Haynes International, Inc.
Q3 2022 Earnings Call Transcript

Published: 29 Jul 2022

[Operator:]

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Haynes International, Inc., Third Quarter Fiscal 2022 Financial Results. At this time, all participants are in a listen-only mode. After management's prepared remarks, there will be a question-and-answer session. I would now like to turn the call over to your host, Controller and Chief Accounting Officer David Van Bibber. Please go ahead.

[David Van Bibber:]

Thank you very much for joining us today. With me today are Mike Shor, President and CEO of Haynes International and Dan Maudlin, Vice President and Chief Financial Officer. Before we get started, I would like to read a brief cautionary note regarding forward-looking statements. This conference call contains statements that are forward-looking within the meaning of the Private Securities Litigation and Reform Act of 1995 and Section 21E of the Securities and Exchange Act of 1934. The words believe, anticipate, plan and similar expressions are intended to identify forward-looking statements. Although we believe our plans, intentions and expectations regarding or suggested by such forward-looking statements are reasonable, such statements are subject to a number of risks and uncertainties, and we can provide no assurances such plans, intentions or expectations will be achieved. Many of these risks are discussed in detail in the company's filings with the Securities and Exchange Commission, in particular, Form 10-K for the fiscal year ended September 30, 2021. The company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. With that, let me turn the call over to Mike.

[Michael Shor:]

Thank you, Dave. Good morning, everyone. We continue to make excellent progress in our third quarter. The highlights are as follows

[Daniel Maudlin:]

Thank you, Mike. Financially this was another impressive quarter with the 25.5% gross margin, representing a 550 basis point sequential improvement and a 1,000 basis point improvement over the same period last year. Net income of $15.5 million and 84% sequential increase. Looking at year-over-year, last year's third quarter net income was just above breakeven, which is when we proved our new GBP3.7 million breakeven point, which was 25% lower than previously. Now this year's Q3 was GBP4.5 million shipped, the profitability leverage is evident with strong incremental margins. Our successful efforts to increase production rates with workforce additions and continued investment in inventory has driven increasing shipments this quarter, resulting in strong profitability and a bullish forward outlook. A few important points, I wanted to address early in my prepared remarks. First, the raw material tailwind, while favorable was not the main driver of our profitability improvement. The raw material impact this quarter from nickel and cobalt was estimated to be $4.1 million or 310 basis points. Even without the tailwind, our gross margin would have been still very solid at 22.4%. If we then remove the raw material impact from last year's results as well, the 1,000 basis point improvement only slightly narrows to 930 basis points. The main driver of our improvement was our price and cost improvements, combined with our higher production and sales volumes. Second, our order entry and backlog are at extremely high levels, we had $184.5 million in order entry this quarter with aerospace order entry hitting a $100 million with a 1.6 book-to-bill ratio. Backlog was $338.2 million at June 30 ’22, an increase of $57.5 million or 20.5% sequentially over the March quarter end. Third, the $46.5 million utilization of our revolver, the primary item, which drove this cash deployment was increased inventory. Over the quarter inventory increased $52 million with nearly all of this increase in work in process inventory. The increase in inventory was both price related and volume related. In fact the majority of the increase in inventory value was from raw material market price increases about two-thirds of the inventory increase were $34 million was from higher raw material prices. This will get recouped as the inventory ships with a higher raw material component of our sales price, but initially consumes cash with the higher raw material purchase costs. The remaining one-third of the inventory increase or $18 million is volume from our higher melt rates to keep up with our surging backlog. This decision to invest in increasing our melt rates, which increases our work in process inventory pounds is the fuel for our top line growth. We expect to further utilize the credit facility going forward to support our growth. We estimate that our cash need will balance out with our utilization at around 60% to 70% of the credit facility size. While this is safely below the maximum, we are in talks with our bank group about potentially increasing the size of our credit facility as our borrowing base exceeds the current facility size by over 40% or a borrowing base of $140 million. Finally, EBITDA hit $26.1 million for the quarter exceeding a milestone $100 million annual run rate. We provided our definition of EBITDA in our press release schedule six, starting with our P&L, operating profit plus add backs from the cash flow statement of depreciation, amortization and stock compensation, which is non-cash amortization. One additional comment on nickel prices, we are benefiting from a tailwind now, but with the recent decline of nickel and the volatility of nickel this tailwind could neutralize and potentially become a headwind. We will continue to be very transparent about the estimated raw material impact on our results. Additionally, Haynes like every business has encountered inflationary pressures, a tight labor market and supply chain delays, but our team continues to successfully navigate our way around these issues. Our goal continues to be offsetting inflationary pressures with price increases and/or cost reductions, such as improving yields, productivity and process improvement. Continuing with the P&L SG&A with research and technical expense was $12.8 million in the third quarter or 9.8% of net sales, great to see that to be single-digits again. We expect this to continue to decrease as our revenue increases, but with SG&A costs rising at a much slower rate. Operating income was $20.4 million this quarter, which represents sequential growth of $9.7, compared to the second quarter of fiscal ‘22 and $19.1 million growth from last year's third quarter. The operating income improvement on a year-to-date basis, compared to last year is $48.5 million. Non-operating retirement benefit income of $1.1 million was favorable to last year's quarterly expense of $1.5 million this is a $6 million improvement, which is expected for the full-year. The U.S. pension funding percentage is impressively holding at 92% even during recent market volatility. As Mike mentioned, we're very proud of how well our customized LDI strategy is securing our funding percentage. Our effective tax rate for the first nine months of fiscal ‘22 was 25%. Current estimates for the full-year effective tax rate would be 25% to 26%. And all in our net income this quarter was $15.6 million with a diluted earnings per share of $1.24, representing an 85% sequential increase. Liquidity, we had cash on the balance sheet of $9.4 million at June 30 and $46.5 million borrowed on the company's credit facility. This represents a net cash change over the quarter of $27.8 million. Controllable working capital changed by $39.8 million with inventory increasing $52 million and AR increasing $4.2 million with a sizable offset from accounts payable and accruals changing by $16.4 million. Our liquidity at the end of the quarter was $62.9 million with $53.5 million available on the credit facility. Capital spending was $11.5 million in the first nine months of fiscal ‘22 and we're planning to spend $15 million in fiscal ’22, slightly lower than the $17.7 million previously estimated, primarily due to equipment supply constraints. These constraints are not expected to impact our operations. Outlook for next quarter, we intend to continue the ramp up of both production and sales levels in response to our record backlog. We expect revenue and earnings in our fourth quarter of fiscal ‘22 to be slightly above the results from the third quarter of fiscal ‘22. In conclusion, it is very exciting to see our strategy driving our financial recovery. Our growing revenue, gross margins at 25.5% and strong profitability are expected to lead to increasing shareholder value. And our current investments in working capital are required for this growth, it is estimated to set us up nicely to generate positive operating cash flow starting around the midpoint of fiscal ‘23 and strengthening over ‘24 and ’25. Achieving an EBITDA milestone of exceeding $100 million annual run rate is exciting and provides enthusiasm for our forward outlook. Mike with that I will now turn the discussion back over to you.

