Good day, ladies and gentlemen, and welcome to the Universal Stainless Fourth Quarter 2017 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 conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. June Filingeri. Ms. Filingeri, you may begin..

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 and webcast. We are here to discuss the company's fourth quarter 2017 results reported this morning.

With us from management are Denny Oates, Chairman, President and Chief Executive Officer; Chris Zimmer, Executive Vice President and Chief Commercial 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. 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 the formalities complete, I would now like to turn the call over to Denny Oates.

Denny, we are ready to begin..

Thank you, June. Good morning everyone. Thanks for joining us today. Our fourth quarter was marked by very positive customer sentiment and increasing market momentum, which continues today. That's evident in our bookings, which reached their highest level since the first quarter of 2012.

Our backlog also grew substantially, amounting to $78 million before surcharges, an increase of 17% sequentially and up almost 80% from the fourth quarter of 2016. Fourth quarter backlog was the highest since the 2012 second quarter.

Sales remained strong in what is normally our seasonally slower quarter of the year, totaling $50.3 million, essentially matching the 2017 third quarter and were up 47.2% from the fourth quarter a year ago. Premium alloy sales remained at record levels in the quarter, reaching almost 15% of total net sales.

The fourth quarter capped a year of top line recovery for Universal and brought full year sales to $202.6 million, which is up 31% from 2016 and included a near doubling of our premium alloy sales to $27.3 million, an increase of 90% from the prior year.

We achieved moderate improvement in our gross margin in the fourth quarter, which totaled $6.2 million or 12.3% of sales compared with 10.7% of sales in the 2017 third quarter and 9.1% of sales in the fourth quarter of last year.

You will recall that the third quarter of 2017 was unexpectedly challenged by the disruption caused by two facility fires that compounded production ramp-up issues as we work to meet strong levels of demand. As a result, we reported increased maintenance spending and higher outsourcing costs.

There was a spillover impact of those issues into the fourth quarter as we sold through third quarter production and worked to keep orders flowing on schedule.

An additional challenge developed late in the fourth quarter, namely extreme winter weather with Arctic temperatures and record snow accumulations in locations near our facilities, such as Erie, Pennsylvania. While the impact was felt in all of our facilities, the Dunkirk plant, which sits adjacent to Lake Erie was particularly hard hit.

The weather caused numerous issues in December and the first couple of weeks of the New Year, specifically customer trucks were unable to pick up shipments, especially those moving through the Erie/Buffalo corridor, rolling power outages occurred, and numerous equipment and infrastructure issues needed to be addressed.

I want to compliment and thank all of our employees, particularly the team at Dunkirk for all their efforts to work through these challenging conditions. Fortunately, the residual challenges from the third quarter and fourth quarter that adversely impacted our second half margins are now largely behind us.

Selling, general and administrative costs in the fourth quarter were $5.1 million, or 10.2% of sales compared with 8.7% of sales in the third quarter of 2017 and 13.3% of sales in the fourth quarter a year ago. The sequential increase was due to increased legal expenses and adjustments to employee programs.

The tax provision in the quarter warrants some further discussion. We recorded a $7.9 million benefit for income taxes, which mainly reflects the new federal tax legislation with some minor offsets for state tax items and the new stock compensation accounting guidance for 2017.

The net benefit to our bottom line was a positive $1.06 per fully diluted share. With this adjustment recorded and the new legislation taking effect in 2018, we are estimating our go-forward effective tax rate to be in the range of 20%.

Net income for the fourth quarter of 2017 was $7.9 million, or $1.06 per diluted share, including a net tax benefit also of $1.06 per diluted share. Fourth quarter net income before that net benefit was, therefore, breakeven compared to net income before unusual items of $0.02 per diluted share in the third quarter of 2017.

We reported a net loss of $1.6 million or $0.22 per diluted share in the fourth quarter of 2016.

For full year 2017, net income was $7.6 million, or $1.03 per diluted share, including $0.03 per diluted share for fire related expenses in the third quarter and $1.03 per diluted share for net tax benefits in the fourth quarter compared with a net loss of $5.3 million or $0.74 per diluted hare for the full year 2016.

EBITDA for the fourth quarter of 2017 was $5.8 million, an increase of 2.3% from the third quarter of 2017 and up 82% from the fourth quarter of 2016.

Looking at our balance sheet, managed working capital for the fourth quarter was $106.8 million, an increase of $5.3 million from the third quarter of 2017, driven by higher inventory partially offsets by lower accounts receivable and increased payables. The increase in inventory is primarily to support higher backlog and higher value product mix.

Capital expenditures for the fourth quarter of 2017 were $3.3 million bringing full year capital expenditures to $8 million, which is inline with our forecast from the last call. The fourth quarter amount includes down payments on capital projects scheduled for 2018 in Dunkirk and Bridgeville.

