June Filingeri - Investor Relations, President of Comm-Partners LLC Denny Oates - Chairman of the Board, President, Chief Executive Officer Paul McGrath - Vice President of Administration, General Counsel, Secretary.

Michael Gallo - CL King Phil Gibbs - KeyBanc Capital Markets Bob Sales - LMK Capital Management.

Good day, ladies and gentlemen and welcome to Universal Stainless second quarter 2015 conference call and webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this call will be recorded.

I would now like to introduce your host for today's conference Ms. June Filingeri. Please go ahead..

Thank you. Good morning, this is June Filingeri of Comm-Partners and I also would like to welcome you to the Universal Stainless conference call. We are here to discuss the company's second quarter 2015 results reported this morning.

With us from management are Denny Oates, Chairman, President and Chief Executive Officer and Paul McGrath, Vice President of Administration and General Counsel. Before I turn the call over to management, let me quickly review procedures. After management has made formal remarks, we will take your questions.

Our conference coordinator, Catherine, 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..

Thanks, June. Good morning, everyone. Thanks for joining us here today. The second quarter of 2015 was challenging due to the growing impact of decrease in commodity prices, specifically the drop in oil, nickel molybdenum and scrap.

The price of nickel saw an additional 7% in the second quarter, moving from $6.23 a pound in March to $5.80 a pound in June bringing the decline to 20% for the first six months of the year. Moly was at $7.30 a pound at quarter-end, down 12% from the end of the first quarter and down 23% so far this year.

Both commodities have continued to decline since the end of June, with nickel down another 12% and moly down another 20%. These falling commodity prices reduced surcharges faster than melt cost over the short-term resulting in a temporary contraction gross profit margins.

They also caused customers to delay purchases in place smaller order sizes in order to average down their inventory costs on lower future surcharges. Current mill lead times are short and reinforces such conservative buying patterns.

The decline in demand the oil and gas market accelerated during the second quarter, reflecting falling recounts, sharply curtailed E&P budgets and excess inventory throughout the supply chain. As a result, demand for the specialty metal grades used in oil and gas is down significantly.

Additionally, there has been a spillover effect into other metal grades, product forms and use markets as service centers and forgers moved to rebalance their overall inventories to meet aggressive inventory reduction targets. Lastly, the competitive landscape has grown more challenging as producers jockey to fill underutilized facilities.

With this as background, let me turn to our results announced this morning. Net sales in the second quarter of 2015 were $49.6 million, which is down 11% sequentially on 10% lower volume and 5% lower than the second quarter last year also on 10% lower volume.

Year-to-date net sales of $105.6 million were up 7% compared to the first half of 2014, despite 2% lower volume, indicating further progress in moving to a higher value sales mix. In fact our sales of premium alloys were up 34% in the first half of 2015 versus the same period last year and represented 8.8% of net sales.

As a reminder, we define premium alloys as the advanced alloys produced through the vacuum induction melting furnace in North Jackson.

We realized an average selling price of $2.78 a pound in the second quarter of 2015 and $2.81 year-to-date, despite a 21% reduction in surcharges in the quarter and a 30% reduction over the past six months, again indicative of improving mix.

Our gross margin in the second quarter of 2015 was $5.2 million or 10.5% of sales, which is up from 10.2% of sales in the first quarter, but well below the 16.1% in the second quarter of last year, as the drop in commodities continued to take its toll.

I said on the last call that we expected our surcharges and material costs to become better aligned as we move into the second half of the year. That was based on analyst and industry commentary that forecast a stabilizing commodity prices in the second quarter, which obviously did not materialize. Today, the outlook is mixed.

There is anecdotal commentary about increased nickel buying in China, LME inventories seem to be at peak and begun to decline, production cuts have been announced by Mincor and Sherritt in recent weeks and if you can risk the 23 commodity bank experts, they suggest sideways trends for the rest of the third quarter with upward movement in nickel prices in the fourth quarter.

We need two to three months of relative stability to bring the spread between surcharges and melt cost into alignment and return margins to more normal levels. In any event, we are currently taking further proactive measures to reduce operating costs, inventory and certain capital expenditures.

There was a sequential increase in our selling, general and administrative expenses which totaled $5 million, resulting from actions taken to strengthen our operating, commercial and technical leadership with onboarding of key personnel. SG&A expenses were down 4% from the second quarter last year.

Operating income in the second quarter of 2015 totaled $200,000, a little less than 1% of sales. Our effective tax rate was 32.7%. Our current net operating loss carry forward totals $48 million. We incurred a net loss for the second quarter of $400,000 or $0.05 per diluted share. Turning to our financial position.

