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USAP > SEC Filings for USAP > Form 10-Q on 12-Nov-2013All Recent SEC Filings

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

Form 10-Q for UNIVERSAL STAINLESS & ALLOY PRODUCTS INC


12-Nov-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains or incorporates forward looking statements within the meaning of the Private Securities Reform Act of 1995, which involves risks and uncertainties. The following information should be read in conjunction with the unaudited consolidated financial information and the notes thereto included in this Quarterly Report on Form 10-Q. You should not place undue reliance on these forward looking statements. Actual events or results may differ materially due to competitive factors and other factors referred to in Part 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2012, our other filings with the Securities and Exchange Commission and elsewhere in this Quarterly Report. These factors may cause our actual results to differ materially from any forward looking statement. These forward looking statements are based on current expectations, estimates, forecasts, and projections about the industry and markets in which we operate, and management's beliefs and assumptions. In addition, other written or oral statements that constitute forward looking statements may be made by us or on our behalf. Words such as "expect," "anticipate," "intend," "plan," "believe," "could," "estimate," "may," "target," "project," or variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that are difficult to predict.

Business Overview

We manufacture and market semi-finished and finished specialty steel products, including stainless steel, nickel alloys, 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, oil and gas and general industrial markets. 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.

During the first nine months of 2013, we have experienced a lower demand for our products compared to the similar period in the prior year as our shipments are being negatively impacted by unfavorable market conditions as customers continue to destock their inventory levels. We believe this business condition, as well as lower raw material prices and shorter lead times, are causing our customers to delay orders. Over the first nine months of 2013, we shipped 28.0 million tons compared to 38.9 million tons over the same nine month period last year, a decrease of 28%. Correspondingly, our sales revenue was down $63.4 million, or 31.1%, on the lower volume of tons shipped. Although we saw our revenues increase in the third quarter of 2013 to $48.5 million from $42.9 million in the second quarter of 2013, our gross margin decreased to 5.0% of sales in the third quarter of 2013 compared to 12.4% of sales in the second quarter of 2013. The primary factors negatively impacting our gross margin in the third quarter of 2013 were as follows:

1. The mix of products sold was such that we sold more of our lower margin products such as re-rolled billets and less of our higher margin products. This unfavorable mix negatively impacted our gross margin by approximately $0.9 million during the current quarter when compared to the quarter ended June 30, 2013;

2. Our margins were negatively impacted by unfavorable operating rates as a result of our reduced operating activity and reduced raw material surcharges due to continued falling raw material prices, which were not aligned with the higher raw material cost due to longer manufacturing cycles and current inventory turns;

3. Although we flexed our production levels downwards at all of our operating facilities, we were unable to absorb all of our fixed costs throughout our organization which increased our operating costs;

4. Although sales of our premium alloy products increased $1.4 million in the third quarter of 2013 compared to the same prior year period, the costs of products sold were relatively high as we continue to evaluate potential improvements in operational efficiencies. In addition, we have made a conscious decision to maintain our newly trained workforce at our North Jackson facility to position ourselves for what we believe will be improving business conditions in 2014, as we continue to gain more customer acceptances of our newer products being produced at this location.

During the third quarter of 2013, we made positive strides to reduce our inventory levels and overall bank debt levels. Our total inventory at the end of September 2013 was approximately $82.7 million, a decrease of $12.4 million, or 13%, from June 30, 2013 when our inventory level was approximately $95.1 million. During the third quarter, we generated cash from operations of $11.5 million, primarily as the result of our reduced inventory levels and in turn reduced our total long-term borrowings from $100.4 million at June 30, 2013 to $91.6 million as of September 30, 2013, a decrease of $8.8 million. In addition, we entered into a new credit agreement amendment with our banks that provides us with additional flexibility under our covenants.


