Good day, ladies and gentlemen, and welcome to the Universal Stainless & Alloy Products Second Quarter 2019 Conference Call and Webcast. [Operator Instructions]. As a reminder, this conference is being recorded.I would now like to introduce your host for today's call, Ms. June Filingeri. Ms. Filingeri, you may begin..

Okay. Thank you, Sherri. 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're here to discuss the company's second 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 that in this morning's call, management will make forward-looking statements under the Private Securities Litigation Reform Act of 1995 regarding future events and financial performance.

We caution you that such statements reflect management's best judgment based on factors currently known and that the actual events or results could differ materially.Please refer to the company's documents that are filed from time to time with the SEC, in particular, the Form 10-K, 10-Q and Form 8-K filed today with the company's press release.

These documents contain and identify important risks and other factors that may cause actual results to differ from those contained in management's forward-looking statements. Forward-looking statements made during the call are being made as of today.

If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. The company disclaims any obligation to update or revise any forward-looking statements.

Management may provide guidance on today's call but will not provide any further guidance or updates on the performance during the quarter unless it is done in a public forum.During this call, management will also discuss non-GAAP financial measures.

These non-GAAP financial measures were not prepared in accordance with generally accepted accounting principles. A reconciliation of the GAAP and non-GAAP results is provided in today's press release.With these formalities complete, I would now like to turn the call over to Denny Oates. Denny, we're ready to begin..

Thanks, June. Good morning, everyone. Thanks for joining us today. The second quarter was a quarter of tangible progress for Universal. Let me hit some of the highlights. Net sales of $71 million were at the highest level in 28 quarters. That would be since the first quarter of 2012.

Second quarter 2019 aerospace and premium alloy sales set new records as did total shipments from our North Jackson facility. Gross margin improved versus the first quarter to 12.8% of sales and excluding the North Jackson fire-related charges, which we'll touch on later in our remarks, totaled 13.3% of sales.

Gross margin is expected to continue to improve in the third quarter. Cash flow from operations turned positive in the second quarter and reduced inventory to levels by 5% or $7 million. Although there was more work to be done, we are headed in the right direction.

Backlog at the end of the second quarter totaled $116.9 million, up more than 12% from the year-ago period but down from the all-time record high at the end of Q1 of this year. The mix of current backlog is in line with our second quarter end market sales.

Significant progress is made on our new $10 million intermediate bar cell in our Dunkirk facility, which will provide growing margin and cash flow benefits as we move through the second half of the year.Overall, business was solid in the second quarter, especially aerospace.

We continue to anticipate top line growth and margin improvement in 2019 as we execute our plan to further penetrate attractive end markets, continue our transition to higher-value premium alloys and drive manufacturing performance by applying best practices across our plants and deploying capital to high-return capital projects.Taking a closer look at the second quarter with details.

Sales of $71 million were up 17.8% sequentially with all end use markets positively contributing. Sales were also 7.5% higher than the second quarter of 2018.

Premium alloy sales reached a record $12.8 million or 18% of sales, which is up 37% sequentially and up 6.4% from the second quarter last year, mainly driven by our record aerospace sales.Turning to gross margin. The pace of improvement in margins was tempered by decreasing surcharges caused by fluctuating commodity prices.

After rebounding in the first quarter, nickel prices softened somewhat in the second quarter but have been coming back strongly in July. This morning, nickel was being quoted around $6.60 per pound, which is up 19% since June 30 on lower LME inventories and stronger-than-expected Chinese production.

Among other key commodities, molybdenum prices have remained in the $12 to $12.25 per pound range. However, vanadium, chrome and scrap, all key ingredients, particularly in tool steel, have consistently fallen in the first half by 66%, 13% and 32%, respectively. The net effect is that surcharges are coming down faster than our melt costs.

We expect some moderation in nickel prices and a bottoming out on other commodities over the next few months, which will ease misalignments late in the third quarter and fourth quarter on a net basis.On the pricing front, we announced a base price increase of 5% to 10% on low alloy bar products on July 2, which was effective immediately.

That covers about 10% to 15% of our business and should start penetrating sales and margins later this year. Net income in the second quarter totaled $2.1 million or $0.24 per diluted share and included unusual charges of $0.03 related to a fire at the North Jackson hydraulic forge, which has returned to operation.

Adjusted EBITDA increased 17.9% sequentially to $8.5 million or $8.9 million excluding the North Jackson fire-related expenses, which approximates 12% to 13% of sales. Chris will cover cash flow, managed working capital and other related items in his remarks.

