Good day, ladies and gentlemen and welcome to the Universal Stainless & Alloy Products' First Quarter 2017 Conference Call and Webcast. At this time, all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will follow at that time [Operator Instructions]. As a reminder, this call is being recorded.

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

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 are here to discuss the company's first quarter 2017 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 our procedures at that time.

Also, please note that this morning's call, management will make forward-looking statements under the Private Securities Litigation Reform Act of 1995, I would like to remind you of the risks related to these statements, which are more fully described in today's press release and in the company's filings with the Securities and Exchange Commission.

With these formalities complete, I would like to turn the call over to Denny Oates. Denny, we're ready to begin..

Brian thanks. Good morning, everyone. Thanks for joining us today. After two years of very challenging business conditions in our industry, we're encouraged by the strong start to 2017 in sales, order entry and backlog. We expect a general increase in business activity to continue as we move through 2017, subject to normal seasonal trends.

Bookings in the first quarter of 2017 were the highest in five years at $57 million and 24.4 million pounds. The bookings were broad-based by end used market and by market channel with a substantial increase in vacuum induction melting product produced in our North Jackson facility. Let me briefly hit some specifics.

Sales of $48.9 million were up 43% sequentially and up 23% compared to the prior year Q1. Sales of premium alloys totaled a quarterly record of $5.8 million or 11.9% of total sales. Order backlog before surcharges of $57.1 million grew by 30% sequentially. The backlog of premium or vacuum induction melting product more than doubled during the quarter.

We announced price increases for certain stainless and low alloy products, which are effective with order entry on April 1 and will begin to impact results in the July timeframe. While all of end markets deliver topline growth, aerospace, oil and gas and general industrial were the most notable contributing sequential growth in the 50% to 60% range.

Similarly, all major market channels delivered sequential growth. Service centers up 38%, re-rollers up 110% and forgers up 89%. Our team has done a great job ramping up production levels in response to the sharp increase in demand.

Plant activity levels are generally running at the highest level since early 2015 with electric art melt shop in Bridgeville producing at a higher rate in any quarter since the first quarter of 2012.

These higher plant volumes in the current quarter are not only generating the normal favorable operating leverage on product cost, but are also enabling added variable cost savings from improvement initiatives completed in recent years and projects currently underway, all of which will contribute positively to margins over the next few quarters.

Some additional highlights from Q1 include, three new products were commercialized and additional approval was received from Rolls-Royce. Customer service levels as measured by on-time delivery were maintained at record levels despite the spike in activity. Safety metrics are tracking towards the fifth consecutive record year.

The 20-inch bar mill installation Dunkirk is in production, reducing cost, improving safety and expanding our size range. New productivity records were established in vacuum induction melting in terms of heats per campaign. Finally, virtually all operational performance metrics are flashing green.

Overall, commodity prices have continued to be relatively stable, albeit with Nichol softening somewhat in recent months. Nickel is currently at the low end of its recent range between $4.15 and $5 per pound and trending lower. Scrap iron is trading on the higher end of its recent range of $0.14 to $0.16 a pound.

Molly has stayed high across the first quarter, an average of $7.55 per pound, compared with $6.85 per pound in the fourth quarter. Most notably chrome has remained high in the first quarter at approximately $1.48 per pound, following a significant jump in the fourth quarter.

The relative stability in commodities has continued to maintain good alignment between surcharges and melting costs, which was a significant negative impact of profitability throughout 2015 and the first half of 2016.

Despite the increase in our topline, gross margin of 8.7% in the first quarter of 2017 was approximately flat as a percent of sales, compared with the fourth quarter of 2016. The lack of improvement reflects three issues; first, certain higher-margin legacy products were underrepresented in first quarter shipments.

However, we have a strong backlog of these same products at March 31. Second, the sell-through of product produced in the lower volume, higher cost fourth quarter of 2016. The majority of the efficiencies associated with higher first-quarter production levels will benefit future quarters.

Third, we elected to move some nonprime research and development material at lower than normal prices and margins, but well above scrap value.

Going forward we anticipate improving gross profit margins as the benefits of higher 2017 volume-driven operating leverage, improving mix profiles, process improvements and selling price increases flow into our financial results.

