Ladies and gentlemen, thank you for standing by, and welcome to the Universal Stainless Third Quarter 2020 Conference Call. [Operator Instructions] Now, it's my pleasure to turn the conference over to your speaker, June Filingeri. Please go ahead..
Thank you, Carmen. 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 third quarter 2020 results reported this morning.
With us from management are Denny Oates, Chairman, President and Chief Executive Officer; John Arminas, Vice President, General Counsel and Secretary; 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. Carmen 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..
Okay, June. Thank you. Good morning, everyone. Thanks for calling in today. As we described during our last conference call in July, we expected a very challenging third quarter.
Second quarter order entry and backlog trends pointed towards a steep sequential step down in sales and operating activity, reflecting lower supply chain demand, customer destocking and shorter industry lead times. In fact, third quarter sales of $37.4 million were down 29% sequentially, while shipped pounds declined 32%.
Currently, we are seeing sales level stabilizing and modest month-to-month improvements in order entry. We reacted quickly to the COVID induced market disruptions in the second and third quarters executing on plans designed to rapidly reduce costs, conserve cash and pay down debt without jeopardizing our long-term strategic plans.
Despite these actions, the decrease in sales and operating activity took a heavy toll on our bottom line. And we reported a net loss of $7 million or $0.79 per diluted share on a generally accepted accounting principle basis.
Excluding, the pretax fixed cost absorption charge of $4.3 million, due to abnormally low activity levels and the $300,000 pre-tax gain on insurance proceeds the third-quarter net loss was $3.9 million or $0.44 per diluted share. Let's look more closely at third quarter results, starting with the top line.
Consistent with last quarter, aerospace and oil and gas sales were hard hit, declining 32% and 24% respectively on a quarter-over-quarter basis. Other end-market sales were sequentially lower as well, with Power Generation down 25%, Heavy Equipment down 16%, and General Industrial down 7%.
However, I should point out that General Industrial sales increase a noteworthy 43%, from the third quarter of 2019, due mostly to semiconductor business.
Premium alloy products which reached nearly 25% of our total third quarter sales are holding up better than air melted products, reflecting ongoing demand coming from defense and specialty applications.
It is worth underscoring that premium alloys are our highest priority for targeted growth and remain a focus of our very active product development and customer approval efforts. Order backlog before surcharges fell to $54.8 million at September 30, compared to $71.7 million at June 30 and $119.1 million at year-end 2019.
Gross order entry stabilized at $21 million before surcharges, compared to $45 million in the first quarter. Interestingly, July was the low month for gross order entry this year, with steady increases in August and September.
September order entry was the highest monthly total since the COVID pandemic hit, and October is tracking about 10% ahead of September. Also on a positive note, cancellations have slowed significantly following the $2.3 million in the third quarter versus $10.5 million in the second quarter.
We continue to expect more modest improvements in order entry during the fourth quarter and sequential improvement as we move through the first half of 2021.
From a profitability standpoint, the reduced sales and operating activity in the third quarter resulted in reporting a negative gross margin of $4.4 million, which included the $4.3 million write-off of fixed cost, due to the abnormally low production levels as required under GAAP.
Additionally, $2.1 million in negative efficiency variances associated with sharply lower activity levels were expense during the quarter. We've been working our operating plan designed to reduce cost and conserve cash.
Our plan includes periodic shutdowns of entire facilities, coupled with rolling shutdowns of major work centers, surge in capital and operating spending controls, workforce reductions and reduced work schedules. Here are the results in terms of plan activity levels and our cost structure.
Plan activity levels were driven down 45% sequentially and 60% compared to the first quarter as measured by pounds processed through our facilities. Air melt operations were reduced 50% sequentially and 67%, compared to the first quarter.
Vacuum melting operations were static sequentially due to somewhat healthier backlogs, but declined 35% compared to Q1. Variable non-material spending has been cut in half since COVID hit. Controllable fixed spending has been reduced 30%, since March. SG&A expenses totaled $4.2 million in the third quarter, down $1.8 million or 30%.