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On July 1, 2013, we reached a new five-year collective bargaining agreement (the "CBA") with the United Steelworkers, representing the hourly employees at our Bridgeville facility. The CBA has been ratified by the bargaining unit and was effective September 1, 2013.

Although we have seen a slight uptick in our bookings in the last part of the third quarter and early in the fourth quarter, we project our sales and operating profit for the fourth quarter being lower than the third quarter as the fourth quarter is normally slower due to holidays and customers managing their year-end inventory to lower levels. In addition, we were notified by a customer that accounted for approximately 10% of our sales for the year ended December 31, 2012 that the customer will begin to internalize the production of certain lower margin products that it had previously been purchasing from us. We do not believe this will have a material impact on our overall business because the products that they plan to internalize are among our lower gross margin products. We anticipate adjusting our production activity and cost structure to partially offset any reduction in our gross margin as a result of this development.

During October, we achieved our final Nadcap (National Aerospace and Defense Contractors Accreditation Program) and ISO 17025 lab testing certification at our Dunkirk facility. These critically important steps are instrumental in our strategic move towards premium alloys and more technologically advanced products for our targeted markets, including aerospace, oil & gas and power generation. We believe we are now in a stronger position to capitalize on improving market conditions with these certifications now achieved and by investing in our people, particularly at our North Jackson facility, where we expect higher margins on premium produced alloys.

As a result of the North Jackson acquisition, our operating facilities have become more integrated, resulting in our chief operating decision maker ("CODM") viewing the Company as one unit. Our CODM sets performance goals, assesses performance and makes decisions about resource allocations on a consolidated basis. As a result of these factors, as well as the nature of the financial information available which is reviewed by the CODM, we commenced reporting as one reportable segment beginning with the three months ended March 31, 2013.


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Results of Operations

Three months ended September 30, 2013 as compared to the three months ended
September 30, 2012



                                                            Three months ended
(in thousands, except per shipped ton                         September 30,                 Dollar/ton           Percentage
information)                                              2013              2012             variance             variance
Net sales:
Stainless steel                                         $  38,133         $ 48,432         $    (10,299 )              (21.3 )%
High-strength low alloy steel                               4,373            4,880                 (507 )              (10.4 )
Tool steel                                                  3,849            4,768                 (919 )              (19.3 )
High-temperature alloy steel                                1,168            1,930                 (762 )              (39.5 )
Conversion services and other sales                           937            1,350                 (413 )              (30.6 )


Total net sales                                            48,460           61,360              (12,900 )              (21.0 )
Cost of products sold:
Material cost of products sold                             25,589           30,988               (5,399 )              (17.4 )
Operating cost of products sold                            17,004           18,036               (1,032 )               (5.7 )
Depreciation expense                                        3,429            2,999                  430                 14.3


Total cost of products sold                                46,022           52,023               (6,001 )              (11.5 )

Gross margin                                                2,438            9,337               (6,899 )              (73.9 )
Gross margin as a percentage of net sales                     5.0 %           15.2 %                N/A                  N/A
Selling, general and administrative expenses:
Selling, general and administrative expenses                4,467            4,422                   45                  1.0
Severance expenses                                             -               263                 (263 )             (100.0 )


Total selling, general and administrative expenses          4,467            4,685                 (218 )               (4.7 )


Operating (loss) income                                 $  (2,029 )       $  4,652         $     (6,681 )             (143.6 )


Tons shipped                                                9,843           11,614               (1,771 )              (15.2 )


Sales dollars per shipped ton                           $   4,923         $  5,283         $       (360 )               (6.8 )%

Market Segment Information



                                           Three months ended
                                              September 30,              Dollar           Percentage
(in thousands)                             2013            2012         variance           variance
Net sales:
Service centers                         $   30,748       $ 36,631       $  (5,883 )             (16.1 )%
Rerollers                                    8,577         10,429          (1,852 )             (17.8 )
Forgers                                      4,688          8,056          (3,368 )             (41.8 )
Original equipment manufacturers             3,510          4,894          (1,384 )             (28.3 )
Conversion services and other sales            937          1,350            (413 )             (30.6 )


