Operator: Good day, everyone. Thank you for standing by, and welcome to the Universal Stainless Third Quarter 2021 Conference Call. . And now I would like to hand the conference over to your speaker today, June Filingeri. Thank you.

Please go ahead.

June Filingeri: Thank you. Good morning. This is June Filingeri of Comm-Partners, and I also would like to welcome you to the Universal Stainless Conference Call and Webcast. We are here to discuss the company's third quarter 2021 results reported this morning.

With us from management are Denny Oates, Chairman, President and Chief Executive Officer; Chris Zimmer, Executive Vice President and Chief Commercial Officer; and John Arminas, Vice President, General Counsel and Corporate Secretary. Before I turn the call over to management, let me quickly review procedures. After management has made formal remarks, we will take your questions. The conference operator will instruct you 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 complete, I would now like to turn the call over to Denny Oates. Denny, we are ready to begin.

Dennis Oates: Okay. Thanks, June.

Good morning, everyone. Thanks for joining us this morning. Positive business momentum continued to build during the third quarter. Our backlog of $125.1 million increased 27% from the second quarter, reaching the highest level since early 2019 on continued strong order entry. That 27% increase was on top of a 74% increase in the second quarter.

Gross bookings remained high at $58 million, and September had the second highest order entry of the year. Bookings are being driven by aerospace, our largest market. Demand has begun to ratchet up and more is expected in 2022 and 2023, with a planned step-up of commercial airplane build rates, travel growth and expanding freight traffic. Our sales momentum moderated in the third quarter. In total, net sales of $37.2 million were off 3.5% from the second quarter.

This was not the normal seasonality we commonly see during summer months. Like every industrial business I know, we wrestled with chronic supply chain issues, particularly trucking, coupled with labor shortages. These factors negatively impacted our third quarter revenues by about $2 million to $2.5 million. Our gross margin expanded to 6.2% in the third quarter due to

4 factors: higher activity levels and correspondingly lower fixed charges, reduced variable operating cost per pound processed; surcharges offset, increasing raw material costs; and lastly, proactive pricing actions. Our overall plan activity level in the third quarter, as measured by pounds processed was up 6% from the second quarter and up 53% from the recent cyclical low in the third quarter of 2020.

However, plant production remains almost 40% below pre-pandemic levels. We also received forgiveness of our $10 million term note from the Paycheck Protection Program, and we recorded a gain in debt reduction this quarter. Our balance sheet remains strong to support our strategic initiatives and the ramp in our business. Let's take a closer look at the third quarter results. Net sales are $37.2 million in the third quarter compared to $38.5 million in the second quarter and $37.4 million in the third quarter of 2020.

We shipped 12.3 million pounds versus 14.5 million pounds in the second quarter and 12.1 million pounds in the 2020 third quarter. Third quarter premium alloy sales totaled $5.9 million or 16% of sales, virtually unchanged from the second quarter of 2021. With the recovery in aerospace demand beginning to gain traction, we expect to resume growth in our premium alloy starting in the first quarter of 2022. Gross margin in the third quarter increased to $2.3 million or 6.2% of sales from $2.2 million or 5.6% of sales in the second quarter and a loss of $4.4 million or 11.8% of sales in the third quarter of 2021. Gross margin amounts included fixed cost absorption charges of $1.5 million, $2.1 million and $4.3 million in each of the respective periods.

While activity levels have improved in recent quarters, they remain at historically low levels, hence, the fixed cost charges. Our goal is to maximize operating leverage as we ramp up operations to meet growing demand while mitigating the negative impact of upward spiral in raw material costs and general inflationary trends on labor and major operating supplies. To be more specific, depending upon grade, third quarter surcharges rose 20% to 30%, largely offsetting sharply higher commodity prices and increasing melt material costs. We've announced 4 base price increases this year to stay ahead of double-digit percentage increases in parts and consumable operating supplies like lubricants and refractories. The increase in ounces in March is benefiting shipments now, while the other 3 increases will begin to impact results as we move into 2022.

