Universal Stainless & Alloy Products, Inc.

Thank you, Sam. Good morning.

This is June Filingeri of Comm-Partners, and I also would like to welcome you to the Universal Stainless conference call. We are here to discuss the company’s second quarter 2012 results reported yesterday afternoon.

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 and Sam will instruct you again our -- 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 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. For the second quarter of 2012, our sales were $68 million, up 7% over the second quarter of 2011, but down 9% from the record sales of the first quarter of 2012.

Fully diluted earnings per share were $0.62, compared to $0.79 and $0.86 in the second quarter of 2011 and the first quarter, respectively. We also reported a decrease in our backlog to $89 million at June 30.

In short, our results reflect short-term cuts for inventory corrections and margin compression due to falling raw material costs against a backdrop of continued strong end-use market activity.

So let’s take a look. After record sales and order entry in the first quarter and near record backlog of $101 million, we began to see a significant change in customer buying behavior in the second half of May.

Several things were happening.

First, a combination of growing economic uncertainty and less than expected growth rates led customers, particularly service centers, to switch from building inventories as they did in the first quarter to lowering them. Service centers normally represent 50% to 60% of our sales on a direct basis and a portion of our sales to forgers moved to service centers in the supply chain.

Second, there was also a sharp drop in raw material prices with a prospect for customers of lower future surcharges. By June 30, scrap prices fell 26% from the 2012 high and nickel was down 20%.

With lower acquisition prices in future months, customers began buying on a week-to-week as needed basis. We have managed to short term commodity price volatility before and we are beginning to see some stabilization.

Third, no lead times improved which provides customers much more leeway in when they place orders and how large the orders need to be.

So growing economic uncertainty, the prospect of lower future acquisition prices associated with raw material volatility and shorter mill lead times negatively impacted our sales and backlog in the quarter, especially when you consider that we have a significant service center business and a substantial percentage of transactional versus contract business.

I also want to point out that our service center sales are actually up in the second quarter and forger sales are down. To avoid any confusion, keep in mind that our service center business also includes tool steel plate which was exceptionally strong and masks a decrease in aerospace sales.

Also, the reduction in forger sales is a symptom of service center purchasing restraint. Portions of our forger sales are quick-turn ingot sales destined for service centers after processing and cutting by the forgers.

Once the summer slowdown is behind us, inventory balancing has been completed and raw materials have stabilized, we expect to see order entry begin to resume and begin to get back to a level consistent with the activity levels and growth prospects of our end markets which remain strong.

Our consolidated operating margin for the second quarter was 10.8% of sales. That’s down both from the second quarter last year, as well as sequentially due to lower shipment volume in the quarter and the gap between surcharges and raw materials.

Cash flow from operations was a negative $500,000 in the second quarter versus a negative $3.8 million in the first quarter when we were investing in working capital to support increased sales activity, as well as North Jackson. Capital spending for the most recent quarter was $10.3 million, of which $7.2 million was for North Jackson.

Our North Jackson operation was operationally accretive in the second quarter. Let me take a moment to cover some highlights.

Our conversion sales gained traction with shipments reaching nearly 2 million pounds, an increase of 89% sequentially. Forge shipments increased 22%, while forge production was up 13%.

Production from the new vacuum induction melting furnace increased over 200%, compared to the first quarter and the second crew began training late in May. The two vacuum arc remelt furnaces continued in round-the-clock operation with a 76% increase in production sequentially.

The third and fourth vacuum arc remelt furnaces have arrived and will be installed in the third quarter with a September commissioning target.

Finishing operations all demonstrated strong production growth. Heat treating was up 25%, peeling was up 35%, and sawing was up 37%.

Our chemical lab received 17025 certification and the melt shop was awarded AS 9100 certification during the quarter. If you recall, that forge received AS 9100 certification during the first quarter.

We continue to host prospective customers as we jointly work on approvals and new product development.

Let me turn to our sales by end market. Aerospace remained our largest market in the second quarter at 50% of total sales, which is in line with the first quarter and up from 40% of sales in the second quarter last year.

Our sales to aerospace increased 33% from the second quarter of 2011, but were down 9% from the 2012 first quarter, another example of service center inventory management.

The backlog of aircraft manufacturers which stands at about seven years got a further boost from the Air Show at Farnborough. Although below the record order rate of Paris in 2011, the orders were generally as expected and confirmed interest in key new planes like the 737 MAX.

Overall, commercial aerospace production remains robust and is scheduled to increase over the next few years. The chew-up rate for our metals continues unabated, which gives us great confidence in the future and confirms that the second quarter sales reduction represents a short-term realignment of the supply chain.

