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USAP > SEC Filings for USAP > Form 10-K on 18-Mar-2013All Recent SEC Filings

Show all filings for UNIVERSAL STAINLESS & ALLOY PRODUCTS INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for UNIVERSAL STAINLESS & ALLOY PRODUCTS INC


18-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The following Management Discussion and Analysis ("MD&A") is intended to help the reader understand the consolidated results of operations and financial condition of Universal Stainless & Alloy Products, Inc. ("the "Company"). This MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and the accompanying notes to the financial statements.

We manufacture and market semi-finished and finished specialty steel products, including stainless steel, tool steel and certain other alloyed steels. Our manufacturing process involves melting, remelting, heat treating, hot and cold rolling, forging, machining and cold drawing of semi-finished and finished specialty steels. Our products are sold to rerollers, forgers, service centers, original equipment manufacturers and wire redrawers. Our customers further process our products for use in a variety of industries, including the aerospace, power generation, petrochemical and heavy equipment manufacturing industries. We also perform conversion services on materials supplied by customers that lack certain of our production capabilities or are subject to their own capacity constraints.

We recognized net income for the year ended December 31, 2012 of $14.6 million, or $2.02 per diluted share, compared with net income of $18.1 million, or $2.56 per diluted share, for 2011.

Our net sales for 2012 were largely consistent with the record level of sales recognized in 2011, decreasing slightly from $252.6 million in 2011 to $251.0 million for the current year. This decrease is largely due to decreased volume recognized in the current year partially offset by favorable product mix. Tons shipped decreased by 5% in the current year when compared to the prior year. This decrease in volume was partially offset by higher average sales price per pound of our stainless steel products in 2012 when compared to 2011.

During the current year, we continued to increase production at our North Jackson facility, a start-up facility which was acquired in the third quarter of 2011. In addition to conversion services provided to external customers, the North Jackson operation has provided increasing forging and remelting capacity for our other facilities, as well as providing our legacy operations with operating synergies. Melting in the facility's vacuum induction melting (VIM) furnace continued throughout 2012. Material produced in the VIM is now being qualified for future customer orders. We expect to recognize incremental increases in sales of our VIM material throughout 2013. In October 2012, we commissioned two additional vacuum arc remelting (VAR) furnaces at our North Jackson facility, which brings the total number of VAR furnaces company-wide to eleven, including four at North Jackson. The additional VAR furnaces will be used to service our aerospace and petrochemical customers.

Our cost of products sold increased by $4.7 million, or 2%, from $205.1 million in 2011 to $209.8 million in 2012. Our operations costs, which include certain infrastructure costs such as overhead and depreciation, increased in the current year when compared to the prior year. We have placed a substantial amount of fixed assets in service over the past year, primarily at our North Jackson facility, which has increased our depreciation expense. The higher depreciation expense, coupled with developing production at our North Jackson facility, had a negative impact on our operations costs as a percentage of sales in the current period. As we continue to increase production at our North Jackson facility, we believe that our infrastructure costs as a percentage of sales will decrease from current levels.

Selling and administrative ("S&A") expenses decreased slightly from $17.8 million during 2011 to $17.7 million in 2012. During 2012, we incurred an additional $1.5 million in S&A expenses at our North Jackson facility as a result of operating the facility for the entire year. Our results for 2011 were negatively affected by acquisition related expenses of $2.1 million associated with the North Jackson facility, which are included within S&A expenses.


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Interest expense increased from $1.4 million for 2011 to $2.6 million in 2012. This $1.2 million increase is primarily due to the higher average debt balance maintained during 2012 to finance the North Jackson facility acquisition and subsequent start-up activities.

Our effective tax rate decreased from 36.4% for 2011 to 30.2% recorded in 2012. Our 2012 effective tax rate benefited from research and development tax credits and a change in state income tax apportionment. The American Taxpayer Relief Act of 2012 extended the tax benefit for research and development tax credits for 2012 and 2013. We expect to realize an effective tax rate benefit of approximately 1.8% relative to research and development tax credits during 2013.

