Universal Stainless & Alloy Products, Inc.

Thank you, Shawn. Good morning.

This is June Filingeri of Comm-Partners and I'd also like to welcome you to the Universal Stainless conference call. We are here to discuss the company's fourth quarter 2011 results, reported this morning.

With us from management are Denny Oates, Chairman, President and Chief Executive Officer; Paul McGrath, Vice President of Administration and General Counsel; Doug McSorley, Vice President of Finance and Chief Financial Officer; and Chris Zimmer, Vice President of Sales and Marketing.

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 again 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 out of the way, I would now like to turn the call over to Denny Oates. Denny, we are ready to begin.

Thanks, June. Good morning, everyone.

Thanks for joining us today.

This morning we announced that fourth quarter sales were $62 million, an increase of 21% over the fourth quarter of 2010. In comparison to the third quarter 2011, which was our all-time record sales quarter, sales were down 8%, reflecting earlier than normal customer delivery cutoffs and declining raw material surcharges.

Nickel alone fell almost 20% from late summer to November, moving roughly from $10 a pound to $8 a pound. Interestingly, nickel is now rebounding and it appears headed back towards $10 a pound in the current quarter.

For the full year 2011, sales were up 33% reaching $253 million, a new company record, on a 16% increase in volume. The sales to volume trend evident in our 2011 sales demonstrates the general benefits of our strategy to expand our product portfolio with more higher value and more technologically advanced products.

A more specific example of these benefits is the record performance of our Dunkirk operation, which grew sales 72% to almost $100 million or 39% of company sales. Our progress in adding higher value products combined with cost reductions and pricing actions is also evident in the higher operating margins we are achieving on our legacy Universal business.

Operating income before expenses associated with the North Jackson investment was $7.9 million or 12.8% of sales in the fourth quarter versus 10.9% in the fourth quarter last year. The operating margins achieved during the past 3 quarters are among the highest on record and have been accomplished despite falling nickel prices and a resulting decline in surcharges.

Fourth quarter net income was $0.72 per share before including the $0.13 per share impact of our North Jackson acquisition, compared to $0.52 per share in 2010's fourth quarter, a 38% improvement. Adjusting for North Jackson's after-tax costs of $0.51 per share, 2011 earnings per share increased 60%, reaching $3.07 compared to 2010's $1.93.

Cash flow from operations totaled $9.6 million in the fourth quarter. We invested $16.6 million in capital projects during the quarter, including $14.4 million for North Jackson.

Total debt at the end of the quarter was $95 million or 34.4% of total capitalization, a slight reduction versus September 30 despite heavy capital spending.

We ended the year with a record backlog of $103 million, including $14 million for our North Jackson facility. At the beginning of the third quarter, the backlog associated with North Jackson was $9.5 million.

I'm going to correct that. At the beginning of the fourth quarter, the backlog associated with North Jackson was $9.5 million.

The increased backlog reflects strong underlying market demand, record fourth quarter bookings and shipments pushed into 2012 by customers receiving practices at year-end. Before my update on operating progress in North Jackson, let's take a closer look at end markets.

Aerospace sales were up 62% for the full year. For the fourth quarter, aerospace remained our largest market at 46% of total sales, which is up from 42% of sales in the 2011 third quarter and 36% in the fourth quarter of 2010.

Our sales to aerospace rose 53% from the fourth quarter last year and 1% from the 2011 third quarter.

News from the aircraft makers continues to be very positive. Airbus recently reported booking 1,419 net orders in 2011 and ended the year with an order backlog of over 4,000 aircraft.

Boeing booked 805 net orders last year, including 13 for the 787 despite its production delays, as well as 200 orders for the popular 777, 551 orders for the 737, with strong demand for the new 737 MAX.

Boeing ended 2011 with a backlog of 3,771 airplanes, which analysts estimate represents 6 to 7 years of annual output at current production levels. Airbus' backlog is estimated at 8 years at current production rates.