Managed working capital, defined as accounts receivable plus inventory minus accounts payable, was $110 million at June 30, an increase of $1.3 million from March 31, mainly due to a $600,000 increase in inventory and a $4.1 million reduction in accounts payable.

Given current business conditions and seasonality, we have reduced melt schedules and plan to reduce working capital during the third quarter. Capital expenditures totaled $2.8 million in the second quarter, while depreciation and amortization totaled $4.6 million.

Capital spending was focused on systems, controls and equipment to debottleneck operations, support testing and processing of new products, reduce outsourcing and to better monitor and improve key processes. Total debt at June 30 was $92.7 million, representing a small increase of $900,000 from March 31.

And the debt to total capitalization ratio was 31.2%. At June 30, our backlog before surcharges totaled $48.9 million, compared with $58.5 million at March 30 pointing to another challenging quarter, as we noted in today's release. Let me take a minute to review a few operational highlights.

In my year-end 2014 comments, I reported on the substantial progress we had made in earning customer approvals and introducing new products. That process has continued in 2015. We added seven new products along with seven customer approvals in the first six months this year, in both aerospace and in power generation.

That's on top of total of 30 new products we introduced between 2012 and 2014. Our commercial and technical groups currently have an additional 10 new products in development.

Melt down from our vacuum induction melting furnace in the second quarter topped the record reached in the first quarter 2015 in support of a growing order book for premium melted products and new product development. To drive in support the transformation of Universal, we have made developing and strengthening our organization essential priority.

In addition to the talented individuals we have added to our team over the years, we recently named Larry Pollock to the new post of Executive Vice President and Chief Manufacturing Officer. Larry is now responsible for manufacturing operations and engineering at all Universal Stainless facilities.

Our most recent priority has been to recruit a new Chief Financial Officer. We plan to make an announcement about the individual we have selected shortly. Turning to our end markets, starting with aerospace.

Our sales to the aerospace market reached 61% of sales in the second quarter of 2015, compared with 58% of sales in the second quarter of 2014 and 60% of sales in the first quarter of 2015.

Aerospace sales totaled $30.4 million the second quarter of 2015, representing an increase of 1% from the first quarter of 2014 with a similar increase in volume, but 10% lower than the record reached in the first quarter of 2015 on 13% lower volume. For the first six months of 2015, our sales to aerospace increased 13% on 10% higher volume.

The strong fundamentals that has driven the aerospace market in the last several years remain intact. Growth in global air traffic remains robust with passenger traffic up 6.3% through May and air freight up 4% over that period. Backlog to the air freight manufactures remain at impressive levels.

The next generation models are starting to roll the assembly line with more to come in the future. On their second quarter call, GE reported a 37% increase in aviation equipment orders driven by a 71% increase in commercial engine orders. GE orders for commercial spare parts also continued to grow at an impressive 33%.

One of the highlights for GE in the quarter was the $19 billion in commitments they won at the Paris Air Show. Boeing, on their investor call last week, reported capturing $13 billion in net commercial airplane orders in the second quarter with their backlog of nearly 5,700 aircraft, representing eight years of production.

Boeing remains on track in developing the 737 MAX, the 787-10 and the 777-8X and 9X. Among their announcements at the Paris Air Show they reported that the 737 MAX will roll out of the factory by the end of 2015 and fly for the first time early next year.

They also confirmed that the 787 will move to a production rate of 12 airplanes per month in 2016 and 14 per month by the end of the decade with delivery of the 787-10 scheduled for 2018. They also plan to begin final assembly of the 777X in 2018 with delivery starting in 2020.

Their continuing optimism has also up in their latest long-term forecast delivered last month. Boeing increased the number of new airplanes they believe the market will demand our next 20 years to 38,050. That's up 3.5% from their forecast last year. Airbus was somewhat more conservative in the long-range forecast.

They project a 32,600 aircraft above hundred seats will be needed over the next 20 years. In the first half of the year, Airbus won orders for 382 airplanes with net orders of 348, after cancellations and model conversions. Announcements from United Technologies and Rolls-Royce were more mixed this quarter.

Both companies reported aerospace after market activity growing in the single digits, lower growth expectations for new engine sales in 2016 and confirmed expectations of significant growth over the next 10 years.

From our standpoint, our sales to Rolls-Royce this year are on target with our contract and our expectations and our participation in the supply chains of United Technologies company is improving.

Our power generation market sales represented 10% of net sales in the second quarter of 2015, compared with 13% of sales in both the second quarter of 2014 and the first quarter of 2015. Sales were down 23% from the second quarter of last year on a 30% decrease in volume.

