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USAP > SEC Filings for USAP > Form 10-K on 5-Mar-2014All Recent SEC Filings

Show all filings for UNIVERSAL STAINLESS & ALLOY PRODUCTS INC

Form 10-K for UNIVERSAL STAINLESS & ALLOY PRODUCTS INC


5-Mar-2014

Annual Report


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

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. and its wholly-owned subsidiaries (collectively, "we," "us," "our," or the "Company"). This MD&A should be read in conjunction with our consolidated financial statements and accompanying notes included in this Form 10-K. When reviewing the discussion, you should keep in mind the substantial risks and uncertainties that characterize our business. In particular, we encourage you to review the risk and uncertainties described under Item 1A., "Risk Factors," of this Form 10-K. These risks and uncertainties could cause actual results to differ materially from those forecasted in forward-looking statements or implied by past results and trends. Forward-looking statements are statements that attempt to project or anticipate future developments in our business; we encourage you to review the discussion of forward-looking statements under "Cautionary Statement for Purposes of the "Safe Harbor" Provisions of the Private Securities Litigation Reform Act of 1995," at the beginning of this report. These statements, like all statements in this report, speak only as of the date of this report (unless another date is indicated), and we undertake no obligation to update or revise the statements in light of future developments. Unless otherwise specified, any reference to a "year" is to the year ended December 31.

Business Overview

We manufacture and market semi-finished and finished specialty steel products, including stainless steel, nickel alloys, tool steel and certain other premium 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.

During the year ended December 31, 2013, we experienced lower demand for our products compared to the prior year as our shipments were negatively impacted by unfavorable market conditions, as customers in all of our end markets continued to destock their inventory levels. These business conditions, as well as lower raw material prices and shorter lead times, gave reason for our customers to delay orders, especially over the last quarter of 2013, when seasonality also played a role. During 2013, we shipped 73.0 million pounds compared to 95.6 million pounds over the same period last year, a decrease of approximately 24%, and as such, our corresponding sales revenue was down $70.2 million, or 28%. These market conditions also had an unfavorable impact on our gross margin as well as our operating margin compared to 2012. We responded to these conditions by flexing down our operating levels, in particular, our melting levels at both our Bridgeville and North Jackson operations, especially during the third quarter of 2013. In addition to lower operating levels negatively impacting our margins, lower raw material prices caused a misalignment with steel surcharges as we were selling higher cost inventory melted in early 2013 and prior throughout the year as a result of longer manufacturing cycles. We also made a conscious decision to maintain our newly trained workforce at our North Jackson facility as we continued to focus our efforts on gaining additional customer acceptances for our new products being produced from this location in anticipation of improved 2014 business conditions.

Although 2013 was a challenging year for the metals industry, we made several positive strides throughout 2013.

1. In April 2013, we were awarded our first contract with Rolls Royce, which officially began on January 1, 2014; however, we did make our initial shipment in December 2013. This is a five-year contract that required an extensive effort to meet demanding requirements for qualifying our entire manufacturing system, including Vacuum Induction Melting ("VIM") and forge production at North Jackson.

2. In August 2013, we announced the early signing of a new five-year labor contract with our hourly workforce at our Bridgeville facility as we maintain a productive relationship with our workforce.

3. In October 2013, we announced a long-term agreement with Haynes International, Inc. ("Haynes") whereby we will provide VIM capacity as well as forging services on a conversion basis to Haynes.

4. Throughout 2013, we achieved customer approvals and developed new products for major customers in our aerospace, power generation and oil and gas markets as we introduced 15 new products in 2013, defined by grade and shape.

5. During 2013, we generated $28.6 million in cash flow from operating activities primarily by focusing our efforts to reduce inventory levels in response to market conditions. In addition, we lowered our capital expenditures and in turn, repaid $16.9 million in debt while improving our debt to capitalization to 31.4% from 35.1% at the end of 2012. We amended our credit facility in November 2013 which also provides us with sufficient working capital to meet our cash requirements moving into 2014.

6. Lastly, we attained a number of industry certifications in 2013, and nine altogether since 2012, as we moved toward the more technically advanced and higher margin products that we anticipated with our acquisition of our North Jackson facility.


