Good day ladies and gentlemen and welcome to the USAP fourth quarter 2016 conference call and webcast. At this time, all participants are in a listen-only mode and later we will conduct a question-and-answer session and instructions will follow at that time [Operator Instructions]. As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Mr. Brian Rayle. Sir, you may begin..

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

With us from management are Denny Oates, Chairman, President and Chief Executive Officer and Ross Wilkin, Vice President of Finance, Chief Financial Officer and Treasurer. Before I turn the call over to management, let me quickly review procedures. After our management has made formal remarks, we will take your questions.

The conference operator will instruct you on procedures at that time. Also, please note that in this morning's call, management will make forward-looking statements.

Under the Private Securities Litigation Reform Act of 1995, I would like to remind you of the risks related to these statements, which are more fully described in today's press release and in the company's filings with the Securities and Exchange Commission. With these formalities complete, I would now like to turn the call over to Denny..

Thanks Brian. Good morning and Happy New Year to everyone. Thanks for joining us today. While we expected a challenging operating environment in the fourth quarter of 2016, our results did reflect broad-based improvement on several measures compared with the fourth quarter of 2015. Sales of $34.2 million were up 8%.

Order entry before surcharges of $37.8 million increased 17%. Order backlog before surcharges of $43.8 million grew by 14.5%. Gross margin of 9.1% compares to a negative 2.8% a year ago. On a sequential basis, we reported a 14% sales decline, in line with our outlook reviewed during our last call.

The decline was directly attributable to year-end inventory management by service centers and forgers providing product to the aerospace and power generation markets.

Partially offsetting this sequential decline was a 40% improvement in plate sales driven by strong automotive and general metal fabrication markets coupled with share gains from imported product.

Premium alloy product sales of $3.1 million, or 9.1% of total sales, decreased 9% sequentially and reflect the customers destocking of aerospace inventories leading up to year-end. However, it is noteworthy that premium alloy backlog at year-end were up 66% sequentially and 49% compared to December of 2015.

With each quarter of 2016, we achieved productivity gains and expanded product portfolio and better alignment of surcharges with our raw material input costs, all of which position Universal for growth and a return to profitability as market conditions improve in 2017. Let me hit some key highlights.

During 2016, we received 28 new customer approvals, have 11 new products in the development process and 15 new products in our 2017 plan. Our newly upgraded bar mill in Dunkirk became operational during the fourth quarter with less than a one year payback expected on the roughly $1 million investment.

Customer service, as measured by on-time delivery, marked a new company record during 2016. Safety performance improve for our fourth consecutive year, resulting in a new record low for OSHA recordables.

Vacuum induction melting operation reported another step change in performance with a 45% improvement in productivity and a 150% improvement in refractory life.

Fourth quarter variable manufacturing cost per produced pound were 15% lower than the fourth quarter of 2015 while pounds produced per labor hour were up 8% compared with the fourth quarter of 2015. I deeply appreciate the support, hard work, commitment and ingenuity of all of our employees in making these things happen.

Plant activity levels, although down roughly 7% to 8% sequentially in the fourth quarter of 2016, show significant increases compared with the fourth quarter of 2015.

As measured by pounds produced, the fourth quarter of 2016 compared with the fourth quarter of 2015 reported vacuum induction melting up 187%, electric art melting up 45%, radial press up 88%, hot rolling up 33% and vacuum arc remelting up 20%.

Although we are moving in the right direction year-over-year, we remain well below plant utilization levels recorded in years past. Overall commodity prices have continued to be relatively stable with an upward bias. Nickel is currently at the low end of its recent range between $4.40 and $5.20 per pound.

Iron scrap trading on the higher end of its range $0.09 to $0.14 per pound, Moly has been generally flat at just under $7 per pound. The exception is chrome, which jumped about 40% during the fourth quarter. I would offer two comments on these trends.

The relative stability has improved the alignment between surcharges and melting cost which challenged profitability throughout 2015 and into the first half of 2016. And surcharges in most grades increased this month $0.05 to $0.08 per pound with further increases likely over the next few months.

With improved plant productivity, increased activity levels and stability in commodity prices, our gross margin continued to improve year-over-year with fourth quarter of 9.1% of sales, an improvement from a negative 2.8% in the fourth quarter of last year.

Lower shipment and plane activity levels led to our lower sequential gross margin in the fourth quarter, which will improve with higher activity levels this quarter. Our net loss for the fourth quarter was $0.22 per share, an improvement from a net loss of $0.48 per share in the fourth quarter of 2015.

Adjusted EBITDA for the fourth quarter 2016 was $3.6 million, substantially improved from the negative $0.5 million in the fourth quarter of 2015. Our full year 2016 adjusted EBITDA was $15.5 million, an improvement of 52% from the full year of 2015.

