Haynes International, Inc.
Q3 2018 Earnings Call Transcript

Published: 5 Aug 2018

[Operator:]

Greetings, and welcome to the Haynes International Third Quarter Fiscal 2018 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, David Van Bibber, Controller and Chief Accounting Officer. Thank you. You may begin.

[David Van Bibber:]

Thank you very much for joining us today. With me today are Mike Shor, Chairman, 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 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 could provide no assurance that 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, 2017. 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, and thank you for joining us on the call. The agenda for today's call will be similar to what has been done in the past, some introductory overview comments, followed by my thoughts and observations about our business and end markets. Dan will then give you greater detail on the financial results. Since this is my first call, I'd like to take a moment to introduce myself. I've been a Director of Haynes since August 2012 and have been Chairman of the Board since February 2017. I retired as Executive Vice President, Advanced Metals Operations and Premium Alloys Operations in 2011 after a 30-year career with Carpenter Technology. During my career, I held managerial positions in metallurgical engineering, marketing and operations, including Vice President of Manufacturing, before assuming full responsibility for the performance of the company's operating divisions. As I now sit into this role with Haynes, I am truly energized when I see and understand the significant potential that exists within Haynes. That potential falls into 4 categories. First, Haynes, in my opinion, is the industry leader in developing new alloys and developing new applications for new and existing alloys. Alloys developed by Haynes represent over half of our total revenue and total product margin dollars. Our strong research and development capabilities, our focused application group, our relationships with the end users of our alloys and our sales and distribution capabilities provide a very powerful combination, which will allow us to continue to bring significant value to the marketplace. As an example, one of our newest alloys, HAYNES 282, has gained significant traction in the marketplace. This alloy provides an excellent combination of high temperature strength, formability and weldability for aircraft and industrial gas turbine assemblies. Another new alloy, HAYNES 244, has already been specified into a new major commercial aircraft engine program. This alloy has an excellent unmatched combination of low coefficient of thermal expansion and high temperature strength. I'm also thrilled with our specialty application projects pipeline, all with a focus on solving customer application problems within aerospace, chemical and other markets. The second area of significant potential at Haynes is the nearly $120 million we have invested in what we categorize as growth capital over the past 5 to 6 years. These investments provide significant growth opportunities for us in the future as our markets recover and as we take focused actions to improve our volumes in certain areas. Products involved in this investment include our high-value cold finish flats, where our capacity is expected to increase from approximately 13.5 million production pounds to 18 million pounds within the next 12 to 18 months. We are currently at a production rate pushing 14 million to 15 million pounds annually. Our cold finish flat products represent our thinner-gauge coil sheet and cut pieces that primarily serve the robust aerospace market. In addition to cold finishing, we have also invested in our fleet capacity, increasing capacity by 50% from approximately 6 million to 9 million produced pounds. In an effort to fully utilize these capacities, we are currently pursuing higher-volume plate opportunities focused on corrosion products in the chemical processing market. This increase in plate product volume would allow us to more effectively utilize our assets. The corrosion plate products typically have lower margins versus our average, but increasing volumes will allow us to more fully absorb the fixed costs to the plant and add margin dollars and profitability to our bottom line. Other meaningful capital spend includes our tubular products expansion that benefits both titanium and nickel-based tubular shipments. Next, our investment in our LaPorte service center continues our movement to get closer to our customers and, as importantly, their processes. Finally, our new IT systems provide us with the opportunity to effectively mine our mountains of data to allow us to focus on and attack cost and waste. The third area of significant potential for Haynes involves focusing our entire team on improving our processes and performance in everything that we do. We believe that significant improvement is possible across our entire company. Our team is now implementing initiatives focused on each of the following

[Daniel Maudlin:]

