Good day, ladies and gentlemen. And welcome to the USAP Third Quarter 2018 Conference Call and Webcast. At this time, all participants are in the listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this call is being recorded.

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

Thank you, Sara. 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 third quarter 2018 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; Paul McGrath, Vice President of Administration and General Counsel; and Chris Scanlon, Vice President, Finance, Chief Financial Officer and Treasurer.

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 these formalities complete, I would now like to turn the call over to Denny Oates. Denny, we are ready to begin..

June, thank you. Good morning, everyone. Thanks for joining us today. This morning we announced that sales reached $69.1 million in the third quarter, and year-to-date sales are approaching $200 million, driven by broad based and strong business conditions. Normal third quarter seasonality was somewhat muted this year.

Frankly, it's rare for our third quarter sales number to exceed the second quarter in our industry. Incoming business is measured by bookings of $69.2 million before surcharges continue at near-record levels during the quarter and our backlog reached $111.4 million at September 30, validating that the demand cycle remains intact.

Taking a closer look at the details. Third quarter sales of $69.1 million were up 35.7% from the third quarter last year and up 4.5% from a 2018 second quarter. Tool steel sales were especially strong in the quarter and reached a record $13.1 million.

Premium alloy sales totaled $9.2 million, an increase of 24.3% from the 2017 third quarter, but lower than the record second quarter 2018. I should point out that third quarter bookings in September 30 backlogs reflect record levels for our premium products, and we remain upbeat about our prospects for future growth.

Gross margin as a percentage of sales for the third quarter of 2018 was 15.1% which was the second highest in 13 quarters, but trailed 17.7% achieved in the 2018 second quarter, lower value shipments coupled with spending and production inefficiencies associated with our new labor contracts adversely impacted margins.

Similarly, earnings before interest taxes and depreciation of $10.1 million increase from the third quarter of 2017 by noteworthy 79.5%, was 9.8% lower sequentially. Third quarter net income total $3.9 million, or $0.44 per diluted share compared with a loss of $300,00 or $0.04 per diluted share in the third quarter of 2017.

And net income a $4 million, or $0.50 per diluted share in the second quarter of 2018. Today's press release references the puts and takes on earlier periods along with further details on our shares outstanding. Regarding raw materials, nickel reflect lower during the third quarter reaching at 2018 low of $5.68 a pound in September.

Although down from the 2018 high of $6.85 per pound reported in June, nickel remains higher than the $5.10 per pound reported in September of 2017. We attributed declines to mainly to lower Chinese production and tariff concerns. Earlier this morning, nickel was quoted at around $5.57 per pound.

We expect nickel to move sideways the rest of 2018 and agree with most of the experts who are calling for increases in 2019. Other key commodities such as molly, chrome and scrap have been basically flat for the last several months.

Because of these raw material trends, we did experience some minor misalignment between surcharges and mullet cost which will continue during October and November. Earlier this week, we announced a price increase of 3% 8% on selected specialty steel loan products. The products involved represent about 15% to 20% of our shipment volumes.

Regarding our balance sheet, Chris Scanlon will provide an update in his review but just let me reiterate that we are heading into 2019 with a much stronger financial structure because of the initiatives completed in 2018, which added significantly to our flexibility to pursue our growth strategy. Turning the third-quarter operating highlights.

The installation of our $10 million midsized bar cell at Dunkirk, New York facility is proceeding on schedule and initial production is slated to begin in November. We'll spend the rest of the quarter in early 2019 fully commissioning all functions of the new line.

We're looking forward to the resulting cost reductions, quality improvements, cycle times and lower inventory requirements afforded by the state-of-the-art operation. The union and management negotiating teams did an excellent job of hammering out two key collective bargaining agreements during the quarter.

A five-year contract with our Bridgeville employees effective September 1st and a six-year contract with North Jackson employees effective earlier in the quarter. Both agreements contain flexible work rules and profit sharing incentives.

We did incur one-time cost of approximately $0.01 per share for expenses directly associated with a potential work stoppage in Bridgeville and certain production inefficiencies associated with the negotiations having an estimated impact of another $0.02 per share.