Although we have seen an uptick in our bookings in the fourth quarter of 2013 and at the start of 2014, we anticipate our first quarter results could be similar to our results for the third and fourth quarters of 2013, in terms of top line growth and gross margin compression as some of our older higher cost materials make their way through the sales cycle and customers remain cautious in their buying patterns. However, indications from the marketplace suggest that 2014 will provide progressive demand improvement and with our development and integration of North Jackson adding to market opportunities, we remain optimistic that the second half of 2014 will provide us with improved financial results.

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 January 1, 2013.

Results of Operations

2013 Results as Compared to 2012





For the years ended
December 31,                           2013                          2012
(dollars in thousands,
except per shipped ton
information)
                                         Percentage of                 Percentage of    Dollar / ton    Percentage
                              Amount       net sales        Amount       net sales        variance       variance
Net sales:
Stainless steel             $ 137,383        76.0  %      $ 195,315        77.8  %       $  (57,932)      (29.7) %
Tool steel                     18,112        10.0            20,420         8.1              (2,308)      (11.3)
High-strength low alloy
steel                          17,894         9.9            21,897         8.7              (4,003)      (18.3)
High-temperature alloy
steel                           4,277         2.4             7,787         3.1              (3,510)      (45.1)
Conversion services and
other sales                     3,102         1.7             5,571         2.3              (2,469)      (44.3)

Total net sales               180,768       100.0           250,990       100.0             (70,222)      (28.0)
Cost of products sold         166,888        92.3           209,841        83.6             (42,953)      (20.5)

Gross margin                   13,880         7.7            41,149        16.4             (27,269)      (66.3)
Selling and
administrative expenses        17,885         9.9            17,746         7.1                 139         0.8

Operating (loss) income        (4,005)       (2.2)           23,403         9.3             (27,408)     (117.1)
Interest expense and
other financing costs          (3,042)       (1.7)           (2,592)       (1.0)               (450)       17.4
Other income, net                 481         0.3               140            -                341       243.6

(Loss) income before
income taxes                   (6,566)       (3.6)           20,951         8.3             (27,517)     (131.3)
(Benefit) provision for
income taxes                   (2,504)       (1.4)            6,334         2.5              (8,838)     (139.5)

Net (loss) income           $  (4,062)       (2.2) %      $  14,617         5.8  %       $  (18,679)     (127.8) %

Tons shipped                   36,477                        47,802                         (11,325)      (23.7)

Sales dollars per shipped
ton                         $   4,956                     $   5,251                      $     (295)       (5.6) %


Market Segment Information:





For the years ended
December 31,                           2013                          2012
(dollars in thousands)
                                         Percentage of                 Percentage of      Dollar       Percentage
                              Amount       net sales        Amount       net sales       variance       variance
Net sales:
Service centers             $ 115,859        64.1  %      $ 151,034        60.2  %      $  (35,175)      (23.3) %
Forgers                        21,254        11.8            36,678        14.6            (15,424)      (42.1)
Rerollers                      27,021        14.9            37,343        14.9            (10,322)      (27.6)
Original equipment
manufacturers                  13,532         7.5            20,364         8.1             (6,832)      (33.5)
Conversion services and
other sales                     3,102         1.7             5,571         2.2             (2,469)      (44.3)

Total net sales             $ 180,768       100.0  %      $ 250,990       100.0  %      $  (70,222)      (28.0) %

Melt Type Information:







For the years ended
December 31,                           2013                          2012
(dollars in thousands)
                                         Percentage of                 Percentage of      Dollar       Percentage
                              Amount       net sales        Amount       net sales       variance       variance
Net sales:
Specialty alloys            $ 167,040        92.4  %      $ 234,588        93.5  %      $  (67,548)      (28.8) %
Premium alloys (A)             10,626         5.9            10,831         4.3               (205)       (1.9)
Conversion services and
other sales                     3,102         1.7             5,571         2.2             (2,469)      (44.3)

Total net sales             $ 180,768       100.0  %      $ 250,990       100.0  %      $  (70,222)      (28.0) %

(A) Premium alloys represent all VIM produced products.