Thank you, Mike. Gross margins this quarter were 11.7%. This is higher than the previous six quarters and clearly moving in the right direction but certainly not where they need to be. The pace of margin expansion needs to accelerate. Margin growth this quarter was driven by improved product mix, pricing strengths and favorable market conditions in aerospace and chemical processing. However, the margin headwinds this quarter were the low volumes shipped into the industrial gas turbine market and the low toll conversion revenue. In addition, this quarter included shipments of lower-value orders from the backlog that were taken in prior quarters. As we've mentioned in previous calls, it typically takes 2 to 3 quarters to cycle through these lower-margin orders from the backlog in a period of market recovery, thus resulting in a lag of margin recovery. At the end of this third quarter, we have, for the most part, cycled through these lower-margin orders, thus alleviating this particular headwind going forward. Our overall volume this quarter was still below 5 million pounds, resulting in a margin headwind from poor fixed cost absorption. We are targeting this issue with several of the initiatives Mike mentioned earlier. Improving our asset utilization, especially to get us over the 5 million pound level, is an important component of our ongoing strategy. This is our goal to achieve end of fourth quarter, even with the continued weak demand in industrial gas turbines. Our specialty application project sales in Q3 were $8.2 million. This compares sequentially to Q2 of this year of $6.7 million and is a significant increase from last year's Q3 of only $1.2 million. Regarding overall gross margins, continued improvement is expected in the fourth quarter fiscal 2018 with increasing volumes and strengthening prices. The inflationary pressure we are seeing in things like graphite electrodes, fuel costs and mill rolls are expected to be offset by increasing pricing, combined with cost reductions and efficiency improvements in other categories. SG&A costs, including research and technical costs, were $14.7 million in the third quarter of fiscal 2018. This is $3.2 million higher than the same period of last year, driven primarily by the 2 events that took place during the quarter

[Michael Shor:]

Thanks, Dan. The third quarter volume, revenue and margins increased sequentially and increased above last year's third quarter. In addition, we moved back to profitability this quarter. While these trends are pointing in the right direction, continued focus on accelerating improvement is our priority. The initiatives that I just outlined in my introduction have been launched and are focused on increasing volumes, enhancing price, reducing costs and improving our working capital management. Our focus is to gain momentum to meaningfully accelerate improvement in each of these areas. With that, Donna, let's open the call to questions.

[Operator:]

[Operator Instructions]. Our first question is coming from Edward Marshall of Sidoti & Company.

[Edward Marshall:]

Mike, welcome to the call. So I wanted to ask, the 5 million pound mark, you said it's critical to offset unfavorable fixed absorption. I'm curious if you can try to share with us maybe the incremental margin change that would occur at that 5 million pound mark.

[Michael Shor:]

Let me just start in general with that, Ed. When you look at our history, it's really clear. When we do not clear 5 million pounds a quarter, we struggle to make money. And when we do clear it, for the most part, this is a very profitable enterprise. So our goal with this is to say, okay, we've got ITT issues, we know that. We've got special projects, which are terrific, but they're lumpy. And so our goal is to find a way to achieve 5 million pounds without hoping that those come back -- without assuming that they come back. And when they come back, they will be [indiscernible]. So our goal and what we're going to do is go after cold finish flat business, which we are at capacity and at extended lead times now. As we get the Drever up and running, as Dan talked about, so that'll take us from the current 14.5 million pounds to 18 million pounds, a very profitable business. We want to expand our wire volume, which we have relatively low use of capacity in some very profitable products to that, and go after plate, which I would say the plate would be below average margin, but the other 2 would be above.

[Daniel Maudlin:]

And we would think about this on the corrosion plates that Mike's mentioning. We'd look at it more from a bit of a contribution margin point of view, but it would be a strong positive contribution margin to help offset some of the fixed costs. And if you think about it, if we -- the 5 million pound per quarter level, 20 million pounds for the year, the last time we were over 20 million pounds back in 2015, just quoting margins there, it was 19.2% margin. When we're over that 20 million pound mark, we definitely can get some leverage on that margin percentage, and that's our goal.

[Edward Marshall:]

Great. That adds some color. I'm curious, you talked about the backlog at the end of July 31. Are any of the initiatives that you talked about within CPI the base volume? And I guess maybe it's too early for plate, but did that start to show up in the July 31 backlog component?