Managed working capital has reduced $16.8 million during the third quarter, reflecting a reduction of $14 million in inventory and $6.7 million in receivables. These reductions were partially offset by lower payables of $4.1 million. We are tracking to the $30 million second half reduction in managed working capital, we committed to in our last call.
Similarly, capital spending was $1.2 million in Q3 and it's tracking to the $9 million to $10 million annual estimate cited on our last call. Taken together, these actions generated $11.9 million in cash, which we used to pay down total debt to $60.6 million at September 30.
The $20 million second half debt reduction called out on our last call, remains our goal. I would be remiss, if I did not also highlight that our safety performance as measured by an OSHA recordable rate of 1.3 marked the new Universal record low during the third quarter, despite the many disruptions on the shop floor.
My compliments to all, great job again. With regard to COVID, we have been very fortunate to only have two positive cases given that we have worked throughout the pandemic, as an essential business. Cost for COVID related mitigation have run $150,000 to $200,000 per quarter for PPE and enhanced sanitizing activities.
Our priorities for the balance of the year are to continue executing our operating plan to reduce cost and generate cash. We are expecting fourth quarter activity levels and sales to closely parallel our third quarter performance.
For the longer term, we are moving forward with our strategic initiative to add a Vacuum Arc Remelt Furnace, which will be installed in the second quarter of 2021 and an 18 ton crucible for our Vacuum Arc Melting operations, which is scheduled to be installed and commissioned by 2021's third quarter.
These investments are critical to support our growth in premium melted products and reduce operating cost significantly. Turning to commodity prices. Nickel strength in each month in the third quarter reaching $6.74 per pound in September, a 17% increase from the end of the second quarter and the highest level since November of last year.
This morning, nickel was at $7.23 a pound. Moly and vanadium exhibited small sequential increases and scrap started to show an upward trend in September. As a result, our surcharges on shipments have been moving up in a positive direction, maintaining metal spreads. We expect these trends to continue this quarter.
Let me turn to our end markets beginning with aerospace. Our aerospace sales were $25.1 million or 67% of sales in the third quarter of 2020, compared with $37.2 million or 71% of sales in the second quarter of 2020. In the third quarter of 2019, aerospace sales were $40.9 million or 72% of sales.
The challenges faced in the aerospace industry are many. 737 MAX is returned to service, reduced air travel, weak financial health of airlines, growing order cancellations, uncertain build rates and unstable supply change, just to name a few. Let's start with the 737 MAX.
It appears that the 737 MAX will be returned to service by year-end based on recent developments. Europe's top regulators said this 737 MAX is safe enough to return to flight in Europe by the end of the year. Europe is one of the largest markets for the MAX.
American Airlines also announced plans to reintroduce the 737 MAX on domestic flights beginning with New York to Miami runs, pending at late November FAA approval.
Well this news is a welcome boost for the industry, and the supply channel we do not see an immediate effect on airplane build rates given Boeing has an estimated 450 MAX airplanes on the ground ready for delivery. Another issue weighing heavily in the commercial aerospace market has been the Coronavirus pandemic, and its impact on air travel.
IATA now expects full year 2020 traffic to be down 66% from 2019 versus their previous estimate of 63% decline. Travel for August 2020 was down 75% from August of 2019, including an 88% drop in international passenger demand and a 69% drop in U.S. domestic travel.
While these numbers do reflect improvement compared to the April and May timeframe, when domestic travel was down over 90%, the pace of improvement has slowed due to secondary COVID outbreaks.
Aftermarket aerospace demand will be stressed until travel demonstrates more meaningful improvement, probably not until vaccines are readily available next year. The latest reports from U.S. carriers further tested depressed industry conditions with difficult liquidity issues at the forefront.
Not surprisingly, this has resulted in order cancellations and postponements of new aircraft. Although a possible upside in this situation is that airlines are also retiring older aircraft, which may eventually bolster new plane sales.