Our net loss for the first quarter was $0.17 per share, an improvement from a net loss of $0.22 per share in the fourth quarter of 2016 and a net loss of $0.34 per share in the first quarter of 2016.

Included in the first quarter of 2017, net loss was $0.06 per share impact for unusual SG&A items and adverse tax rate impact, which Ross will discussion in a few minutes. EBITDA for the first quarter of 2017 was $4.2 million, substantially improved from $1.1 million in the first quarter of 2016 and $3.2 million in the fourth quarter of 2016.

Total debt, net of cash was $74.3 million up $1.8 million compared with the end of 2016's fourth quarter, reflecting the impact of higher working capital to support increased business activity. The overall demand environment has started 2017 on a positive note and we're optimistic that it will continue.

Mill lead times have moved out, most customers are signaling real demand growth and adequate to slightly lean inventory. Taking a closer look at the end markets, our aerospace sales represented 55% of first quarter 2017 sales.

Aerospace sales totaled $26.7 million in the first quarter, up $10 million or 60% sequentially compared with the fourth quarter of 2016 and up $1.3 million or 5% compared with the first quarter of 2016.

We remain very positive about prospects in the aerospace market over the near and long-term, the healthy backlog of Boeing and Airbus are well documented with narrow bodies ramping about 12% this year. Boeing announced this morning that 2017 deliveries will be 760 planes to 765 planes versus 748 planes last year.

Passenger and freight traffic growth continue to surprise on the upside, growing 6% to 8% depending on whose numbers you use, fueling improved expectations regarding the aerospace aftermarket. The supply chain is also adjusting for the growing likelihood of meaningful increases in defense spending.

We see a further positive impact as our expanding product portfolio gains traction in the marketplace. Lastly, from a mill perspective, customer arrow inventories appear to be in the lean side as we start 2017.

The heavy equipment market was our second-largest market in the first quarter of 2017, representing 16% of total sales compared to 13% in full year 2016 and 20% in the fourth quarter of 2016. Heavy equipment sales totaled $7.7 million the first quarter up 13% compared with the fourth quarter of 2016 and up 91% compared with the first quarter of 2016.

Strong domestic demand for tool steel plate drove the increase in sales, primarily reflecting pull-through from automotive production and changeover activity, which has remained strong in around 17 million units, although somewhat less than previous projections of $17.3 million units.

Off-road and heavy equipment markets are also showing some light as evidenced in Caterpillars results announced yesterday. Lastly, share gains from imported product continue to deliver growth. We continue to expect a solid 2017 year in the plate business.

The oil and gas end market continues to report modest improvement despite remaining depressed from previous highs. Sales in the first quarter of 2017 were $4.9 million up 55% sequentially and representing 10% of total sales, up from 8% of total sales in 2016.

With oil prices range bound in the $50 per barrel area, customers report a modest loosening of E&P budgets and increasing holes in their inventory after over two years of steep destocking. The increased activity is centered onshore in North America with offshore and international markets still in the doldrums.

Onshore rig counts are up 25% since year-end and about 70% year-over-year. We remain unchanged in our anticipation of an improving 2017 and gathering positive momentum heading into 2018. We are actively developing some new products focused on this sector and plan to be in a position to benefit as activity returns.

General and industrial sales were $4.7 million up 45% sequentially or 10% of sales increase from 8% of sales in 2016. The increases to this end market are a reflection of our improved participation in infrastructure-related projects and business development activities involving domestic manufacturing. We expect this growth to continue into 2018.

Power generation sales of $4.2 million were 9% of total first quarter sales and delivered 9% growth sequentially and 21% growth compared to the first quarter of 2016. Major players in the gas turbine space like GE and Siemens, reported weak new turbine orders in Q1, but continue to call for flat year-over-year activity in 2017.

Our customers report steady maintenance business as natural gas solely supplants coal as a fuel choice and existing turbine population works at higher activity levels. Oil and gas weakness continues to be a drag on the power generation market. We expect to see these dynamics play out over the remainder of 2017.

Let's now turn to our financial report, Ross?.

Thank you, Denny. As Denny noted, first quarter 2017 sales of $48.9 million were up 43% sequentially compared with the fourth quarter of 2016 and up 23% compared with the first quarter of 2016. The increase was broad-based across all of our end markets, both sequentially and versus prior year.