Petrochemical market sales which are mainly oil and gas related represented 21% of our second quarter sales, also in line with the first quarter and compared to 24% in the second quarter of 2011. Our petrochemical sales were down approximately 8% from both the second quarter of 2011 and sequentially.

Current oil and gas pricing may have temporarily tampered the market, but offshore exploration trends remain strong. Currently, demand is moving sideways but at a strong level and inventory seem to be in balance.

The steepest decline in the second quarter was in power generation where sales were down 18% from the year-ago second quarter and 27% sequentially. Power generation represented 12% of second quarter sales versus 16% in the 2011 second quarter and 15% of sales in the 2012 first quarter.

Orders for metal to build new turbines have not materialized yet despite many hints that they were close at hand. What affected us in the second quarter were fewer quick-turn maintenance orders.

However, the current hot weather demands on equipment should create greater maintenance needs in the coming months, and the outlook for low gas prices bodes well for the long-term IGT market.

In positive contrast, we reported a 53% sequential rise in our sales of service center plate which rose to 10% of total sales in the second quarter, compared with 12% in the second quarter of 2011 and 6% of sales in the 2012 first quarter. Service center plate sales were 12% lower than the second quarter of 2011, continuing to display the unevenness we have seen over the past few years.

There has been good news in the auto industry which is accounted for the strong tool steel sales in the quarter. GM reported that vehicle sales in US were up 16% in June, compared to June of last year, reaching that company’s highest level since September of 2008.

Ford also reported good sales numbers, if not as high as GM’s. Their June vehicle sales were up 7% over June last year and also up 7% year to date.

At this point, let me turn the report over to Doug.

Thank you, Denny. Our second quarter sales were $67.9 million, an increase of $4.5 million or 7.2% from the second quarter of 2011 on a 5.5% increase in shipments.

A favorable sales mix of higher value products along with increased pricing also contributed to the sales increase. Sequentially, sales decreased by $6.7 million or 9% on a 5.4% decrease in shipments, which Denny has discussed.

Our gross margin in the second quarter was $11.6 million, a decrease of $600,000 or 4.9% from the same quarter last year. It was lower by $2.7 million or 18.9% than the record level gross margin recorded in the first quarter this year.

The sequential drop in gross margin is due primarily to reduced volume and the margin impact that Denny also spoke to in his comments. As a percentage of sales, the gross margin was 17%, which was lower than 19.2% in the second quarter of 2011 and 19.1% in the first quarter of this year.

Selling, general and administrative expense for the second quarter was $4.3 million, an increase of $570,000 or 15.3% from the second quarter of 2011, but down $320,000 or 7% from the first quarter of this year. The reduction in our SG&A is due primarily to reduced incentive compensation.

Our second quarter 2012 SG&A includes $590,000 for the North Jackson operation. As a percentage of sales, SG&A expense was 6.3% in the second quarter versus 5.8% in the same quarter last year, and 6.1% in the first quarter this year.

Operating income was $7.3 million in the second quarter of 2012, a decrease of $1.2 million from the second quarter of 2011 and $2.4 million from the first quarter this year. This represented decreases of 13.8% and 24.6%, respectively.

The operating margin was 10.8% in the second quarter, compared with 13.4% in the 2011 second quarter and 13% in the 2011 first quarter. In the second quarter of 2012, the North Jackson operation became slightly accretive at an operating income level for the first time.

In the second quarter of 2011, we recorded $496,000 of due diligence costs for the acquisition of North Jackson. Before including the North Jackson related expenses and income per each period, we achieved an operating margin of 11.4% of sales in the second quarter of 2012, compared with 14.2% in both the second quarter of 2011 and the first quarter of this year.

Interest expense was $618,000 in the 2012 second quarter, compared with $118,000 in the same quarter of 2011 and $704,000 in the first quarter of this year. The most recent periods reflect our increased debt for the North Jackson acquisition.

Late in the first quarter of 2012 we amended our credit facility, which is having a positive impact and reduced the second quarter interest costs compared to the previous quarter.

Turning to taxes, our effective tax rate for the second quarter of 2012 was 32.9%. The effective rate for the six-month period ended June 30 was 31.4%, including a net discrete tax benefit of $580,000 for state income taxes, research and development tax credits, and a net operating loss carryback.

Based on our current tax position, we expect that our annual effective tax rate will be 35.1%.

