Good day, ladies and gentlemen, and welcome to the Universal Stainless First Quarter 2014 Conference Call and Webcast. [Operator Instructions] As a reminder, this conference may be recorded. I would now like to turn the conference over to our host for today's call, Ms. Filingeri. You may begin. .

Thank you, LaTonya. Good morning, everyone. This is June Filingeri of CommPartners, and I also would like to welcome you to the Universal Stainless conference call. We are here to discuss the company’s first quarter 2014 results, which were reported this morning.

With us from management are Denny Oates, Chairman, President and Chief Executive Officer; Mike Bornak, Vice President of Finance and Chief Financial Officer; Paul McGrath, Vice President of Administration and General Counsel; and Chris Zimmer, Vice President of Sales and Marketing..

Before I turn the call over to management, let me quickly review procedures. After management has made formal remarks, we will take your questions. LaTonya 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 these formalities out of the way, I would now like to turn the call over to Denny Oates. Denny, we are ready to begin. .

Thanks, June. Good morning, everyone. Thanks for joining us here today. As we reported this morning, our results for the first quarter of 2014 showed strong improvement over the 2013 fourth quarter. Sales increased 16% sequentially on 10% higher tons shipped. Our gross margin improved to 13% of sales.

Operating income was positive at $1.4 million and we had earnings per diluted share of $0.05, excluding 2 tax charges. We ended the quarter with backlog of $59 million, which is up 26% from December 31. That's the highest it's been since the third quarter of 2012..

Debt was reduced despite the additional commitments to inventory in support of our sales and backlog growth. There are several drivers of these results. First, market demand improved in the first quarter led by aerospace.

We've had several months of solid aerospace bookings, which adds to the growing evidence that destocking in the channel is mainly finished. As a result of our stronger bookings and backlog in the first quarter, operating activity levels were higher across all of our facilities, increasing productivity..

Mix is improving. For example, melting production increased 19% while vacuum arc remelting increased 30%, indicating more remelted premium products. We reopened our Titusville remelt shop during the quarter after a 6 months shutdown..

Our operating team has been doing a great job, adjusting to higher activity levels, reporting controlled spending, higher yields and reduced scrap rates. Our first quarter margins also benefited from higher surcharges that better match raw material cost. Nickel rose 12% during the first quarter and has continued to increase through April.

Surcharges will continue to rise in the current second quarter. Additionally, our recently announced base price increase will begin to take effect very late this quarter and more fully in the third quarter. It's also worth noting that the improvement in our margins was accomplished despite higher costs incurred due to the severe winter weather.

All told, those costs approximated $600,000 pretax, consistent with our estimate on the last quarter's call..

We made additional progress in gaining customer approvals in the quarter. One of the main highlights was our announcement in March that we received Pratt & Whitney's LCS approval for all of our facilities. LCS is a system that validates the testing and control materials and processes used in Pratt & Whitney's aerospace products.

Customer response to the news has been positive and they've already placed orders for our LCS approved products..

Looking at cash flow and balance sheet highlights. For the quarter, cash flow remained positive at $2.2 million, even with an increase of working capital to support higher activity levels. If we're paying down another $1.7 million of debt, our debt to total capitalization was 30.9%, that's 30.9% at quarter end.

We are operating well within the covenants of existing lending arrangements..

Let me note a few additional operating highlights for the first quarter, beginning with North Jackson. Activity levels were up overall at North Jackson and remain so today. Compared with the fourth quarter of 2013, pounds produced in the vacuum induction melting furnace more than doubled. Vacuum arc remelting production increased 77%.

Forge production pounds were up 71%. Although we are comparing the first quarter to a very low fourth quarter the magnitude of the improvement shows solid advancement. We continue to introduce new products and have now introduced 20 new products over the last 12 months.

We're committed to maintaining a healthy and safe working environment throughout all of our operations, which is essential for our long-term success.

So we're very proud to announce that we achieved OHSAS 18001 Certification at North Jackson for occupational health and safety activities related to melting, forging, heat treatment and finishing of metal products..

Let me take a few minutes to our end markets. Aerospace remained our largest market in the first quarter at 57% of total sales, which is in line with the 2013 fourth quarter and above the 52% of sales they represented in the first quarter of 2013. Our aerospace sales were up 17% sequentially on an 8% increase in tons shipped.