So I'll turn back to operations.We reported a fire at the North Jackson facility back in June. By way of background, we acquired the North Jackson forge and the adjacent vacuum induction melting facility in 2011 as a way for us to add key capabilities in aerospace and oil and gas applications.

The completion of all equipment installations took another 18 months. The acquisition led to our successful market entry into the aerospace engine market, additional critical aerospace structural parts, including landing gear, helicopter, rotor masts and gears and drill shafts for oil and gas applications.

The North Jackson facility acquisition was a key part of our strategy of moving toward technologically advanced and higher-margin alloys.The fire at the North Jackson plant was caused by a ruptured hydraulic line, which resulted in hydraulic fluid coming in contact with hot metal and igniting. There were no injuries.

Electrical and hydraulic repairs commenced immediately. Product delivery schedules were minimally impacted as our team did an outstanding job in responding. In fact, we recorded record shipments in North Jackson in the second quarter despite the disruption from the fire.

During the third quarter, we have a normal annual planned outage of the forge during which time we will expand our work to ensure all fire-related issues have been addressed.

Our insurance coverage has a $350,000 deductible, which has already been incurred.We are rapidly moving up the learning curve operating the new bar cell in Dunkirk after completing virtually all items on the punch list except a few level 2 items in our new inspection system, which will require customer approval.

We essentially doubled the output of the line during the second quarter, processing a mix heavily weighted towards smaller bar diameters. As a reminder, this capital project involves the modernization of our intermediate bar processing operation by consolidating 6 discrete processing steps into one fully functioning automated workstation.

The project will increase efficiency and speed, reducing costs, lead times and work-in-process inventories while enhancing the safety environment. We expect a 2-year payback on the project.

Additionally, the project was financed in a tax-advantaged manner utilizing new market tax credit.Overall, underlying plan activity levels continue to be strong in the second quarter, and we expect them to remain strong in the current quarter even with some anticipated third quarter seasonality.

We believe that seasonality will be moderated by the strength in the aerospace market. in addition to more extensive forge planned outage, we'll be taking selective facilities down for normal 1 week outages during the quarter.

More broadly, we continue to execute successfully on our plan of moving to higher-value premium alloy sales, optimizing our integrated manufacturing system, expanding customer approvals for new products and targeting our capital investment to high-return opportunities. We have a strong focus on employee safety, employee engagement and retention.

Today, our business is focused on attractive end markets, most of which have experienced growth rates in excess of the economy generally, which provides a strong tailwind for our business over the long term.Turning to those end markets, let me start with aerospace, our largest end market.

Our aerospace sales reached $49.3 million or 70% of sales in the second quarter of 2019 compared with $43 million or 71% of sales in the first quarter of 2019 and $42 million or 61% of sales in the second quarter of 2018.Demand from our customers remained strong in the second quarter and continues the pace today.

The sentiment is basically that customers want their orders, and they want them now.

Demand remains strong even with the uncertainty surrounding the 737 MAX that has hung over the market for months.Boeing issued a press release last Thursday that added clarity to their expectations for the return to service for the 737 MAX now forecasted for early in the fourth quarter in their production schedule plans, essentially a the gradual increase in production rate from the current reduced 42 airplanes per month to 57 planes per month in 2020, the original plan.

Apart from some minor inventory adjustments, most Boeing suppliers have maintained a steady production rate to avoid falling short or late when the 57 planes per month target is back in play. Boeing's earnings call may add more perspective.

I believe their call starts at 10:30 this morning.As an added comment, I must say that we were literally unable to find any customers at the recent Paris Air Show that were anything but positive about aerospace over the next several quarters and bullish on the long-term outlook.

So overall, the aerospace market, from our standpoint, remains healthy as do our aerospace bookings and backlog.The oil and gas end market moved to second position among our end markets in the second quarter of 2019 at 11% of total sales after some softness in the first quarter of 2019.

Oil and gas sales were 12% of sales in the second quarter of 2018. Second quarter oil and gas sales totaled $7.7 million, an increase of 44% sequentially and slightly below the 2018 second quarter.Demand in the oil and gas market is solid.

In its earnings report last week, Schlumberger reported a 5% sequential increase in worldwide revenues, including an 8% increase in its international business, citing a broad upturn in E&P investment and activity, while in North America, land revenues increased 1% and offshore revenues were up 10%, which they attributed to stronger exploration-led activity.

At the same time, their total revenues were flat year-over-year. While Schlumberger's oil demand forecast for 2019 has been reduced slightly on trade war fears and global geopolitical tensions, it was clear on its earnings call that it does not anticipate a change in the structural demand outlook for the third quarter.