Results of Operations

An analysis of our operations is as follows:

For the years ended December 31,                                      2012                              2011                             2010
(dollars in thousands; percentages of total
net sales)
                                                     Amount              %            Amount               %            Amount              %
Net sales:
Stainless steel                                 $   195,315           77.8       $   202,000            80.0       $   142,302           75.1
Tool steel                                           20,420            8.1            21,963             8.7            26,196           13.8
High-strength low alloy steel                        21,897            8.7            17,532             6.9            10,310            5.4
High-temperature alloy steel                          7,787            3.1             6,809             2.7             5,853            3.1
Conversion services                                   4,868            2.0             3,905             1.5             2,719            1.5
Scrap sales and other                                   703            0.3               387             0.2             2,043            1.1

Total net sales                                     250,990          100.0           252,596           100.0           189,423          100.0
Cost of products sold                               209,841           83.6           205,148            81.2           155,651           82.2
Selling and administrative expenses                  17,746            7.1            17,761             7.0            13,349            7.0


Operating income                                $    23,403            9.3       $    29,687            11.8       $    20,423           10.8

2012 Results as Compared to 2011

Net sales for 2012 decreased slightly by $1.6 million as compared to 2011. The decrease is largely due to a 5% decrease in tonnage shipped, offset by base price increases and a change in product mix. Shipments of power generation products, petrochemical products and service center plate decreased 24.0%, 13.0% and 9.5%, respectively, over 2011. These decreases were partially offset by 6.1% and 17.3% increases in aerospace products and conversion services shipments, respectively, in 2012 when compared to 2011.

Net sales by market segment are as follows:

For the years ended December 31,                                   2012                             2011                             2010
(dollars in thousands; percentages of
total net sales)
                                                  Amount              %            Amount              %            Amount              %

Net sales:
Service centers                              $   151,034           60.2       $   131,624           52.1       $    88,421           46.6
Forgers                                           36,678           14.6            48,432           19.2            41,793           22.0
Rerollers                                         37,343           14.9            47,114           18.6            36,515           19.3
Original equipment manufacturers                  15,874            6.3            16,427            6.5            13,800            7.3
Wire redrawers                                     4,490            1.8             4,707            1.9             4,132            2.2
Conversion services                                4,868            1.9             3,905            1.5             2,719            1.5
Scrap sales and other                                703            0.3               387            0.2             2,043            1.1


Total net sales                              $   250,990          100.0      $    252,596          100.0       $   189,423          100.0


Tons shipped                                      47,802                           50,164                           43,373


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Cost of products sold as a percentage of net sales increased slightly from 81.2% in 2011 to 83.6% in 2012. The increase in this percentage is largely attributable to increased infrastructure costs, such as overhead and depreciation, incurred in 2012. We have placed a substantial amount of fixed assets in service over the past year, primarily at our North Jackson facility, which has significantly increased our depreciation expense. The higher depreciation expense, coupled with developing production at our North Jackson facility, had a negative impact on our current year gross margin. As we continue to increase production at our North Jackson facility, we believe that our infrastructure costs as a percentage of sales will decrease from current levels.

S&A expense for 2012 of $17.7 million was consistent with 2011 expense of $17.8 million. On a percentage of sales basis, S&A expenses increased from 7.0% of sales in 2011to 7.1% of sales in 2012. Our current year results were negatively impacted by the inclusion of an additional $1.5 million of S&A expenses in 2012, when compared to 2011, as a result of having an entire year of activity for the North Jackson facility in 2012. The 2011 expense includes acquisition related costs associated with the North Jackson acquisition of $2.1 million.

2011 Results as Compared to 2010

Net sales for 2011 increased $63.2 million as compared to 2010. The increase was largely due to a 16% increase in tonnage shipped, combined with price increases and a change in product mix, which favorably affected our net sales. Shipments of aerospace products, petrochemical products, conversion services and power generation products increased 43.1%, 18.8%, 32.1% and 7.0%, respectively, over 2010. These increases were partially offset by a 21.0% reduction in service center plate shipments in 2011 when compared to 2010.