The challenge for aerospace suppliers is to keep pace with demand and expected production rate increases, which is a good challenge to have.

Our full year petrochemical sales were up 42%, the petrochem market remained our second largest market in the fourth quarter, representing 21% of total sales compared with 23% of sales in the third quarter and 22% in the fourth quarter of 2010.

Petrochemical sales were up 13% from the fourth quarter of 2010, but were 16% lower than the record third quarter, mainly due to seasonal buying patterns rather than a change in market demand or in the balance of inventory in the channel.

The market opportunity remains very positive. Schlumberger is forecasting growth in exploration and production in 2012, especially in North America, on land and in deepwater.

On Monday, Halliburton reported a record fourth quarter overall as well as in North America, where they say the horizontal drilling activity continued to increase and the U.S. rig count increased 3%.

We expect the positive trend to continue into 2012, coupled with additional growth in the Gulf where activity is reaching pre-moratorium levels.

Power generation sales increased 23% compared to 2010, even though the new turbine business never developed as expected. After strong growth and record sales in the third quarter, our fourth quarter sales to the power generation market were down 5% sequentially and at level with the fourth quarter last year.

Power generation represented 18% of both fourth quarter and third quarter sales and 22% of sales from the fourth quarter last year. There are positives on the horizon.

GE shipped more turbines in 2011 than they did in 2010, and they expect that number to increase again in 2012.

Alstom in their fiscal third quarter announcement last week reported seeing continued demand for new equipment in emerging markets coupled with demand for maintenance service activity in mature markets, including the U.S. We continue to believe energy needs will grow as the global economy recovers, driving higher maintenance spending and new equipment demand in the developing and developed world.

Our service center plate sales, while remaining at 8% of total sales, were down 12% year-over-year, and tool steel sales were down 16%, indicating the magnitude of the re-stocking which took place in 2010. The 35% increase in tool steel imports through the end of October was also a contributing factor.

Fourth quarter service center plate sales increased 27% from the 2010 fourth quarter, but were 12% below the third quarter of 2011. Meanwhile, our tool steel plate sales were down 4% from the fourth quarter last year and 34% sequentially.

We're seeing continued volatility in tool steel plate demand and customer inventory levels.

Despite the rise in imports, we have seen an increase in our backlog in tool steel, which points to improvement in 2012. The backlog increase is in line with the news from the automotive and off-road leaders.

Ford reported an 11% increase in vehicle sales worldwide and a 17% increase in 2011 Ford brand sales in the U.S.

Similarly, GM saw a 14% increase in vehicle sales in 2011 and they are forecasting further growth in 2012. In the off-road market, Caterpillar delivered record sales and earnings in 2011 and projects 2012 to be another record as developed economies continue to recover on top of robust business in the developing world, all of which is positive for tool steel demand.

With our new radial forge in North Jackson, Universal has begun producing tool steel rounds, making us the first domestic producer in that market in nearly 15 years. We shipped our first round bar earlier this month.

Let me turn to our North Jackson operation where we remain on track with our accelerated schedule for startup, including construction projects and equipment commissioning. Production on a new radial forge is ramping up as planned with 6.4 million pounds moving across the dies in the fourth quarter.

Production was increased each month of the quarter, with December production about 150% above September's.

Forge backlog now stands at $14 million with $11 million being new business captured due to North Jackson capabilities. Although third-party conversion work has been somewhat slower to build than we originally planned, we expect this business to build each quarter of 2012, especially after North Jackson earns AS9100 aerospace approval, which is targeted for the second quarter this year.

Construction of vacuum induction melting furnace has been completed, and the first heat was made in December as scheduled. We're now working through a punch list of minor issues and plan to start a 16 heat melting campaign next Monday, January 30.

We also completed first heats on each of our 2 new vacuum-arc remelt furnaces in December. Our goal is to be running these furnaces around the clock by the end of March.

Two additional vacuum-arc remelt furnaces for North Jackson have been ordered. Delivery is scheduled for the 2012 third quarter and production slated for the fourth quarter.