[Michael Shor:]

Thank you, Dan. Teamwork shown by our employees and the excellent results achieved make me very proud of everyone at our company. The best part of our story is that any one UAS within Haynes will tell you that we believe the best is yet to come. To my co-workers well done, and thank you. At this point Kelly, please open the call to questions. Thank you.

[Operator:]

Certainly, the floor is now open for questions. Your first question is coming from Steve Ferazani with Sidoti & Company. Please pose your question. Your line is live.

[Steve Ferazani:]

Good morning, Mike. Good morning, Dan. Thanks for all the detail on the call.

[Michael Shor:]

Hi, Steve.

[Steve Ferazani:]

Obviously the one I want to hone in on a bit here is the gross margin, I thought you did a great job explaining the impact on the raw material tailwind. But I'm trying to think about, even if we back that out, if you're in that 22% to 23% range. Given that you should be increasing some volume moving forward, and maybe get a little bit more productivity and efficiency at the plants. Are you thinking there is upside from that number? Are we near peak gross margin type level?

[Michael Shor:]

Steve, hi. It’s Mike, obviously, we expect revenue to grow -- to continue to grow as you know, therefore, we certainly expect gross margin dollars to grow, as far as gross margin percent we typically don't provide that type of guidance. Obviously, we saw excellent results and we gave you the actual number as to how much was the tailwinds. I would say right now, we're at a neutral nickel level right now, when you can take that 3.1% out, so we're in the 22% range. And we have the potential if nickel drops on some of that coming down, but we also have potential offsets that we continue to gain momentum with more volume in this plant with continued work on price and continued work on costs.

[Daniel Maudlin:]

Yes. And I would just add to that I mentioned incremental margins and with volumes continuing to increase and we were GBP4.5 million this quarter, and back to that $5 million quarterly run rate is where we're hoping to get, and that's going to continue to provide incremental strength, continue to provide some contribution margin. The lower breakeven point that we've accomplished here really is a game changer, and really makes that profitability leverage that we're going to be able to get, as we continued increased volumes very exciting. So it's good stuff.

[Steve Ferazani:]

Okay. Just, and I know this is a great problem to have. But I'm thinking about the turn on to a cash flow positive level. And just given the huge orders you're continuing to get and obviously the positive momentum in aerospace the widening natural gas price differential, which certainly I would expect driving in the near-term U.S. chemical demand. I would think that could stretch out as your book-to-bill continues to be well above one. So how are you thinking about the revolver given that maybe that stretches out a bit before it -- before the turn to a more positive cash flow?

[Michael Shor:]

Yes. We're certainly monitoring that closely and that's why I mentioned we are talking to our banks about the possibility of increasing that if order entry continues. We're forecasting to have utilization on the revolver up to maybe 70%. So talking to increase that and our borrowing base $140 million and that's even with -- a cap on work in process inventory of 40%. So we got a $40 million cap on work in process, so increase the size of the revolver to say $150 million, then our borrowing base would actually go up a bit to right there to $250 million. So I think we have plenty of liquidity related to that and our bank group is a great, great relationship with a great with the bank group in that basin. Our strategy and they're very happy with that. So we're in talks to do that if backlog continues to increase.