Total net sales                         $   48,460       $ 61,360       $ (12,900 )             (21.0 )%


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Melt Type Information



                                               Three months ended
                                                 September 30,             Dollar          Percentage
(in thousands)                                 2013           2012        variance          variance
Net sales:
Specialty alloys                            $   43,808      $ 57,675      $ (13,867 )            (24.0 )%
Premium alloys (A)                               3,715         2,335          1,380               59.1
Conversion services and other sales                937         1,350           (413 )            (30.6 )


Total net sales                             $   48,460      $ 61,360      $ (12,900 )            (21.0 )%

(A) Premium alloys represent all vacuum induction melt (VIM) produced products.

We do not sell the majority of our products directly to end markets. The end market information in this Quarterly Report is our estimate based upon our customers and the grade of material sold that they will in-turn sell to the ultimate end market customer.

End Market Information



                                               Three months ended
                                                 September 30,             Dollar          Percentage
(in thousands)                                 2013           2012        variance          variance
Net sales:
Aerospace                                   $   28,723      $ 32,615      $  (3,892 )            (11.9 )%
Power generation                                 6,378         8,294         (1,916 )            (23.1 )
Oil & gas                                        5,045        11,854         (6,809 )            (57.4 )
Heavy equipment                                  4,167         4,768           (601 )            (12.6 )
General industrial, conversion services
and other sales                                  4,147         3,829            318                8.3


Total net sales                             $   48,460      $ 61,360      $ (12,900 )            (21.0 )%

Net sales:

Net sales for the three months ended September 30, 2013 decreased $12.9 million, or 21.0%, as compared to the same prior year period in 2012. This sales decrease primarily reflects a 15.2% decrease in consolidated shipments for the quarter ended September 30, 2013 compared to the same prior year period. In addition, our sales dollars per shipped ton decreased by 6.8% from the third quarter of 2012 to the current quarter. This reduction is primarily the result of a lower product mix as well as lower overall selling prices in the current quarter. For the most part, our raw material costs have decreased over last year, which has resulted in lower raw material surcharges in the current quarter compared to the same quarter last year. These unfavorable variances are partially offset by a higher percentage of premium alloy sales recognized in the current quarter. Our premium alloy sales increased from 3.8% of total sales for the quarter ended September 30, 2012 to 7.7% in the current quarter. We believe that the decrease in our sales for the third quarter of 2013 is primarily a result of inventory adjustments being made by our customers as well as declining raw material prices and shortened lead times that we believe are encouraging our customers to delay orders.

Gross margin:

Our gross margin, as a percentage of sales, was 5.0% and 15.2% for the quarters ended September 30, 2013 and 2012, respectively. Our gross margin decline in the current quarter is primarily the result of the 21.0% decrease in net sales and the increase in our operating cost of sales and depreciation expense when compared to the third quarter of 2012. Our operations costs as a percentage of sales increased from 29.4% for the third quarter of 2012 to 35.1% for the current quarter. We have flexed our production levels down as a result of the lower demand for our products; however, we have been unable to absorb all of our fixed costs. Going forward into the fourth quarter and early 2014, we believe our margins will continue to be negatively impacted until normal production levels return. The decrease in our gross margin is also due to increased depreciation expense as a percentage of sales incurred in the current quarter as compared to the prior year third quarter. On a percentage of sales basis, depreciation expense increased from 4.9% for the quarter ended September 30, 2012 to 7.1% in the current quarter. This increase is primarily a result of the significant amount of fixed assets that have been placed in service over the last two years at our North Jackson facility, coupled with the aforementioned reduction in production and sales levels.