They were up 4% from the 2013 first quarter on 10% higher tons. Our bookings in aerospace remained strong. As I said at the outset, based on what we're seeing in our bookings and backlog, aerospace inventory destocking appears to have slowed, if not ended.

That view is also consistent with customer commentary, as well as with recent reports from the airframe and engine manufacturers about their increasing backlogs and build rates.

Last week, Boeing reported intake of 235 net orders in the first quarter as market demand for fuel-efficient airplanes remained strong and the need to replace aging aircraft continues and global passenger traffic rises. Current build rates have moved to higher levels.

Production of the 787 has reached 10 per month and is scheduled to increase to 12 for month in 2016. Next-Generation 737s are now being produced at the increased rate of 42 airplanes per month. That production is slated to move to 47 per month in 2017.

Boeing also is expecting a good order year this year for both the 777 and the new 777X, which is due for production in 2020. Boeing's backlog of $374 billion and over 5,100 aircraft at the end of the first quarter equate to approximately 7 years of airplane production by their estimation..

Airbus reported that their net orders totaled to 103 in the first quarter and the backlog stood at 5,521 aircraft as of March 31. They have noted that they are sold out on the A320neo until the 2020s. As to commercial engines, GE reported that its engine backlog was $21 billion at the end of the first quarter, 68% higher than in the prior year.

And although Rolls-Royce is not scheduled to report results for another week or so, their order book in 2013 increased by 22%. In the aftermarket, the Pratt & Whitney saw an 11% increase in commercial spare part orders in the first quarter while GE's commercial spare part orders were up 17% and their military spare parts orders were up 19%.

With build rates and backlogs strong and growing, aftermarket activity expanding and material inventories in better balance, the outlook for aerospace demand continues to be very positive..

Power Generation was our second largest market in the first quarter at 12% of sales. That's consistent with both the fourth and first quarters of 2013. Sales increased 8% from the fourth quarter on a 7% increase in volume. Sales were 6% lower than the first quarter last year on that volume..

Maintenance rather than new turbine builds has been the main driver of market demand and that's expected to continue at least through the balance of 2014. Some of the puts and takes of the market are evident in GE's first quarter report, while they had 31 gas turbine orders in the first quarter compared with 8 in the first quarter last year.

That's down from 65 orders they reported in the 2013 fourth quarter. We expect our Power Generation sales to be stable to somewhat higher in 2014 with some fluctuation in demand quarter-to-quarter..

The oil and gas market sales represented 9% of first quarter sales versus 8% in the fourth quarter of 2013 and 13% of sales in the 2013 first quarter. Our oil and gas sales increased 39% from the fourth quarter on an 11% increase in volume. They were down 32% from the first quarter last year on 29% lower volume.

As the comparisons suggest, there has been a whipsawing in oil and gas demand as customers work to adjust their inventories in the context of changing trends in rig and well counts and various weather disruptions affecting the oil service providers.

Schlumberger reported that severe winter weather impacted their operations in North America, as well as in Russia and China in the first quarter. Nonetheless, they view the fundamentals of global recovery being intact so oil market is tighter than what's expected and remain positive about growth in 2014..

BakerHughes reported a severe weather in the Northeast and the Rockies reduced well count in the first quarter, but the rig count picked up in the Permian Basin during that period. They're forecasting a 4% increase in overall U.S. rig count for the year.

So directionally, oil and gas is positive, but channel inventory adjustments will continue to be a factor in 2014. The second half of the year is expected to be stronger than the first half..

Heavy equipment market sales were 8% of first quarter sales versus 11% in both the fourth quarter and first quarters of 2013. First quarter 2014 sales were 14% lower sequentially on 10% lower volume and down 28% from the first quarter last year on 30% lower volume.

Our tool steel plate sales, which represent the majority of the sales in this category typically vary quarter-to-quarter depending on level of imports, as well as on service center inventory decisions, both impacted the first quarter.

While the recent news from the automakers has been focused on recalls and related reserves, the heavy schedule of model changeover in 2014 is continuing, which is a positive for tool steel plate demand. Our outlook for tool steel is stable with a positive bias..

With my review of the end market complete, let me turn the call over to Mike for his financial review.

Mike?.

Thanks, Denny. As Denny indicated, our first quarter 2014 net sales were $46.7 million, which is an increase of $6.4 million or 16% when compared to the fourth quarter of 2013.

The increase in the first quarter net sales reflects improving business conditions, especially in the aerospace market where net sales have increased by approximately $4 million and our shipments have increased 8% from the fourth quarter of 2013.

