Good day, ladies and gentlemen, and welcome to the Universal Stainless First Quarter 2019 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 call is being recorded.

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

Thank you, excuse me. 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 first quarter 2019 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, in this morning's call, management will make forward- looking statements under the Private Securities Litigation Reform Act of 1994. 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..

shipments of tool steel plate products were substantially lower, down 46% and 27%, when compared to the first quarter 2018 and the fourth quarter of 2018, respectively. In addition to the short-term inventory adjustment after record buying in 2018, buying patterns are being impacted by sharp drops in surcharges closed by declining vanadium prices.

We expect tool steel volume to improve in the second half of 2019. Key commodities like nickel rebounded during the quarter, which is leading to rising surcharges in April and May on virtually all products except tool steel. However, the recovery in surcharges lagged about one month behind our expectations.

As a result, we experienced a slightly longer tail in the misalignment we reported in the fourth quarter of 2018. A couple of positive items of note. We ended the first quarter with record backlog of $130 million before surcharges despite the decline in tool steel activity.

The backlog has a healthy mix of higher-margin finish bar and premium melted products with over 60% aerospace products. The commissioning of our new $10 million bar cell is moving towards completion with only a few items remaining on the punch list. The bar cell will process 3/4-inch through 3 3/4-inch round bar.

We processed over 1.3 million pounds in Q1 as commissioning accelerated each month of the quarter. We are planning to triple that production level this quarter, and we are positioning build at Dunkirk to take full advantage of the state-of-the-art equipment.

Despite the significant challenges created by an ever-tightening labor market, our first quarter production from our four facilities marked a new record for Universal. In short, we expect double-digit sales growth, further margin improvement and positive cash flow in the current quarter. Taking a closer look at first quarter details.

First quarter sales of $60.3 million were up 5.6% from the fourth quarter, although they were 5.4% below 2018's first quarter. Aerospace and power generation sales increased sequentially and year-over-year in the first quarter, offset by lower sales to the oil and gas, heavy equipment and general industrial markets compared to both prior periods.

First quarter premium alloy sales totaled $9.4 million or 15.5% of sales compared with $8.1 million or 14.2% of sales in the fourth quarter of 2018, $11.8 million or 18.6% of sales in the 2018 first quarter. Let me note a few additional items related to our first quarter gross margin.

After several quarters of spiking electrode costs, the prices have stabilized in – prices did stabilize in the first quarter. Meanwhile, other commodity prices were mixed. Nickel prices ended the quarter up at $5.92 per pound versus $4.92 at the end of December, and moly increased to $12.38 per pound from $12.16 at the end of 2018.

Vanadium, a key ingredient in tool steel, fell 31% from $51.44 a pound to $35.61 during the quarter. Most commodities are down slightly in trading so far this quarter. For example, this morning nickel was recorded at $5.66 per pound and moly at $12.05 per pound.

First quarter 2019 net income totaled $1.2 million or $0.14 per diluted share compared with $600, 000 or $0.07 per diluted share in the fourth of 2018 and $2.1 million or $0.28 per diluted share in the first quarter.

The first quarter of 2019 and the fourth quarter of 2018 included an additional 1.4 million weighted average shares outstanding due to our equity offering in the second quarter of last year. EBITDA in the first quarter of 2019 was $7 million, up from $5.4 million in the fourth quarter of 2018, but below $8.8 million in the first quarter of 2018.

Chris will discuss our financial position in his report. However, I would like to reiterate what I said in the last call, which is we entered 2019 with a much stronger balance sheet because of our financing activities in 2018, which adds to our flexibility to pursue our long-term strategy and implement short-term tactics.

Turning to our major end markets. Let me start with aerospace where it seems all eyes are focused on Boeing as it attempts to resolve the issues with the 737 MAX.

Our aerospace sales reached a record $42.6 million or 71% of sales in the first quarter of 2019 versus $35.1 million or 62% of sales in the fourth quarter of 2018 and $36.2 million or 57% of sales in the first quarter of 2018.

Regarding the 737 MAX situation, it has been widely reported that Boeing's first quarter orders declined to 95 planes from 180 last year with no orders for the 737 MAX. Further, Boeing announced it would cut 737 MAX production to 42 units per month from its current rate of 52 per month and a previously planned ramp to 57.