We look for government assistance to support the industry's financial health and employment levels over the near term. Our aerospace customers and the entire supply chain for that matter are destocking at an unprecedented pace. We expect this process to continue through the end of the year and perhaps into Q1 of 2021.
With destocking easing by then orders to the mill sector will increase. We expect this increase to be supported as we move through 2021 by further travel growth especially upon the introduction of vaccines. Against this challenging backdrop, there are some positives.
The defense market has been a strong and a positive countervailing force in the aerospace market for Universal and are expanding premium alloy offerings. Although small, it's also worth noting that the business jet market is active as well.
In summary, our aerospace customers continue to expect solid demand from the defense and general aviation sectors over the next few quarters. Slow improvement in mill bookings as destocking eases and travel picks up are also in the books. Significant improvement in the commercial aerospace build rates are not expected until beyond 2021.
The heavy equipment market remained our second largest market in the third quarter of 2020 with sales of $4.7 million or 12% of sales compared with $5.6 million or 11% of sales in the second quarter, and $4.4 million or 7% of sales in the third quarter of 2019.
After two quarters of recovery in plate sales, the market pause somewhat for normal seasonal reasons. Our plate sales are driven by a variety of metal fabrication markets, particularly automotive and new model introductions.
News from the automakers has been mainly favorable lately aided in part by low interest rates, but also by what General Motors describes as pandemic induced order demand as consumers are up for more private vehicle transportation over public transportation. Families taking more vacations by car, and city residents move to the suburbs.
New model launches are projected to recover to the 2019 level in 2021 and accelerate in 2023 and 2024. This is all good news for plate demand. We expect our fourth quarter plate sales to be up 10% based on existing backlogs in recent bookings trends.
The general industrial market became our third largest market in the third quarter, with sales of $2.9 million or 8% of sales, or 7% lower than the second quarter of 2020 sales of $3.1 million or 6% of sales, that increased 43% from $2 million or 4% of sales in the third quarter of 2019.
As a reminder, our general industrial category includes such markets as semiconductor, medical, and general manufacturing.
The Semiconductor Industry Association reported a 4.9% increase in worldwide sales of semiconductors in August 2020 versus August 2019, using a three-month moving average, and a 3.6% increase from the July 2020 totaled $35 billion. Growth was especially strong in the Americas, where sales increased nearly 24% year-over-year.
We are continuing to focus on the semiconductor market as well as pursuing opportunities in the additional markets within the general industrial segment to broaden our future sales potential. We already have the grades of steel and the service center relationships. So there is no need to invest capital or develop new products to support this effort.
The oil and gas end market became our fourth largest end market in the third quarter with sales of $2.8 million or 7% of sales. This compares to the sales of $3.6 million or 7% of sales in the second quarter of 2020, and $5.7 million or 10% of sales in the third quarter of 2019. That represents declines of 24% and 51% from respective prior periods.
The severe challenges in oil and gas demand are reflected in the latest rig count data from Baker Hughes. The average U.S. rig count for August 2020 was 250, down 5 from July and down 679 from August 2019, while the rig count seems to be stabilizing, we are a long way from what many analysts would consider a normalized U.S.
rig count of 400 rigs to 600 rigs. Likewise worldwide rig count for August 2020 stood at 1,050 up 25 but hybrid down 1,156 or 52% from August of 2019. E&P companies are continuing to restrict spending to protect cash flows.
On Friday, Schlumberger reported a 2% sequential decline in third quarter North America revenues with improved land well completions, offset by reduced land drilling and lower oil shore activity impacted by lower rig counts and hurricane disruptions.
On the other hand, Halliburton called out and I'll quote second half 2020 as the bottom with a better 2021 reflecting progressive improvement, connectivity throughout the year in group.
From our vantage point after a long period of hunkering down by our customers, they are now looking for gradual improvement in 2021, whether there's not yet a lot of firmness in demand, the customer inventories are low.
Power generation market sales were $1.6 million or 4% of sales in the third quarter of 2020, down 25% from the $2.1 million or 4% of sales in the second quarter of 2020, and $2.9 million or 5% of sales in the third quarter of 2019.