[Daniel Maudlin:]

And Steve, just one more point on this, I think what's really important is that we are booking as I said in the scripted about $61 million a month for the past half of the year and over that time, we’re only shipping at $41 million, because of lead times. So as we now begin to get this product through the plant. Obviously, our revenues go up, which also will assist for cash flow.

[Michael Shor:]

Absolutely.

[Steve Ferazani:]

So you’ll catch up no borrow, even if you maintain this type of booking level, you're going to catch up on the other side anyway, is what you're saying?

[Michael Shor:]

With the lead time, we are going to see a steady increase in our revenues absolutely once we get through that lead time.

[Daniel Maudlin:]

And the increasing profitability of course drives cash flow as well.

[Steve Ferazani:]

Right, right. Fantastic again, it's a great problem to have. And certainly I think the business banking group would have no issue here. Great, thanks for the time folks, appreciate the call.

[Michael Shor:]

Thanks, Steve.

[Operator:]

Your next question is coming from Michael Leshock at KeyBanc Capital Markets. Please pose your question. Your line is live.

[Michael Leshock:]

Hey, good morning.

[Michael Shor:]

Good morning, Mike.

[Michael Leshock:]

First, I wanted to ask on 4Q guidance, obviously there is a lot going your way, but I wanted to ask about anything that might be a negative impact. Sequentially, we've seen raw material prices stayed, so maybe there could be a headwind there all else equal. But anything else to consider as a potential headwind that may be was stronger in fiscal third quarter than what you're expecting in fourth quarter?

[Michael Shor:]

We -- as we take a step back and look at this business what everyone talks about is manpower and is inflation. And what we have been able to do in each of our facilities has been able to do related to manpower has been outstanding. We, I think, I said in the last call or call before we were fully staffed in our pick on Kokomo and Kokomo, we're now adding another 100 people in Kokomo to be able to handle this increase that were continue to increase that we're seeing in bookings. So we feel really good that we are man forward, they’re trained to work safely, they're getting trained on their jobs and that's going really well. And then the other issue out there is inflation, this is again beyond raw materials. And on the inflation side, we continue to focus on not using inflation as an excuse. We continue to focus on what are we going to do to lower our variable cost to manufacture and significant at where possible increase our price-based on the value we provide in order to offset that. So we feel good about what's going forward, oh and the increased volume on top of that.

[Michael Leshock:]

Got it. That's helpful. And I wanted to ask also on what the biggest supply chain can streams are for you? Is it that manpower that you mentioned? We heard Boeing this week cite some of the casting straints, particularly on the engine side. But what are you seeing within your supply chain? Is it labor or logistical or anything in particular that, that you're seeing?

[Michael Shor:]

It's definitely not labor, we have -- I won't say that we're fully staffed, but we're a handful away to be staffed for the levels that we have right now and we're actively successfully hiring for the levels that we see three months and six months out, so not an issue. I would say the biggest issue we deal with on a regular basis, but our team works around it is transportation. Trucking for every body is an issue, not only outgoing, but incoming for our raw materials. So that's an ongoing issue our people are very proactive and I think they've done a heck of a job with it.

[Daniel Maudlin:]

And the comment that I made about CapEx, that's kind of an incoming issue as well where the delivery of the equipment is just a longer lead time than we expected. So that may be partly freight coming into us or it may be partly the manufacturing of that equipment.

[Michael Leshock:]

Got it. And then just lastly for me, what's your outlook for special projects within CPI for fiscal ’23? You did call out some pent up demand there? Do you see that lasting over the next 12 to 18-months or any color you can provide on the duration of that pent up demand for CPI? Thanks.

[Michael Shor:]

We saw -- just talking about current quarter, we saw increases not only in revenue, not only in margin, but the margin percent in our special projects and we do expect to see continued growth in special projects, because of the real strong application development and I've talked about our technical staff a lot. When you have alloys like 282 HYBRID-BC1, G-35, B-3, that are out there to solve problems. In my mind, as long as you're spending it's going to continue to grow. So we see a lot coming from CPI, we also see coming from emerging technologies and so called clean energy production like supercritical CO2 and even small modular power plants. So we feel good about what's happening and that's going to continue to grow.

[Michael Leshock:]

Thanks guys. Appreciate the color.

[Michael Shor:]

Thanks, Mike.

[Daniel Maudlin:]

Thank you.

[Operator:]

There appear to be no further questions in queue at this time. I would now like to turn the floor back over to the President and CEO, Mike Shor for any closing remarks.

[Michael Shor:]

Thanks, Kelly. To our shareholders and our audience in the call today, we thank you very much for your ongoing interest in our company and for being part of our improvement journey. We'll talk to you again next quarter. Thank you.

[Operator:]

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time and have a wonderful day. Thank you for your participation.