Gross margin in the first quarter was $4.2 million or 8.7% of sales, up $1.1 million compared with the fourth quarter of 2016 at approximately flat with the fourth quarter of 2016 on a percentage basis.

Gross margin in the first quarter was negatively impacted by adverse mix, the sell-through of product produced at lower volume, higher cost fourth quarter and also the sale of R&D material at lower than normal margins.

Although first quarter 2017 production volumes increased by 23% compared with the fourth quarter of 2016 only 16% of first quarter shipments were melted in the first quarter of 2017, resulting in a significant portion of the efficiencies associated with the first-quarter ramp up to benefit the second quarter and beyond.

As Denny has noted already, we remain confident in the benefit of volume-driven operating leverage, improving mix profiles, process improvements and selling price increases, will meaningfully improve our gross margin going forward.

Looking at selling, general and administrative costs, for the first quarter SG a was $4.7 million up $200,000 compared with the fourth quarter of 2016 and included a total of $300,000 of costs related to both the bad debt for a customer bankruptcy as well as legal expenses associated with an ongoing claim with the supplier for the recovery of a previously recorded loss.

Operating loss in the first quarter of 2017 was $500,000, a $1 million improvement compared with the fourth quarter of 2016 and a $2 million improvement compared with the first quarter of 2016.

Our tax rate was 17.7% in the first quarter of 2017, significantly lower than the full year 2016 tax rate of $39.7 and lower than the standard corporate rate of 35%.

With our first quarter being in before tax loss position, the impact of having a low tax rate resulted in our after-tax loss per diluted share, being adversely impacted by $0.03 per share relative to the standard 35% corporate tax rate.

In addition, our 17.7% income tax rate includes $50,000 income tax expense from the adoption of new accounting guidance related to stock-based compensation, which resulted in additional tax expense that would have previously been booked to stockholder’s equity.

For full-year 2017, tax expense impact of this is expected to be at least $300,000 assuming forfeiture of underwater options that expire this year.

The bottom line net loss in the first quarter was $1.2 million or $0.17 per diluted share and includes $0.06 loss per diluted share associated with the SG&A items noted earlier, combined with the impact of the low-income tax rate also noted earlier.

That said, reported first quarter 2017 results show improvement over both the fourth and first quarters of 2016, which were losses per diluted share of $0.22 and $0.34 respectively. It remains our primary focus to return the business to profitability as quickly as possible.

From an EBITDA standpoint, first quarter EBITDA was a positive $4.2 million, improved from $3.2 million in the fourth quarter of 2016 and improved from $1.1 million in the first quarter of 2016. Adjusting for non-cash share comp expense EBITDA was an adjusted $4.7 million in the first quarter of 2017.

The EBITDA and adjusted EBITDA calculations are provided in the tables of the press release.

Turning our attention to the balance sheet, during the first quarter, managed working capital of $92.2 million increased $1.3 million compared with the fourth quarter of 2016 to support the increase in business activity with backlog at quarter end up 30% compared with the end of 2016 and up 44% compared with March 2016.

Despite the increase in working capital, overall managed working capital efficiency improved in the first quarter with managed working capital as a percent of annualized sales improving to 47% at the end of the first quarter, compared with 67% at the end of the fourth quarter and 55% a year ago.

Capital expenditures for the first quarter were $1.4 million roughly flat with the fourth quarter of 2016, which was $1.3 million and up compared with the first quarter of 2016, which was $800,000.

Full-year 2017, we continue to expect CapEx to be in the $8 million to $10 million range and is consistent with what is needed to support the business as we ramp up.

Total debt, net cash was $74.3 million at the end of the quarter, an increase of $1.8 million compared with the end of 2016, driven primarily by the working capital increase noted earlier.

Borrowing availability under our credit facility at the end of the first quarter was $21 million, a record high since entering into the credit facility 15 months ago. In addition, we're in the final stages of discussions with our existing bank group regarding securing additional availability to further support the growth of the business.

Importantly, we remain in compliance with all covenants under our credit facility at the end of the quarter of 2017 and anticipate remaining in compliance going forward for the foreseeable future. This concludes my financial report, Denny, I'll turn the call back to you..

Thanks Ross. In summary, the past two years have been challenging in our industry, due to the adjustments made for significant price reductions in key input commodities, the collapse of the oil and gas sector and the evolution of the current super-cycle and aerospace against a backdrop of political and economic uncertainty around the globe.