The continued shutdowns due to the Coronavirus pandemic has sharply limited maintenance demand, which has been a major driver of our power generation sales. We expect maintenance to eventually return to more normal seasonal levels as states open and stay open.
Additionally rumors of forging work for power generation coming back to the states continue, but we've seen nothing tangible at this time. Before I turn the call over to Chris Scanlon for his financial review, let me mention, our new 5-year collective bargaining agreement with the hourly employees at our Titusville facility, effective as of April 1.
The new contract maintains the flexible work rules and profit sharing incentives contained in the prior agreement and also allows us to be competitive in the marketplace and attract skilled employees. That concludes my review. Chris, let's have your financial report..
Great. Thank you, Denny, and good morning everyone. Let's get started with the income statement. As Denny discussed third quarter 2020 sales of $37.4 million were down 29% or $15 million from the 2020 second quarter, and down 34% compared with the 2019 third quarter.
Our aerospace sales were lower than the second quarter 2020 by $12 million or 32% and $15.7 million or 38.5% lower than the third quarter 2019. Our aerospace sales approximate 67% of our third quarter sales. Sales to the balance of our end markets declined from the second quarter of 2020.
Third quarter gross margin was a loss of $4.4 million compared to $1.9 million in the second quarter 2020 and $5.3 million in the 2019 third quarter. Our Q3 gross margin was unfavorably impacted by $4.3 million direct charge related to fixed cost absorption.
This charge was a result of reduced third quarter operating levels, while we have aggressively reduce cost due to our reduced production levels there is an amount of our fixed cost that was not absorbed in inventory and taken as a charge in the third quarter.
We anticipate these fixed cost absorption charges to continue in the 2020 fourth quarter by continued lower activity levels. Gross margin as adjusted for the $4.3 million of fixed cost absorption direct charge was at a breakeven level.
Gross margin also included $2.1 million of negative operating efficiency variances during the quarter which were also expense. These variances were associated with low activity levels.
Selling, general and administrative costs in the third quarter totaled $4.2 million or 11% of sales, a decrease of $1.2 million compared to 2020 second quarter, and $372,000 compared to 2019 third quarter. Other income included $307,000 associated with the receipt of insurance proceeds.
Specific to the third quarter, our income tax benefit was $1.9 million. Net loss in the third quarter was $7 million or $0.79 per diluted share. Third quarter earnings per share adjusted for the $4.3 million fixed cost absorption direct charge, aimed to be $307,000 gain on insurance proceeds is a loss of $0.44 per share.
Second quarter 2020 net loss totaled $3.3 million, or $0.38 per diluted share, and 2019, third quarter net income totaled $800,000 or $0.09 per diluted share. Our third quarter EBITDA totaled a loss of $3.6 million. Q3 EBITDA, as adjusted for non-cash share compensation, fixed cost absorption direct charges and our insurance gain totaled $636,000.
The EBITDA and adjusted EBITDA calculations are provided in the tables to the press release. Third quarter cash flow provided from operations was $13 million, compared to our second quarter cash flow provided from operations of $7.4 million, and third quarter 2019 cash flow provided by operations of $6.6 million.
Regarding the balance sheet, managed working capital totaled $135 million and decreased by $16.8 million compared with the second quarter of 2020. Accounts receivable decreased by $6.7 million and inventory decreased by $14 million, while accounts payable decreased by $4.1 million.
The decline in inventory is primarily due to reduced production activity to maintain an inventory level commensurate with our order backlog. Third quarter 2020 backlog totaled $54.8 million and is down $17 million, or 24% from the 2020 second quarter.
Year-over-year, third quarter 2020 backlog decreased $63.5 million or 54% compared to the 2019 third quarter. Capital expenditures for the third quarter were $1.2 million, while second quarter 2020 CapEx totaled $3.2 million, and third quarter 2019 capital expenditures totaled $3.9 million.