In addition, our first quarter 2014 shipments to the oil and gas markets were up 11% and power generation was up 7% [ph], while heavy equipment shipments were down 10% compared to the fourth quarter of '13..

Our gross margin in the first quarter of 2014 was $6.1 million or 13% of net sales compared to $1.5 million or 3.7% in the fourth quarter of 2013. This increase from the fourth quarter of 2013 was primarily due to higher shipment volume, improved product mix, higher production levels of yields and a better match of surcharges to raw material costs.

On our last call, we estimated that weather-related costs in the first quarter would range between $500,000 and $600,000. The actual cost came at the high end of our range at approximately $600,000 and were primarily due to higher natural gas costs..

Our selling, general and administrative costs for the first quarter of '14 were up from the 2013 fourth quarter, but were in line with the SG&A cost incurred in the same period last year.

As a result of our increased sales levels and improved gross margins, we posted operating income of $1.4 million in the first quarter of 2014 compared to an operating loss of $2.6 million in the fourth quarter of '13, an improvement of over $4 million in just one quarter.

In the first quarter of 2014, we incurred 2 tax charges that approximated $900,000. These included a noncash write-down of a state deferred tax asset of approximately $100,000 as a result of new legislation in the State in New York.

New legislation enacted in New York on March 31 reduced the state income tax rate to 0% for qualified manufacturers for tax years beginning January 1, 2014. We are a qualified manufacturer in the State of New York, thus we have a 0% tax rate going forward as a New York qualified manufacturer.

However, the result of this legislation had a negative impact on the preferred tax asset on our books as this tax asset will no longer be able to utilize under the new legislation, there's no future liability offset with a 0 tax rate and therefore was written off in the quarter..

Second tax item was an accrual of approximately $300,000 related to a pending Pennsylvania settlement regarding the deductibility of certain tax expenses on prior year returns. These 2 tax charges had no impact on our bank covenants. However, they did reduce our first quarter 2014 diluted earnings per share by approximately $0.12.

Therefore, excluding these tax charges, we would have posted earnings per share of $0.05 on approximately 7 million diluted shares outstanding..

Turning now to the balance sheet and our working capital. On March 31, our managed working capital defined as accounts receivable plus net inventory minus accounts payable increased by $2.7 million to $92.5 million compared to $89.8 million at the end of 2013.

Our net accounts receivable increased by approximately $6.6 million due primarily to the 16% higher sales level in the first quarter compared with the previous quarter.

Our inventory rose by $8.6 million as we strategically increased inventory levels on certain grades of material due to increased booking levels in advance of some planned short-term outages scheduled in April. Accounts payable levels rose by $12.4 million in the first quarter due primarily to higher operating and inventory levels.

Capital expenditures were approximately $1.3 million for the first quarter. Both of our capital spending will be geared towards maintenance CapEx in 2014 as costs associated with bringing up the North Jackson plant are mainly behind us.

During the first quarter of 2014, we did generate cash of $2.2 million and repaid $1.7 million of bank debt and we are in compliance with all of our bank covenants..

That concludes my financial report. Denny, I'll turn the call back over to you. .

Okay. Thanks, Mike. In summary then, our results for the first quarter of 2014 showed strong improvement over the 2013 fourth quarter. Sales bookings and backlog all rose by double digits. That was driven by strong demand in the aerospace market where destocking is winding down as well as by our progress in winning customer approvals.

As a result of our strong bookings in backlog, production levels were up company-wide in the first quarter, which increased our productivity and cost absorption. Higher surcharges also better match raw material costs in the quarter, and they should continue to rise in the current second quarter.

Our base price increase also begin to take effect very late in this quarter. Even though we increased working capital to support the higher activity levels, our cash flow from operations remained positive in the quarter, enabling us to pay down more debt. Our total debt has been reduced by 16% since the first quarter last year.

Looking ahead, the aerospace market demand remains very strong and we expect that aerospace will continue to drive our results in coming quarters while recovery in the balance of our end markets is expected to be more gradual.

Last quarter, I said that our strategy was to keep ourselves laser focused on executing our long-term plan so that as demand recovered, we would be ready to seize the opportunities. Demand has started to recover. We have been seizing opportunities and our full focus now remains on executing our long-term plan..

With that, I will end my formal remarks and turn it over to everyone for questions. .

