Good day ladies and gentlemen and welcome to the Universal Stainless & Alloy Products' Third Quarter 2016 Conference Call. 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]. I would now like to the call over to Brian Rayle.

Please go ahead..

Hi. Thank you. Good morning. This is Brian Rayle with Libertatis Consulting, and I would also like to welcome you to the Universal Stainless & Alloy Products conference call. We're here to discuss the Company's third quarter 2016 results reported this morning.

With us from management are Dennis Oates, Chairman, President, and Chief Executive Officer; Ross Wilkin, Vice President of Finance, Chief Financial Officer, and Treasurer; Larry Pollock, Executive Vice President and Chief Manufacturing Officer; Paul McGrath, VP of Administration and General Counsel.

Before I turn the call over to management, let me quickly review procedures. After our management has made formal remarks, we'll 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 these formalities complete, I would like to turn the call over to Dennis Oates.

Dennis, we are ready to begin..

Okay. Thanks Brian. Good morning everyone. Thanks for joining us this morning. Following a very challenging 2015, we delivered 25% sequential sales growth in the first quarter of 2016, and have reported stable top-line revenue performance in the subsequent two quarter, including most recently in the seasonally soft third quarter.

Despite the sales trend, we delivered meaningful sequential profitability improvement, reflecting the continued benefits of operational productivity gains, higher plan activity levels, and continued commodity price stability. Let me hit on a couple of key highlights.

Our third quarter sales decreased 3% sequentially to just under $40 million, and volume has declined 5%. The sales decline was driven mainly by a 10% decrease in aerospace, with all other end markets reporting increased sales.

Specifically, a 17% increase in power generation, the 12% increase in heavy equipment, and 11% increase in general industrial and an 8% increase in oil and gas. Premium alloy product sales were down 10% sequentially, reflecting the impact of lower aerospace sales, continued weakness in oil and gas, and service center inventory fine-tuning.

We continue to focus on our strategic plan to add more premium alloy sales. Thus far in 2016, we have received 28 new customer approvals with five new products having been commercialized and 19 new products in development process. There have been 49 direct customers for our premium products over the past 12 months.

Order entry was £19 million and $38 million before surcharges, representing the highest quarterly bookings rate on our six quarters in terms of [Indiscernible]. Backlog was $39 million before surcharges, up 2% from June 30th. Mill lead-times continue to remain incredibly short, destroying the product relationship between sales backlog and sales.

Plant activity levels in the third quarter of 2016 continue to be up significantly over the depressed second half of 2015. Specifically, looking at the third quarter of 2016 compared with the third quarter of 2015 as measured by pounds produced, electric art melting was up over 67%, remelting was up over 29%, and radial forging was up 74%.

All facilities and work centers operated during this quarter. The team has continued to do a great job generating tangible results from our maturing operational excellence and targeted capital spending progress. Let me give you some examples. Newly automated parcel installations incurred was completed on time and within the budgeted $800,000.

Initial production is underway with full benefits expected to begin in late fourth quarter of 2017. Thermal treating capabilities and [indiscernible] expanded and control systems were enhanced lowering cost, improving quality, and opening certain market segments for further penetration.

North Jackson Vacuum Induction Melting operations posted new healthy records in each for campaign and cost per pound. Productivity gains continued with third quarter pounds produced per man-hour up 22% compared with the third quarter 2015. Variable spending per pound produced improved 24% compared with third quarter of 2015.

Switching to commodities, commodity prices have continued to be relatively stable with nickel trading in a band between $3.77 per pound and $4.70 per pound through the first nine months of 2016. Mali and scrap remained relatively flat for the third quarter as we’re trending up in the first-half of this year by approximately 60%, and 80% respectively.

Earlier fourth quarters scrap is trending down it's still higher than earlier in the year. While these commodity prices are well below 2014 and early 2015 levels, the mouldable month's stability is improving the alignment between surcharges and melting costs, which challenged profitability throughout 2015 and the first quarter of 2016.