Capital expenditures for the nine months of 2020 totaled $8.5 million versus $13.3 million for the nine months 2019. Capital expenditures are expected to approximate $9 million to $10 million for the year 2020. Lastly, the Company's total debt at September 30, 2020 is $60.6 million, a decrease of $11.9 million from the prior quarter.
This reduction is consistent with our focus on working capital and debt reduction. The Company's debt is primarily comprised of our revolving credit facility and term loan, which collectively totaled $35.7 million as of September 30, 2020 and our notes, which were issued in connection with the acquisition of our North Jackson facility in 2011.
These notes totaled $15 million. We continue to include this $15 million in current debt as these notes are due and payable in March 2021. We intend to pay these notes off in the first quarter via utilization of our revolver.
Due to the variance in interest rates between the 6% fixed rate of the North Jackson notes, and the approximate 2% current interest rate on our revolver, we anticipate annual savings of approximately $600,000 in interest expense following the pay-off of the North Jackson seller notes.
Additionally, the $10 million term note related to the Paycheck Protection Program is included in our long-term debt. In the third quarter 2020, the Company applied for full loan forgiveness under the Paycheck Protection Program, and the PPP loan forgiveness process is currently underway.
As of September 30, 2020, we maintained revolver borrowing availability of $44.2 million. Our strong liquidity position, coupled with the solid creditworthiness of our customer base provides the ability to continue to endure our future uncertainties. This concludes the financial update, and Denny, with that, I'll hand the call back over to you..
Thanks Chris. In summary then, on our last call we provided our outlook for the second half of 2020. The third quarter played out as expected with a step-down in sales and activity levels, but also, and importantly with tangible progress in flexing spending down - excuse me, and improving our liquidity.
Total debt was reduced $12 million on an 11% decrease in managed working capital, including a $14 million reduction in inventory. We ended the quarter with $44 million in liquidity, which positions us to successfully navigate through the current downturn and seize opportunities as business conditions recover.
We ended the third quarter with incoming business slowly improving in each month since the low point in July and October bookings are currently running ahead of September.
We will continue to diligently work our operating plan during the normally seasonally slower fourth quarter and expect results to closely parallel third quarter performance, in terms of sales, activity levels and cash generation.
Longer term, we are actively focused on future growth opportunities including our strategic investment in an additional Vacuum Arc Remelt Furnace and an 18 ton crucible for Vacuum Induction Melting operations. These will reduce costs and expand our premium alloy capabilities.
We are also pursuing new product and market opportunities to further diversify our revenue stream in future years. Lastly, these times of lower production provide opportunities to really get after initiatives to debottleneck operations, increase first time through quality and continuously improve our safety processes.
In closing, I'd like to express my personal deep gratitude to our entire team, whose commitment and relentless effort are enabling us to navigate through these challenging times. And to our customers Board and shareholders for their continued support. That concludes our formal remarks. Carmen, we are ready for any questions..
[Operator Instructions] Our first question is from Tyler Kenyon with Cowen. Please go ahead..
Denny you noted a steady improvement in order entry as the quarter grew to a close, and it sounds like that has continued here into October. Can you talk maybe a little bit about kind of where you're seeing that improvement across end markets or product-specific applications? I mean, it sounds as though you're mostly seeing that in tool steel plate..
Plate is a component of that, and also at defense in the aerospace side, in the last six weeks or so, we're starting to see some orders, which I would characterize as service centers, looking at their inventory and finding some holes as they destock, which I look at as a good sign, because it says that inventory levels are starting to get to the point where people are getting surprised.
So three areas basically tool - the plate business, largely the automotive and the new models coming back next year, which is going to require new jigs and fixtures and metal sales on our part this year, and in the early part of next year the defense end of the aerospace market and some holes in inventory on regular commercial aerospace products..
And are your cost reduction efforts that you've been pursuing here call it over the course the past quarter, are they fully reflected in the third quarter? Or should we expect more benefits as we move into the fourth?.
I would say, 80% of it's reflected in the third quarter.