We do not sell the majority of our products directly to end markets. The end market information in this Annual 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:





For the years ended
December 31,                           2013                          2012
(dollars in thousands)
                                         Percentage of                 Percentage of      Dollar       Percentage
                              Amount       net sales        Amount       net sales       variance       variance
Net sales:
Aerospace                   $ 102,341        56.6  %      $ 129,172        51.4  %      $  (26,831)      (20.8) %
Power generation               21,671        12.0            33,532        13.4            (11,861)      (35.4)
Oil & gas                      18,880        10.5            49,126        19.6            (30,246)      (61.6)
Heavy equipment                19,788        10.9            20,421         8.1               (633)       (3.1)
General industrial,
conversion services and
other sales                    18,088        10.0            18,739         7.5               (651)       (3.5)

Total net sales             $ 180,768       100.0  %      $ 250,990       100.0  %      $  (70,222)      (28.0) %

Net sales:

Net sales for the year ended December 31, 2013 decreased $70.2 million or 28.0%, as compared to the similar period in 2012. The decrease in our sales primarily reflects a 23.7% decrease in consolidated shipments in 2013 compared to the same prior year period. Our product sales to all of our end markets decreased as noted in the above table. The reduction in our net sales is also the result of a lower priced product mix as well as lower overall selling prices in the current year. For the most part, our raw material costs have decreased over last year, which has resulted in lower raw material surcharges in the current year compared to the same prior year period. These unfavorable variances are partially offset by a higher percentage of our premium alloy sales recognized in the current


year. Our premium alloy sales increased from 4.3% of total sales for the year ended December 31, 2012 to 5.9% in the current year. We believe that the decrease in our sales during 2013 was primarily a result of inventory adjustments being made by our customers as well as declining raw material prices and shorter lead times that we believe were encouraging our customers to delay orders.

Gross margin:

Our gross margin, as a percentage of sales, was 7.7% and 16.4% for the years ended December 31, 2013 and 2012, respectively. Our gross margin decline in the current year is primarily the result of the 28.0% decrease in net sales and the increase in our operating cost of sales and depreciation expense when compared to 2012. Our operations costs as a percentage of sales increased from 28.1% for 2012 to 31.1% for the current year. We flexed our production levels down as a result of the lower demand for our products; however in certain cases, we were unable to absorb all of our fixed costs. The decrease in our gross margin is also due to increased depreciation expense compared to the prior year. As a percentage of sales basis, depreciation expense increased from 4.7% for 2012 to 7.8% in the current year. 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.

Selling and administrative and expenses:

Our selling and administrative ("S&A") expenses consist primarily of employee costs, which include salaries, payroll taxes and benefit related costs, severance expenses, legal and accounting services, stock compensation and insurance costs. Our S&A expenses for 2013 were largely consistent with those incurred in 2012. However, our S&A expenses as a percentage of net sales increased to 9.9% for the year ended December 31, 2013 from 7.1% for 2012. This increase is primarily due to maintaining comparable S&A expenses and headcount between periods despite the aforementioned 28.0% decrease in sales in order to achieve our strategic objectives of certifying all of our plants and continuing to obtain customer approvals of our new products. Included within S&A expenses is approximately $0.4 million of severance expense for both 2013 and 2012.

Interest expense and other financing costs:

Interest expense increased from $2.6 million for the year ended December 31, 2012 to $3.0 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. The interest rates on our variable rate debt is determined by a LIBOR-based rate plus an applicable margin based upon achieving certain covenant levels. Also, included within interest expense is the amortization of deferred financing costs incurred from the issuance and subsequent amendments to our debt facilities. During the years ended December 31, 2013 and 2012, we recognized $444,000 and $308,000, respectively, of deferred financing amortization. Based upon the maturity date of our current debt facility, we expect that our annual deferred financing amortization from 2014 to 2016 to be approximately $639,000 and $107,000 in 2017.

Other income:

In August 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 year ended December 31, 2013, we entered into a settlement agreement with the sellers of the North Jackson facility, whereby we received $425,000 as a final settlement of certain claims under the escrow agreement. The settlement was recognized as a gain during the year ended December 31, 2013, which was included as a component of other income on the consolidated statement of operations.

Income tax (benefit) provision:

Our effective tax rate for the years ended December 31, 2013 and 2012 was 38.1% and 30.2%, respectively. During 2013, we recorded a tax valuation allowance of approximately $1.0 million against certain New York State deferred tax assets, which negatively impacted our effective tax rate. These deferred tax assets have no expiration date and will be applied against future tax liabilities for income apportioned to New York State; however, at this time we do not believe we will generate sufficient taxable income to utilize all tax credits generated. Our 2013 effective tax rate benefited from approximately $1.0 million of research and development tax credits that we generated for 2012 and 2013. Our 2012 effective tax rate benefited from prior years' research and development tax credits claimed on amended federal income tax returns and a change in state income tax apportionment.