The stabilization is also beginning to unlock the market demand from customers who are holding back purchases in order to assess the potential for further commodity price deterioration.

With the improved plant productivity, higher activity levels, and stable to increasing trends in commodity prices, our gross margins continues to strengthen, rising 130 basis-points to 11.9% of sales in the third quarter from 10.6% of sales in the second quarter, and 3.4% of sales in the first quarter.

Despite the improvement to our gross margin in the third quarter, it's important to highlight that we still are having a normal plan activity levels. We anticipate activity levels stay below normal for the balance to 2016 and moving higher in the first half 2017.

Our net loss for the third quarter was $0.07 per share, an improvement from loss of $0.11 per share in the second quarter. Third quarter adjusted EBITDA improved to $5 million, 10% growth sequentially. We delivered $1.7 million of cash flow from operations in the third quarter for a total of $8.5 million in the first nine months of 2016.

Total debt of $71.5 million is down largely compared to the end of the second quarter, and has reduced by $5.1 million since the end of the first quarter.

While the overall demand environment has clearly improved during the first nine months of 2016 relative to latter part of 2015, there remains ongoing market uncertainty, which will impact balance for the year.

Service centers, forgers, and re-rollers are signalling mixed outlooks for the balance of 2016, and generally planned further inventory reductions by year end. Early customer receiving cut-offs are already being announced and appear more pronounced in recent years. In addition short mill lead-times continued in their short-term visibility.

For example, semi-finished products with lead-times of six to eight weeks a year ago are currently available in three to four weeks. Finished products with lead-times of 10 weeks to 12 weeks a year ago are now available in five or seven weeks.

Given the caution we're hearing from our customers, we expect that sales in the fourth quarter will be less than recent quarters, but comfortably higher than 2015’s fourth quarter. In addition to maintaining our industry-leading customer service, we will continue to improve our mix with development of new higher value alloys.

And operationally, we will continue to drive improvement programs to increase productivity and yields, and improve safety. Taking closer look at the end markets. Starting with aerospace, our sales to the aerospace market represented 60% of third quarter 2016 sales, down from 64% in the second quarter and down from 65% in the third quarter of 2015.

Aerospace sales totaled $23.6 million in the third quarter of 2016, down 10% compared to $26.3 million in the second quarter of 2016. Aerospace sales were 16% lower than the third quarter of 2015 on 10% lower volume.

Although, an active market overall, aerospace has generated some negative commentary during the third quarter, and in the current earnings release season. Here is our view on the commercial aerospace trends. Long-term, we remain bullish.

Revenue pass-through miles continue to grow 6% plus annually, load factors remain in the low 80% range, freight transport is increasing at 1.5% to 2% despite anaemic global economic growth.

Global airlines are enjoying record profit margins of 8% to 9%, new engine technology continues to evolve meeting needs fuel efficiency and environmental friendliness, and driving growing demand for specialty metals. There is a high probability than aero defense spending will be increasing post election.

The aftermarket continues to run at 5% to 10% annual growth as described recently by major Tier 1s like GE, Honeywell, HiCo, and Rockwell Collins. Commercial backlogs remained at seven to eight year range. In the short-term, however, the aerospace metal supply chain for Universal products is adjusting to several factors.

The current book-to-bill ratio is a form below 1:1, and annual growth in deliveries has slowed, albeit at historically high levels. For example, Boeing announced this morning the third quarter deliveries totaled 188 planes, and 107 new orders were booked. The mix of new bills is shifting to more single aisle versus wide-body aisle models.

The new engines are also beginning to ramp as legacy engine need scale off. Once again, as just one example perhaps geared turbo backlog in our total is 8,400 units. As the supply chain transitions based on these factors and element of uncertainty and conservatism has appeared in customers’ purchasing and inventory plan.