We would expect to get some further benefits in the fourth quarter from a full quarter of spending reductions in certain categories, and also, I mean obviously when you're running - when you dip down to these low levels of activity, it is very challenging to run efficiently, out in the middle, you think of each furnace that it's going to run a load for five hours.
Typically if you have adequate volume you can fill that furnace up, what's hypothetically with 20 large bars. In today's environment we might only have 5. That's the efficiency issues. So as we go through the fourth quarter, we will get better and better at running at these lower activity levels.
I would expect some of those efficiency variances that we had in the third quarter, which were negative to be much smaller in the fourth quarter..
And Denny, in your closing comments you talked about how this challenging time has kind of brought a fresh perspective in terms of pursuing debottlenecking efforts and enhancing sales through various channels.
Just curious if maybe you could talk a little bit about some of those efforts you're undertaking or considering at this point?.
We have a situation, where you know, when you're busy there never seems to be, you're always working on these kinds of things basic blocking and tackling out in the shop, but you're also busy getting production and getting product to customers in the climate like we are in today it does free up some time for us to focus on some other areas of process improvement.
I'm not talking necessarily about capital projects here. So we're looking at maintenance practices in our remelt facility, which in the past has been a bottleneck for us. We also are bringing our new furnace on as well, but I'm talking about process improvements, particularly on the maintenance side.
We're going paperless on our shop floor, which will help significantly in terms of cycle times.
We're looking at different chemistry modifications and heat treat modifications on some of the newer alloys, where we have approval, and the plan obviously would be that, now that we have the approval to see where we don't have fixed practices, what can we do to further reduce costs.
So there's a whole range of items that I would categorize as debottlenecking, which basically taking existing facilities and increasing the capacity. So that we can sell more and cycle things through our facilities, faster when things recover over the next couple of years. And the other one would be continuous improvement on product quality.
So as we have things going through our shop, they go through basically once we reduce rework and so forth, when things recover..
And, Chris, just one for you. It sounds like the working capital reduction targets in the second half as well as the debt reduction targets remain intact. On the $20 million reduction in debt, does that include some assumption around the forgiveness of the PPP loan.
And then not sure, if you made some specific comments in your remarks, but maybe if you could kind of talk about where you are in that process? And kind of when you would expect that to be resolved?.
Sure thing. So the $20 million debt reduction excluded any application of PPP forgiveness. So as organic debt reduction associated with our revolving credit facility coupled with our term note.
With regard to timing of the PPP application that was submitted in the third quarter, the bank has 60 days to review our application, once they are complete that will get handed over to the SBA who then has 90 days to conduct their review, and make a conclusion on our application.
So what we had originally went into this process is thinking that we would get forgiveness maybe in that Q3, Q4 timeframe obviously we're in Q4 now, depending on the timing of the review by both the bank and the SBA, it appears that application for full forgiveness will most likely occur, and let's call it the first quarter of 2021..
Our next question is from Phil Gibbs with KeyBanc Capital. Please go ahead..
Denny, so if we surmise that revenues are between $35 million and $40 million for next quarter, and let's just postulate stay there in Q1. Should we expect that your gross margins will begin to improve all else equal as your own destocking efforts subside, because I think that's an important point.
Right now, that I'm perceiving that you guys are getting hit with a double whammy, obviously lower sales. But you're taking your own inventories down. So I think that could be helpful to educate people on..
Yes. As you look at the - first of all, with regard to the fourth quarter of the quarter we're in, I would look at the third quarter and I expect performance to be very similar in the fourth quarter in terms of activity, topline profitability as well as cash generation.
As we get into the first quarter, I'm looking at bookings improving in the fourth quarter compared to the third quarter, we've seen now four consecutive, or 3 consecutive months and it looks like we'll have a fourth consecutive months of improving bookings. So what that means as we get into the first quarter, our activity levels should rise.
We'll be able to absorb more of those fixed costs that we're writing off currently, and we'll be able to run more efficiently. So right now it's pacy because I don't know how much things are going to improve during the fourth quarter for first quarter production. But I do expect higher production levels.