So what's been the effect on our supply chain? As of now, there is a great deal of vigilance, but we are seeing no short- term change in production schedules. We're not seeing push-outs. We're not seeing cancellations or any significant changes in aerospace order rates.

Therefore, we are moving forward with our healthy production schedules this quarter and our planned ramp of the new bar cell based on our record backlog and continued strong aero market activity. Our industry is optimistic that the issues for Boeing will be resolved in a timely fashion, and so are we.

The heavy equipment market remained our second-largest market in the first quarter of 2019, representing 11% of sales, which is down from 16% of total sales in both the fourth quarter and the first quarter of 2018.

first quarter of 2019 heavy equipment sales, which are primarily tool steel plate sales, totaled $6.4 million, a decrease of 29.3% from the fourth quarter of 2018 and down 36% from the first quarter of 2018.

As mentioned earlier, our tool steel customers are in the process of adjusting their inventories in the first quarter after strong buying in 2018. End-use demand for tool steel from automotive changeovers or for equipment, mining, cutlery and general metal fabrication remains strong.

Based on our regular conversations with them, customers expect to begin placing new orders towards the end of the second quarter. The oil and gas end market remained our third-largest market in the first quarter of 2019, a 9% of total sales versus 11% of the sales from the fourth quarter of 2018 and 13% of the sales from the first quarter of 2018.

First quarter oil and gas sales totalled $5.4 million, which was 14.4% lower than in the fourth quarter of 2018 and 36.4% lower than 2018’s first quarter. We view the first quarter softness in our oil and gas sales as temporary.

After a successful 2018 when we won several bids and successfully introduced new products, we did see a decline in transactional business in the first quarter. Nevertheless, confidence from our service center customers about demand the next few quarters remains strong.

Power generation market sales represented 4% of total sales in the first quarter of 2019 compared with 3% in the fourth quarter of last year and 4% of sales in the 2018 first quarter. First quarter of 2019 power generation sales totaled $2.5 million which is up 28.9% from the fourth quarter of 2018 and up 9.4% sequentially.

There was a pickup in maintenance spending in the quarter. Whether this partially reflects GE's initiatives to improve their power business is not clear, although in their recent outlook conference call, they did note they have contractual service contracts for over 1,700 gas turbines in their fleet, and they are focusing on better execution.

As to new builds, GE forecasted 40 to 45 heavy-duty gas turbines this year. We continue to expect that maintenance revenues will be our main revenue source in power generation for the foreseeable future.

Our general industrial market sales were 4% of first quarter 2019 sales versus 7% of sales in the fourth quarter of 2018 and 8% in the 2018 first quarter. General industrial sales totaled $2.2 million a decrease of 42.2% from the fourth quarter of 2018 and down 58.5% sequentially.

Our general industrial market sales go to the semiconductor, medical, infrastructure and general manufacturing markets. As in the fourth quarter, softness in the chip sector was the main contributor to decline in our sales.

As I indicated last quarter, the growth outlook for the balance of the markets in our general industrial business remains generally positive. Let me take a few minutes and turn the call over to Chris for his financial report.

Chris?.

Thank you, Denny, and good morning, everyone. Let’s start with the P&L. As Denny noted, first quarter 2019 sales of $60.3 million were up 5.6% or 3.2 million compared with the 2018 fourth quarter and down 5.4% of $3.5 million from the 2018 first quarter.

First quarter revenues were led by aerospace sales, which increased $7.5 million from the 20187 fourth quarter and $6.4 million from the first quarter of 2018. First quarter oil and gas, heavy equipment and general industrial sales declined both sequentially and compared to the prior year first quarter.

first quarter gross margin totaled $7.4 million or 12.2% of sales up nearly 1% from the 2018 fourth quarter and down 2.3% from the prior year first quarter.

As Denny noted, in the 2019 first quarter, our gross margin was negatively impacted by the continued melt cost misalignment as the recovery in surcharges was delayed by approximately one month compared to our original expectations. Additionally, we experienced lower-than- forecasted shipment volumes and unfavorable product mix.

Looking now at selling, general and administrative costs. First quarter SG&A was $5 million or 8.2% of sales, a decrease of approximately $600,000 compared with the 2018 fourth quarter and a $240,000 decrease compared to the 2018 first quarter.