As a result, most customers plan to reduce inventory through year-end. We expect the usual year-end early receipt cut-offs, and we’re already receiving notices of cut-offs as early as December 4th. At the same time, we expect incoming orders to accelerate as we move within the lead time window for 2017 shipments.

These underlying trends toward higher incoming orders will be augmented by our expanding product portfolio. Switching to heavy equipment market, this was our second largest market in the third quarter of 2016, representing 12% of the sales compared to 11% in the second quarter and 9% in the third quarter of 2015.

Heavy equipment sales totaled $4.9 million in the third quarter of 2016, up 12% compared to the second quarter of 2016 and up 20% compared to the third quarter of 2015. Consistent with what we had noted in the past, we expect a solid year of automotive production and a gradual improvement in the plate business to remove through the year.

Our first nine months of 2016 prove to be on track, especially in the face of model changeovers just considered. Incoming orders accelerated in the third quarter, and we expect the solid fourth quarter and a solid 2017 fuelled by domestic production at a healthy 17 million unit level with increased in model programs in 2017.

We are currently not seeing much activity fuelled by mining or off-road vehicle applications. The power generation market was our third largest market in the third quarter of 2016, representing 10% of sales compared to 8% in the second quarter, and 9% in the third quarter of 2015.

Power generation sales totaled $4 million in the third quarter of 2016, up 17% compared to $3.4 million in the second quarter of 2016, and up 5% compared to the third quarter of 2015. Our power generation revenues reflect relatively stable maintenance driven business, coupled with growing backlogs for new equipment and OEMs like GE and Siemens.

GE reported third quarter power systems orders grew by 6%, driven by aero derivatives and gas turbines, additionally, a backlog of eighth-series turbines to the 33 units versus third quarter delivery of 11 units. Similarly, Siemens reported a 28% backlog increase in the second quarter.

Another double-digit increase is expected when third quarter results are released in a few weeks. Ultimately, all these positive news from GE and Siemens appears to be positive for our forging customers and through them for Universal.

Lastly, we are starting to see stabilization in the oil and gas sector with crude now at $50 per barrel or higher and recount starting to increase. That said, the news in the oil and gas market remains booming with our sales showing some positive improvement.

Oil and gas sales in the third quarter of 2016 were up 8% compared to the second quarter, and up 10% compared to the third quarter of 2015. In total, our oil and gas sales represented 8% of total sales in the third quarter versus 7% in the second quarter, and 6% in the third quarter of 2015.

Halliburton reported last week that their third quarter North American revenues grew 9% for the period, representing their first revenue increase in seven quarters. Also, they reported that the average U.S.

recount grew 14% over the quarter, but the next question about the going forward view of the fourth quarter with activity levels very difficult to predict. Schlumberger reported increased activity in North America, the Middle East and Russia.

If you got [Bakers] (ph) release yesterday, earnings were stronger than expected based on cost reductions, but a sustained price above $60 per barrel is called out as a minimum for a true global recovery to begin.

All told, it seems the consensus is building with the worst that’s behind us in oil and gas, and 2017 will be year of further slow recovery. We, at Universal remain cautious about near-term recovery and anticipate that it will be late 2017 at the earliest, before we see meaningful upside from oil and gas.

However, we still plan to continue introducing new products into the market to better positioning Universal as demand covers. Let me now turn the call over to our Chief Financial Officer, Ross Wilkin, for our financial report.

Ross?.

Thank you, Dennis, and good morning everyone. As Dennis noted, our third quarter sales of almost $40 million were down 3.4% sequentially, or remain well above the lows experienced at the bottom of the cycle in the fourth quarter of last year.

That said, demand remains constrained with our customers beginning to dial-in the inventory levels, leading up to yearend.

Looking at gross margin, in the third quarter, we delivered 130 basis-points of sequential improvement with gross margin expanding to $4.7 million or 11.9% of net sales, compared with the second quarter, which was $4.3 million or 10.6% of net sales.