Variable operating cost per pound processed around 15% to 18% lower than 2020's third quarter, reflecting higher throughput and process improvements. Control of our overhead spending is being tightly controlled, with third quarter spend down 9% sequentially and remains 40% below pre-pandemic levels. Looking more closely to headline-grabbing increases in commodity prices. Nickel prices increased another 8% sequentially and up 31% from the third quarter last year. Carl manganese and tungsten were up more than 30% during the quarter.

In a year -- on a year-over-year basis, moly, manganese, ferrotitanium more than doubled, while chrome ores rose more than 90%. Scrap prices also more than doubled from the third quarter last year, but appear to have stabilized at a high level with expectation of sideways movement over the near term. The positive misalignment between the timing of surcharges and increasing melt costs continue to narrow as we expected, an amount to less than $200,000 during the quarter. Power outages and related capacity reductions, primarily in China, are adding to the volatile outlook for commodities this quarter and into 2022. Selling, general and administrative expenses of $5 million, where 13.5% of sales were essentially unchanged from the second quarter, and we expect little change for the remainder of the year.

SG&A expenses remain 26% below pre-COVID levels. Our effective tax rate for the third quarter was a negative 17% due to the impact of our tax-free gain on the PPP loan forgiveness. We recorded net income for the third quarter of $7.9 million or $0.87 per diluted share, which included a $10 million gain on the PPP loan forgiveness. Before the gains, the net loss for the third quarter narrowed to $2.1 million or $0.23 per diluted share from a net loss of $2.5 million or $0.28 per diluted share in the second quarter and net loss of $7 million or $0.79 per diluted share in the third quarter last year. Third quarter EBITDA was $12.1 million, including the $10 million gain.

Adjusted EBITDA was $3.8 million versus $4.1 million in the 2021 second quarter and $635,000 in the third quarter of 2020. Looking at our financial position. Managed working capital at September 30 was $124.4 million versus $116 million at June 30 and $133 million at the end of the third quarter 2020. More specifically, inventory increased $14.8 million or 12% to $135.6 million from the end of the second quarter. Of the $14.8 million sequential increase, raw materials accounted for $5.4 million, with $3.6 million of the increase due to higher commodity prices and $1.8 million due to increased melt volume and advanced buying of certain difficult-to-get items.

Work in process and supply inventory increased $9.4 million as a growing backlog and its production. Third quarter receivables decreased by $1.6 million or 7.5% from the second quarter and were down $6.7 million or 25% from the third quarter last year as DSOs continued to improve. Accounts payable increased $4.8 million or 19% from the second quarter of $29 million to $29.9 million due primarily to higher melt activity and $1.3 million in capital spending-related payables. Capital spending in the third quarter totaled $2 million, bringing the year-to-date capital spend to $6.5 million. Third quarter depreciation and amortization totaled $4.8 million.

Most of the capital spend this year has been for 2

strategic parts: The addition of the state-of-the-art vacuum arc remelt furnace to support growth in premium products and an 18-ton crucible for our vacuum induction melting facility to further reduce operating costs as we scale up. Both capital projects are generally on time and within budget. We continue to expect capital expenditures to approximate $11 million in 2021. Total debt at September 30 was $51.5 million, down $1.4 million or 2.7% from the second quarter. Excluding the $10 million note forgiveness, total debt in the third quarter was up $8.6 million or 20% sequentially on higher capital spending and working capital.

Total gross availability under the revolver stood at $39 million on September 30, providing more than ample liquidity for the expected ramp in activity. Now let's take a look at end markets, beginning with aerospace, our largest market. Our aerospace sales increased 4.4% to $22.3 million or 60% of sales in the third quarter of 2021, up from $21.3 million or 55% of sales in the second quarter of 2021. In the third quarter of 2020, aerospace sales were $25.1 million or 67% of sales. Year-to-date, 2021 aerospace sales are $65.8 million or 58% of total sales.

We continue to expect recovery in commercial aerospace demand to gain traction as we move through the fourth quarter. Our current backlog and bookings reinforce the expectation that demand recovery will accelerate as we move into 2022 and 2023. Another part to sign supply chain inventories have been worked down and are running generally lean in most instances, which is also reflected in our order entry. Lastly, we have begun to hear rumblings of pull-ins for engine parts, which contributes to our confidence. The recovery and demand is supported by the latest forecast for commercial airplane build rates and travel trends.