In terms of cash taxes, as we discussed previously, we generated a taxable loss in 2011 and refundable taxes due to the acquisition of North Jackson and the accelerated depreciation from placing those assets in service. In the first quarter, we received reimbursement of $4.5 million of estimated tax payments made in 2011.

In the second quarter, we filed to carry back the net operating loss generated in 2011 to the 2010 tax year. We received that refund of $5.1 million in the current third quarter.

The number of shares used in computing the diluted earnings per share in the second quarter was 7.4 million, which is the same level as the first quarter this year, but above the 7 million shares in the second quarter of 2011. The increase is a result of the convertible note provided as consideration for the North Jackson acquisition.

Our net income for the second quarter of 2012 was $4.5 million or $0.62 per diluted share. This included a benefit of $0.01 per diluted share attributed to the North Jackson facility and $0.02 per share as a result of the tax benefits noted earlier.

In the second quarter of 2011, net income was $5.5 million or $0.79 per diluted share, including $0.04 per diluted share of acquisition expense for North Jackson. In the first quarter of this year, net income was $6.3 million or $0.86 per diluted share, including a total of $0.03 per diluted share of expense related to North Jackson, offset by the benefit of $0.07 per diluted share related to the discrete tax adjustments.

Turning to the balance sheet, our managed working capital as of the end of the 2012 second quarter, which includes receivables and inventory less accounts payable, was 42.4% of annualized sales, compared with 36.7% in the second quarter of 2011 and 35.6% in the first quarter of this year. The increase in managed working capital from the first quarter is $8.9 million, of which $5.5 million is due to the increased inventory in North Jackson and the ramp-up of the VIM production which Denny spoke to.

Capital expenditures for the second quarter were $10.3 million, including $7.1 million for North Jackson. At the end of the quarter, our total debt was $114.7 million and our debt to total capitalization was 37.3%.

And I’ll turn the call back to you, Denny.

Thanks, Doug. In closing, despite our progress at North Jackson and operationally throughout Universal in the second quarter, we’re disappointed by the results we reported yesterday afternoon.

While we have managed the raw materials swings and world economic concerns for the past several years, the intensity of both cause customers, especially the service centers to suddenly move to the sidelines beginning in mid-May. The fact that service centers represent a significant portion of our sales and that we have such a large quick-turn business rather than extensive contractual agreements made that sudden move at the end of the quarter insurmountable.

Realistically, no one expects order activity to pick up until after we are past the normal summer slowdown. We are fully ready to seize those orders when it does, and we will be even farther ahead at North Jackson at that time.

Finally, let me underscore what I said in the release. The fundamental drivers of our end markets remain in place, and our long-term growth strategy and prospects remain intact.

Our story is the same story it was three months ago. We’re relentlessly pursuing operational excellence and profitable growth.

On that note, I’ll end my formal remarks and turn it over to you for questions.

Denny, the -- obviously, the incoming order rate, I think it was $55 million in the second quarter, clearly fell off considerably in May and June. Is it stabilized or is it still declining, because I guess if I look at where nickel prices are, they’ve even come off further since the end of the second quarter?

If you look at incoming business, just to give some background on this, in the first four months of the year through April, we were running $20 million to $23 million a month basically, that was the range. In May, bookings fell to around $17 million, then fell to $13 million in June.

As we look at July, we’re running slightly behind June. The only caveat I would put on that being ever the optimist is that typically, when you look at July and you got the 4th of July weekend, you get a lot of vacations.

So, as I look at last year’s July, for example, in 2011 you saw the same phenomena where July was a very weak month, largely because of those vacations and slowness in placing orders. But at this point in time, we’re tracking behind June.

Right. Okay.

Sort of along those same lines, when you look at the composition of the backlog, what kind of shipment expectations do you have for the third quarter? Are any orders getting pushed out or cancelled, or just give us a feel for should we expect revenue to kind of be similar to what you saw bookings in the second quarter or some of those backlog times getting elongated as people take a wait-and-see approach?

I think just to -- as you look at the backlog, let me pick apart and try and answer your question in its entirety. The steel -- the tool steel plate business is going to be lower clearly in the third quarter if you look at bookings.

We had a very strong shipment quarter and that’s a very cyclical business. So that’s going to be lower from a shipment standpoint or from a booking standpoint in the third quarter.

As you look at bar and some of the other aerospace products, we expect that to move sideways to up. So, if you look at the entire quarter, something on the range of the second quarter, up slightly would be our best look at the third quarter right now.

So third quarter, if I heard you right, in total you think the shipment revenues will be, I mean, similar to the second quarter, is that what I heard you say?

Similar, with a slight upward bias.