In addition, gross margin was dramatically better than the third quarter of 2015, which was a negative $400,000 or a negative 0.09% of net sales.

The two key contributors to the sequential improvement in gross margin include the further benefit of operational productivity enhancements combined with the significant improvement in the alignment of customer surcharges and commodity input costs.

The relative stability in commodity prices thus far in 2016 was notably nickel, Mali, and scrap iron has resulted in significant improved alignment of surcharges and melt cost.

Looking at selling, general, and administrative costs, for the third quarter, SG&A was $4.5 million, improved marginally from the second quarter, which was $4.6 million and $700,000 better than the third quarter of 2015, which was $5.2 million.

Tight spending controls, lower share compensation expense, and reduced headcount levels from actions taken in the second half of 2015 continue to contribute year-over-year savings.

Operating income in the third quarter of 2016 was $230,000, a $500,000 sequential increase from the second quarter, and is the first quarter positive operating income in the last, I should say, since the second quarter of 2015.

Our effective tax rate was 36% for the third quarter of 2016, approximately flat with both the second quarter of 2016 and the third quarter of 2015. The net loss in the third quarter was $500,000 or $0.07 per diluted share improved from the second quarter, which was a loss of $800,000 or $0.11 per diluted share.

And dramatically improved from the third quarter of 2015, which was a loss of $17 million or $2.41 per diluted share. The prior year included $15.5 million or $2.19 per diluted share from the impact of goodwill impairment cost associated with driving the plans, supplier loss impact, non-cash inventory write-offs, another exit and severance costs.

Going forward, it continues to remain the central focus of the management team to return the business to sustainable profitability as quickly as possible. Importantly, from an EBITDA standpoint, third quarter adjusted EBITDA was a positive $5 million, 10% growth sequentially from the second quarter, and more than double the first quarter.

This is the highest quarterly level of EBITDA in seven quarters. The growth in EBITDA demonstrates the underlying health for the business.

Note, a line item reconciliation of adjusted EBITDA can be seen in the tables provided in press release, which note that adjusted EBITDA only include adjustments for its share comp expense and prior period right-offs of goodwill and deferred financing costs.

Turning our attention to the balance sheet, during the third quarter, our managed working capital increased $2.4 million to $88.6 million. The primary contributor to the increase in managed working capital was an increase in accounts receivable and to a lesser extent inventory.

The $1.5 million increase in the accounts receivables reflects the timing of sales within the quarter, relative to the timing of sales within the second quarter. The underlying quality of AR has actually improved with the greater proportion of our September 30 receivables being under 60 days than that of the June 30 receivables.

No bad debts were realized in the third quarter. Inventory is up approximately $900,000 or 1.1% on a tonnage increase to 5.2%, primarily reflecting inventory position for fourth quarter shipments. Capital expenditures for the third quarter were $1.4 million compared with $900,000 in the second quarter, and $2.6 million in the third quarter of 2015.

The reduced level of capital expenditure versus the prior year reflects continued selective completion of capital projects with a focus on maintenance projects and high return manufacturing enhancement projects.

That said it remains a key priority of ours to invest in our mills plus ensuring we maintain our infrastructure, expand our capability, and deliver productivity enhancements.

From a cash flow standpoint, during the third quarter, as Dennis already noted, we generated $1.7 million of cash flow from operating activities through improved profitability, partially offset by increased working capital.

Despite the recent downturn, this is the sixth consecutive quarter we have generated positive cash flow from operating activities. Cash generation remains a significant priority of ours.

Total net cash debt of $71.2 million at end of the third quarter was $400,000 favorable compared to the end of the second quarter, and we have reduced our debt by over $20 million in the last five quarters. Importantly, we remain in compliance with all covenants and we anticipate remaining in compliance going forward.

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

Thank you, Ross. In summary, our third quarter results reflect a couple of things. First, the short-term transitions impacting aerospace demand, at the same time, we remain optimistic about continued positive aerospace trends in 2017.