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Selling, general and administrative expenses:

Our selling, general and administrative ("SG&A") expenses consist primarily of employee costs, which include salaries, payroll taxes and benefit related costs, legal and accounting services, stock compensation and insurance costs. Our total SG&A expenses decreased by $0.2 million for the three months ended September 30, 2013 as compared to the similar period in 2012. The decrease in total SG&A expense in the current quarter is a result of the $0.3 million reduction in severance expense when compared to the prior year third quarter. However, our total SG&A expenses as a percentage of net sales increased to 9.2% for the quarter ended September 30, 2013 from 7.6% for the third quarter of 2012. This increase is primarily due to maintaining comparable SG&A expenses and headcount between periods despite the aforementioned 21.0% decrease in sales in order to achieve our strategic objectives of certifying all our plants and continuing to obtain customer approvals of our newer products.

Interest expense:

Interest expense increased from $0.6 million for the three months ended September 30, 2012 to $0.8 million in the same period of 2013. This increase is primarily due to higher interest rates incurred on our debt in 2013 when compared to 2012. Our interest rates are determined by a LIBOR-based rate plus an applicable margin based upon achieving certain covenant levels.

Other income:

On August 18, 2011, we entered into an escrow agreement with the sellers of the North Jackson facility, pursuant to which $2.5 million of the purchase price of the North Jackson facility was placed in escrow until certain claims under the purchase agreement were resolved. During the quarter ended September 30, 2013, we entered into a settlement agreement with the sellers of the North Jackson facility, whereby we will receive $0.4 million as a final settlement of certain claims under the escrow agreement. At September 30, 2013, the settlement amount is included as a component of accounts receivable on the consolidated balance sheet. As a result of the settlement, we recognized a gain of $0.4 million during the quarter ended September 30, 2013, which is included as a component of other income on the consolidated statement of operations. We received the settlement payment in October 2013.

Income tax (benefit) provision:

Our effective tax rate for the quarters ended September 30, 2013 and 2012 was 27.6% and 32.7%, respectively. Our estimated annual effective tax rate on ordinary income for 2013 is 47.0%.

Net (loss) income:

Our net (loss) income decreased from $2.7 million, or $0.38 per diluted share, for the quarter ended September 30, 2012 to $(1.7) million, or $(0.25) per diluted share, for the third quarter of 2013 for the reasons stated above.


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Nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012

                                                        Nine months ended
                                                          September 30,             Dollar/ton        Percentage
(in thousands, except per shipped ton information)     2013           2012           variance          variance
Net sales:
Stainless steel                                      $ 105,803      $ 160,844      $    (55,041 )           (34.2 )%
High-strength low alloy steel                           14,831         16,959            (2,128 )           (12.5 )
Tool steel                                              13,951         15,638            (1,687 )           (10.8 )
High-temperature alloy steel                             3,243          6,099            (2,856 )           (46.8 )
Conversion services and other sales                      2,654          4,300            (1,646 )           (38.3 )


Total net sales                                        140,482        203,840           (63,358 )           (31.1 )
Cost of products sold:
Material cost of products sold                          74,769        102,016           (27,247 )           (26.7 )
Operating cost of products sold                         42,740         57,966           (15,226 )           (26.3 )
Depreciation expense                                    10,581          8,676             1,905              22.0


Total cost of products sold                            128,090        168,658           (40,568 )           (24.1 )

Gross margin                                            12,392         35,182           (22,790 )           (64.8 )
Gross margin as a percentage of net sales                  8.8 %         17.3 %             N/A               N/A
Selling, general and administrative expenses:
Selling, general and administrative expenses            13,459         13,150               309               2.3
Severance expenses                                         356            381               (25 )            (6.6 )


Total selling, general and administrative expenses      13,815         13,531               284               2.1


Operating (loss) income                              $  (1,423 )    $  21,651      $    (23,074 )          (106.6 )


Tons shipped                                            28,027         38,925           (10,898 )           (28.0 )


Sales dollars per shipped ton                        $   5,012      $   5,237      $       (225 )            (4.3 )%