At the start of 2017, we are cautiously optimistic that we're experiencing a sustained upswing in activity and look forward to a continued improved operating environment in the balance of 2017.

Our focus at Universal remains on expanding our product portfolio with more technological events products, maintaining competitive lead times and best-in-class customer service in a period of higher activity levels, driving process improvements across all facilities, improving first time through product quality, developing our organization and preserving a strong balance sheet and liquidity position.

We are excited about the increased business activity, the higher backlog and the prospects for meaningful increases in profitability in the current quarter. As one last data point, the positive momentum in order intake is continuing in April and we expect month-end backlog before surcharges to build to the $62 million to $64 million range.

Well let's some calls from the listeners..

[Operator instructions] Our first question comes from Michael Gallo with C.L. King. Your line is now open..

Hi. Good morning and congratulations on the turn in the business. Obviously, the improvement was broad-based and the sales and the backlog certainly strong improvement.

I just wanted to drill down a little bit on the gross margin line because obviously, there was some noise there between the nickel prices as well as shipping product that you melted last year.

So I guess as you go to Q2, are you totally through that? What percentage of the product have been melted this year? Obviously, too soon to see the benefit from the base price increases, but do you expect will be back in double-digit gross margins in Q2?.

Yeah Michael I think we are very confident we'll be in double digits, I would say to be specific and just cutting through the chase somewhere in that 13% to 15% margin range..

Okay.

So, you say you expect substantial improvement in Q2 and based on the improvement in backlog and bookings is it fair to assume we should continue to expect sequential improvements in revenue here in Q2?.

Well, we came out to shoot stronger in the first quarter than most people anticipated and that activity -- that momentum has continued in the month of April. So, as I mentioned, we expect to see our backlog continue to build in April relative to the end of March. Bookings are holding up, customers remain positive.

So that's why we have the cautious optimism, I guess you always put a cautious sign on top of it about the rest of the year. So, I expect specifically sales will be higher in the second quarter than the first quarter with a much-improved margin profile as we discussed..

And I guess again to come back to April and your commentary on April it's notable given that I think you're talking about backlog before surcharges and obviously, you had the base price increase. So certainly, it seems that that did not slow demand and that base price increase seems to be sticking pretty well.

Is that a fair characterization of your comments?.

We have Chris Zimmer, our Executive VP of Sales and Marketing here. So, let me as Chris to answer that one price increase..

Yeah, we put two price increases out in the first quarter that went into effect for new order entry for noncontractual business and what we call the capture rate has been very good. The marketplace has been very receptive to it and it hasn’t slowed our order entry pace that we've seen coming into the year here. We've continued at a strong level..

Okay. Great. Thanks very much..

You're welcome Mike..

And our next question comes from Phil Gibbs with KeyBanc.

Your line is now open?.

Hi. Good morning..

Hi Phil. Good morning..

Denny, can you explain some of the competitive dynamics in terms of I know during the oil and gas downturn, you said a lot of folks may be moved material into your core markets away from that to fill capacity.

Are we now seeing at least in the short-term some of your competitors move away -- moving back more so to the oil and gas market or is this more the industry just enjoying your better volume momentum you think overall?.

I think it's more the latter Phil. I think this is pretty broad-based. Most markets are generally up as we see it. I can't point to any specific cases where people may have moved into our space given what's happening in other markets have moved back and going back to the old way of doing business. It's still pretty competitive out there.

I just think that fundamental demand has improved. If you go back historically, you and I have talked about this before because we have a relatively high exposure to service centers and forgers.

We tend to see an improvement sooner than the rest of the industry by same token we see downturn sooner than the rest of the industry and I think this just validates that phenomenon that we've seen several times over last 10 years..

I appreciate that and is the 2Q cost compression a result of the fact that in the first quarter you had some pretty strong melting campaigns and so you're seeing that lag into Q2 in a positive way just as though you saw in Q1 sort of the other side of the coin from Q4 given maybe work in process inventory cost? Is that a decent way to the think about it?.

We're running average score system, so the higher activity levels in the first quarter, because there are two things. One is the straight operating leverage on fixed cost, plus many of the things that we've done over the last couple years to improve performance.