Our third quarter results reflect expanding profit margins due to significant productivity improvements, higher plant activity levels, and an improving alignment between surcharges and material costs. Third quarter results also reflect improved underlying profitability with EBITDA growing 10% to $5 million.

And lastly, third quarter results continued to reflect success n earning customer approvals and introducing new products to fuel future growth. Our outlook suggests business conditions in the fourth quarter will remain challenging as customers fine-tune their year-end inventory, and position for an increase in mill deliveries in 2017.

Operator, let's take some questions from our audience..

Thank you [Operator Instructions]. Our first question comes from Michael Gallo from C.L. King and Associates. Your line is now open..

Couple of questions, Dennis, in terms of the state of the inventory and the supply chain in aerospace, how long do you think it will take to get that cleaned-up.

I mean, do you expect, with presumably guys managing inventory down to year-end, but that will be worked out by the first quarter? Or is this something you expect will linger into 2017?.

Right now, I don’t see it lingering into 2017. From talking to our customers, their expectation is inventory reduction by the end of the year, which means, of impairing back ordering during the third quarter and early fourth quarter.

And my expectation is we just started to see bookings expand as we get into that mid-November-December timeframe in anticipation of higher shipments from the mills to our service centers customers, in particular, in the first quarter.

So to me, this is a short-term thing, a quarter or two, third quarter and fourth quarter kind of thing, in 2017 we expect more activity..

In terms of your gross margins obviously, nice improvement here in the third quarter. Given you’re going to have somewhat lower I guess activity levels it looks like in Q4.

Would you expect to be able to maintain or expand that margin as you get again better alignment of surcharges, and you’ve worked some of that higher cost material through? Or do you expect gross margins to be similar to the third quarter?.

I would expect them right now to be similar. And you hit on the nail on the head it has to do with activity levels in the fourth quarter. Right now our expectation is we’ll see sales dip somewhat but incoming business pick-up, which will maintain activity levels at a decent point in the fourth quarter.

If that's the case, we'll get the normal absorption and our margins will be okay. If things do not materialize like that and we end up not operating, you could see some modest, very modest deterioration.

At the same point, if things come-in and one of my concerns is inventories have gotten so low and the lead times are so short, we’re going to hit it with a lot of stuff without the line of notice, which could show some upside around there.

So, my advice to you would be, take a look at our margins, assume about the same, and it could go up modestly, it could go down modestly. All wrapped around the attributed levels. I don’t see any big price increases, and I don’t anticipate any wild moves in commodities here over the fourth quarter, which should be other factors that would impact it..

And then just one other follow-up; power gen, oil and gas, they had a little bit of an uptick this quarter.

Would you expect to stay around this level over the next 12 months? Do you expect we’ll start to see some modest growth with rig counts moving up significantly over the last four or five months or so? Or is it just bounce around this level?.

I'd be very surprised and disappointed if we don’t see some growth here as we get into the first half of 2017, Mike. I don’t anticipate we’re going to be hanging around with the current levels..

Okay....

I'm not calling for a borrowing burn in 2017, where everything is taking off. But I clearly think that some of the corrections we’re doing on an aerospace were short-term in nature, and we've got some steady slow growth in some of the other markets, work its way back to the mills in terms of activity levels as we get into 2017..

Right, okay....

We have some new products we’re introducing, which we keep leading those into the marketplace with this pacing quarter..

Our next question comes from Phil Gibbs with KeyBanc Capital. Your line is now open..

I had a question on the VIM, the VIM sales. I missed some of your script, because it was little choppy in terms of the line.

But what are you seeing there in terms of the sales in total this year? And what are your expectations for next year, assuming that the current market conditions remain intact?.

My expectations for next year is growth, we’ll be shipping more of VIM products. What happened in the third quarter was primarily tied to three things; one was the general slowdown in aerospace if you will, which impacted our aero melting product, as well as Vacuum Induction Melting product.