Market Segment Information



                                              Nine months ended
                                                September 30,              Dollar           Percentage
(in thousands)                              2013            2012          variance           variance
Net sales:
Service centers                           $  92,360       $ 120,091       $ (27,731 )             (23.1 )%
Rerollers                                    19,657          31,851         (12,194 )             (38.3 )
Forgers                                      15,750          30,924         (15,174 )             (49.1 )
Original equipment manufacturers             10,061          16,674          (6,613 )             (39.7 )
Conversion services and other sales           2,654           4,300          (1,646 )             (38.3 )


Total net sales                           $ 140,482       $ 203,840       $ (63,358 )             (31.1 )%


Table of Contents

Melt Type Information



                                              Nine months ended
                                                September 30,             Dollar          Percentage
(in thousands)                               2013           2012         variance          variance
Net sales:
Specialty alloys                           $ 130,027      $ 191,840      $ (61,813 )            (32.2 )%
Premium alloys                                 7,801          7,700            101                1.3
Conversion services and other sales            2,654          4,300         (1,646 )            (38.3 )


Total net sales                            $ 140,482      $ 203,840      $ (63,358 )            (31.1 )%

End Market Information



                                              Nine months ended
                                                September 30,             Dollar          Percentage
(in thousands)                               2013           2012         variance          variance
Net sales:
Aerospace                                  $  79,448      $ 103,507      $ (24,059 )            (23.2 )%
Power generation                              16,668         27,678        (11,010 )            (39.8 )
Oil & gas                                     15,821         41,546        (25,725 )            (61.9 )
Heavy equipment                               15,201         15,638           (437 )             (2.8 )
General industrial, conversion services
and other sales                               13,344         15,471         (2,127 )            (13.7 )


Total net sales                            $ 140,482      $ 203,840      $ (63,358 )            (31.1 )%

Net sales:

Net sales for the nine months ended September 30, 2013 decreased $63.4 million, or 31.1%, as compared to the similar period in 2012. The decrease in sales primarily reflects a 28.0% decrease in consolidated shipments over the first nine months of 2013 compared to the same prior year period. Product sales to all of our end markets decreased as noted in the above table.

Gross margin:

Gross margin, as a percentage of net sales, was 8.8% and 17.3% for the nine months ended September 30, 2013 and 2012, respectively. The decrease in gross margin is primarily due to the 31.1% decrease in net sales, the increase in our material cost of sales and depreciation expense as a percent of sales. Our material cost of sales increased from 50.0% of sales for the nine months ended September 30, 2012 to 53.2% for the nine months ended September 30, 2013. We believe that the increase in material cost of sales is largely the result of reduced raw material surcharges due to continued falling raw material prices, which were not aligned with the higher raw material cost due to longer manufacturing lead times and current inventory turns. Depreciation expense as a percentage of sales increased from 4.3% for the nine months ended September 30, 2012 to 7.5% for the first nine months of 2013. This increase is a result of the significant amount of fixed assets that have been placed in service over the last two years, primarily at our North Jackson facility, coupled with the aforementioned decline in sales.

Selling, general and administrative expenses:

Our total SG&A expense increased by $0.3 million for the nine months ended September 30, 2013 as compared to the same period in 2012. Total SG&A expenses as a percentage of net sales increased to 9.8% for the nine months ended September 30, 2013 from 6.6% for the same prior year period. There are no significant individual expense increases in our SG&A costs when comparing the first nine months of 2013 to 2012; however, as mentioned previously, we have maintained our headcount for strategic reasons throughout 2013 rather than reducing these costs.

Interest expense:

Interest expense increased from $1.9 million for the nine months ended September 30, 2012 to $2.3 million in the same period of 2013. This increase is primarily due to higher interest rates incurred on our debt in 2013 when compared to 2012. Our interest rates are determined by the LIBOR rate plus an applicable margin based upon achieving certain covenant levels.

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