Cost of products sold as a percentage of net sales was 81.2% and 82.2% for 2011 and 2010, respectively. Excluding a favorable $1.0 million inventory adjustment recorded in 2010 for additional metal recovered as a result of a capital project streamlining in the scrap loading area, our material cost as a percentage of net sales increased slightly from 42.4% in 2010 to 42.6% in 2011. Our operation costs as a percentage of net sales decreased from 40.3% in 2010 to 38.6% in 2011. The reduction as a percentage of sales is due to operational benefits that we recognized in 2011 from process improvement projects. In addition, our 2011 cost of products sold as a percentage of sales benefited from reduced fixed costs as a percentage of sales. A portion of our cost structure is relatively fixed in nature, such as overhead and depreciation costs. These fixed costs combined with significantly higher net sales in 2011, resulted in a lower cost of products sold as a percentage of net sales for 2011.

S&A expenses increased in 2011 to $17.8 million, or 7.0% of sales, from $13.3 million, or 7.0% of sales, in 2010. The increased cost in 2011 is primarily due to increased acquisition related costs associated with the North Jackson acquisition of $1.9 million, a $937,000 increase in compensation and compensation related costs, which includes North Jackson personnel, and $728,000 of additional North Jackson S&A expenses. Our 2010 S&A costs included an additional $647,000 stock option compensation charge as a result of changes in estimated forfeiture rates and to fully expense vested options. Excluding the North Jackson acquisition related costs, the 2010 additional stock compensation charge and North Jackson S&A expenses, our S&A expenses as a percentage of net sales would have decreased from 6.6% for 2010 to 5.9% in 2011.

Business Segment Results

We are comprised of four operating locations and a corporate headquarters. For segment reporting, the Bridgeville, North Jackson and Titusville facilities have been aggregated into one reportable segment, Universal Stainless & Alloy Products ("USAP"). The USAP manufacturing process involves melting, remelting, heat treating, forging and hot and cold rolling of semi-finished and finished specialty steels. The manufacturing process at Dunkirk Specialty Steel, our other reportable segment, involves hot rolling and finishing specialty steel bar, rod and wire products.

From the North Jackson acquisition date through December 31, 2012, Management has included the results of North Jackson in the USAP segment. North Jackson was included in the USAP reporting segment as a result of


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North Jackson having consistent characteristics as identified in Accounting Standards Codification Topic 280, "Segment Reporting", with the USAP segment. As a result of the North Jackson acquisition, our operating facilities have become more integrated, resulting in our chief operating decision maker ("CODM") increasingly viewing the Company as one unit. When full integration occurs and information and metrics are established and used by the Company's CODM to make key decisions including allocation of resources, it is expected that we will move to one reportable segment.

UNIVERSAL STAINLESS & ALLOY PRODUCTS SEGMENT

An analysis of the segment's operations is as follows:



For the years ended December 31,                                   2012                             2011                            2010
(dollars in thousands; percentages of
total net sales)
                                                  Amount              %            Amount              %           Amount              %
Net sales:
Stainless steel                              $   120,071           56.4       $   125,936           55.9       $   99,092           57.2
Tool steel                                        17,584            8.3            20,248            9.0           25,325           14.6
High-strength low alloy steel                      6,062            2.8             3,026            1.3            2,091            1.2
High-temperature alloy steel                       2,647            1.3             2,791            1.3            2,427            1.4
Conversion services                                4,439            2.1             2,985            1.3            2,110            1.2
Scrap sales and other                                481            0.2               401            0.2            1,928            1.1

                                                 151,284           71.1           155,387           69.0          132,973           76.7
Intersegment                                      61,618           28.9            69,946           31.0           40,321           23.3

Total net sales                                  212,902          100.0           225,333          100.0          173,294          100.0
Material cost of sales                           107,042           50.3           116,959           51.9           85,507           49.3
Operation cost of sales                           82,980           39.0            76,014           33.7           61,428           35.4
Selling and administrative expenses               11,332            5.3            12,184            5.4            9,048            5.2


Operating income                             $    11,548            5.4      $     20,176            9.0       $   17,311           10.0

Net sales for 2012 decreased by $12.4 million, or 5.5%, in comparison to 2011 primarily due to a 4.6% decrease in tonnage shipped, offset by base price increases realized in 2012 and product mix. Shipments of power generation products and petrochemical products decreased 24.6% and 18.0%, respectively, over 2011. These decreases were partially offset by increases in shipments of aerospace products, conversion services and service center plate products of 8.4%, 44.8% and 13.4%, respectively, in 2012 when compared to 2011.