Total debt at year-end 2017 was $79.7 million, an increase of $2.6 million from the end of 2017’s third quarter with the increase mainly for higher working capital to support strong bookings and backlog growth along with new product development.

As discussed last quarter, we secured a favorable amendment to our ABL bank agreement facility that is now in effect and is yielding interest savings. There were no changes to our covenants as part of that amendment, and we remain in full compliance with all covenants. Let me turn from the financial to some other important updates on our business.

Our base price increase of 5% on all stainless products that went into effect on October 1st is holding. It was our second base price increase in 2017. In November, we announced an electrode surcharge of $0.04 per pound effective January 1st to address the significant increase in electrode prices.

Graphite electrodes are a critical consumable use on electric arc steelmaking. The electrode market has grown increasingly chaotic over the last six months. Supply constraints caused by needle coke shortages have driven prices up four to six fold. Universal has contracts in place for electrodes to support operations throughout 2018.

Looking at commodity prices; last quarter, I mentioned that at the end of September, nickel, moly and chrome had all reached their highest levels in two years. While chrome prices remained fairly level through the fourth quarter, prices for nickel and moly continued to move up, and nickel prices have had a solid start in 2018.

In fact, nickel was up to $5.95 per pound earlier this morning. With the exception of moly, we're planning on fairly stable commodity prices with an upward bias based on fundamentals during the first half of 2018.

Regarding the Section 232 steel import investigation, the Commerce Department has completed its investigation, and its recommendations went to the White House on January 11. The President has 90 days to decide on any potential action based on the findings of the investigation.

While we don't know the details of Secretary Ross's recommendations, we continue to feel that some form of trade relief is needed and will occur. Earning customer approvals, expanding relationships and developing new products continued to be a driving force in the fourth quarter.

High on the list of accomplishments is the extension of existing Rolls-Royce contract and the expansion in a number of alloys to be produced by Universal. The expanded contract will go into effect in January 2019. We also added two new OEM approvals for products used in the semiconductor market during the quarter.

Taking a look at our major end markets starting with aerospace; our aerospace sales totaled $28.4 million in the fourth quarter of 2017, representing 56% of fourth quarter sales versus 54% in the 2017 third quarter and 49% of sales in the fourth quarter of last year.

Aerospace sales increased 2.4% sequentially and were up 70.1% from the fourth quarter 2016. The aerospace market is healthy, and so are the businesses of our customers. We've entered 2018 on very solid footing. The strength of the market is fully evident in the year-end order and delivery reports from Airbus and Boeing.

Airbus net orders increased 52% in 2017 and totaling 1,109 planes for the year enabling Airbus to beat out rival Boeing in the number of 2017 orders. Airbus indicated jet demand is growing faster than they expected and attribute that pace to the sharp pickup in global economies, which is driving higher air traffic.

Earlier this month, IATA reported that total revenue passenger miles in November rose 8% compared to November of 2016, which is the fastest growth in five months. Meanwhile, Boeing scored the most deliveries in 2017 with a record 763 and Boeing remain the world’s largest manufacturer of passenger jets.

Both airframe makers continue to have backlogs exceeding seven years of production.

Also contributing to the strength and optimism in aerospace demand are the anticipated increases in defense budgets, continued growth in aftermarket sales, strong 6% plus airfreight growth and emerging science that tax reform may benefit the lagging business jet market.

The heavy equipment market continued to be our second largest market in the fourth quarter, representing 15% of total sales compared with 19% of sales in the third quarter of 2017 and 20% of sales in the fourth quarter of 2016.

Fourth quarter 2017 heavy equipment sales totaled $7.5 million which is down 22% from the third quarter of 2017 although sales were up 10.4% from the fourth quarter of 2016. Tool steel plate sales are the main component of our heavy equipment category.

And from time to time, they do become somewhat lumpy, as they did in a sequential drop in the fourth quarter. Based on our strong tool steel bookings and current backlog, the tool steel market remains very strong and the fourth quarter dip was temporary as manufacturing activity continues to grow overall.

Recent channel checks with the machinery group remain very upbeat, with demand potentially benefiting from tax reform along with more activity across end markets. Dealer inventories are generally lean, and lead times are getting shorter.

In automotive, vehicle production numbers dipped slightly in 2017 but remained at very healthy historical levels, and the forecast for automotive model changeovers continue to trend up with over 40 model changes expected in 2019, driving demand for tool steel plate in 2018.

The oil and gas end market remained at 9% of fourth quarter sales, which is inline with both the third quarter of 2017 and the fourth quarter of 2016. Our oil and gas sales totaled $4.8 million in the 2017 fourth quarter, an increase of 3.9% from the third quarter and up 51.7% from the fourth quarter a year ago.

Last Friday, Schlumberger reported 2017 with its first year of growth, and I'll quote, "in all parts of our global operation since 2014." That included 82% revenue growth in land activity in North America, which they note was in line with the increase in rig count.