Our precision rolled products group serving aerospace and power generation customers out of our Titusville location continued on a record-setting path for 2018. Turning to our major end markets, we start with aerospace.

Our airspace sales represent a 54% of total sales in the third quarter of 2018 consistent with a third quarter last year, but below 61% of sales in the 2018 second quarter. Third quarter aerospace sales totaled $37.3 million which is up 34.6% from the third quarter of 2017, although 7.2% lower sequentially.

The sequentially lower sales notwithstanding commercial new build activity remains robust. The after market remains strong and there is a growing defense market. Additionally, IATA continues to report air traffic demand ahead of expectations and noted the global load factors in August were the highest since they began keeping records.

Analysts see the ongoing air traffic growth is further supporting long- term OEM builds rates. For Universal, the robust activity is translated into continued high levels of aerospace backlog at the end of the third quarter, including record backlog in our premium melted products.

One of the aero space industry concerns earlier this year was the pace of production ramp ups by the airframe manufacturers due to engine and supply challenges. Boeing and Airbus are signaling that these engine issues are being overcome and production ramps are getting back on track.

In any event, we have not experienced any pushback or delays from our aerospace customers, quite the contrary customers are demanding more as evident in our bookings and backlog.

In other industry news, Honeywell reported on Friday that their airspace sales for the third quarter up 10% driven by robust demand from business aviation, original equipment manufacturers continued strength in the US international defense business and growth in the Air Transport business aviation aftermarket among other factors.

We could cite other similar reports from aerospace companies based on third quarter releases, but suffice it to say demand an aerospace market remains very robust.

The heavy equipment market remained our second-largest mark in the third quarter of 2018 representing 19% of total sales which is in line with the third quarter of 2017 and compares with 14% of sales in the second quarter of 2018.

Third quarter of 2018 heavy equipment sales which are primarily tool steel plate sales totaled $13.4 million, an increase of 38.4% from the third quarter last year, and up 48.4% sequentially. Those of you who have followed us for a while know that our tool steel plate sales tend to be lumpy.

In the third quarter of 2018, tool steel sales reached a new company record. Automotive production especially model changeovers off-road equipment, mining equipment, cutlery and general industrial manufacturing requiring metal fabrication all drive tools steel demand.

While order production is down modestly, production remains well above the last 10 year annual average. Model change over are happening in a healthy clip. At the same time on the industrial side the last few days which suggests investor sentiment has turned somewhat negative due to concerns over tariffs politics and geopolitical issues.

That said, we have a decent backlog to ship in the fourth quarter and our customers continue to be very positive about 2019. Lastly, favorable rulings in a first quarter 2017 trade case have leveled the playing field for Universal as a domestic producer of a steel plate and enabled us to gain market share, which bodes well for the future.

The oil and gas end market remained our third largest market in the third quarter of 2018 representing 13% of total sales versus 9% of sales in the third quarter, and 12% of sales in the second quarter of this year. Third quarter oil and gas sales totaled $8.9 million, an increase of 94.4% from the third quarter of 2017 and up 14.1% sequentially.

The ongoing recovery in oil and gas generally continues despite some of the negative news regarding futures global economic growth and Saudi plans for output. Our opportunities are centered in North America currently based on fundamental activity increases coupled with some of our new capabilities being provided by the North Jackson facility.

Orders and backlog are up and we see this trend continuing well into 2019. Power generation continues to be the weak spot for both Universal and the industry as a drop-off a new-build turbine demand is fully evident. I think it's safe to say that recovering the new build mark is a few years off at best.

In the third quarter of 2018, our power gen market sales represented 4% of total sales. The same level was in 2018 second quarter but down from 9% of sales in the third quarter of 2017. Third quarter of 2018 power gen sales totaled $2.7 million, which is down 16.7% from the third quarter last year although up 16.3% sequentially.

As we've noted previously, our power generation sales continued to be mainly for the maintenance market. In the third quarter, there was a nice pickup from second quarter as customers feathered in inventory for their next round of scheduled maintenance.