Our finishing operations at North Jackson including heat treating, straightening, sawing and peeling are ramping up as the major equipment comes on-stream, with interim support from our Bridgeville team as required.

We're on our way to making North Jackson an integral part of our manufacturing process, serving customers directly and supporting our Dunkirk, Bridgeville and Titusville facilities with high-quality products and services. We continue to expect the North Jackson operation to be accretive from operations this quarter as we originally reported last summer.

Let me turn the call over to Doug for his report on the finances of the company.

Thank you, Denny. As Denny said, sales for the fourth quarter of 2011 were $62.2 million, an increase of $10.6 million or 20.5% compared to the fourth quarter a year ago on 4% increase in shipments.

A more favorable mix of higher value products and increased pricing also contributed to the sales increase.

Sequentially, sales decreased by $5.1 million or 7.6%, on a similar decrease in shipments due to the year-end seasonality. Full year 2011 sales increased by $63.2 million or 33.4% compared to 2010, reaching a record $252.6 million on a 15.7% increase in tons shipped.

Our gross margin in the fourth quarter was $11.9 million, an increase of $3.1 million or 34.6% from the same quarter last year. It was $670,000 or 5.3% lower than the 2011 third quarter due to lower sales.

For full year 2011, the gross margin increased $13.7 million to a record level of $47.5 million. As a percentage of sales, the gross margin was 18.8% for 2011 compared with 17.8% for 2010.

Selling, general and administrative expense for the fourth quarter was $4.9 million or 7.9% of sales. After excluding $800,000 of North Jackson related costs, the adjusted fourth quarter SG&A was $4.1 million or 6.6% of sales compared with $3.3 million and 6.6% of sales in the fourth quarter a year ago.

SG&A costs were $452,000 lower than the 2011 third quarter, which included $1.3 million in acquisition related expenses and North Jackson start-up costs.

For full year 2011, SG&A expenses were $17.8 million or 7% of sales. Excluding the impact of $3 million of acquisition-related expenses and North Jackson start-up costs, recurring SG&A costs were $14.8 million or 5.9% of sales.

For full year 2010, SG&A expenses were $13.3 million or 7% of sales.

Operating income for the 2011 fourth quarter was $7 million or 11.3% of sales. After adjusting for $850,000 of operating expenses related to the start-up of North Jackson, fourth quarter income was $7.9 million or 12.8% of sales.

That is an increase of $2.4 million from operating income of $5.5 million or 10.6% of sales in the fourth quarter of 2010.

Operating income in the 2011 third quarter was $7.2 million and included $1.7 million of expenses related to the acquisition and start-up of North Jackson. The adjusted operating income was $8.9 million or 13.2% of sales.

For full year 2011, our adjusted operating income was $33 million or 13.1% of sales, compared to $20.6 million or 10.9% of sales for 2010.

Interest expense in the 2011 fourth quarter was $570,000, which is in line with the third quarter. Both periods reflect our increased debt for the North Jackson acquisition.

Interest expense was $118,000 in the fourth quarter last year.

Turning to taxes. As discussed last quarter, our acquisition of North Jackson results in a taxable loss for federal tax purposes in 2011.

Based on our year-end assessment of our tax position and the increased commissioning of assets into service, which is subject to accelerated depreciation under the 2010 Tax Relief Act, our tax rate for this quarter is 34.2%. This rate reflects an adjustment to our full year tax rate of 36.4%.

Early in 2012, we filed for the recovery of $4.5 million of estimated tax payments made in 2011 prior to the acquisition, which we expect to receive before the end of the current quarter. Also, we have the option to elect to carry back for cash recovery -- to carry back our operating tax loss for cash recovery of federal taxes paid in 2010 as well, which would have an estimated cash recovery of $5.4 million but if we do so, it would result in an increased tax rate.

At this time, we expect our initial tax rate in 2012 to be 36.5%.