They were down 31% sequentially to first quarter on 29% [indiscernible] pound shipped. Year-to-date sales were up 46% on lower volume. Even though our power generation sales declined in the second quarter, we view it is as temporary lumpiness caused mainly by supply channel inventory management.

The positive drivers for us in power generation, as I discussed last time, remain intact. Those would include the environmental concerns over coal, plentiful attractively priced natural gas supplies and the inroads we have made in the market utilizing the unique capabilities of our Radial Forge in North Jackson.

While our primary market remains the quick turn maintenance market, GE has some positive news to report on the new turbine front booking 18 gas turbines in the second quarter, up from 10 last year. For the full year 2015, GE plans to ship a total 100 to 105 turbine units in line with 2014.

Our sales the oil and gas market represented 8% of second quarter 2015 net sales versus 10% in the second quarter of 2014 and 11% in the first quarter of 2015. Sales declined 24% from the second quarter of 2014 on 11% lower volume and 32% from the first quarter of 2015 on 34% lower volume.

Year-to-date, our oil and gas sales are up 6% on 12% higher volume. It was hard to find positive news coming out of the oil and gas industry in the second quarter.

Schlumberger reported a 12% sequential decline in revenues driven by what they described as a dramatic decline in North America land activity is the rig count dropped by a further 40% and as pricing erosion continued in both North American and international areas.

They did sell a small bit of optimism in their belief that North American rig count may be touching bottom. Halliburton's companywide revenues declined 16% sequentially and were down 25% in North America, but their North American market sales were actually higher than expected. All told, that's not much in the way of positive news.

With the unfavorable supply demand equation in the oil and gas market, our customers are focusing on managing their inventories lower and writing up this down cycle as effectively as they can. That's creating a pause in buying, not only in products for oilfield applications, but also in grades commonly used in other end markets like aerospace.

There was a strong pickup in demand for our products in the heavy equipment market in the second quarter, with sales up 35% from the second quarter of 2014 on 55% higher volume and up 25% from the first quarter of 2015 on 38% higher volume.

As a result, heavy equipment sales increased to 10% of total second quarter sales compared with 7% of sales in both the second quarter of 2014 and the 2015 first quarter. Year-to-date, our heavy equipment market sales were up 17% on a 27% increase in volume.

While market demand in the tool steel plate market tends to be uneven, as we noted many times before, continued strength in automotive production and our ability to service this market with speed and reliability pave paid dividends. We expect continued strength through the second half of the year.

In summary then, the second quarter of 2015 was marked by challenging market conditions, including a further drop in commodity prices especially nickel and moly and a dramatic decline the oil and gas market.

The significant fall of demand for oil and gas grades of specialty metals has a spillover effect into other grades and end-use markets as service centers and forgers manage inventories to reach their overall targets.

As a result, Universal sales, margins and order entry were under pressure in the second quarter producing a net loss of $0.05 per share and a lower backlog going into the third quarter.

Even with these challenges, our sales were then 7% year-to-date, including a 34% increase in our premium alloy sales which is a major measure of progress in our transformation strategy. We have also earned seven new customer approvals and introduced seven new products year-to-date with 10 more on the way.

All combined, we are the strongest position we have ever been to capture opportunities as market demand returns.

While especially challenging market conditions are expected to continue for a few more months, the fundamental growth drivers of our targeted markets remain intact with the exception of oil and gas, a market where we generally see weak conditions continuing into 2016.

We are also hearing emerging view among customers of a potential pickup in demand in the fourth quarter and growing optimism about a stronger 2016. In any event, we will manage the business to current market realities while continuing to aggressively pursue our strategic transformation to higher margin more technologically advanced alloys.

Thanks for your attention. And operator, if we can have the questions now, that will be great..

[Operator Instructions]. Our first question comes from Michael Gallo with CL King. Your line is open..

Good morning, Mike..

Denny, a couple of questions. It looks like the incoming order rate in the quarter was about $40 million.

I was wondering when you look sequentially, did you see a fall in aerospace orders as a result of the nickel phenomena? Or is it just everything else with oil and gas and power gen and the like?.

We saw a fall in all markets except the heavy equipment market, which is primarily the tool steel plate driven by automotive. And what we are seeing is, I mean it is pretty straightforward on the oil and gas side, but what that has generated out on the marketplace is a desire to reduce inventory, particularly in the part of service centers.

And as you know, service centers represented almost 69% of our sales in the second quarter. So as they work to reduce their inventory, they look at the oil and gas business and quite frankly they can't get to their targets with just oil and gas and that desire to reduce inventories bleed over into power generation and aerospace.