[Operator Instructions] And our first question comes from Phil Gibbs of KeyBanc Capital. .

I had a question on the tally business and the business effectively that started to wane for you guys beginning this year and how you're approaching the strategy to offset that and/or what impacts that had on the first quarter, maybe relative with the fourth? Or give us some sort of assistance on that. .

Okay. As far as bookings from Carpenter's tally operations, they ceased in the fourth quarter, so we had no bookings in the fourth quarter and the first quarter. So as you look at our improvement in bookings, it's not much better so to speak if you look at it that way.

From a sales standpoint, it was little over $1 million in revenues in the first quarter of 2014 and we do not anticipate any further revenue from the tally operations.

Chris Zimmer, do you have anything to add to that?.

I think that this has created an opportunity for us in the face of an improving market demand, utilizing this capacity now to serve those target customers and products with an improved mix.

The market environment has really begun to improve as we thought and the freed-up capacity allows us now to service those markets with speed, maintaining our lead times. .

So I would just to add to that, Phil, that there's some -- I wouldn't look for any one big contract to replace the tally business. We've been adding to things that as we go here, and you see that in our bookings, and we're focused on higher-margin products, as Chris said.

We are working on some other sizable opportunities that, frankly, I don't know they'll come to fruition or not.

We're making some test each for folks that I could, perhaps, at some quarter in the future call out as a specific piece of business that we targeted to replace tally, but I think this is going to be more a thing of quarter-to-quarter as we start to piece together business that we didn't have before because we have the open capacity here. .

Okay.

And then on the VIM piece, Denny, or the premium alloys, last year, fairly low utilization as anticipated, but this year, what should we expect the cadence to be in '14 and '15 either from a volume standpoint or call it a cap utilization standpoint, North Jackson?.

As far as the vacuum induction melting furnace, we're beginning to get approvals, they're coming slower and they take a long time to get, as you know. Our expectation is you should see gradual improvement in vacuum induction melting activities. You should see improvement quarter-to-quarter.

As we get these new approvals, we obviously -- that's the first step that we've got a negotiated arrangements for business and actually get into production. So, we see that ramping over the next 2 years.

We've called out the fourth quarter of 2015 is kind of a target date to get a sizable percentage of that facility utilized and we're still focused on that date. So I would take where we're at today and look at the fourth quarter of 2015 and expect to see gradual improvement there.

That said, as we get major approvals, so probably lumpier than what I'm describing, but that's the best we can -- it's the best crystal ball I have at this point in time. .

Okay, I just have one more, and then I'll turn it over. I appreciate it. The -- call it the legacy air melt products that then get further remelted.

So basically prior to North Jackson, your mix of remelt, are you seeing that you materially better than the second half '14 run rate?.

If you look at the remelt -- the non-vacuum induction melted remelt volume, it clearly increased in the first quarter of 2014.

If you look at the percentage increase in our AOD melting that I alluded to in my prepared comments versus the increase in the remelting, that shows you that the business going through has a sweeter mix, if you will, higher margin mix, which means basically, in our case, more remelting.

As I look to the future here, you look at the markets that are trending up, aerospace has a higher percentage of remelt. Obviously, oil and gas where we are targeted has a higher percentage of remelt. So I would expect that relationship to continue and expect to see stronger remelting as we go through 2014. .

[Operator Instructions] And our next question comes from Dan Whalen of Topeka Capital. .

Just on the gross margins, certainly good to see pendulums moving in the right direction here.

Just in terms of the better matching on the raw material cost with the selling prices, certainly been a bit of a headwind for some time, is it now in more of a balanced scenario or was it a little bit of a tailwind to this quarter?.

It's a little bit of a tailwind for the quarter. You're starting to see the surcharges, which are, following nickel prices, increased at a faster rate than our costs are. So you're starting to see that switch over.

As you look at the month of April, Dan, and I know you follow us this, so I'm not telling you anything you don't already know, nickel has continued to accelerate in the month of April at a higher rate, if you will, than it did during the first quarter.

So that's to my point that we would expect to see surcharges continue to increase in the second quarter. .

Okay. So we could see an incremental tailwinds as well. Great. And then -- thanks for the color on the end markets.

Just wanted to try and get a better sense in terms on the 26% sequential improvement on the backlog, do you think that was kind of raw demand or maybe a little bit of a restocking ahead of this higher nickel price, how are you kind of viewing that?.