The number of shares used in computing the diluted earnings per share for the fourth quarter was 7.4 million. It was 7.1 million for the year.

As a reminder, there was an increase in shares as a result of the convertible note provided as consideration for the North Jackson acquisition. The number of shares that will be included in subsequent quarters is 427,000 shares.

The EPS reported for the fourth quarter of 2011 was $0.59 per share including dilution adjustments totaling $0.13 per share related to the impact of the North Jackson acquisition.

In total, these adjustments include $0.07 per share of after-tax operating loss resulting from the start-up of North Jackson and $0.08 per diluted share for the continued dilutive effect of interest rate -- interest expense and the increase in outstanding shares resulting from the acquisition financing, offset by $0.02 per share for the effective or reduced tax rate.

Excluding these adjustments, fourth quarter EPS was $0.72 per share compared to $0.52 in the fourth quarter of 2010. Similarly, adjusted EPS for full year 2011 was $3.07 compared to a $1.93 for 2010.

Turning to the balance sheet, our managed working capital at the end of the fourth quarter, which includes receivables and inventory less accounts payable, was 35% of annualized sales, representing an improvement from 36% at the end of last quarter and 38% at the end of 2010.

Capital expenditures for the fourth quarter were $16.6 million, including $14.4 million for North Jackson, for a total capital investment in 2011 of $24.5 million. At the end of the quarter our total debt was $94.7 million, a reduction of $950,000 from last quarter.

Our debt to total capitalization is 34.4% and we have $37.1 million available under the revolver facility at the end of the quarter.

Denny, I'll turn the call back to you for concluding remarks.

Okay, Doug. Thanks.

2011 was a year of important progress for Universal. Sales grew 33%, exceeding $250 million for the first time.

We increased our earnings power by expanding our product portfolio with higher margin products, squeezing returns from recently completed capital projects, improving manufacturing processes to reduce cost and cut cycle times, and continuing to build our organization for the future.

Acquisition of the North Jackson operation was successfully completed in August and our start-up has been fast tracked. We are more convinced than ever that this is a game changer for Universal as it broadens our production capabilities, expands our product range in higher-value higher-margin products, and positions us to enter new market niches on a global basis.

We have entered 2012 with a record backlog and with momentum in our end markets. Our full focus is on achieving further profitable growth in the coming quarters.

That concludes our formal remarks. We're now looking forward to taking your questions.

Denny, when I look at the fourth quarter, it seemed like the sequential fall-off at traditional was more than what we've seen historically seasonally. And obviously, you always get the service center inventory management on year-end.

But I guess when I look at your book-to-bill in the fourth quarter, stripping out Patriot, which obviously had a lot of bookings and not a lot of shipments in the fourth quarter, it looks like it was below 1. So help us just to kind of understand your confidence that you're still seeing demand pick up and that you've seen just a shift in shipments from Q4 to Q1.

And then also on that note, the $14 million that you booked at Patriot, how much of that would you expect to ship in the first quarter?

As far as the year-end -- the fourth quarter versus the third quarter, the sequential trends that we're seeing in the base business, as I look at the normal service center stuff that happens every year, and it's not just service centers, it was a little more severe this year. Several of our largest customers cut off a week earlier than they did the last couple years, and also did not take any product at the tail-end of the year for delivery early in the New Year.

So it was a more severe year from our standpoint, dealing with service centers in particular, than it has been in prior years. That was a big player in our numbers.

I'm struggling a little bit with your book-to-bill comment because our bookings, our total bookings in the fourth quarter were a record for the company.

Let me just clarify it. I think it was $72 million-ish of bookings for the fourth quarter.

I think you noted you booked $14 million or so at -- I think you booked $14 million…

There was $14 million in the backlog for North Jackson, that wasn't bookings, and the prior number for North Jackson was $9.5 million, I think, at the beginning of the fourth quarter, end of the third quarter.

Okay. So $14 million was the total backlog.

Okay, that was the clarification.