Earlier this week, Halliburton reported strong results in North America and improvement in international markets, which underscore their confidence in 2018. As we noted on our last call, we are seeing increasing optimism from our customers as they recover from the poor conditions of 2015 and 2016.

That optimism continues against a backdrop of rising oil prices, positive oil market sentiment and a strong global economy. Power generation market also represented 9% of fourth quarter sales, up from 6% of sales in the third quarter of 2017 and inline with 9% of sales in the fourth quarter of 2016.

Our power generation sales totaled $4.3 million in the 2017 fourth quarter, an increase of 33% sequentially and up 33% from the fourth quarter last year. Our power generation sales continued to be driven by maintenance business on installed turbines, which saw a pickup in activity in the fourth quarter after slowing in the summer months.

We expect the opportunities in power generation to remain in the maintenance market over the next few quarters as large OEMs, such as GE and Siemens, work through their restructuring programs.

Our general industrial market sales were 5% of sales in the fourth quarter of 2017, consistent with the 2017 third quarter and compared to 10% of sales in the fourth quarter of last year. Fourth quarter 2017 general industrial sales totaled $4.7 million, an increase of 2.5% from the third quarter and 45% higher than the fourth quarter of 2016.

Our new products for infrastructure-related projects are the main driver of our general industrial sales as are our business development activities for domestic manufacturing. Excuse me.

We continue to expect growth in this market in 2018, subject to normal project seasonality and before including any benefit from a potential federal infrastructure bill.

So in summary, our fourth quarter capped the year of recovery for Universal Stainless, marked by growing positive customer sentiment and increasing marked momentum as we move through the end of the year.

That sentiment and the momentum continue today and are evident in our bookings and backlog at year-end and also so far in January, which are basically the highest levels we've seen in the last five or six years. Fourth quarter sales remained strong and premium alloy sales remained at record levels.

As a result, our full year sales totaled $202.6 million, up 31% from 2016, while our premium alloy sales increased 90% from the prior year. We added 10 new customer approvals and commercialized 12 new products during the year.

We achieved moderate improvement in our gross margin in the fourth quarter, which at 12.3% of sales represented a 151 basis point increase sequentially and a 318 basis point increase from the fourth quarter a year ago.

Our target for gross margin in the mid-teens – is in the mid-teens, but the second half of 2017 was unexpectedly challenged by two facility fires and production ramp-up issues in the third quarter, and there are residual effects in the fourth quarter as we worked to meet strong levels of backlog. Both of these issues are now behind us.

Meanwhile, EBITDA for 2017 increased 82% from 2016. On the organizational front, we are actively interviewing to fill our Chief Financial Officer opening and hope to have something to report by the next call.

We are entering 2018 on a strong footing and are fully focused on expanding margins, driving efficiencies and seizing opportunities in the current strong market. That concludes my formal remarks. Operator if we can take some calls from our – take some questions from our callers..

Thank you. [Operator Instructions] And our first from Michael Gallo with C.L. King. Your line is now open..

Hi, good morning..

Hi Mike how are you doing today?.

I’m doing well.

And yourself?.

Doing fine..

Okay great. Denny, can we just drill a little bit on the gross margin line. Obviously, you had a number of headwinds between the fires you had, the carryover from that. You had nickel going against you. You weren't surcharging for electrodes, et cetera. I guess, as we look forward now into 2018, the fires are behind you.

You have nickel moving in the direction where it actually held margins. Pricing seems to be received well.

What should we expect in terms of gross margin as we look kind of Q1 and beyond?.

You should look at continued improvement in each quarter of 2018 and be looking at and be looking at something in the mid-teens, 15%-plus..

Do you think you can get to the mid-teens just at some point during 2018? Or do you think you can get there sooner?.

I think we can get there by midyear, and I'm being a little cautious there. There are some opportunities to get there in advance, but that's kind of where our heads are collectively..

Okay great. And then just a quick question as we look at – obviously, you have the surge in bookings. Normally, you see a falloff Q4 versus Q3. I'm trying to think back to last year, we saw that was really flat sequentially, pretty unusual. I guess, when we look at now Q1 sequentially versus Q4.

Would you expect that to kind of pick up modestly? Would you expect the normal kind of seasonal pattern? Because it would seem that even though Q4 was strong from a revenue standpoint, the backlog and bookings were even stronger..

Bookings have continued strong. Let me ask Chris Zimmer to answer your question.

Chris?.

Yes. We've continued to see entry strength in January, so I would expect the order entry activity from fourth quarter into the first quarter to continue.

The fourth quarter is seasonally strong from seasonally strong from an entry standpoint as a number of our customers being service centers look to prepare their inventories for the coming year, but we're continuing to see that strength as we move into the first quarter here.