Employee-related costs drove the SG&A change between periods as employee recruiting fees and incentive accrual activity decreased compared to the fourth quarter of 2018 and the prior year first quarter. Our tax rate for the current quarter was 16.9% and was favorably impacted by federal research and development tax credit.

Net income in the first quarter was 1.2 million or $0.14 per diluted share. Fourth quarter 2018 net income totaled $582,000 or $0.07 per diluted share and 2018 first quarter net income totaled $2.1 million or $0.28 per diluted share.

Lastly, the first quarter and fourth quarter – first quarter of 2019 and fourth quarter of 2018 weighted average shares outstanding included an additional 1.4 million shares outstanding due to the second quarter of 2018 equity issuance.

First quarter EBITDA totaled $7 million an increase of $1.6 million or 29% sequentially and a decrease of $1.8 million or 21% compared to the first quarter of 2018. Adjusting for noncash share compensation expense, 2019 first quarter adjusted EBITDA totaled $7.4 million.

The EBITDA and adjusted EBITDA calculations are provided in the tables to the press release. Turning now to the balance sheet. At March 31, 2019, managed working capital totaled $140 million and increased by $17 million compared with the fourth quarter of 2018.

Accounts receivable increased by $2 million, and inventory increased by $12.4 million while accounts payable decreased by $2.6 million. Our increased inventory levels supported our higher backlog, which grew by nearly $4 million during the quarter, up to a record $130 million.

Capital expenditures for the first quarter were $5.6 million with prior year fourth quarter CapEx totaling $2.2 million and prior year first quarter capital spending totaling $2.5 million. Our first quarter capital expenditures were primarily strategic with continued spend on our new midsized bar cell unit at our Dunkirk facility.

As Denny previously discussed, our bar cell commissioning continued throughout the quarter. The company's total debt at March 31 stood at $65.4 million, an increase of $18.7 million from the prior quarter. Our first quarter debt increase was primarily driven by working capital changes.

Lastly, in the current quarter, we made a $2 million payment on our outstanding notes, which were part of the purchase of our North Jackson facility. The balance outstanding on this debt is $17 million as of March 31, 2019.

The outstanding balance is comprised of $2 million recorded from the current portion of our long-term debt and $15 million recorded as long-term debt. This concludes the financial update. And Denny, I'll turn the call back to you..

Okay. Thanks, Chris. In summary then, we made progress in the first quarter of 2019 but not as much as we had planned, and we are far from satisfied. While sales grew sequentially, margins did not meet our target due to the lower-than-expected shipment volume, particularly for tool steel, less favorable product mix and a continued misalignment issue.

On the plus side, aerospace sales were a record level in the first quarter, which helped drive strong premium alloy sales. Our backlog at quarter's end reached a record level of $130 million before surcharge. Surcharges for non-tool steel products are rising in April and May.

While full year 2019 will have its challenges as every year does, we are fully focused on improving our operations and execution. We are even more excited about ramping up our new bar cell after processing some meaningful volumes in the first quarter. The new bar cell in Dunkirk is key to our plan, and commissioning is accelerating.

In terms of organizational development, we announced on Monday that Wendel Crosby is being promoted to Vice President of Manufacturing from his current roles as General Manager of our Dunkirk facility and our Titusville facility.

Additionally, Rick Secola, who started with Universal as an intern nine years ago, has been promoted to Supply Chain Director. Both gentlemen have bright futures and will play key roles in executing our strategy.

Overall, we believe 2019 will be another positive year for Universal with sales growth, margin improvement and positive cash flows expected to begin as soon as the second quarter. Before I close, I want to thank all of our employees for their continued hard work and dedication, which is reflected in the record production across our four facilities.

That concludes our formal remarks. Operator, we're ready to take any questions..

Thank you. [Operator Instructions] Our first question comes from Lucy Guo with Cowen and Company. Your line is now open..

Good morning. Thank you for taking my questions..

Hi Lucy.

How are you?.

Hi.

First, can you maybe just help us update your margins, thoughts in terms of the 13% to 14% range that you provided before?.

Well, as you recall, last quarter, we had a margin in 11.3% range. And we talked about the misalignment at that point of about 180 basis points. We had some melt shop issues, which is another 100 basis points, and some physical inventories of 120.