For 2019 in total, they expect international E&P investment to grow 8% to 9% while North America is expected to decline 10%, in line with their previous forecast due to E&P operator cash flow constraints and declining rig count.

Our strategy for Universal continues to be expanding the penetration of this market, utilizing our new capabilities in North Jackson.Now the equipment market became our third-largest market in the second quarter of 2019, representing 10% of sales compared with 11% of sales in the first quarter 2019 and 14% of sales in the second quarter of 2018.

Second quarter 2019 heavy equipment sales, which are primarily tool steel plate sales, totaled $7.2 million, which is 11% higher sequentially but 21% lower than the second quarter of 2018.In the first quarter, we reported a dip in tool steel plate sales as our tool steel customers adjusted their inventories after strong buying in 2018.

Demand started to pick up in May, leading to a sequential growth in our heavy equipment market sales in the second quarter. We expect a respectable level of tool steel sales in the second half of the year, but we do not see the record buyings reported in the second half of 2018.

Automotive production cuts, somewhat fewer model changeovers in the pipeline, lower surcharges in coming months, short lead times of roughly 6 weeks and service center inventory adjustments are the prime reasons for the modest reduction in outlook relative to 2018.Power generation market sales represented 4.5% of total sales in the second quarter of 2019 compared with 4.2% in the 2019 first quarter and 3.5% of sales in the second quarter of '18.

Second quarter power generation sales increased sequentially and year-over-year and totaled $3.2 million, which is up 28% from the first quarter of 2019 and up 37% from the second quarter last year. This growth mainly reflects seasonal maintenance spending in the quarter.

As to the newbuild market, we do not anticipate any meaningful near-term recovery.

Even with OEMs initiatives to turn around their power businesses, we expect maintenance to continue to drive our sales for the foreseeable future.Our general industrial market sales were 3.4% of second quarter 2019 sales versus 3.7% of sales in the first quarter of 2019 and 7.4% of sales in the 2018 second quarter.

General industrial sales totaled $2.4 million, an increase of 8% sequentially although 51% lower than the second quarter of 2018. Our general industrial market sales go to the semiconductor, medical, infrastructure and general manufacturing markets.

Depressed conditions in the chip sector have negatively impacted demand for the past 3 quarters as manufacturers turned cautious with ongoing U.S. giant trade frictions, compounded by excess inventories in certain memory chip markets.

That said, channel checks with a number of customers at the recent SEMICON show introduced a note of optimism that they expect a bottoming out of demand in the second half of 2019 and a modest recovery going into 2020.

Additionally, the growth outlook for the balance of the markets in our general industrial business is generally positive.Let me turn the call over to Chris for his financial report.

Chris?.

Thank you, Denny, and good morning, everyone. Let's start with the income statement. As Denny noted, second quarter 2019 sales of $71 million were up 17.8% or $10.7 million from the 2019 first quarter and up 7.5% compared with the 2018 second quarter.

2019 first half sales of $131.3 million were up slightly compared to 2018 first half sales of $129.8 million.

Increased 2019 first half revenues were driven by our aerospace end market, which had $91.9 million in revenue for the first half of 2019.Second quarter 2019 gross margin totaled $9.1 million or 12.8% of sales, up 60 basis points from the 2019 first quarter but down 490 basis points from the 2018 second quarter.

In the 2019 second quarter, our gross margin was negatively impacted by fire-related expenses at the North Jackson facility amounting to $357,000.

Additionally, within certain products, we experienced melt cost misalignment compared to our commodity surcharges, which negatively impacted second quarter gross margin compared to the 2019 first quarter.Looking at selling, general and administrative costs.

Second quarter SG&A was $5.6 million or 7.9% of sales, an increase of $638,000 compared with the 2019 first quarter and a $245,000 decrease compared to the 2018 second quarter. Employee-related costs drove the SG&A change between periods, both sequentially and year-over-year.Our effective tax rate for the 6 months ended June 30, 2019, was 16%.

Specific to the second quarter, the income tax provision was $384,000 or 15.5%. Net income in the second quarter was $2.1 million or $0.24 per diluted share. Second quarter diluted EPS adjusted for the North Jackson fire charges totaled $0.27 per diluted share.

First quarter 2019 net income totaled $1.2 million or $0.14 per diluted share, and 2018 second quarter net income totaled $4 million or $0.50 per diluted share.Second quarter EBITDA totaled $8.2 million. EBITDA as adjusted for both noncash share compensation and the North Jackson fire expenses totaled $8.9 million.