737 MAX build rate's moving towards 31 per month and will move even higher pending Chinese recertification. Although nagging short-term quality issues are holding back 787 production, we expect to return to 5 per month during 2022, along with gradual 777 production increases. Airbus recently confirmed its ambitious build rate plan first announced last May, which closed to an average production rate of the A320 at 45 aircraft per month; in the fourth quarter of 2021, increasing to 64 by the second quarter of 2023, as many as 75 when you look out to 2025. IATA certainly projects global revenue passenger miles in 2021 will improve by 18% over 2020 and rise 51% in 2022, reaching 61% of precrisis levels. Global trade is expected to strengthen in 2022 and support growing air cargo volumes.

Looking at the big picture for a minute. Boeing's mid-September annual forecast projected the total addressable aerospace market over the next 10 years at $9 trillion versus $8.5 trillion projected last year and $8.7 million in pre-pandemic 2019. Boeing also projects 10-year global demand for 19,000 commercial airplanes and up their 20-year commercial forecast through 2040 to more than 43,500 new airplanes, an increase of about 500 planes over the 2020 forecast. Significant growth is also expected for dedicated freighters, including new and converted models due to expanding e-commerce and airfreight speed and reliability. Business jet flight hours in 2021 are expected to be almost 50% higher than a year ago and grow above pre-pandemic levels.

Current projections call for up to 7,400 new business jet deliveries over the next decade valued to $238 billion. Financial recovery among the airlines is essential to their willingness to order new planes. That recovery continued for Delta, which reported last week, the revenue recovery in the September quarter reached 66% of 2019 levels compared with 51% in the June quarter and just 25% at the start of the year, mainly due to strong consumer demand and growing improvement in business and international travel. Meanwhile, the aerospace aftermarket continues to improve, and defense spending should continue at current levels in 2022. Our service center and forging customers continue to expect a stronger metal pull in the supply chain to accelerate for building new planes and aftermarket strength in the fourth quarter and well into next year.

The heavy equipment market remained our second largest market in the third quarter with sales of $7.6 million or 20% of total sales versus sales of $9.3 million or 24% of sales in the 2021 second quarter. Year-to-date 2021 sales totaled $25 million or 22% of sales and were 53% higher than the same period of 2020. Metal fabrication markets drive plate sales. We continue to pick up in industrial manufacturing as well as high automotive retooling, and new model development drove the 53% growth in our heavy equipment market sales year-to-date in 2021. While lower sales in the third quarter demonstrate the typical lumpiness in plate shipments as supply chain inventories adjust, we expect plate sales to get back on track as bookings picked up in the fourth quarter and sales picked up in the first quarter based on conversations with our customers.

The oil and gas end market was our third largest market in the third quarter with sales of $4 million or 11% of total sales, an increase of 2.6% from the second quarter and up 47% from the 2020 third quarter. Oil prices are at a 7-year high, trading north of $80 per barrel and natural gas prices were up 50% in the third quarter alone, pointing the further recovery in drilling activity. As noted in the recent release, Baker Hughes reported 264 drilling rigs were added in the U.S. over the past year, while international rig counts were up by 85 just last week. The bottom line for the oil and gas supply chain is the more production equals more parts, equals more demand for metal.

While there has been some excess inventory in the channel, we see our bookings picking up and continue to expect moderate growth in the fourth quarter and further recovery in 2022. General industrial market sales of $2.2 million or 6% of sales were down 4% from the second quarter of 2021 and 25% lower than the third quarter a year ago. Our general industrial market includes sales of the semiconductor, medical and general manufacturing markets. Poorly sales to these markets have been at record highs and near lows over the last year. Although consistent sales growth has been elusive, we expect reasonable volume opportunities in 2022 as labor and supply chain challenges recede.

Power gen market declined to $800,000 or 2% of sales compared with $1.4 million or 4% of sales in the second quarter and $1.6 million or 4% of sales in the third quarter of 2020. Maintenance domain has accounted for most of our power gen sales in recent years. Normal third quarter seasonality was exceptionally strong this year. We expect maintenance activity to improve, coupled with some benefit from increased gas turbine backlogs and major OEMs. In summary then, during the third quarter, we had positive market momentum.