And that's kind of a two-punch because on top of that, you have got commodity prices falling, which drives surcharges down. So most buyers realized that if they can hold off and buy in smaller, just meet barebones needs they will see smaller acquisition prices per pound one and two months down the road..

All right.

I guess I just sort of look at the sale number, how much of the decline year-over-year, Q2-over-Q2, was as a result of lower surcharges?.

I don't have -- I am going to pull a number, an estimated number. I am going to say that roughly 30% to 35% of the number, in terms of reduction is due to surcharges. Surcharge has one impact in terms of the absolute price per pound that's somewhat masked by the fact that we have got an improving trend in mix.

But the other impact is the volume as people work to destock their inventory and rebalance inventories, given what's happened in oil and gas. That phenomena can't continue in the other markets, because on the other ends, when the sell side from our customers, the aerospace business is still pretty active..

All right. In terms of just, I know for the last several quarters, five or six quarters, you bounced around incoming orders in that mid-50s area and you have kind of bounced around sales in that same area.

Would you expect orders and would you expect sales to converge to the current order level rate in Q3? Or would you expect that you will actually work backlog? Or would you expect orders to improve Q3 versus Q2?.

I would expect our sales in the third quarter to be somewhat lower than the second quarter, given where surcharges are going and where incoming business has been in the last couple of months with improvement on average daily basis we get into the fourth quarter..

Do you expect sequentially lower reduced or you expect it to as low was the orders were in Q3? Or do you expect something in the mid-40s?.

Mid-40s would be my number..

Okay. And then, in terms of just obviously you were in a little bit of an operating loss here on roughly $50 million in revenue.

I guess when you look to Q3, are there additional cost you think you can reduce when you think about managing to the current market conditions?.

Definitely. There is things we can do to from an outright variable cost standpoint in terms of spending and as also things we have in the works in terms of ongoing yield improvements, which will pay dividends and we have some lower utility cost which will impact us in the third quarter as well..

All right. Okay. And just final question.

How much of the higher cost nickel inventory do you still have? And is that one or two quarters to work through? You think you will be through it by the end of the third quarter?.

You mean the original startup stock?.

Well the startup stock and maybe it's just fallen pretty rapidly, I think, from kind of the $7 area to $5 area since the beginning of the year?.

If you look at the VIM, if I am understanding your question right, the VIM inventory is roughly around $6 million is some of that material. So in terms of how that worked through the inventory, some of that sits while we wait for approval. It's all good material, but it does have some higher nickel cost in it, because some of that was made in 2014.

So I wouldn't expect that to be all through in the third quarter. I think that will be something that we will be working on the rest of the year. That doesn't mean that our overall margins would stay stuck. We should see improvement.

As I said in my comments, if we can get two to thee months of relative stability in these products, our melt cost will come down and get in sync with where we are from a surcharge standpoint..

All right. Of course, that's been a moving target in terms of the nickel prices..

It has been..

Okay. Thanks very much..

Okay..

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

Good morning, Denny..

Hi, Phil.

How are you doing today?.

Good.

Well, how are you?.

Good..

I just had a question on trade cases and I know it's been throwing there in many different facets.

Has that been a discussion in your neck of the supply chain here right now?.

Yes. I think if you look specifically at our business and if I define our business as long products specifically bar, imports are clearly up. They are running just under 54% so far this year, on a year-to-date basis.

In the last month, it was reported they were at 59% with Italy, Germany, India and Taiwan are all at double digit increases so far in 2015. So that's getting up near the pain point. Now a lot of that goes into more commodity oriented bar products that we don't really play in, but it still has an impact on the overall environment..

When you say 54%, [indiscernible]? I am sorry..

The percentage of the domestic of the U.S. apparent consumption of bar products supplied by foreign producers was 53.6% through the first four months of the year, to be specific..

Okay..

And in the last month reported, which was April, it's 58.7%. I haven't seen the main numbers yet. So you do see an increasing trend. And if we look at the first four months f this year compared to the first four months of last year, those countries I named are up double digits in terms of the increase in imports.

And some of that has to do with the changing value of the dollar, some of that has do what's going on in their home markets in Europe. There were trade cases in Europe, as you probably know, a couple of months ago. So some of those doors got closed, which makes our market a little more attractive to some of the foreign producers..

What's the typical penetration in terms of consumption historically?.

Historically, it's 45% to 50% and by historically, I am going back the last 20 years..

Sorry, I jumped on a little bit late, Denny.

What comments did you make on the VIM in terms of where that is as a percentage of your sales and how the pipeline [indiscernible]?.