Our second quarter adjusted EBITDA of $8.9 million was $1.5 million higher than the first quarter of 2019 and $2.7 million lower than the second quarter of 2018. The EBITDA and adjusted EBITDA calculations are provided in the tables to the press release.Taking a look now at our balance sheet.

At the end of the second quarter, managed working capital totaled $147.8 million, an increase by $7.9 million compared with first quarter of 2019. Accounts receivable increased by $6.4 million, and inventory decreased by $7 million while accounts payable decreased by $8.5 million.

Our decline in payables compared to first quarter of 2019 coincided with decreased inventory levels in the quarter. In the first quarter, inventory levels and melt activity were higher as we positioned inventory at our Dunkirk facility's midsized bar cell unit for second quarter processing. Second quarter 2019 backlog totaled $116.9 million.

This is down $13.2 million from record backlog of $130.1 million from the first quarter of 2019. Year-over-year, second quarter 2019 backlog increased $12.7 million or 12.1% compared to the 2018 second quarter.Capital expenditures for the second quarter were $3.8 million with year-to-date capital expenditures totaling $9.4 million.

Prior year second quarter capital expenditures totaled $4.2 million with 2018 first half CapEx totaling $6.6 million.

Increased 2019 capital expenditures relate to strategic spend, primarily our new midsized bar cell unit at our Dunkirk facility with bar cell commissioning activities nearly complete at the close of the 2019 second quarter.Our restricted cash balance totaled $430,000 at June 30, 2019, which was in line with first quarter 2019 and $5.7 million lower than the prior year second quarter.

Our restricted cash is related to the New Markets Tax Credit Program. These funds are limited to use in the financing of our midsized bar cell capital project.Lastly, looking at our debt. The company's total debt at June 30 stood at $68.2 million, an increase of $2.7 million from the prior quarter.

Net of cash and restricted cash, our debt totaled $67.5 million at the end of the second quarter.This concludes the financial update. And Denny, I'll turn the call back to you..

Okay. Chris, thank you. In summary then, business was strong in the second quarter 2019, especially aerospace, and we made tangible progress. Total net sales where the highest in 7 years. Aerospace and premium alloy sales were at record levels.

Gross margin improved sequentially and totaled 13.3% of total sales, excluding North Jackson fire-related charges. Our new bar cell is ramping up and performing above expectations.

Underlying plan activity levels continue to be strong in the second quarter, and we expect them to remain strong in the current quarter even with some anticipated third quarter seasonality, which should be moderated by the strength we're seeing in the aerospace market.

Overall, we continue to believe 2019 will be another positive year for Universal, and we anticipate sales growth and sequential margin improvement and positive cash flow for the remainder of the year.Before I close, I want to thank all of our employees for their continued hard work and dedication and especially for the outstanding job our team did in responding to the fire at North Jackson, where we recorded record shipments despite the disruption.That concludes our formal remarks.

Operator, we're ready to take any calls..

[Operator Instructions]. Our first question comes from Tyler Kenyon with Cowen..

Denny, the backlog's still up a healthy 12% year-over-year.

But is there any color you could provide just on what drove the sequential weakness, just with respect to the various end markets you serve? And any update on kind of where the backlog stands quarter-to-date?.

Let me throw that question to Chris Zimmer..

Yes. I'd say the primary drivers are despite the continued strength initiatives at the North Jackson plant to ramp up production and as we continue to bring onboard the new mid cell -- bar cell range in Dunkirk, it' s opened up our production bandwidth. It's actually offered us opportunities to pull our cycle times in.

So that has slowed order entry in the near term simply because our customers are adjusting to the new shorter cycle times that we have for new order placements. And I think there's also a degree of potential pause in the marketplace as our customers look at commodity prices coming down, which is normal buying behavior.

So I expect that as our lead times stabilize and commodity prices stabilize and trend back upwards again, that they'll return back to that normal buying pattern. Then we'll see that reflected in our backlog..

So I guess I would just summarize. I don't look at the decrease as a negative. I actually look at it as a positive. If you look at it by product, we've seen a decrease in tool steel as the main product line is down in the backlog just numerically. And keep in mind that, that is one of our shortest lead time products as well.

So if you're a buyer of tool steel today, you're looking at relatively short lead times of 6 weeks or so. You know that your prices are going to be down in a couple of months because surcharges driven by what I described in chrome and vanadium and scrap, in particular, will be going down.

So there is little change in purchasing pattern out there where we're seeing smaller orders and customers waiting until last-minute to place an order, particularly in the tool steel environment..