Our backlog increased to $25.1 million, the highest level since the first quarter of 2019. Gross bookings were healthy at $58 million. Sales did moderate somewhat in the third quarter as we wrestle with the same supply chain challenges and labor shortages concerning virtually all industrial businesses. Our third quarter gross margin increased to 6.2% of sales due to higher activity levels and corresponding lower fixed charges, controlled spending and prudent pricing and surcharge management. We received forgiveness on our $10 million PPP term loan and recorded a gain in debt reduction during the quarter.

Excluding the gain, the net loss for the quarter narrowed to $2.1 million or $0.23 per diluted share, while adjusted EBITDA was $3.8 million. We continue to move forward with our growth initiatives, including the addition of the new VAR furnace as well as an 18-ton crucible. While we expect the current supply chain and labor challenges to persist through the rest of the year, we are determined to make further progress in the fourth quarter and take full advantage of our recovering markets, especially aerospace as we move into 2022. In closing, I want to recognize and thank each of our employees. We've wrestled together with many unprecedented challenges over the past 15 months, and I remain in all of how each of you is powering through to overcome each of those challenges.

With markets recovering and our continued commitment I remain extremely confident in Universal's future. That concludes my formal remarks. Lovely, we're ready to take some questions.

Operator: . Our first question comes from the line of Mike Hughes with SGF Capital.

Michael Hughes: First question just is on the inventory days. I know this is partially a function of the revenue falling off so significantly over the past year, but they've really drifted up over the past few years. I think they're north of 300 days now. Can you just address that issue and where you see them falling out over the next few quarters?

Dennis Oates: If you look at the next few quarters, you will see those numbers improve. And the reason for that will be, you'll see higher sales volume is the #1 contributor to that.

The other point I would make is you look at our -- uniquely look at our inventory levels ex the growth in backlog, which has been -- our backlog has basically doubled here in the last 6 months, 9 months, is the fact we carry about $5 million or $6 million of what I'll call R&D inventory as we work on approvals at our North Jackson facility, primarily for premium, what we call premium melted products, vacuum induction melted products. The other issue that I would call out this morning is, and I mentioned in some of my script, we have had a spike in commodity prices, which has caused a fairly sizable increase in our inventory carrying costs as well. From a P&L standpoint, that has a pass-through to the supply chain via our surcharge mechanism, but the cash out the door upfront as we purchase those raw materials and increase our melt schedules is pretty significant.

Michael Hughes: Okay. And then just thinking about the backlog, I think it's roughly $125 million now.

And if you go back to -- on a quarterly basis back to 2007, you've historically converted 75% of your backlog into revenue in the following quarter. That's obviously not happening in this environment. And just over the last 3 years, that number of the conversion is 50%. I'm assuming that's not going to happen in the December quarter. So could you just give us maybe a way to think about the December quarter revenue and gross margins? I'm not sure you give guidance, but maybe just some rough parameters?

Dennis Oates: We don't give guidance, but I can tell you that 66% of the $125 million is scheduled to ship next year.

And 34% is scheduled to ship before the end of this year.

Michael Hughes: 34% of the $125 million?

Dennis Oates: Yes.

Michael Hughes: Okay. And then...

Dennis Oates: So we don't give guidance, but I assume you can figure that one out.

Michael Hughes: Yes, appreciate that. And then just the gross margins on a go-forward basis, it seems like there's a number of things that should drive them higher. Number one, the fact that year-to-date, there's $6 million that you directly charged rather than capitalizing into inventories, that's going to be a nice boost to gross margins on a go-forward basis, right, because it hasn't been capitalized in inventory, your costs are lower in the inventory, right?

Dennis Oates: That's correct. Yes.

Michael Hughes: Okay, and then the second thing, can you help quantify how much the 3 price increases that are going to start to flow through gross margins will help gross margins?

Dennis Oates: In terms of putting an exact dollar figure on it, that's a challenging thing to do.