So I would expect that same level of activity from fourth quarter to continue into the first quarter..

Actually, Mike, just to put a number like….

[Indiscernible] shipments – yes..

To put a number on what Chris said while he was talking, our bookings through the first 23 days of January are 40% higher than they were a year ago. So the strength in the market has continued into 2018..

Okay, great. Thanks very much..

You’re welcome..

Thank you. [Operator Instructions] Our next question comes from Phil Gibbs with KeyBanc Capital Markets. Your line is now open..

Hey good morning Denny..

Hey Phil how are you?.

Good.

Chris you are there too?.

Yes I am..

Nice, good morning..

Good morning..

Denny, I had a question on the VIM sales. I know you alluded to some new contracts and some good momentum there clearly in 2017.

What target do you have in mind for sales growth for the VIM specifically in 2018 versus 2017?.

We see significant growth, double digit, in the range of mid-teens, and I'm being conservative. There are some opportunities for some things to break our way, which should drive that even higher..

And what unbalances is driving that from an end market standpoint or new product standpoint to the extent you could share?.

It's primarily aerospace, and I think it's a reflection of a strong underlying market. I think it's also a reflection of time, as people are growing increasingly comfortable with Universal as a supplier of these metals. If you remember way back when we did the North Jackson investment, we talked about it, it's almost like a quoting kind of thing.

You get – people need to get confidence in you as the new guy on the block. And I think we're starting to see a reflection of that confidence based upon our performance over the last several years..

Okay. I appreciate that. And the inventories picked up some in Q4 probably more so than we thought.

How much of that was related to somewhat of an inability to get shipments out in the fourth quarter versus preparing for a strong Q1, meaning how much revenue do you think you may have lost because of the weather? And then secondly, what are your goals or aspirations for that net inventory levels? I think it's right now $116 million.

How are you thinking about that as you move through the year?.

We missed $1.6 million of sales in the last week of – last week and a half of December. Most of that was at the Dunkirk facility where, frankly, trucks could not get through Erie, Pennsylvania. If you look at the weather there, it occurred Christmas, and then two days after Christmas, 50-some-odd inches of snow. So it's a logistical thing.

So $1.6 million from a sales standpoint was missed in 2017. As far as the inventory goes, we did get – as good as a good news, bad news thing, we got some nice orders for vacuum induction melted product mid-December. And we had a campaign going, so we did manufacture some product.

There's a fair amount of that build that has to do with end-of-year production of premium product that will be sold in the first quarter of this year. As far as our outlook for the rest of the year, in 2018, our plan is to pull that inventory level down. We feel we have some programs in place that will do that on a gradual basis.

We don't look to any further increase in inventories, so somewhere in the range of a 5% to 10% reduction as we move through the year..

Terrific..

The other thing that impacts that inventory, as I said a couple of times on calls before, we have about $6 million of inventory and work in process that is all experimental new product, testing – products going through testing. So that continues to be an issue as well with some of these products.

For example, on the Rolls-Royce contract, they are going through their testing phases and approval phase as well. They will turn into sales effective January 2019..

Got it. Denny, any thoughts longer term or, call it, three to five years out in terms of capital deployment? Clearly, the market's better. It looks like it will continue to be that way for a few more – at least a few more quarters.

Who knows what's going to happen in a year from now? But assuming it continues, any thoughts on M&A or potentially, at some point, putting in a dividend? And how are you thinking about other ways to deploy capital and the CapEx and plans that you have? Thanks..

one is to reduce debt, to basically pay towards debt; and we have a $10 million capital project at Dunkirk to put in a bar cell, which will be a high-return project. It will pay a lot of dividends to the company from a cost standpoint and also expand our reach from a commercial standpoint. So that's the short-term focus.

As far as M&A goes, there's always discussions that go on through the industry, it's a small part of the industry. There's nothing – I don't want to infer there's anything imminent.

But I can't really say anything that's going to happen, other than the fact that we're always looking at things and have conversations and it's a small part of the industry that we're in..

Just a follow-up on the comment.

Yes, I was just going to say just to follow-up – can you hear me?.

Yes. There are some new technologies as well that we're evaluating. So if we're going long term for capital deployment, there could be some opportunities there as well..

Just to follow-up on your response here on the bar cell investment.

Now the $10 million investment, is that going to be largely for 2018? And I'm sorry if I missed it earlier on the call, but did you talk about a CapEx budget for 2018?.

Bar cell is $1 million of capital spend in the fourth quarter that was basically a progress payment on the bar cell. Bar cell will be installed over the course of 2018, and the benefits of that will be in 2019. As far as capital spending budgets for 2018, I would model around $15 million..

Thanks Denny. I appreciate it..

You’re welcome..

Thank you. [Operator Instructions] And I am not showing any further questions at this time. I would now like to turn the call back over to Dennis Oates for any further remarks..

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

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