, benefiting domestic demand for materials. The administration has now proposed an increase to the 2025 defense budget to $895 billion. As a major supplier of the premium and specialty alloys required for defense applications, our participation in that market is growing. We estimate 15 to 20% of our aerospace sales are going to defense. Overall, the aerospace market remains robust and the supply chain remains in a full pull mode based upon our channel checks. Supply chain challenges since COVID have compelled the primes to strengthen and diversify their supplier sources and we have benefited. This has been evident by the pace of our approvals that we are receiving and the new business that we're winning. We expect strong growth in our aerospace sales, including premium alloys, to continue as we move through 24 and into 25 and 26. Fourth quarter heavy equipment market sales were $6.4 million, a decrease of 28% from the third quarter, but up 14% year over year. Full year sales increased 15% to $31.2 million, or 8% of sales. As we discussed last time, customers grew cautious in the fourth quarter as the outlook for EV sales weakened, and we are seeing that near-term caution in the first quarter as well. Even so, the carmakers are continuing to introduce new models requiring retooling and tool steel. We do expect demand to improve in the second half of the year. General industrial sales increased 68% sequentially to 5.6 million in the fourth quarter. Full year sales of 2023 rose 43% to 15.7 million, or 7% of sales. Our general industrial sales are mainly for semiconductor manufacturing. Our latest results show the growing strength of that market. The Semiconductor Industry Association has projected double-digit growth for 2024. Given the need for increased chip manufacturing and the move to onshore, we remain very optimistic about 2024, especially in the second half of the year and beyond. Looking at our energy markets, oil and gas market sales totaled $3.6 million in the fourth quarter, which is 38% higher than the third quarter, although 32% lower than the fourth quarter of 2022. reflecting our shift of production to higher margin aerospace products in 2023. That shift is also reflected in full year oil and gas sales that totaled $14 million, a decline of 22% from 2022. Oil and gas sales were 4% of total 2023 sales. We plan to temporarily continue to strategically shift our production assets to aerospace in 2024. That same shift especially for finishing capacity, is evident in our power generation market sales, which were $1.1 million in the fourth quarter. While that's up 51% from the third quarter, full-year 2023 sales were down 31% from a year ago to $4.2 million, or just 1% of sales. I noted last time that as we continue to ramp our production levels, we remain very well positioned to expand our sales into the energy markets in the future. Now let me turn the call over to Steve for his report on our financials.