The vast majority of that is transactional freight business for us. The other issue is oil and gas with the other market into which we sell Vacuum Induction Melting products. And that's simply very lumpy at a negative, not a very positive outlook in oil and gas in the third quarter.

So they would assume main factors that impacted the 10% decline in Vacuum Induction Melting. Third factor is simply that we do sell some of that material through the service center supply chain. And service centers during the third quarter did being to reduce inventories.

Some service centers are actually up, basically operating and what they do in December, the fourth quarter. So we did see receipts being held up and things along those lines over the course of the third quarter. So I don’t see that as a long-term thing. As I indicated to Mike a few minutes ago, Phil, I see that turning around as we get into the 2017.

And a lot of people are focused on what their inventory levels have to be at the end of December. We’re already starting to see a lot of conversation in inquiries and discussions about the first quarter..

Any line of sight into your own jet engine, call it opportunity, because I know that the VIM at least over-time probably actually started first on some at least some stata qualifications and maybe overtime rotating quality. But any insights you have there just based on your conversations with some of the OEMs, and [multiple speakers]....

I can’t give you a percentage or a way to how much our product that’s in the each one of the engine. What I likely to tell you is that aerospace portion of our VIM production is clearly targeted at engines. As you know, we’ve captured some contractual business, which gets us on to with the engine.

And as we look at the first half of 2017, we would expect to get some additional approvals that are currently in process, which would add to that. So, if you look -- step back and how we’re positioning in the Company, we’ve been in structural for a long time. And with Vacuum Induction Melting products, we’re migrating into the engine side.

And doing that one product at a time and dealing with just about all the OEMs that are in that business..

And then on the inventories, what are you anticipating in terms of your own inventory management into the year end and maybe over the next couple of quarters?.

Flattish I guess would be the best way I would describe that. If we get a real sharp snap in the November-December timeframe, you could see a very modest increase. Our mapping out of our inventory level would be relatively flat as we go into, as we exit this year and go into the first quarter..

And some of the headwinds from the nickel to pricing mismatch.

Have those basically been alleviated in whatever gross margins that we see right now would reflect current market pricing dynamics and current, call it, alignment versus relevant to your cost and those alignment headwinds dissipated?.

In which field again, Phil?.

The misalignment between selling prices and then the lagging cost of nickel, because it was coming down. I was asking if that misalignment that we’ve been seeing and talking about for the last, call it, six to 12 months has dissipated..

In large part, it's behind us. As you look at the fourth quarter, it gets going down the road. You won't hearing us talking much about that unless something changes wildly. If you take a snapshot of our inventory, the only place where that still would come into play, and I would -- this just kind of ties into your earlier question about inventories.

We are doing a lot of approval work. So we are carrying some unusual inventories where we produced products working with customers to get approvals. And some of that product, frankly, it was produced back in -- earlier in 2016, let’s say 2015. So it might be a little pinch when those products ultimately get approved and sell-through.

But it won't be big enough to be inerasable at this point in time..

And then in terms of the liquidity position, what's the liquidity at present versus the last couple of quarters? Because I know that you might have some covenants on that that might restrict or expand liquidity. So, I am just [multiple speakers] upon that..

So our liquidity does flex based upon our working capital levels and what not. And so at the end of the quarter, it was around $19 million, which was up marginally from the end of the last quarter, and higher than what we had at the start of the new bank facility in January..

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

Okay, thank you. First of all, an unusual comment, I just want to apologize to everyone, I understand we've been getting calls that we have some bad audio as the early part of the commentary. So if there is any questions or any issues that come-up that you missed, please feel free to give me a call or Ross a call.

And with that said, I'm going to thank you for joining us this morning and your interest in the Universal. And we’ll look forward to speaking to you in late January, and giving you update on our total year 2016 and fourth quarter. Have a great day..

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