Cash flow from operating activities in the fourth quarter of 2016 was essentially flat, reflecting the impact of increased inventory to service anticipated higher shipments in the first quarter. Full year 2016 cash flow from operating activities was 8.4 million.

Total debt of $72.5 million was up $1 million compared to the end of 2016's third quarter, but down over $3 million for the 2016 full year. The overall demand environment is more optimistic as we start 2017 with the uncertainty of the election season behind us and the pressure for customers to reduce year-end inventories now past.

Service centers, forgers and rerollers are all signaling improved outlooks at the start of 2017. That said, short mill lead times continue to hinder indivisibility beyond the first quarter. Taking a closer look at the end markets. Our aerospace sales represented 49% of fourth quarter of 2016 sales, lower than the 60% waiting for the full year 2016.

Aerospace sales totaled $16.7 million in the fourth quarter of 2016, flat compared to the fourth quarter of 2015 and down 29% sequentially.

Customer destocking in aerospace impacted us negatively in the fourth quarter, however we remain positive about near and long-term aerospace end market growth, given the significant backlog in new commercial builds, increase in defense spending, a renewed business jet cycle and sustained growth in passenger and air freight traffic.

As a point of interest, Boeing announced this morning that airline deliveries in 2017 will increase to 700 to 765 planes from 2016's 748, albeit with a mix shifting towards more single aisle airframes, lower 777 production as the new 777X is developed and the book-to-bill ratio probably paralleling 2016.

We see a further positive impact as our expanding product portfolio gains traction in the market. Lastly from a mill perspective, customer inventories appear to be in balance at best and probably somewhat lean suggesting improved mill shipment volume opportunities.

The heavy equipment market was our second-largest market in the fourth quarter of 2016, representing 20% of sales compared to 13% in the full year of 2016. Strong domestic demand for tool steel plate drove the increase in sales, primarily reflecting pull through from the automotive industry and share gains from imported product.

We expect a solid year of automotive production in 2017 and another strong year in the plate business. Power generation sales of $3.2 million delivered 8% growth compared with the prior year fourth quarter. For full year 2016, power GEN sales were 9.2% of total sales, down from 10.6% in 2015.

Major players in the gas turbine space like GE and Siemens are reporting low single-digit growth in equipment order intake as in aerospace newer designed to operate at higher temperatures requiring specialty metals, but demand for new turbines has been lumpy over the past decade.

Additionally, a significant portion of smaller turbines provide power to operations in the very depressed oil and gas sector. As a result, we continue to see a high percentage of maintenance business as opposed to a robust new turbine market. We will see more of the same in 2017. Lastly, the oil and gas market continues to remain depressed.

However sales in the fourth quarter of 2016 were up 3% compared with the third quarter of 2016. For full year 2016, sales to the oil and gas end market were 8% of total sales compared with 9.4% of total sales in 2015. Despite the continued weakness in the oil and gas sector, we are starting to see stabilization.

Oil prices appear to be stabilizing around $50 to $55 per barrel. E&P budgets appear be loosening up. Rig counts are rising modestly. In any event, we anticipate a slow road back in 2017gathering positive momentum heading into 2018.

We are actively developing some new products focused on this sector and plan to be in a position of benefit as activity returns. Let me now turn the call over to our Chief Financial Officer, Ross Wilkin, for our financial report.

Ross?.

Thank you, Denny. As Denny noted, fourth quarter 2016 sales of $34.2 million were up 8% compared with the fourth quarter of 2015, but down 14% sequentially compared with the third quarter of 2016. The increase versus prior year was driven by higher sales to our service center customers.

Sequentially, our sales decline was attributable to actions by several of our customers as they decreased their inventories, leading up to year-end. Looking at gross margin.

The fourth quarter gross margin was $3.1 million, or 9.1% of sales, significantly improved from the fourth quarter of 2015, which was a negative $900,000 or a negative 2.8% of sales, but down sequentially versus the third quarter of 2016, which was $4.7 million or 11.9% of sales.

The dramatic improvement compared with the fourth quarter of 2015 is primarily attributable to the benefit of operational productivity enhancements combined with the significant improvement in the alignment of customer surcharges and commodity input costs.

The sequential decline in gross margin from the third quarter of 2016 is primarily attributable to lower sales, partially offset by continued operational productivity savings. Looking at selling, general and administrative costs. The fourth quarter SG&A was $4.5 million, flat with the third quarter and flat with the fourth quarter of 2015.

Full year SG&A was $17.5 million, down $1.9 million, compared with full year 2015. Operating loss for the fourth quarter of 2016 was $1.5 million, a $4 million improvement compared with the fourth quarter of 2015, but down compared with the third quarter of 2016, which was operating income of $200,000.

Our effective tax rate was 35.6% for the fourth quarter of 2016, approximately flat with the third quarter of 2016, but lower than the fourth quarter of 2015, which was 42.4%. For full year 2016, the effective tax rate was 39.7%, marginally higher than the 37% in full year 2015.