So, as I'm looking at our bookings, the fourth quarter for Universal was a record quarter for bookings. As I look at the first 20 -- look at the bookings this morning, for example, with 27 days in the month of January, we're running at a pace -- that's about just under 10% greater than what we averaged each month of the fourth quarter.

So we're seeing sustained level of business coming in, in fact, a stronger level of business coming in. When you say, “Where is it coming in from?”

The 3 major markets we talk about all the time, all are playing a role in there. But the major improvements are coming from petrochem, aerospace, and we've seen increases in tool steel bookings so far this year.

Right. And in terms of just the backlog at Patriot, how much of that you expect to kind of ship first quarter or second quarter?

I'm going to say half of it is first quarter, tail-end of the quarter, and the rest of it would be early second quarter. And understand on Patriot, this is not a stand-alone operation.

So we're talking about a fair amount of business that is -- Bridgeville normally would have been booked at Bridgeville and perhaps forged outside by a third-party before. Okay, they're not doing the business directly.

Similar question, just trying to better understand the sequential movement on the top-line. The scheduling shift, does that revenue evaporate or is it shifted just to the first quarter or especially with nickel prices escalating again, are we seeing a step-up here, or how should we be thinking about that as that flows through into the first quarter?

We have seen no cancellations of orders that I'm aware of. I'm looking at Chris Zimmer, but we have had no cancellations.

Therefore, anything that doesn't get shipped in the fourth quarter is going to roll over into the first quarter. As far as the nickel dynamic, if you think back to the last conference call we had, there were a number of questions and a lot discussion about how the fourth quarter would play out based upon different trends in nickel.

We said back then if nickel could stabilize or even start to increase, it would be bullish for the fourth quarter. And as you know, looking back now, nickel continued to decrease.

In fact, November was the low-water mark. So that has a depressing effect in terms of buying.

People tend to push things out even further, assuming there's going to be even lower prices -- lower total acquisition prices in the future.

Okay. So this is really more of a timing function versus a fundamental issue?

Yes. And that nickel thing, just let me finish my thought.

And it's also turning around, as I said in my prepared comments, where nickel has had a rally here so far this year. It's pushing towards $10.

So you will have the inverse of what you saw during the fourth quarter.

Great. And then, I know we're not done with January yet, but is there any color you can give in terms of how the backlog is progressing here in January?

Our backlog is going sideways because we're shipping fairly heavy at this point in January. However, I would point to the bookings number just to give you a sense of the activity level out there.

We had a record -- as I was saying, a record quarter in the fourth quarter for bookings. The previous record was the third quarter last year.

And currently, in the fourth quarter through 27 days, we're on a pace to beat those numbers by about 10%. So we've seen a pick-up in bookings here the first 3.5 weeks of the month.

Excellent. And then, you've already made some comments on the petrochem, and I know a lot of that is seasonal related but are we seeing a decent or a fair uptick in that market as well?

On the petrochem market?

Yes.

Petrochem market is very hot. So it's very strong.

Everybody does business with different customers in that market space. So you get some quarters that get a little lumpy, a little up and down that have to do with individual customers and where they are in their business.

But the fundamental drivers of that business are very strong. The capital is flowing into exploration.

It's going into areas that are going to require more and more of the products that we make. So we're very bullish on that business.

Great, and then one last maintenance or one maintenance, if I may. You mentioned, I think, 36.5% for targeted 2012 tax rate.

There are a lot of moving parts and timing. Any sort of first quarter?

How should we be looking at that?

That would be the rate I would use, Dan.

Even with throughout the year?

That's right. And unless -- that's the best rate to use.

We have -- or I think you have some targets for gross profit as a percent of value added sales, what 30% at USAP, 40% at Dunkirk. Now with North Jackson coming into the fold, should we be thinking of those percent targets moving higher?

And if so, is there any amount that you envision?