As we look at this first quarter's gross profit margin at 12.2%, we had felt that the misalignment would shrink. It would still be there but not be as big as it was in the fourth quarter, which happened, but it did not shrink as much as we thought. So I would estimate that the – our base margin was 12.2%.

The misalignment would be roughly 125 basis points in there. And as we look down the road, we expect in the second quarter continued improvement in the margins. We've got – as I mentioned, we've got surcharges up in April and May. We'll see how June plays out based upon what happens here over the next week with commodities.

It looks today like surcharges will flatten out in month of June. And we expect shipment volume – yes..

Okay.

So that's still a good reference point of range for 2019?.

Yes..

Got you. So sorry to cut you off, but maybe a high-level question just given the positive comments around aerospace. And clearly, it is an important end market for premium melt products and others. Can you just – I know that you participate in a lot of the conversations with the industry and participated in trade associations and such.

Is there any chatter as to potentially any long-term market share impact? And this kind of goes to the current outlook for the supply chain, which is no change in schedule, but I just wonder whether there’s another shoe to drop..

There’s no chatter about any long-term changes in market share. I think fundamentally, there’s a lot of chatter about the subject of the 730 MAX and what it means. It largely comes down to a timing issue. The feeling is that this will get resolved this year, and it gets resolved this year.

From a metal supply chain standpoint, you should not see much of an impact.

There is a school of thought that would suggest that this is actually could be a good thing because frankly, the metal supply chain in general has been struggling to keep up, and this will give a little window of opportunity for people to get caught up in the supply chain as things come back together.

But I’ve not heard any chatter about any long- term share loss or anything like that..

Thanks for the comment. And then third question is probably for Chris and Denny. Just in terms of how working capital and inventory levels may be worked down later on this year. And if there is any – it sounds like there may be some pull-forwards on CapEx. Help us with the seasonality on free cash here..

As far as inventory goes, we are in the process of positioning some more inventory up at Dunkirk, so that we can take full advantage of the bar cell, which we’re becoming increasingly excited about based upon what we’ve seen in the first quarter.

So as far as working capital goes, as you look at the next couple of quarters, you should expect to see increases in receivables because we expect higher sales. You should expect to see decreases in inventory and a flattish level from accounts payable standpoint when the three major components are working capital..

And how about CapEx?.

Hi Lucy, CapEx will be declined from the first quarter levels. As we discussed in prior calls, year – full year CapEx probably will land around the $17 million mark. But we will not have CapEx levels in the second quarter as we did in the first quarter..

Sounds great. I will pass it on. Appreciate the time..

You’re welcome Lucy..

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

Hi, good morning..

Hey Phil..

Hi Denny, just in terms of the sales in Q1, what was the bigger surprise? Was it the tool steel business? Or was it the energy piece? And within your second quarter view because you do have some sales under your belt at this point, are you expecting the oil and gas sales to rebound versus the Q1 level?.

I would say the bigger surprise was clearly tool steel. Let me turn it over to Chris Zimmer, and he can answer the rest of your question.

Chris?.

I think for the oil and gas business and the tool steel business, what we found was – and where the surprise was, the amount of buying ahead that we saw from our customer base in 2018. I think there was a level of anxiety about what the tariffs would mean as people shifted some of their supplies.

So there are opportunities for us to be able to pick up business that was historically purchased offshore. And I think as the oil and gas and tool steel industry shifted those supply chains, they leaned into their inventories. So we saw buying patterns that were really ahead of those demand levels.

We’re experiencing right now an adjustment of their inventories. I think the fundamental demand profile in both markets is still very good, but our customer bases just got too much inventory that they’ve been adjusting and working through.

So we expect them to be largely through that year in the first, second quarter and then returning back up to those healthy demand levels in the second half of the year. So it was really those buying patterns and a level of caution that they took layering in inventory.

We’ll see that play itself out here as they adjust those inventories in the first half of the year and get back to those healthy levels by the second half of 2019..

What about oil and gas specifically, Chris, in terms of the tax share of the sales or shipments in Q2? Or should we look at the Q1 as a little bit of a one-off? Or do we have more inventory to bleed there before sales pick up in oil and gas? Because the rig count’s still pretty healthy. Completion activity’s strong. Offshore’s strong, stronger.