We continue to expect maintenance or an installed gas turbines to drive our power generation sales until the replacement cycle does kick in. Our general industrial market sales were 7% of sales in the third quarter 2018 compared with 9% of sales in the third quarter of 2017 and 7% of sales in the 2018 second quarter.

General industrial sales totaled $5.1 million, an increase of 10.9% from the third quarter of 2017 and up 5.1% sequentially. Our General industrial business continues to develop nicely serving the semiconductor, medical, infrastructure and general manufacturing markets.

As we've discussed in the past, we continue expect continued growth in these markets in 2019 and beyond. Let me down turn the call over to Chris Scanlon for our financial report.

Chris?.

Thank you, Denny, and good morning everyone. This morning, I'll cover the financials and then conclude with some points summarizing our August PNC Bank Credit Agreement amendment. Starting with revenues, third quarter 2018 sales of $69.1 million were up 4.5% sequentially and up 35.7% compared with the 2017 third quarter.

Current year-to-date sales of $198.9 million were up 35.5% compared with the prior year-to-date sales. Increased revenues for both the third quarter and year-to-date 2018 were driven by all end markets except for power generation.

Gross margin in the third quarter was $10.4 million or 15.1% of sales down 260 basis points from the 2018 second quarter, and up 440 basis points from the 2017 third quarter. The sequential decline in gross margin was driven primarily by a decline in premium product sales.

Note the third quarter 2017 gross margin included approximately $300,000 of charges related to facility fires. Adjusting for this, Q3 2017 gross margin was 11.2%. Lastly, we did see a mild pinch in melt cost alignment compared to our commodity surcharges in the 2018 third quarter.

Turning now to selling, general and administrative costs, our third quarter SG&A was $5.1 million or 7.4% of sales, a decrease of approximately $720,000 compared with the 2018 second quarter and $680,000 higher compared to the 2017 third quarter.

The largest driver in SG&A changed between periods was employee and setup compensation with current period incentive compensation decrease in compared to the second quarter of 2018, while employee incentive compensation increased from the prior year third quarter.

Our tax rate for the nine months ended 9/30/18 was 19.1% and included approximately $100,000 of unfavorable discrete tax items, primarily comprised of the expiration of fully vested stock options, partially offset by research and development credits. Excluding discrete tax item, our underlying annual effective tax rate is 18.6%.

Specific to our third quarter income tax expense totaled $460,000 and was favorably impacted by discrete tax items totaling $270,000. These favorable discrete items were primary comprised of R&D credits and then to a lesser extent stock option exercise benefits. Net income in the third quarter was $3.9 million or $0.44 per diluted share.

Second quarter 2018 net income totaled $4 million, or $0.50 per diluted share. You will recall our 2018 second quarter earnings included a gain on a legal settlement totaling approximately $520,000 net of taxes.

Excluding this one-time gain, our adjusted second quarter 2018 earnings totaled $0.44 per diluted share or flat to current quarter diluted earnings per share. Current quarter diluted shares outstanding total approximately $9 million, while second quarter of 2018 diluted shares outstanding totaled approximately $8.1 million.

The difference of approximately 900,000 shares is due to our Q2 equity raise and the weighted average calculation of diluted shares outstanding.

Current quarter share count includes the full effect of the 1.4 million additional shares issued while the diluted shares outstanding in the second quarter, which totaled approximately 550,000 shares were prorated based on the Q2 equity raise date. 2017 third quarter net loss totaled approximately $300,000 or $0.04 per diluted share.

The prior year third quarter net loss included a $0.03 loss per share related to facility fires, as well as a $0.03 loss per share for a discrete tax expense charge related to the change and stock compensation accounting guidance. Excluding these items, 2017 third quarter net income totaled $0.02 per diluted share.

Year-to-date 2018 net income totaled $10.1 million or $1.23 per diluted share and was significantly improved from the 2017 year-to-date total which was a loss of $250,000/ I'll cover EBITDA next with our third quarter EBITDA totaling $10.1 million, which was a decrease of.

$1.1 million or approximately 10% sequentially, and an increase of $4.5 million or 80% compared with the third quarter of 2017. Year-to-date 2018 EBITDA totaled $30.4 million compared to EBITDA of $17.1 million in the 2017 nine-month period ended September 30th.