What I would say is if you look at the March increase, we're already benefiting from that. If you look at the grades that we had price increases in and the timing of shipments of those products, those other 3 price increases will start to hit late this year and into next year. But keep in mind in the back of your mind what's transpiring here. We are seeing inflation on parts and consumables, and we're -- our goal is to grow our gross profit margins. To do that, we need to stay ahead of the inflationary trends not only in those categories, but also in labor.

So that's essentially what we're doing. So as things go down the road into 2022, rather, you should see higher activity levels that will improve the fixed cost absorption issues we've been wrestling with. We've got process improvements, which will continue to work to improve our productivity and offset some of the inflationary trends. We've got price-based price increases to also offset and then we've got surcharges as a pass-through for the raw materials. So you put that all together and we would expect to see continuous improvement.

By that, I mean increases in our gross profit in each quarter going forward.

Michael Hughes: Okay...

Dennis Oates: And the reason I -- I'm not trying to be evasive on a selling price thing. The problem is it's -- there's some variables in there that are difficult to quantify. We know we've got significant inflationary items already that we are buying.

So it really depends upon the amount of inflation as we go through 2022 as to what the impact is going to be on the gross profit of the selling prices on a net-net basis.

Michael Hughes: Understood. Just one more question. I think on the last call, you indicated a desire to hire maybe 100 people over the next few quarters. Where does that stand? And if you're short of that number, how much of a gating factor is it on revenue growth?

Dennis Oates: It is a definite issue in terms of revenue growth.

It has been to date. I would say that we have seen very modest improvements in terms of applications and hiring over the last 2 or 3 weeks. So it's a relatively short period of time, but we have seen a noticeable improvement there. We are supplementing our hourly workforce with outside contractors as best we can, but there's no doubt there's a challenge there. As far as the absolute number of people we need, that moves around a little bit based upon the backlog.

Backlog has continued to grow. So arguably, we need a little bit more than that 100 number as I sit here today.

Michael Hughes: Have you made any progress? Have you hired on a net basis since the last call?

Dennis Oates: Yes, yes, but it's relatively nominal. It's not something I'm jumping up and down and saying that the problem is over. All I'm saying is, directionally, if you're an optimist as I am, we have seen some improvement in applications and in hiring and our net headcount is up, but it's nowhere near where it needs to be.

So that is -- that continues to be one of the major issues we're wrestling with, as is everybody that I know in manufacturing these days.

Michael Hughes: Okay, my last question. This came up on the last call, but any additional thoughts on hiring a CFO?

Dennis Oates: We're continuing to work our internal plan, which is to evaluate our internal candidates and compare to outside options. And as I think I said in the last call also, we're going to take this year to do that.

Operator: Our next question comes from the line of Phil Gibbs with KeyBanc Capital.

Philip Gibbs: Can you elaborate a little bit on the comment that you made during your script on engine pull-ins and what that means or suggests or maybe related to other cycles just in terms of what that signifies?

Dennis Oates: Well, we've been looking at demand and inventory levels, right? So we've gone through multiple quarters of destocking. So next step in aerospace recycling is to start to replenish inventories. And if you look at that, it'll checklist to what normally happens in recoveries, you're going to start to see some of the OEMs start to pull in requests through forgers and then into us. So we're beginning to hear some rumblings. There's a term I think I use.

So I'm not saying that any of our backlog is due to that, but we're beginning to hear some talk about, can you -- in the supply chain about can you accelerate some things. And normally, pull-ins like that. In other words, we need the metal in the forgings faster than we told you before, suggests that things are starting to heat up a little quicker than people anticipated, which from our standpoint continues to support our view that we'll see continued quarterly improvement in aerospace demand.

Philip Gibbs: And then on the oil and gas side, sales picked up marginally, but obviously, rig counts sequentially, I'm talking about, obviously, rig counts are starting to move up, and there's a lot of thoughts for greater spending next year. Maybe talk a little bit about what you're seeing in that supply chain and what your customers are telling you.

Dennis Oates: Earlier this year, I think I said on the call, what we were hearing in the marketplace was kind of sideways movement with appreciable improvement in the second half of 2021. We haven't seen an appreciable improvement. We basically have seen that mindset pushed into 2022. So as we talk to our customers today, they point to what's happening with the price of oil and natural gas and so forth. The increase in spending has been anticipated next year, more activity.