I think you should look for progressive improvements in those margins just due to the capital that we're spending in those direct operations, as well as process improvements we plan to make, and a higher value mix going through those plants. I won’t to attribute that all to North Jackson, because we basically transfer a product between our plants at a market level.

So each plant is earning a profit. But each plant is a profit center, I guess, for lack of a better term.

So you won't see the benefits of North Jackson showing up in the Dunkirk segment. You'll see the benefits of what we do to Dunkirk itself showing up in the Dunkirk segment.

And that should -- you should see steady improvement in those margins as we do our thing with regard to adding higher value products with higher margins and we make strategic investments in the Dunkirk facility to improve our operations and do our process then each year.

As we look into 2012, can you give us a sense of the capital expenditures?

At this point, Phil, our capital projects that we're currently working on that are in-flight, you should expect about $30 million capital spend, which is largely the North Jackson operation. We have some other strategic investments that we're looking at, but right now our committed spend rate is about $30 million.

Okay. And Doug, I think you mentioned earlier in the call about an income tax receipt, you expect to get about $4 million to $5 million in the cash -- in a cash receipt in the first quarter, is that right?

That's right. And those are payments that were made early in 2011 as estimated payments for 2011, prior to North Jackson being acquired.

Okay. And Denny, how has the start-up of the VIM gone relative to your expectations?

Any start-up is a wild ride, so we've learned a lot. But it was pretty standard start-up in the sense that we put things together.

We had cooperation with the vendor. We have a good team of people working on that.

We made our first heat. We learned a lot about the equipment.

We tested just about everything. And you try and push those things to failure, as you know, when you're doing these early start-ups.

So that's where the punch list of issues came from. We've been working on those for the last few weeks, and I think the fact that we're going to start a 16 melt [ph] campaign on Monday speaks to our confidence in that facility and the people we have operating it.

I know you guys are generally pretty conservative and the start-up costs were a little bit ahead of what you expected. I think it was a $0.10 drag is what you were looking for.

Was that due to the fact that you just were pushing the VIM hard in December?

Well, if you remember way back when, we didn't anticipate doing any melting on the VARs or the VIM in the fourth quarter. We expected to do that in 2012.

So we did adopt an accelerated strategy. That had some effect.

But the real issue there was we expected some more conversion business, to be candid with you, which would absorb some of those start-up costs, and that was slower in coming. Why was it slow in coming?

A major reason -- the 2 major reasons; one is we do not have AS9100 Certification. So there are some folks who just flat out, because of their quality systems, can't give us conversion work.

And so we have that approval at North Jackson, which will be early in the second quarter. At least, that's our target.

Obviously, we have to pass all the audit work along those lines. The other issue, quite frankly, was the transition between the prior owners and Universal.

If you remember, we said in our June announcement, we would close in July and we ended up closing in the third week of August. And obviously, people have to run their business, and then they had a new cast of characters, things were delayed.

So they went a different direction for the second half of their year. So all those customers have now talked to us directly.

All of them have been through North Jackson again. All of them want to retest material under Universal ownership, which is in process.

So that's why we expect that conversion business to increase each quarter as we go through 2012.

Now does that increase conversion business in the first quarter, is that what is going to join to push the North Jackson facility into the black in the first quarter of the year?

It's some of that. The majority of that, though, is additional business.

I would call it, without confusing you, it's the business that Universal is now able to go after because we have the facility. So it's essentially business that Universal has always been in through the Bridgeville operation, where we can now take third-party forging and shift it over to North Jackson.

Second part would be business that we weren't competitive in, because we didn't have the cost position or the cycle times to go after those sizes. And the third area is products that are going to go from Bridgeville to North Jackson, and all smaller sizes go up to Dunkirk.

So I would say that the majority of the reason why we expect to operationally be accretive is those kinds of products. Conversion will help but that's not the sole reason.

Thanks again for joining us today. We've entered the New Year better-equipped than ever to capitalize on the opportunities in our markets.

We're all looking forward to updating you on our progress at the end of the first quarter. Have a good day.

Thanks again.