Adjusting for non-cash share compensation expense 2018 third quarter adjusted EBITDA was $10.5 million. The EBITDA and adjusted EBITDA calculations are provided in the tables to the press release. I'll cover the balance sheet next. And I'll start with managed working capital.

During the third quarter, managed working capital totaled $136.9 million, and increased by $11.4 million compared with the second quarter of 2018. The increase is consistent with continued strong end markets and improved business activity.

Accounts receivable increased by $8.4 million and inventory decreased by $2.8 million, while accounts payable declined by $5.8 million. We were able to decrease inventory while still supporting our higher backlog, which grew by $7.2 million during the quarter to $111.4 million.

Lastly, the increase in accounts receivable is directly attributable to the higher third quarter sales activity. Capital expenditures for the third quarter were $6.6 million with year-to-date capital expenditures totaling $13.2 million.

Prior year third quarter capital expenditures totaled $1.6 million with prior year-to-date CapEx totaling $4.7 million. For the full year 2018, we expect our capital expenditures to approximate $16.5 million. Our September 30th restricted cash balance totaled $6.2 million, relatively unchanged from the second quarter.

We began recording restricted cash in the 2018 first quarter upon utilizing new markets tax credit program funds for our Dunkirk New York mid-sized bar cell capital project. Lastly, we continue to record $2.8 million within long-term liabilities related to qualified investment funds received.

As Denny previously discussed, our bar cell project is continuing to progress well and we should begin operating here in the fourth quarter. We also expect annual depreciation expense related to the bar cell unit to approximate $700,000.

With this additional depreciation, our 2019 depreciation and amortization expense is estimated to total $20 million. Moving on to debt. The company's total debt at September 30th stood at $62.5 million, an increase of $5.3 million from the prior quarter, while our debt net of cash and restricted cash totaled $56.2 million at the current quarter end.

Our increased debt level was primarily driven by increases in working capital as well as increased capital spending. I'll touch on our PNC Bank amendment activity next. On August 3rd, we amended and restated our asset based lending credit agreement with PNC Bank.

The new agreement increases the maximum line of the company's revolving credit facility to $110 million and reduces the term loan facility to $10 million. The new agreement also includes a more favorable interest rate structure.

The amended credit agreement continues to be collateralized by substantially all of the company's accounts receivable, inventory and fixed assets and will expire in August of 2023. Our amendment activity included reducing the size of the term loan which was reduced to $10 million at the amendment date.

Due to this, $7 million of outstanding term loan borrowings were transferred to revolving line of credit borrowings as of the amendment date. I will conclude my comments by adding some color on the timing of the receipt of expected insurance proceeds related to the 2017 Dunkirk facility fire.

We currently estimate these funds to be received in the second half of 2019 and that gross proceeds should approximate $650,000. This concludes my financial update, and with that Denny I'll turn the call back to you..

Okay, Chris. Thank you. In summary then third quarter sales reached $69.1 million which was a record for a third quarter. And year to date sales near $200 million as very strong business continues to drive strong demand. Overall, third quarter bookings were near record levels and premium melted product order entry did set a new record.

Order backlog at September 30 totaled over $111 million also a record. The demand cycle remains intact and we feel well positioned for a solid fourth quarter in 2019. We're continuing to focus on growing profitability through better price realization, ramping up plan activity levels, lowering variable cost and targeted capital spending.

The addition of the state-of-the-art bar cell in Dunkirk this quarter will be an important step forward in this regard as we capture cost reductions, quality improvements, faster cycle times and lower inventory requirements.

Our new collective bargaining agreements eliminate a major distraction for the next five to six years, and we're all renewing our focus on taking production levels, taking production to new levels.

We will continue to be relentless in executing our growth strategy in the coming quarters, and are equipped with a stronger financial structure because of initiatives undertaken in 2018, all of which have added significantly to our financial flexibility. That concludes our prepared remarks. Operator, let's take some questions..

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

Hi, good morning. Denny couple questions, normally in the fourth quarter you tend to see the normal seasonal patterns are kind of service center matters the year-end inventory. Seems like your backlog has continued to be really strong and the bookings in Q3 were strong.