International is stronger. Prices are rising. So I think it would be temporary, but curious what you’re seeing..

I do think it was a bit of a one- off. The demand keep – continues to flow in. It’s reflected in our backlog. Customers have layered in orders for this year. Some of them are already reaching out to the first quarter of 2020. So the activity levels are still robust.

Plans to continue to drill are ongoing, and the supply chain right now is now that they’ve gotten ahead of where they wanted to be from an inventory standpoint, they’re really just trying to balance the flow of everything. So we saw that adjustment in the first quarter, but I’d expect to get back to those robust levels.

So the feedback that we have about it at the marketplace is still very strong..

That’s good. And then, Denny, I’d just want to qualify your comments. So I think you had said double-digit revenue growth.

Was that sequentially? Or was that year-over-year?.

Sequentially was what I was specifically addressing there..

And is that uplift sequentially more of this oil and gas snapping back and the -- and just continued momentum in aerospace?.

It’s primarily aerospace, oil and gas coming back and some of the general industrial markets improving, not the semiconductor part of it but the other markets..

And I was just also unclear about your margin parameters. So second quarter, are we getting back into that normalized 14% to 16% range or you’re not going to be there yet? And are you thinking that the automation investment is accretive to that range? Thanks..

As you look at the second quarter, we see improvement in margin. Basically, we're a quarter off from what we said last quarter in my mind. So we'll be in a lower range of that 14% to 16%, and then as we get into the third quarter, you'll start to see benefits, true benefits from the bar cell, which should give us further lift on that.

The only headwind in that regard is what's going to happen with commodities here. As I said in my prepared comments, nickel, for example, is up 17%, 18% far this year. But in the last two or three weeks, things have tailed off. So if we were to close out the month of April, surcharges would probably be flat with a downward bias in June.

That's the only wild card in some of the margins as we look out into the third quarter. Other than that, you should see continuous improvement the next two quarters..

Thank you..

You’re welcome..

Thank you. [Operator Instructions] We do have a question from the line of Scott Blumenthal with Emerald Advisers. Your line is now open..

Good morning, Denny and Chris..

Hey Scott, how are you doing?.

Hey, Scott..

Okay. Danny, can you maybe take a moment and reconcile the record production with the weak shipments? I know you mentioned tool steel destocking.

And maybe you can go through some of the segments and talk about where kind of a mismatch between the production and the shipments was during the quarter?.

There is two mismatches if you want to call them mismatches. One is we were candidly a bit surprised by the reduced level of shipment requirements in tool steel, and the other issue is we have been rebuilding and melting in anticipation of growing demand as we move through the year coming from the bar cell.

So we are moving material up to our Dunkirk facility in anticipation of continuing that ramp. That's the two reasons for what you're seeing in terms of a build-in in inventory. There were some other one-offs in inventories as well.

We had a large shipment of cobalt, which we received during the quarter, which is just under $1 million, which will last us well into the fourth quarter. But fundamentally, the two issues I mentioned earlier is what's driving the what you're characterizing as the mismatch of inventory.

As you look at the rest of this year, you should expect to see that inventory come down as we begin processing and get caught up and the bar cell starts to pull material through our manufacturing process..

Okay. That’s really helpful..

Hit me with the second part of your question again.

Or did I answer both parts?.

No. I think you got everything there..

All right. Okay..

And just specifically related to the current quarter, Phil mentioned that you do have a little bit of the quarter under your belt here.

Have you noticed any rebound in tool steel orders yet at this point? Or is that something that you're just not expecting until the latter part of the quarter or early Q3?.

We haven’t seen any big movement in tool steel orders at this point in time. And as I said in the prepared comments, we're not really expecting that until later in the second quarter based upon our conversations with customers..

All right. That’s also very helpful. Thank you..

You’re welcome..

Thank you. [Operator Instructions] And there are no further questions at this time. I would now like to turn the call back to Mr. Dennis Oates for further remarks..

Okay. Thank you very much. I want to thank everybody for joining us this morning. We do sincerely appreciate your ongoing support and interest in Universal Stainless, and we'll be looking forward to updating you on our progress at our next call in July. Have a nice day..

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..