So I would expect to see margins improving with lower fixed cost write-offs and lower negative variances, as we get later in the second quarter, latter part of the first half of next year if things continue to tracking the way we see them tracking, we should be working our way out of this requirement to book unabsorbed fixed cost and so forth.
So to answer your question fourth quarter pretty much same as the third quarter, improvement in the first quarter and some of these unusual things should disappear as we get into the second quarter of next year, if things play out the way we are projecting them. That doesn't require a return to 2019 aerospace market. That's not what I'm saying..
All right..
Right now - we got from a commercial standpoint, kind of a triple whammy, right. We got lower demand in the supply chain driven by COVID. We've got our customers also very quickly, trying to get their inventories down. So you get the bullwhip effect on the mill.
And then, I'd throw into that, the fact that lead times are so short, people know that they can get product in fairly short order from the mills, right now. So there is no need to really lay in orders for the first quarter. I mean, we're still selling into our fourth quarter on many products.
So, you put those three things together and that's what's - which makes things very supporting currently in the market..
I get all that. I'm just trying to understand, if let's just say, this quarter you did $37 million, next quarter you did $37 million. And I'm just saying, if you do $37 million in Q1 next year, you may anticipate a pick up or decline probably a pickup. But just saying, let's just assume revenues are flat.
Should your margins improve alone just on the fact that by Q1 you won't be taken out as much inventory?.
Yes, they will. They will. We'll be running slightly higher. We would expect production there will be coming up. So it was at the delink to topline from what we see in production based upon the timing of incoming business. Yes..
Because, I think you said in the third quarter that your own internal production was down something like 50%, correct me if I'm wrong there. But your revenues were not down that much sequentially..
Correct. Yes. We are producing in a much lower level than we're selling. So the selling is depressed, but we're producing an even lower level than you're seeing that in our reduced inventory levels. And that will continues through the fourth quarter.
We expect that start to turn around here as we exit this year and go into next year, which will result in lower fixed cost being written off, and better performance out in the shop with higher volumes to better plan schedule or operations..
Do you expect to take out more inventory in the fourth quarter than you did in the third, just absolute dollar basis, or similar?.
It would be about the same, maybe a little bit less currently. But overall, if you look at managed working capital, and cash generation it should be very close to what you saw in the third quarter..
So if I look at the $4.3 million fixed cost charge that you took this quarter, how much of that is due to the fact that your production, let's just say how much is due to the fact that you took out inventory?.
100% of it is due to the reduction in inventory, which has been accomplished by lower production. If you look at the elements of fixed cost, non-depreciation fixed cost, they have been reduced 30% to 35% over the last 3 months or 4 months.
So we've taken a fair amount of what we can control in the fixed category like longer term maintenance items and things like that. They have been reduced, but we had something like depreciation that is truly fixed, that's going to be there..
So if you guys didn't take out any inventory in the third quarter, your gross margins would have been around zero?.
It would have been higher than that. If you add back just the 4.3, that would get you to zero. Yes. But I also - you also can't minimize the impact on operations from an efficiency standpoint, because what I described in my heat treat example I could give you an example virtually, a peeler for example, we've got decent volume flowing through the shop.
You can schedule things by size, so you can run fairly efficiently. In today's climate, you got a lot of onesies and twosies, which required to take the machine apart, basically set it up again. So you're set ups increase and your throughput per hour, it goes down, even though you're spending per hour is down. That makes sense to you.
So, as volume picks up, we'll be - we'll get more productive. So some of those efficiency variances will also turnaround, and I would expect that to add further improvement to gross profit margins..
[Operator Instructions] All right. I will turn the call back to Mr. Oates for his final remarks..
Thank you, Carmen. That concludes our formal remarks. Once again, thank you for joining us this morning. We truly appreciate your ongoing support and interest in Universal. And we'll look forward to updating you on our next call in January. Continue to be well stay safe in during the holidays and have a great day..
And with that ladies and gentlemen, we thank you for participating in today's program. You may now disconnect. Have a wonderful day..