Do you expects we'll see the normal seasonal pattern around the end of the year or might it be a little less than what you see normally this year?.

I think it will be a little less than what we normally see, but there will be some window dressing at the end of the year.

At this point in the quarter, we've already gotten indications from several of our larger customers about what they're receiving plans are, but there's always a little qualifier in there that they really need the material, we can ship it but some of our customers are off Christmas week.

There's a few of them that are not receiving anything after the second week of December, but as you look at the overall picture and look at backlog bookings in general activity level and the needs of our customers, I don't, I think they're still in the mode from my perspective of meeting their customer demands which are very strong.

So I expect some seasonal activity but I don't expect it to be as severe as we've seen in prior years..

Great, next question I have Denny just on the gross margins. Obviously, you had a couple things going on in the third quarter between obviously a lower mix of premium products, you had some misalignment with nickel and then you had some production efficiencies around the labor contract negotiations.

Your commentary on the backlog and what you're seeing suggests you have seen very strong orders and backlog for premium product. So I guess should we look at the fourth quarter starting to resume some of the sequential growth.

Will that be kind of a low point as we look forward or will some of the issues around misalignment et cetera continue to drag? We expect premium product sales to be similar and then how should we think about that gross margin line next year? Thanks..

The way we're looking at that I guess let me just talk about headwinds and tailwind if I can. So from a headwind standpoint, yes, there will be some misalignment here. You can see our surcharges in October and November. I would point out though that we're not 100% nickel based, so some of those surcharges as DC in October and November are down.

And for some of our other products you'll see surcharges that are actually going up. So it's not-- I don't want to leave anybody with the impression there's a significant misalignment coming but there will --continue to be what we saw in the latter part of the third quarter occurring in the early part of the fourth quarter. So that's one headwind.

Obviously will have some higher labor costs on a per hour basis. We are seeing continued inflation, some of our supply items like electrodes and refractory brick and things along those lines. On the other side from a positive standpoint, I think you can look towards improvement in mix.

The value of the products more premium melted products as we move through the fourth quarter and in the 2019. The only qualifier I put on that is what happens to the end of the year as we just discussed. I don't expect the significant window-dressing but that's one of the wildcards that we have to face every year.

We do have a strong backlog, so we can get focused on that backlog. We have the distraction of the negotiations behind us and ramped up and have looking forward to a very solid fourth quarter from an operating perspective, which will drive better absorption and drive lower variable costs.

Although I don't expect significant improvement in margin based upon the bar cell in the fourth quarter, optimistically, we could see some benefit here as we exit the fourth quarter and start up the first quarter. So that's kind of a picture of some of the headwinds we're looking at.

The other thing from a tailwind standpoint I guess would be with pricing standpoint you did notice we would have a price increase announcement earlier this week. It's not on the universe of our products, it's on 15% to 20% of our volume.

So as we look at some of the higher costs, if you think about what I just said what we're essentially saying is through a combination of mixed improvement, price enhancements and further cost reductions driven by higher volumes and better operations with less distractions, we would hope to maintain or improve upon our margin performance we saw in the third quarter..

I'm kind of looking to 2019 obviously you've had a couple base price increases, your backlog and your bookings levels suggest your revenue will be up, you should have some of the benefits of the round cell bar project.

Is it fair to assume that you should see gross margin growth next year?.

Yes. Absolutely..

Our next question comes from the line of Lucy Guo with Cowen & Co. Your line is now open good..

Good morning, Denny and Chris.

I'll start off with clarification when you said there will be less seasonality in Q4, does that apply to orders and surcharges as well?.

Say that again, into orders and what about surcharges?.

No just orders, Q4 orders, would you also see less seasonal patterns way it applies to orders not just sales. [Multiple Speakers].

At this point in time as we look at the third and the fourth quarter activity level and what people are telling us in the supply chain about early 2019 activity. I would expect bookings to continue strong in the fourth quarter. So bookings typically are not as seasonally affected as sales would be at the end of the year.

There's a window dressing and so forth. We do have some holidays obviously in the fourth quarter. So that's really the only impact you see on bookings..