Thanks, Chris. Good morning, everyone. I have to start by telling you that it feels good to be here before the end of March reporting our results as we committed to you back in January. 2023 was a unique year for us. and we capped it off with our best financial performance since mid-2018 by several measures, including a record-setting top line. But before I dive deeper into the numbers, I'd like to update you on the anticipated filing of our annual report in Form 10-K tomorrow and in Section 9-A of that document. You will find management's report on internal control over financial reporting, where we describe material weaknesses in internal control as of December 31st, 2023. Some detail of those weaknesses will be disclosed in the document, but I would like to provide context and perspective today. The main item to emphasize is that there is no restatement of numbers in the current period or any prior period, and the financial statements present fairly in all material respects the results and consolidated financial position of the company. The core of the weaknesses relates to process and documentation. We have already started improvement actions and our existing processes will be enhanced to meet the standard required to remediate the weaknesses. The internal control weaknesses are being addressed and will be subject to remediation testing in future periods. We will continue to update you as we make progress in that effort. We cannot commit to a specific timeline for formal remediation. However, this is a top priority and we are focused on implementing control enhancements immediately as we turn around and close the books on Q1 2024. Now back to the numbers. Chris already highlighted our record top line sales achievement despite a sequential decline in raw material surcharges per pound within our selling prices. This was the result of many positives, more shipment volume, higher base prices, and a higher mix of then-melted product. That top line drove an increase in gross margin, which reached $13.1 million in the fourth quarter. or 16.4% of sales, an increase from 15.3% in the third quarter, and 4.3% in the 2022 fourth quarter. Note that the prior year fourth quarter was impacted by outages at key production units, and those did not recur this year. The sequential increase is driven by a combination of price and shipment volume as described already, and lower costs as we are beginning to see benefits from increased productivity and better production efficiency. In addition, the margin would have been nearly two percentage points higher if it were not for the $1.6 million of raw material headwind that Chris mentioned. Selling general and administrative costs in the fourth quarter totaled $8.3 million, compared with $6.4 million in Q3. About $1.5 million of the $1.9 million increase is attributable to employee costs. The remaining increase was due to the higher cost of business insurance as we renew our policies annually on October 1st and incurred a premium increase during the current year renewal. For the full year, SG&A expenses increased $6.4 million to $27.8 million from $21.2 million in 2022. And the drivers were the same as those for the quarter. Employee costs made up nearly $5 million of that change. Business insurance contributed $1.2 million. And higher accounting and auditing fees rounded out the increase. The insurance component and portions of the employee costs will persist, but we expect other elements to come down from their Q4 2023 highs, and we expect our first quarter 2024 SG&A expense to approximate $7.5 million. Our operating income of $4.8 million was $400,000 better than Q3 and well ahead of the operating loss posted in the fourth quarter of 2022. The last time we saw operating income of this level was mid-2018 on considerably higher shipment volume. As we continue to execute our growth strategy, deliver on the top line, and bring SG&A back to $7.5 million, we will drive more expansion in operating income in the coming quarters. Total interest expense for the quarter was $2.2 million, approximately flat to Q3, and up about $600,000 from the prior year fourth quarter. Average debt during the fourth quarter was about $6 million lower in 2023 compared to last year, but term SOFR rates climbed from about 3.5% on average during the prior year quarter to 5.3% throughout Q4 2023. Interest expense rose sequentially each quarter in 2022 and this year before flattening in Q4. We expect that trend to reverse now each quarter as we step through 2024. We reported an income tax benefit of about $20,000 on our pre-tax income during the quarter resulting in an effective tax rate of close to zero. This rate would be similar to our annual ETR if not for the impact of discrete items on the quarter. Our income tax expense for the year was about $400,000 on pre-tax income of $4.9 million for an effective ETR of 7.5% for the year. The effective tax rate is less than the federal statutory rate of 21%, primarily due to the impact of our research and development tax credits, which decrease income tax expense for the period. This benefit is partly offset by about $300,000 of tax expense from forfeited stock options. Other elements of the rate calculation are not significant. Net income in the fourth quarter was $2.6 million or 27 cents per diluted share. Our fourth quarter EBITDA was $9.6 million, bringing our full year 2023 EBITDA to nearly $33 million compared with $12.8 million last year. Our adjusted EBITDA was $10 million for the quarter and $34.2 million for the year. Adjusted EBITDA includes an add-back for non-cash share compensation, and there is a reconciliation of EBITDA and adjusted EBITDA in the tables to the press release. We generated more than $7 million of cash from operations in the fourth quarter, bringing our 2023 operating cash generation to over $25 million. After spending $13 million on capital expenditures for the year, We use the remaining operating cash to pay down debt and expand our liquidity. Our debt reduction in Q4 totaled $4 million, and we expect to pay down debt each quarter in 2024, beginning with about $3 million in Q1. Debt reduction is expected to accelerate in the second half on higher sales, higher margins, and managing limited growth in working capital. We also expect to spend about $16 million to $18 million on capital expenditures in full year 2024. This concludes the financial update, and I'll hand the call back to Chris.