Net sales for 2011 increased by $52.0 million, or 30.0%, in comparison to 2010 primarily due to an 18.4% increase in tonnage shipped, base price increases realized in 2011 and product mix. Our intersegment sales as a percent of sales increased from 2010 to 2011 to support the increased sales volume recognized by our Dunkirk segment. In addition, our 2011 net sales included $145,000 of external sales from the North Jackson operation, from August 18, 2011 through December 31, 2011. Shipments of aerospace products, petrochemical products, conversion services and power generation products increased 44.3%, 25.2%, 33.9% and 7.0%, respectively, over 2010. These increases were partially offset by a 20.6% reduction in service center plate shipments in 2011 when compared to 2010.

Our operating income for 2012 decreased by $8.6 million, or 42.8% when compared to 2011. On a percentage of sales basis, our operating income decreased from 9.0% in 2011 to 5.4% in 2012. The decline in our operating income as a percentage of sales is largely due to the increase in operating cost as a percentage of sales in the current year. Our operations costs, which include certain infrastructure costs such as overhead and depreciation, increased on a percentage of sales basis from 33.7% in 2011 to 39.0% in 2012. We have placed a substantial amount of fixed assets in service over the past four quarters, primarily at our North Jackson facility, which has increased our depreciation expense. The higher depreciation expense, coupled with developing production at our North Jackson facility, had a negative impact on our operations costs as a percentage of sales in the current period. As we continue to increase production at our North Jackson facility, we believe that our infrastructure costs as a percentage of sales will decrease from current levels.


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Our operating income for 2011 increased by $2.9 million when compared to 2010, however as a percentage of sales, operating income decreased from 10.0% in 2010 to 9.0% in 2011. North Jackson acquisition and start-up costs negatively affected our 2011 operating income by $3.5 million when compared to 2010. Our 2010 operating income benefited from the $1.0 million favorable inventory adjustment described above. Excluding the impact of North Jackson on 2011 and the inventory adjustment on 2010, our operating income as a percentage of sales, increased to 10.5% in 2011 from 9.4% in 2010. The improved proportion of operating income to sales in 2011 was largely attributable to fixed operating costs being spread over higher production volumes as a result of increased product orders.

DUNKIRK SPECIALTY STEEL SEGMENT

An analysis of the segment's operations is as follows:



For the years ended December 31,                                   2012                         2011                          2010
(dollars in thousands; percentages of total
net sales)
                                                   Amount             %          Amount            %          Amount             %
Net sales:
Stainless steel                                $   75,244          75.2      $   76,064         78.1      $   43,211          76.3
Tool steel                                          2,836           2.8           1,715          1.8             871           1.5
High-strength low alloy steel                      15,835          15.8          14,506         14.9           8,219          14.5
High-temperature alloy steel                        5,140           5.2           4,018          4.1           3,426           6.1
Conversion services                                   429           0.5             920          0.9             609           1.1
Scrap sales and other                                 222           0.2             (14 )        -               114           0.2

                                                   99,706          99.7          97,209         99.8          56,450          99.7
Intersegment                                          350           0.3             169          0.2             150           0.3

Total net sales                                   100,056         100.0          97,378        100.0          56,600         100.0
Material cost of sales                             58,642          58.6          59,835         61.4          33,003          58.3
Operation cost of sales                            25,616          25.6          21,689         22.3          15,000          26.5
Selling and administrative expenses                 6,414           6.4           5,577          5.7           4,301           7.6


Operating income                               $    9,384           9.4     $    10,277         10.6     $     4,296           7.6

Net sales for 2012 increased by $2.7 million, or 2.8%, in comparison to 2011 primarily due to base price increases and changes in product mix. Tonnage shipped from the Dunkirk segment decreased by 1.9% in 2012 when compared to 2011. Sales to service centers in 2012 comprised 87.3% of external sales and 84.1% of external shipments. Shipments of conversion services, service center plate and power generation products decreased 67.9%, 59.0% and 7.7%, respectively, over 2011. These decreases were partially offset by increases in shipments of general industrial and aerospace products of 19.7% and 3.7%, respectively. Over 50% of the segments sales for 2012 and 2011 were derived from sales of aerospace products.