Got it and then the second is also sort of clarification the 200 bps or so sequential gross margins step down, if we think about the plus from your favorable mix and the negative, the headwinds of misalignment and then production inefficiency which could be just in the short term.

How would you say in terms of how they're distributed? Is misalignment and inefficiency potentially a 100 bps of some of that decline or how significant if you can help us to calibrate?.

I would say that misalignments roughly a 100, some of the inefficiencies we've called out to $300,000 pretax and the remainder of that would be basically the mix of products that went out the door in the third quarter if you're reconciling to the second quarter.

As we look at the fourth quarter, we look at that current the margin you saw in the third quarter as a target that we're focusing on improving upon in the fourth quarter. And definitely improving upon as we get into 2019, where we expect commodity prices to improve actually to increase in certain case of nickel.

But more importantly things are under control like the bar cell will be coming online and generating additional profit opportunity..

So just follow up on your commentary there nickel in 2019 for your internal plans.

I think your -- in my sense was that you generally assume nickel prices trending flattish or you're sort of neutral on nickel prices in your own internal plan assumptions but for 2019 are you assuming 5% -10% increase or is it more drastic up or down more than 10% to 15%?.

You've heard me kind of joke about we're cowardly on nickel. So we always assume it's going to be flattish, but if you look at the fundamentals of nickel today, it has drifted down over the last three months largely based upon Chinese production and concerns about what tariffs are going to do to production levels going forward.

But if you look at the nickel market itself, it has been running in a deficit, it's been running as deficit for two years. The huge inventories that were built up a few years back or getting work down. There's a whole specter of the electrical requirements for batteries for automobiles going down the road, which will put a floor under nickel prices.

So when you look at all those fundamentals it's hard to come up with a case even if you don't think there's going to be a resolution of some of these tariff issues. It's hard to come up with a case where you're going to see a drop in nickel.

And the most logical and most probable outlook is you're going to see an increase in nickel prices bouncing back up to where it was earlier this year and then some. So that's kind of where our heads are..

Got it.

The next question is on as it relates to the premium alloys mix, you talked about record levels in your orders and backlogs but Q3 sales is down, is that mostly timing related?.

That was basically two customers and largely timing and what their specific needs were..

Okay, understand. Finally just on free cash conversion, it looks like your working capital may reverse to some extent in Q4, but you are taking up your CapEx expenditure outlook for Q4 into 2018.

Can you just maybe Chris, if you can address what your free cash conversion outlook may be?.

Sure. Q3 was an anomaly. We expect the Q4 activity to revert back to what it was more closely looked like in Q2 and Q1. From a CapEx perspective, we continue to spend to fund growth initiatives, bar cell being the largest driver of CapEx in total. We accelerated some of that spend in Q3.

It'll continue in Q4 as we complete the bar cell agreement or the bar cell unit, Q or I should say 2018 capital spend will probably approximate 2018 capital spent as we continue to work through managed working capital, and make the improvements that we have seen in prior quarters in the fourth quarter.

We should balance out the free cash flow as Q3 as I said earlier was an anomaly..

Our next question comes from the line of Michael Leshock with KeyBanc Capital Markets. Your line is now open..

Hey, good morning. Just one question from me. I was just wondering so you mentioned in last quarter's call you thought revenue could come in above the $70 million this quarter, just wondering what were the drivers that caused you to come in below that number in the quarter..

The main issue was we had lower premium melted products going out the door. It wasn't that we didn't have the backlog. It was largely a timing issue with regard two customers and what their needs ended up being in the third quarter.

But I would point out as I try to do in my prepared comments that the third quarter overall itself from an incoming bookings level for premium melted products was a record. And our backlog at the end of the quarter it stands for the record. So I would not interpret that as any indicator of further declines or anything like that..

Thank you. We have no further questions at this time. Thank you. This does conclude our question- and- answer session. I'd now like to turn the call back over to Mr. Oates for any further remarks..

Thanks Sarah. Once again thanks to everyone for joining us this morning. We sincerely appreciate your support and interest in Universal. And we look forward to updating you on our progress on our next call in January. Have a great day and a great holiday season..

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