The bottom line net loss in the fourth quarter was $1.6 million or $0.22 per diluted share, significantly improved from the fourth quarter of 2015, which was a net loss of $3.4 million or $0.48 per diluted share, but down sequentially from the third quarter 2016, which was a loss of $500,000 or $0.07 per diluted share.

For full year 2016, net loss was $5.3 million or $0.74 per diluted share, significantly improved from the full year 2015 net loss of $20.7 million or $2.92 per diluted share. Importantly, 2015 included an after tax goodwill impairment charge of $13.1 million or $1.85 per diluted share.

Going forward, it remains the central focus of the management team to return the business to sustained profitability as quickly as possible.

From an EBITDA standpoint, fourth quarter adjusted EBITDA was a positive $3.6 million, improved from a negative $500,000 in the fourth quarter of 2015, but down sequentially from $5 million in the third quarter of 2016.

The sequential decline from the third quarter is primarily a result of the lower top line, partially offset by continued operational productivity savings. For full year 2016, adjusted EBITDA was $15.5 million, a growth of $5.2 million or 52% compared with the full year 2015.

Note, a line item reconciliation of adjusted EBITDA can be seen in the tables provided in the press release and only include adjustments for share comp expense and prior period write offs of goodwill and deferred financing costs. Turning our attention balance sheet.

The fourth quarter managed working capital of $90.9 million increased $2.3 million compared with the third quarter and the primary contributor to the increase in managed working capital was $5.7 million increase in inventory as we position inventory for anticipated first quarter 2017 shipments.

Additional inventory is required to support the order backlog, which at year-end was up 11.2% compared with the end of the third quarter of 2016 and up 14.5% compared with the end of the fourth quarter of 2015.

Capital expenditures for the fourth quarter were $1.3 million compared with $1.4 million in the third quarter and $1.2 million in the fourth quarter of 2015. For full year 2016, capital expenditures were $4.4 million or $6.4 million including a capital lease entered into in the first quarter of 2016. This is down from $9.6 million CapEx in 2015.

The reduced level of capital spending in 2016 reflects selective completion of capital projects with a focus on maintenance projects and high return manufacturing enhancement projects. From a cash flow standpoint full year 2016, we generated $8.4 million of cash flow from operating activities compared with $19.2 million in 2015.

Total debt has been reduced by $3.3 million in 2016 and has been reduced by over $20 million in the last six quarters combined. We were in compliance with our covenants under our bank credit facility at the end of 2016 and anticipate remaining in compliance going forward for the foreseeable future. This concludes my financial report.

Denny, I will turn the call back to you..

Okay. Thanks Ross. In summary, the past three quarters of been challenging in our industry as adjustments were made for significant price reductions in key input commodities, the collapse of the oil and gas sector and the evolution of the current supercycle in aerospace against the backdrop of political and economic uncertainty around the globe.

We took advantage of this time to expand our product portfolio, up our game in customer service, drive productivity increase across all facilities, improve internal product quality, develop our organization and secure long-term financing providing more than adequate liquidity for future growth.

We exited 2016 with rising order entry, increasing backlogs, relatively stable commodities and a much more positive tone throughout the supply chain. Shipments in order intake so far in 2017 have built on the positive momentum coming out of 2016. Through three weeks, bookings and shipments are up 50 to 60% over the same period of 2016.

We feel Universal is positioned well in what we feel will be a much more active 2017. Amanda, let's take some questions from our callers..

[Operator Instructions]. The first question comes from the line of Michael Gallo from C.L. King. Your line is open..

Hi. Good morning..

How are you doing, Mike?.

Good morning..

Good. A couple of questions. I guess the fourth quarter seemed like it was much more weighted to tool steel and less weighted to aerospace that I would have thought.

I guess as you look forward, would you expect tool steel to stay up in the same levels? I get that you always have the service center stuff on the aerospace side at year-end, but I mean would you expect to stay in that level? When you look at the increase in bookings and shipments year-to-date, how much of that is just the continuation of the strong tool steel? And would you expect the gross margin to return to where they were in the third quarter? Or given the mix, would you expect that might be a little harder? Thanks..

Okay. Let's go with that tool steel first. We saw improving bookings in tool steel really spike in the third quarter of 2016, back off a little bit in the fourth quarter.

So as we look at 2017 versus 2016, we expect another strong year on the same level, kind of flattish from a volume standpoint, maybe small single-digit growth in volume but probably different from a quarterly flow standpoint. When you look at the bookings in the fourth quarter specifically, those bookings have started to swing more towards aerospace.

Again, we saw shipments decrease in the fourth quarter related to the inventory reduction, but in terms of bookings the mix is much more weighted towards our traditional aerospace, power gen type products going into the first quarter.