Thanks, Steve. In summary, our fourth quarter and full year 2023 results indicate our growth strategy is kicking into high gear. Commercial aerospace demand remains robust, and our participation in defense is growing. Approvals and new orders are rolling in, as the primes want us in their supply chain. We're seeing that in backlog, which remains strong at $318 million, while order entry also remains healthy. We've expanded our premium alloy capacity and capabilities with the capital investment in North Jackson. The balance of our end markets offer continued opportunity, including model changeovers for tool steel demand, on-shoring and expansion in the chip manufacturer for our general industrial sales, and in energy, the need for our grades of steel for drilling in hostile environments and construction and maintenance of gas turbines. Profitability is strengthening with the gross margin of 16.4% at a five-year high. Three years of price increases and increasing premium alloy sales are expanding our top line and margins. We've reduced debt as we continue to generate positive cash flow and plan to reduce debt further in 2024. First-order results are thus far indicating that our growth is continuing. We are genuinely excited about our future and the growth momentum we are seeing for 2024 and beyond. We plan to keep our heads down and execute. That concludes our formal remarks. Operator, we're ready for questions.

As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again.

Please stand by while we compile the Q&A Our first question comes from Phil Gibbs with KeyBank Capital Markets.

Your line is now open.

Hey, thanks. Hello. This is the general. Hi, Phil. Good morning. Good morning. Sense of just revenues and gross margins in the first quarter as you've got pretty good visibility now at the tail end of the quarter. You're at the tail end of the quarter, rather.

Yeah, I think that the key components that we've been talking about, we'll see that continue into the fourth quarter. We're not quite wrapped up with the numbers yet, but I would continue to see that sequential top line growth, margin expansion, and debt reduction.

And you mentioned in your script that you would anticipate the misalignment to be behind you by the end of the second quarter, assuming assuming that raw material prices sort of stay where they are now, do we assume the first quarter has a pretty similar impact as the fourth and then that will nicely moderate in Q2?

Yeah, that's right. I think you're spot on. The first quarter misalignment ought to be in the same neighborhood as fourth quarter. Surcharges have been moving sideways. Right now, we just need to turn through that inventory, which is about about a six-month process, so moderating misalignment in the second quarter.

And then maybe update us on North Jackson in terms of what you'd anticipate from that business in the short term and midterm with some of these new de-bottlenecking initiatives getting kicked off.

Yeah, we talked about the two new VARs, which had been an area of opportunity for us to grow supporting the premium sales. Those two new VARs were moved into the operational side of the business. They're running great, and that's helping to support the new demand that's flowing through on the premium side. The team at the melt shop there is doing a great job executing and growing upon the big backlog that we have. So they're making strides every month to be able to realize that potential there. We do have investments downstream as well, too. Thermal treatments at the Forge and continuing to focus on training our employees. The average tenure, we've talked about it before, these days is lower than pre-COVID. But a lot of that is behind us. The workforce has really done a good job stabilizing and continuing to be able to pull through and hit the productivity levels that we need to support this backlog.

And then on the networking capital side, I think you mentioned that you'd expect minimal minimal change in that working capital for the year. Good to see your inventory was down nicely, getting to a better range relative to the sales. And so I'm just curious in the moving pieces, you know, what the thoughts are with on all the major kind of points of working capital in 2024.

Yeah, we continue to find opportunities to be able to pull that down while still expanding our top line. the orientation of that inventory, aerospace products tend to take about anywhere from four to seven months, depending upon the amount of work that we need to do to pull them through the system. Semi-finished products like our tool steel grades, we can turn around in a couple of months. So the nature of a higher portfolio of aerospace sales does put a little bit more pressure on working capital and our ability to be able to turn it quicker. So my expectation is that that's going to move sideways this year. We're going to continue to expand the top line. Then as that tool steel side of the business heats up in the second half of the year, that should fuel some additional improvements to our inventory turns.

Thank you. Thanks, Bill.

Thank you. Once again, to ask a question, please press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by while we compile the Q&A roster.

This concludes the question and answer session for today's conference call.

I would now like to turn it back to Chris Zimmer for closing remarks.

Thank you again for joining us this morning. Our growth strategy gained momentum in 2023, and our optimism is high for 2024 and beyond. We look forward to updating you on our progress on our first quarter call.

Have a great day. This concludes today's conference call. Thank you for participating. You may now disconnect.