I think -- and you know we mentioned this on the call last quarter that we felt the destocking had largely ended, and I think it's been validated in the first quarter that the destocking has been ended. So at a minimum, our customers are buying to their needs.

Some of them have begun to restock a little bit because they're anticipating stronger demand as we go through the rest of this year. When I asked the question, "Are you buying anything in advance because of nickel?" The answer I typically get is "No." So I can only go by what our customers are saying and what I see in the warehouses.

So I haven't seen that the double ordering and the triple ordering that you historically see sometimes when nickel really takes off, and I think that's probably because they're looking at the nickel and they're saying that some of this spike, is it going to be long-lived or not? And some of this is being driven by increased supply, supply-demand dynamics obviously, but a lot of this has to do with what's going on in Indonesia and what's going on over in the Ukraine, the psychology of that marketplace and the expectation that, that won't continue to drive up nickel prices.

So I don't view our demand -- excuse me, our bookings and backlog increase in the first quarter as being driven by higher nickel prices. .

Great. And if I could may 1 or 2 for Mike. Just on the D&A side, it's been a little bit choppy.

How should we think about that going forward?.

I think it will increase slightly, Dan. I mean we're typically running anywhere between, with D&A together, about $4.2 million, $4.3 million a quarter. .

Okay.

So that's a pretty good run rate going forward?.

Right. .

Great.

And I think in the last call, you mentioned tax rate to be about 34% on a full year basis?.

Yes, that's -- actually, you'll see that in the 10-Q that will be come out later today, the effective tax rate for the first quarter right around 34%. .

Okay.

So that we think we can keep that on a full year basis as well?.

Correct. .

And our next question comes from Luke Folta of Jefferies. .

First question, just trying to get a sense of what the impact, the total impact of improved base pricing could be going forward. Are you -- the increase of that had been announced.

Are you predominantly getting that on the aerospace side of the business? Can you talk about the non-aerospace stuff in terms of what you're seeing in terms of the base pricing trends there?.

Yes, let me turn that one over to Chris Zimmer, our VP of Sales and Marketing, he can run down what we're doing from a pricing standpoint.

Chris?.

Yes, the base price increase that went out at the end of March went through effect for new order entry on April 1. So we're going to begin to see that in shipments here towards the end of the second quarter, but in large part in the third quarter.

The product groups that are impacted represent about 1/3 of our sales, so you'll see that 5% increase primarily start to roll through towards the end of the second quarter, but mostly in the third quarter impacting 1/3 of our sales. The increase would be across all of our markets.

I think it was impacted on premium melted products of VAR and those are going to aerospace and power generation and oil and gas, and the market acceptance of the increase has been very good. What we call our capture rate has been nearly 100%. .

Okay. In the -- it's nice to see some restocking going on, on the aerospace side.

Can you just talk to where supply trends are in the supply chains for power gen, oil and gas?.

As we look at oil and gas, there's -- we still hear discussions about destocking and excess inventories in pockets. That's why we're looking at this year more from our standpoint as picking up as we go through each quarter as they've -- as our customers work off that overstock situation.

I think the weather and some of the issues that our customers -- customers face during the first quarter has had an impact, not a positive one obviously, in terms of the pace at which they're working down some of those inventories.

So I kind of look at the oil and gas business as being 3 to 6 months behind the aerospace industry in terms of the product levels that we see in the inventories of our customers. On power generation, not so much an inventory issue.

In my mind, that's more or less a maintenance business so it's a function of how hard we work in turbines and what kind of maintenance requirements does that entail. And one would expect, given the level of operation of turbines, with the added natural gas that business should have an upward bias as we go through the rest of this year.

We're not anticipating any big boom in new turbine business however, certainly not this year. Maybe we'll see some as we exit the year, which will result in some higher sales opportunities for us as a mill in the fourth quarter, but we're not planning on that at this point in time. .

[Operator Instructions] I'm showing no further questions. I would now like to turn the call back to Mr. Oates for concluding remarks. .

Okay, thank you. Thanks to everyone for joining us here today. I ended our last call expressing cautious optimism about 2014. I think as you look at our first quarter results, it gives us additional support and optimism about 2014.

Although full economic recovery is far from certain, our bookings and backlog continue to show positive signs and in any event, we will continue to execute our long-term strategic plan for growth and building stockholder value and will look forward to updating everyone here on the call at the end of the second quarter.

I hope everybody has a great day. Thank you. .

Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day..