They would also point to the fact that they're working their inventories, however they still have -- they're still a little heavy in certain grades and sizes. So our expectation is we'll see -- we saw a little bit of gradual improvement there in the third quarter, but that should accelerate as we go through 2022. That's what they're telling us.

Philip Gibbs: Denny, you had the overhead charge, carrying charge in the third quarter as well. Is that something that's going to be with you in the fourth quarter, too? Or is that -- dissipation is largely done on that?

Dennis Oates: I can't say for certain it's done.

I would say it's 50-50 at this point in time, to be honest with you. It depends upon how things play out here over the next month or so. We're having active discussions on that subject. It's going to be a function of what our activity levels end up being. Generally, our accounting practices have a very specific level of activity at each one of our plants to the degree we exceed a base level based upon historical performance, then we would stop that practice.

Philip Gibbs: And then my last one is a two-parter. I do appreciate it. You said the price to -- price to surcharge is pretty matched in the third quarter. What's the outlook for Q4? And then how should we be thinking about net working capital in Q4?

Dennis Oates: As far as surcharges, obviously, we know they're going to be up in October and November and probably up a little bit in December, but flat lines kind of flattening out a little bit. So as you think that through, I would expect us to be basically in alignment.

We're slightly positive in the third quarter, and we should be in balance in the fourth quarter. That said, I have to admit the commodity markets are a little bit crazy right now. They always are, but they're especially volatile at this point in time in terms of getting a read on what the direction is going to be with some of the things that are going on in China with power, some of the capacity reductions -- by the way the strike that's now over, but I know they're struggling to get capacity back up. So there's a lot of disruptions in the supply chain. As far as working capital goes, as you look at the fourth quarter, I would expect working capital in general to be up, but not as much as the increase in the third quarter.

We expect to have higher sales. So that should drive higher receivables. We're going to be melting at a comparable level, maybe slightly below in the AOD front, but more on the vacuum induction melting front in the fourth quarter. And if you think about that, you're going to see what we've been melting here over the third quarter, moving through the rest of the operations as we continue to ramp those operations up. So I would think inventory is going to be up, but not nowhere near what it was in the third quarter in terms of increase.

And the payables attract what we do from a melting standpoint. So I would think they'd be in the $30 million range.

Operator: . We have a follow-up question with Mike Hughes with SGF Capital.

Michael Hughes: Question on the tool steel plate market.

I think you've said that historically a big driver is new auto models. Does that -- will that be the case for EVs? Just how does that business play out on a go-forward basis?

Dennis Oates: Yes, that would be positive for the plate market that we serve. Anything -- any kind of retooling that the automakers do, which requires new jigs and fixtures and so forth. There's a new EV plant going in. Where is that in Tennessee? So those kinds of things will benefit us.

It's difficult for me to say what percent or what volume it will be, but that would go into the same general category that we typically reference in terms of new model retooling work that gets done.

Michael Hughes: Okay. And are you one of the few tool steel plate manufacturers in the United States. Is that right?

Dennis Oates: That's correct.

Michael Hughes: So does that mean your margins for that business is a little bit higher than the rest of the business or not?

Dennis Oates: Our margins in that business are attractive.

Michael Hughes: Okay. And is it -- what percent of revenues is from that business?

Dennis Oates: It has ranged over the years from low double digits 10%, 11% up to high teens.

Michael Hughes: Okay. And then last question. In past cycles, did you have the direct fixed cost under absorption charges? I don't remember that happening in the past.

Is that wrong?

Dennis Oates: It happened for a couple of quarters in 2016, but not to the magnitude we have today.

Operator: There are no further questions at this time. I'll hand back the call over to Mr. Dennis Oates for closing remarks.

Dennis Oates: Thank you.

Once again, I want to thank everybody for joining us this morning. I look forward to updating you on our effort to take advantage of our market opportunities and to move forward on our growth initiatives on our next call, and believe it or not, January 2022. Be well, stay safe. Enjoy your holidays, and have a good day.

Operator: This concludes today's conference call.

Thank you for participating. You may now disconnect.