Okay. Great. That's helpful. And then another one of your specialty metal producer peer cited some destocking from a jet engine OEM in the second half of this year.

Are you seeing that? And are you seeing any evidence of destocking just within the structurals market as well?.

We're not seeing any meaningful destocking. I'm familiar with the one situation there. There's some movement of product, pull something in, I'm going to push something out. But generally speaking, on the aerospace side, we're not seeing any evidence of any significant or measurable destocking.

On the tool steel side, which is non-aerospace, we have seen destocking over the first half of the year, which I think reflects more the heavy buying that our customers did in the second half of last year..

And then on -- just last one for me on -- so you pointed toward expectations for gross margins to recover into the third quarter here.

Any sense you can provide us just on the magnitude of the sequential improvement you're looking for? I mean it sounds like there are some crosscurrents here with some maintenance outages in the third quarter as well as some alleviation in just the misaligned surcharges and the general costs..

Generally speaking, we expect strong activity levels in the plants. We do have outages at our forge and melt shop during the summer. That's nothing that is unusual. From a bigger picture standpoint that the -- we have some tailwinds in the sense that we've got the new bar cell coming online.

And as we continue to increase production and sell through that inventory, remember, we're on average cost inventory accounting system, we'll start to see the benefit of the bar cell come out in the third quarter and the fourth quarter and increasing -- positive tailwind.From a mixed headwind standpoint, this is also due to commodities.

Right now, if you look at nickel-bearing products over the course of the last 6 months, you've seen nickel moving up and then decreasing and having a negative impact at the -- during the second half of the second quarter. Nickel has now shot up. So that'll have some positive effects late in the third quarter. We do expect nickel to tail off though.

If you look at the other products, the other commodities rather, like chrome, vanadium and moly that I mentioned, they have fallen significantly. We expect them to basically be bottoming out as we go forward.So you put that altogether on a net basis, we expect the tailwinds to be stronger than those headwinds we see on the commodity front.

Hopefully, that didn't confuse the issue. But commodities has been the one wild card here over the last 6 months, in particular. It's been a little bit of a surprise from our standpoint in terms of the trends we've seen..

[Operator Instructions]. Our next question comes from Phil Gibbs with KeyBanc Capital Markets..

I just had a laugh when you said confuse the issue. I mean there hasn't been any confusion in the trade landscape to date at all. So....

Do I detect sarcasm there?.

Maybe. Never. I had a question more so on just the CapEx outlook for the rest of the year. Chris, still good $14 million-ish or so, so kind of lighter in the back half..

Yes. We expect CapEx levels within 2019 to approximate 2018 levels, potentially a little bit lighter. We're continuing to work through strategic projects. As the timing of those projects settles out within the year, we'll finalize. But at this point, we're still projecting pretty close to 2018 levels..

And Denny, as you look at your inventory over the rest of the year and you think about potential for taking the debt levels down, clearly, looks like your profits are going to be pretty resilient for the rest of the year.

So what are you thinking about in terms of magnitude of just core debt reduction and then -- and taking more out of inventory?.

I think as you look at inventory, we're targeting to get close to 2018 end-of-year inventories, right? And if you take a look at that and where we see things playing out from an earnings standpoint and the capital standpoint, we would expect to make another $7 million to $8 million reduction in debt.

So I think on the last call, I indicated we'd be somewhere with 5 in it, I think in high 5s. I think we'll be in the low 5s, maybe high 4s..

High 5s, low 4s in terms of what, I'm sorry..

In terms of total debt. So 50, low 50s..

Okay. Okay. That seems pretty conservative, I think. And North Jackson, strong quarter in terms of sales.

Any insight in terms of what your outlook there is for the year? And any update on progress of contracts?.

We would expect to continue to see strong activity coming out of North Jackson and continue to have new records in terms of production and shipping as we go through the second half of the year. As you and I have talked in the past, we continue to have opportunities to get additional approval.

We typically have stopped bragging about those in the sense only because where there's some competitive compromise out in the marketplace.

But I will tell you in the aerospace world, we do have some additional approvals that we got earlier this year which we're benefiting from right now, and that's part of reason why the premium alloy sales continue to ramp. So we continue to do that.

We're focused on the aerospace side in those approvals, not so much in oil and gas at this point in time, but that continues..

Ladies and gentlemen, thank you for participating in today's question-and-answer session. I would now like to turn the call back to Mr. Oates for any closing remarks..

Well, once again, thanks, everyone, for joining us this morning. We sincerely appreciate your ongoing support and your interest in Universal Stainless, and we look forward to updating you in October on how we make out in the third quarter. Have a great day. Thanks..

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