The third part of your question, Mike, with regard to margins, I would expect our margins to go back in the double-digit range.

If you take a look at the third quarter of 2016, they are slightly above, would be a reasonable expectation given what we see in terms of volumes of shipments, plant activity and the kicking of some of the operational products in capital projects we have completed. That hit all your questions you asked? I think I did..

I think so. Just to sort of touch on the other areas.

Is it fair to assume power gen and oil and gas will have modest growth in total sales, 2017 over 2016, based on what you see today?.

Yes..

Okay. And then a question for Ross.

What do you expect the full year CapEx to be in 2017?.

We expect it to be in the $8 million to $10 million range, pretty much going back to normalized rate. It is a little bit lower obviously in 2016..

Okay. Thanks very much..

You are welcome..

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

Hi Denny and Ross. Good morning..

How are you doing?.

Hi..

Pretty good.

Denny, any sense of the oil and gas inventories in the specialty or stainless channel right now that you are seeing?.

Over the last two years, they have been drained. There's probably a couple of selected grades of real high-end stuff where there might be some excesses, but generally speaking, I think they have been pretty well drained. So as things recover, I would expect to see some order entry increases as we move through 2017..

And just for some general knowledge, where does a lot of the bar stock, the stainless and nickel alloy bar stock, go in terms of the direct applications? I mean, obviously you have on the carbon side the hot roll gets, or plate gets made into pipe and tube, it goes down in the drill pipe.

But where is the stainless actually used in the process?.

It's a down-hole application. So looking at the E&P budgets, the operation activities would drive the demand for our product. It would be biased towards operations that are more hostile environment. So offshore-type applications or more humid operations..

So this is more potentially later cycle oil and gas, because you see the fracing coming back now, some of the offshore coming back a little bit later in the year?.

Yes..

Okay..

But we are seeing activity up in Western Canada. We are also seeing some activity down in the Permian Basin. It's driving some orders that we are seeing..

Do you think that there is any uplift in your year order entry momentum if customers spur to buy given the increases we have seen in chrome and moly and cobalt.

Nickel has backed off a little bit, but still up well year-over-year, certainly providing an impetus for people?.

I think if things were to continue to rise, we should see that. But I think as I look at the fourth quarter, I am hard-pressed to point out anybody who placed an order for delivery in 2016 to beat the surcharge increase. In fact that occurred in January of 2017. So I don't think it had a big effect.

The overarching impact in terms of purchasing mentality in the fourth quarter was controlling inventory at the end of the year, based upon the vast majority of our customers..

Okay. And then the last one here.

When you speak with your customers, is there a lot of discussion of uncertainty, good and/or bad in terms of the election right now? Or is that not is a discussion point with a lot of the customers right now?.

No. It's a discussion point. There is a great deal of positive vibe out in the marketplace.

If you had asked me that question a month-and-a-half, two months ago, I would have said that the positive vibe was getting ahead of reality, but we are starting to see tangible evidence that it's changing actions in the marketplace, if you look at our bookings and our backlog and what we are seeing so far in 2017.

So clearly, there is a positive trend here. I think a lot of customers are looking at the whole tax proposal and the border tax and what are the implications of the border tax in terms of how they are sourcing material that we sell.

As their plans for the rest of the year and into 2018 looking at domestic buying versus foreign buying, that's a big subject of discussion. And the overall subject of infrastructure spending, which would have a positive effect on us as well as other companies beyond the normal aerospace, power gen, oil and gas that we normally talk about..

Okay. Terrific. Thanks for all the color. Look forward to a better year..

Thanks, Phil..

Thank you. [Operator Instructions]. And the next question comes from the line of John Deysher from Pinnacle. Your line is open..

Hi. Good morning..

Hi John..

I was just curious for the CapEx number, $8 million to $10 million, which is maintenance levels.

What specifically does that mean in terms of maintenance? Where are you targeting those dollars for 2017, please?.

We are focused on quick return, high return type projects as we start to spend more capital. So I would quibble with you a little bit about whether that's all maintenance. It's like capital. There is a fair amount of high return type things.

What we looking at? We are looking at increasing the level two type applications we have throughout the plant to gather information and tighten down controls and improve product quality. We are looking at some new cellular manufacturing applications in our finishing facilities.

They would be the two major areas that we are looking at in terms of capital dollars..

Okay.

And that would be what percentage of that $8 million to $10 million, do you think?.

Roughly two-thirds..

Two-thirds. Okay. Great. Very good. Thank you very much..

You are welcome..

Thank you. And I am showing no further questions at this time. I would now turn the call back over to Mr. Denny Oates for closing remarks..

Okay. Amanda, thank you. Once again, thank you for joining us this morning. We sincerely appreciate your support and interest in Universal Stainless. We look forward to updating you on our progress in our next call in April. Have a great day..

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everybody have a great day..