In shipments were up 34% this year. The VIM itself had a record quarter of production in the second quarter which was on top of the previous record, which was the first quarter. So we are seeing building momentum in the premium melt product.

We talked about new products and I don't know if you heard that part, but we have got another approval for seven more, we have introduced seven new products and have seven customer approvals with four different customers and then we have 10 new products that we are currently actively working on..

And there was just a little bit of news last week about Boeing wanting to try to reduce the cost on the 787, looking at titanium or looking at taking out some of the titanium potentially, trying to reduce the buy-to-fly as they always try to do.

Any discussions that you may have had with the guys on the program or have a feel for what they could do or their place stainless server or alloy to win some applications? Anything that you have hard or know there?.

We have had discussions and they are ongoing discussions, but not on that specific subject..

Okay. Denny and then just lastly on the inventory side.

What do you expect in terms of your own ability to destock here?.

I think our work, it will be $3 million to $5 million in the third quarter..

Thanks so much..

Okay..

Thank you. [Operator Instructions]. Our next question comes from Bob Sales with LMK Capital Management..

Two questions.

Denny, given the destocking that's going on in the industry, do you expect to able to continue to grow your specialty alloy products in Q4?.

I expect the absolute volume to increase in the second half of the year, yes. As far as the percentage goes, I think it will probably stay in that high single-digit level..

Got you.

And then, given your experience in the industry, can you comment a little bit about where you think the destocking process, this inventory reduction process of the customers is, like what inning, if you feel comfortable with that analogy?.

As I look at the oil and gas business, I think we are still in the early innings because I think that will carry through in to 2016, because quite frankly, there isn't much activity on the by or the sell side in oil and gas currently.

As far as the spillover, as people try to rebalance their inventories and this has an impact on the other markets, I don't see that continuing in to 2016.

I see that generally order activity should improve as we get into the fourth quarter because as I look at the end-use markets there, basically what our customer's customers are doing, they are still fairly active, whether it be aerospace or power generation maintenance type work.

And the tool steel business continues to be strong and strong we expect that to continue for the rest of year fueled by the automotive market. So if I parse the industry in to two parts, just to say, oil and gas and everything else, the oil and gas thing I think will continue in to 2016.

The other markets, I expect to get more active in terms of buying from mills as we move into the fall time period..

Okay. And then less question is, unfortunately this reflects the learning process of your business. It sounds like your VIM process is more susceptible to surcharge and fluctuations in underlying material costs than other parts of your business.

So I am understanding that correctly? Or is it different than the rest of the business?.

No. it's not necessarily different. It's basically the same. The one difference would be, if you are nickel alloy, it's got a higher content of nickel..

Okay. Got it..

The issues that I think Mike Gallo was referencing is, we had some startup stock of nickel alloy product, VIM type product that we had produced and we need to get approvals to move some of that inventory. So there is still some of that in our inventory. It's good solid material.

It's a cost that would still generate a profit, but not a normal margin, if you will, simply because the nickel contained in that maybe anywhere from $6.5 to $7.25 a pound and today nickel is down in the low $5 pound range, $5.3, I think I saw this morning..

Got you. So it just got caught in the downdraft of the commodity. Okay. Thank you. Thanks for taking my questions..

You are welcome..

Thank you. [Operator Instructions]. And we had a follow-up from Phil Gibbs with KeyBanc Capital. Your line is open..

Denny, are the distributors destocking because of the nickel price environment? Or are they destocking because their customers are destocking? Just in terms of how to think about that?.

I think what precipitated this was a significant drop in oil and gas because most of distributor are general line and they do business in all the markets we do business in. All right. So that's what I think precipitated it and then on top of it, you have got what's happened with commodities.

So everybody is kind of sitting on year terms, like we are sitting on our hands, we are playing things close to the vest, we are only buying what we absolutely, positively need to, they are some of the phrases that you would hear if you join me on sales calls here over the last couple of months.

So it's really something I have had a hard time saying it's one versus the other, or what the percentage is. Hopefully that helps..

Terrific. Thanks..

Thank you. [Operator Instructions]. And I am showing no further questions. I would now like to turn the call back to Mr. Oates for any closing remarks..

Okay. Well, thanks again, everyone. I appreciate you joining us here today. Despite the challenges we saw in the second quarter, we have made tangible progress on our strategy year-to-date. We are also in the strongest position, I believe, ever to confront continuing industry challenges and to pursue all market opportunities.

We are fully focused on making further progress in our strategy and look forward to updating you on our next call. Have a good day. Thanks again..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day..