It's still frustrating because you don't have the volume to put through to really capture the variable cost improvement on that. So, you the benefit there as well. We expect a better mix as we get into the second quarter based upon what we see sitting in our backlog at the end of March.

So, they are the three main reasons we anticipate stronger margins in the second quarter compared to the first quarter and as we move into the third, our production activities are remaining at a pretty crisp clip. We also have selling price increases that will start to kick in on a portion of the product portfolio there we move into July timeframe..

Got it. That's helpful. Ross any perspective you can provide on net working capital management moving forward. It looks like the inventory is built a little bit in terms of some positive reaction to improvement in business activity. You did have a pretty solid expansion in payables.

How do we think about the net of those couple things moving forward maybe some view on whether or not you think it's going to be a source or use for you on the net working capital side?.

Yeah for the -- in the short term, we will continue to see a slight use of cash for working capital through the end of the second quarter as well expand our receivables predominately and maybe a slight expansion in inventory offset by payables -- partially offset by payables.

To the whole year, I would not expect a further expansion in working capital..

For the year, relative to where you are today you're saying?.

Relative to where we are today that's right..

Got it and then last question Denny, can you remind us what the import sensitivity is for some of the products that you sell and whether or not that that import and/or export dynamic has gotten more favorable, less favorable or about the same?.

Imports on the bulk of our products are about the same. The one area we're seeing some benefit is on plate, primarily tool steel plate. Where there is a plate case, it's involved and we've seen a decrease in the influx of foreign tool steel plate into the U.S. market. The other products we really don't compete when the commodity end.

So, there's really been no change there from a competitive standpoint..

Okay. Thank very much..

You're welcome..

And our next question comes from Charlie Smith with Fort Pitt Capital. Your line is now open..

Hey, good morning, guys.

Quick clarification, the last data point you gave, did you say your backlog is up basically 10% since the end of March?.

It's not finally up, but based upon what we've already booked, yes, we expect our backlog to build during the month of April should be in that $62 million to $64 million range..

Okay. Good.

You mentioned that you expect gross margin in the second quarter improve partly due to mix, is that because your greater portion of premium alloys is a part of your mix?.

That's part of it. The other part of it is some of our legacy products where frankly we had some customers use their terminology. They wanted to confirm what they were seeing on the demand side was for real and not a head fake and as a result of that, they held back when some orders, we saw those orders in the first quarter. They're now in our backlog.

So, we do not anticipate any -- anticipate an improvement in the mix going back to more normal mixes in our legacy products..

Okay. Your sale of premium alloys basically grew at rates double the rest of your mix year-over-year, now at 12% of sales.

Where can that number go in 2017 do you think?.

We're seeing a stronger environment there. We're also gaining more credibility with each passing quarter in terms of our capabilities in that business. So, if you're asking in terms of a percentage or actually dollars, we expect that growth rate to continue as we move through the year. We see no reason for the drop off.

We expect additional approvals in the air, which should result in the second half, some improved opportunities for us to sell that product. So what will the number be by the time the whole year is up in terms of percentage? Obviously, there is two numbers you're looking at right, the absolute growth I would say 15% to 18%..

Okay. Last question, Power GEN up 21% year-over-year with very little growth in sales of turbines.

Can that MRO business continue to grow fast enough to keep your Power GEN sales growing at a healthy rate?.

I believe so. There is a major shift going on obviously with the disfavor of coal, the increasing benefits of people proceed with gas, the historically low cost of gas, the ready availability of gas is all driving more and more fuel sources to go towards natural gas.

So, I see no reason why it can't and the nice thing to see would be and what I anticipate is building is at some point new turbines are going to have to start to sell. The other comment I would make their, I made a little one sentence in my comments is that a fair amount of the smaller turbines, really go into the oil and gas market.

So, as you look at the oil and gas market recovering, their use of gas turbines will drive some additional gas turbine manufacturing, but some of the smaller manufacturers like solar turbine, which is part of Caterpillar..

Okay. That's it for me. Thanks..

Okay Charlie..

At this time, I am showing no further questions. I would like to turn the call back over to Mr. Denny Oates for closing remarks..

Thanks operator. Once again, thank you for joining us this morning. We sincerely appreciate your support and interest in Universal and we look forward to updating you on our progress during our next call in July. Have a great day..

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