Net (loss) income:

Our net (loss) income decreased from $14.6 million, or $2.02 per diluted share, for the year ended December 31, 2012 to $(4.1) million, or $(0.58) per diluted share, for the year ended December 31, 2013 for the reasons stated above.


2012 Results as Compared to 2011





For the years ended
December 31,                           2012                          2011
(dollars in thousands,
except per shipped ton
information)
                                                                                         Dollar /
                                         Percentage of                 Percentage of        ton        Percentage
                              Amount       net sales        Amount       net sales       variance       variance
Net sales:
Stainless steel             $ 195,315        77.8  %      $ 202,000        80.0  %       $  (6,685)       (3.3) %
Tool steel                     20,420         8.1            21,963         8.7             (1,543)       (7.0)
High-strength low alloy
steel                          21,897         8.7            17,532         6.9              4,365        24.9
High-temperature alloy
steel                           7,787         3.1             6,809         2.7                978        14.4
Conversion services and
other sales                     5,571         2.3             4,292         1.7              1,279        29.8

Total net sales               250,990       100.0           252,596       100.0             (1,606)       (0.6)
Cost of products sold         209,841        83.6           205,148        81.2              4,693         2.3

Gross margin                   41,149        16.4            47,448        18.8             (6,299)      (13.3)
Selling and
administrative expenses        17,746         7.1            17,761         7.0                (15)       (0.1)

Operating income               23,403         9.3            29,687        11.8             (6,284)      (21.2)
Interest expense and
other financing costs          (2,592)       (1.0)           (1,421)       (0.6)            (1,171)       82.4
Other income, net                 140            -              212         0.1                (72)      (34.0)

Income before income
taxes                          20,951         8.3            28,478        11.3             (7,527)      (26.4)
Provision for income
taxes                           6,334         2.5            10,356         4.1             (4,022)      (38.8)

Net income                  $  14,617         5.8  %      $  18,122         7.2  %       $  (3,505)      (19.3) %

Tons shipped                   47,802                        50,164                         (2,362)       (4.7)

Sales dollars per shipped
ton                         $   5,251                     $   5,035                      $     216         4.3  %

For the years ended
December 31,                           2012                          2011
(dollars in thousands)
                                         Percentage of                 Percentage of      Dollar       Percentage
                              Amount       net sales        Amount       net sales       variance       variance
Net sales:
Service centers             $ 151,034        60.2  %      $ 131,624        52.1  %      $   19,410        14.7  %
Forgers                        36,678        14.6            48,432        19.2            (11,754)      (24.3)
Rerollers                      37,343        14.9            47,114        18.6             (9,771)      (20.7)
Original equipment
manufacturers                  20,364         8.1            21,134         8.4               (770)       (3.6)
Conversion services and
other sales                     5,571         2.2             4,292         1.7              1,279        29.8

Total net sales             $ 250,990       100.0  %      $ 252,596       100.0  %      $   (1,606)       (0.6) %

Net sales:

Net sales for 2012 decreased slightly by $1.6 million as compared to 2011. The decrease was 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, oil & gas 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.


Gross margin:

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 placed a substantial amount of fixed assets in service over 2011 and 2012, primarily at our North Jackson facility, which significantly increased our depreciation expense. The higher depreciation expense, coupled with developing production at our North Jackson facility, had a negative impact on our 2012 gross margin.

Selling and administrative expenses:

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, which includes severance expense increased from 7.0% of sales in 2011 to 7.1% of sales in 2012. Our 2012 results were negatively impacted by the inclusion of an additional $1.5 million of S&A expenses, when compared to 2011, as a result of having an entire year of activity for the North Jackson facility in 2012. In addition, we incurred an additional $360,000 of severance expense during 2012 when compared to 2011. Our 2011 S&A expense includes acquisition related costs associated with the North Jackson acquisition of $2.1 million.

Interest expense and other financing costs:

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

Income tax provision:

Our effective tax rate decreased from 36.4% for 2011 to 30.2% recorded in 2012. Our 2012 effective tax rate benefited from prior year's research and development tax credits claimed on amended federal income tax returns and a change in state income tax apportionment.

Net income:

Our net income decreased from $18.1 million, or $2.56 per diluted share, for the year ended December 31, 2011 to $14.6 million, or $2.02 per diluted share, for the year ended December 31, 2012 for the reasons stated above.

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