Right. So you think you -- based on what you’ve seen obviously, you think you’ll work some backlog?

Yes.

Okay. And then just...

I also -- I also would say we talk a lot about this quick-turn business and if you go back historically and look at this business and how we have these fluctuations at service center level, typically they start fast and they end fast. So my -- if you look at the quarter, if history holds, you’ll start to see nickel stabilize for a couple of months.

People will start to run out of inventory. They’ll start to place orders and they’ll be in dire need of that inventory.

So it’ll be a great push to get stuff turned around quickly. So, there is still some optimism in Denny Oates that as you go out of the third quarter, you’re going to see some positive numbers from a booking standpoint and to the degree we can perform and execute, we should be able to convert those into sales in the third quarter.

Okay, great. And then, just two housekeeping questions.

What were the revenues related to Patriot in the second quarter? I know you don’t segment it, but just some rough idea, I think you’ve given the number as $3.8 million in the first quarter?

One second, Mike. Combined, Mike, we are posting $4.9 million of revenues related to North Jackson in the second quarter.

Okay. And obviously, you’d expect that to increase sequentially.

I think if I go back earlier, you would have expected maybe to be at a $10 million type of number in the third quarter. It seems like the conversion business has ramped up a little slower.

You’re still getting the third and fourth VIMs installed. Is that an achievable number or is that somewhat aggressive?

Yes, right now, our sales does not include VIM third party sales. Those right now is the ramp-up of production and most of the numbers we’re quoting right now is conversion based activity.

Right. Would you expect it’s going to be similar in the third quarter or do you expect you’ll start to do some third party VIM sales?

As you look at the conversion business, I would expect that to increase but not in the third quarter but not at the same rate as you saw in the second quarter versus first, we’re up 89%, okay?

As far as the VIM -- as far as VIM goes, we are producing in the VIM. As I said, we produced 200% more than we did in the first quarter.

So, we’re beginning to ramp that up, we’re beginning to train new crews but none of that is making it into sales at this point in time. We’ve got to get approvals and coordinate with customers.

Our expectation is that as you get into the latter part of the third quarter, which is consistent with our plan we told you about a year ago, we -- you’d start to see some revenue from the VIM going into our P&L. That would pick up in the fourth quarter and 2013 would be the year we’d have this facility up and running and be ready to go on most -- on a lot of products, not most of the products.

Right. Okay, great.

And then, final housekeeping question for Denny. I think you said the tax rate 35.1% on an ongoing basis.

Is that what you’d expect the tax rate for the year to be, because obviously year to date, it’s lower than that?

No, it would be -- we expect it to be 35%, Mike, through the third and fourth quarter and then obviously the year rate would be averaged in with the first two.

Just 2 questions. First, can you give the breakout of the backlogs for North Jackson?

And then the second question, another housekeeping is just do you expect more SG&A ramp-up there at North Jackson? Just wanted to get a better handle on SG&A going forward.

The backlog at North Jackson is $11.1 million.

And Tim, I would not expect...

I’m sorry. Let me correct that.

I’m looking at a schedule and I’ve got 15 numbers in front of me.

Sorry, Denny.

It’s $16.9 million.

Okay. And...

And Tim, I would not expect an increase in our SG&A as a result of North Jackson. If anything, our costs are coming down in the overhead there as we convert short-term transition costs to long-term staffing and normalizing our cost structure there.

Denny, just with regard to the service center business, you talked about orders churning down monthly. Is that kind of reflected even more so in the service center side of the business?

Yes, it’s service center and forgers; it’s pretty much both of those categories, service centers primarily though. And when you look at our report, you’ll see forger business is down and when you analyze that, the vast majority of that would be product that ultimately ends up in a service center where we’re selling ingot to a forger who’s banging it down and then shipping it off to a service center.

So even the forger decrease you see in our numbers is largely related to service centers.

Okay. And then the petroleum side of the business, that similarly looking forward, you’ve seen that -- that seems to have not weakened as much as the others, but has -- what is the outlook there?

If you take a look at the activity, you hear a lot of negatives there because of low, falling oil prices and lower gas prices. But if you take a look at where our products go, which is in the more hostile environments like offshore, there’s still a strong activity and there is anticipated to continue to be a strong activity through next year.

So we’ve not seen any significant drop off in terms of the market. You see a little fluctuations from an inventory standpoint, but fundamentally, a pretty solid market at this point in time.

Okay. Thanks again for joining us today.

Despite the current market conditions, we remain fully committed to delivering on our strategic plan, and we'll look forward to updating you on our progress on our next call. Have a great day.