Net sales for 2011 increased by $40.8 million, or 72.0%, in comparison to 2010 primarily due to a 57.3% increase in tonnage shipped and base price increases realized in 2011. The increase in shipments was largely attributed to improved economic conditions and market demand. Sales to service centers in 2011 comprised 85.4% of external sales and 80.8% of external shipments. Our service center sales increased by $36.9 million over the similar 2010 period. Shipments of aerospace, petrochemical, power generation and general industrial products increased 72.5%, 79.3%, 24.9% and 18.2%, respectively, over 2010.

Operating income decreased by $893,000 for 2012 as compared to 2011. Cost of products sold as a percentage of net sales was consistent between periods, increasingly slightly from 83.7% in 2011 to 84.2% in 2012. The segment's results were negatively impacted by higher S&A expenses as a percentage of sales in 2012, primarily as a result of higher employee relations expenses in 2012 when compared to 2011.

Operating income increased by $6.0 million for 2011 as compared to 2010. Cost of products sold as a percentage of net sales decreased from 84.8% in 2010 to 83.7% in 2011. This improvement was partially attributable to fixed operating costs being spread over higher production volumes, partially offset by an increase in material cost as a percentage of net sales in 2011. The segment's results also benefited from lower S&A expenses as a percentage of sales in 2011 when compared to 2010.


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Liquidity and Capital Resources

We have financed our operating activities through cash provided by operations and cash provided through our credit facilities. Working capital increased $15.9 million to $129.9 million at December 31, 2012 compared to $114.0 million at December 31, 2011. Accounts receivable decreased $10.3 million as a result of a 24.2% decrease in sales for the three-month period ended December 31, 2012 in comparison to the three-month period ended December 31, 2011. The $10.7 million increase in inventory at December 31, 2012 compared to December 31, 2011 is primarily due to the building of VIM inventory. Material produced in the VIM is now being qualified for future customer orders. We expect to be qualified by these customers throughout 2013 and to recognize increasingly sales of VIM products throughout 2013. Accounts payable decreased by $19.3 million from December 31, 2011 to December 31, 2012. This decrease is a result of the reduced volume of open capital expenditure programs in 2012 when compared to 2011 as well as overall lower spending during the fourth quarter of 2012 when compared to the fourth quarter of 2011.

Cash received from sales of $261.2 million and $247.5 million for the years ended December 31, 2012 and 2011, respectively, represent the primary source of cash from operations. The primary uses of cash for the year ended December 31, 2012 were raw material purchases of $102.8 million, employment costs of $49.9 million, capital expenditures of $34.2 million and utilities of $12.0 million. For the same period in 2011, excluding the purchase of our North Jackson facility, primary uses of cash were raw material purchases of $116.2 million, employment costs of $46.3 million, utilities of $15.2 million and capital expenditures of $16.8 million.

Prior to the North Jackson acquisition, we paid federal estimated taxes of $4.5 million for 2011. As a result of the North Jackson acquisition and the significant amount of machinery and equipment that was placed in service in 2011, we claimed the available 100% bonus depreciation deduction on such equipment and, as a result, generated a net operating loss ("NOL") for the 2011 federal income tax return. We recorded refundable income taxes in the amount of $4.8 million as of December 31, 2011, which mostly represented the amount paid in federal taxes during 2011. In February 2012, we received a federal tax refund of $4.5 million. At December 31, 2011, we had a deferred tax asset of $15.1 million related to NOL carry forwards. During the second quarter of 2012, we carried back a portion of this NOL to 2010 to obtain a refund of the $5.2 million paid for federal income taxes for the 2010 tax year. We received this refund in July 2012. The remaining portion of the NOL is being carried forward.

The following table reflects the average market values per pound for key raw materials for selected months during the last three-year period.

                                 December               June           December               June           December               June
                                     2012               2012               2011               2011               2010               2010
Nickel                         $     7.90         $     7.50         $     8.23         $    10.14         $    10.94         $     8.79
Chrome                         $     0.98         $     1.16         $     1.10         $     1.23         $     1.31         $     1.33
Molybdenum                     $    11.38         $    13.32         $    13.42         $    16.09         $    16.17         $    14.73
Carbon scrap                   $     0.17         $     0.17         $     0.21         $     0.22         $     0.19         $     0.20

. . .

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