[Michael Shor:]

I'd say the answer is yes for two reasons. This year versus last year, cold finish flats, even though they're still constrained and we have a long way to go, they're up 17% year-on-year. So that is being loaded in. Again, not to the volume we would like, but it's being loaded in. Secondly, plate, we started that initiative just about the time that I arrived. And we've had 2 months under our belt, and we've had some fairly significant orders come in and success with that. So they're both beginning. They both have significant upside, but yes, it is beginning to show in the backlog.

[Edward Marshall:]

Got it. And having a mixed voice on the board as well as at the operational level, I'm curious what -- when we look at the acquisitions that you're talking about, I'm curious to the extent of -- maybe a thirst for need for both -- and confidence that you have about the long term. I think it might be helpful to understand whether you are either outfit for the asset or you walked away because the price was too high.

[Michael Shor:]

First, we really cannot disclose any further detail related to the nondisclosure, so we're not going to go there on that one, Ed. But I would tell you, the board and our management team is focused on ways to increase shareholder value. And there's two obvious ways to get after that. And the first is to improve operationally everything we do. That's on the price side, the margin side, the cost side, working capital and getting volume in. So we're focused on that to increase shareholder value, but I think we have an obligation to also continue to look at what is out there, where could there be potential synergies and we'll continue to pursue that as they come up.

[Edward Marshall:]

Got it. And the last one just for me, just on that same line. In the press release, you talked about pursuing alternative strategies to strengthen. Can you elaborate on that? I mean, is that language that we should interpret as obviously seeking potential sale of the business? Just curious what your thoughts are.

[Daniel Maudlin:]

Yes. I think that's included in there talking about even though this acquisition did not result in a purchase agreement, we're not turning away from the strategy. We're certainly looking at opportunities out there to expand and grow shareholder value, whether that be capabilities in our mill or further penetration into our customers' supply chains. So the door is not shut on acquisitions just because this one did not end the way we wanted it to.

[Michael Shor:]

Our focus is to grow profitably, Ed, and there's multiple ways we can do that. We can take advantage of significantly increased internal capacity that's either here coming with the capital we spend, and it's also looking at where we can grow this business should an opportunity come up through acquisition. And just because this did not work out, does not mean we won't pursue in the future.

[Edward Marshall:]

Maybe you misunderstood the question. Would Haynes potentially be for sale? Is that part of the language of what you're trying to tell us?

[Michael Shor:]

No.

[Daniel Maudlin:]

That is not the intent of that language, no.

[Operator:]

[Operator Instructions]. Our next question is coming from Phil Gibbs of KeyBanc Capital Markets.

[Philip Gibbs:]

I have a question just about the strategy that you're outlining for volume growth. I would have thought given the investments that you all made in cold finish capacity that you already would be sort of donning for volume growth to the extent that, that opportunity was available. And then also, on the plate side, I can appreciate the markets coming back from CPI and maybe some orders being more available and you're pushing the envelope there. But how do you balance that thirst for volume and also trying to maintain this other side of the equation on pricing integrity?

[Michael Shor:]

Phil, thanks for the question. On cold finish flats, we've spent obviously a fair amount of money, but there are multiple pieces to this puzzle. And we had to get what Dan referenced as the cap line, one of our annealing furnaces, up and running to be able to take down one of our older furnaces, which is called the Drever. That furnace is now -- as Dan mentioned, is going to go down at some point in October. So we have, with the cap line, as the Drever is beginning to come down, expanded our capacity from 13 million to 14.5 million pound. But what's key with that, our lead times continue to go up and demand continues to rise despite us raising prices in that area. So the big piece for us there is to get the Drever down, get it back up successfully and then be able to move towards rapidly this 18 million pounds. So a significant opportunity for growth there. And as the CPI business comes back, we -- and where the pricing is, we understand where the margins are. We have open capacity, and it's excellent for our bottom line because of the way it absorbs assets.

[Philip Gibbs:]

I just want to be on the same page with the cold finish capacity. So you have about current capacity to be around 14 million, 15 million pounds, and you need to take the Drever outage to tap the higher end of that 15 million pound goal?

[Michael Shor:]

We are maxed out with something that drives, not just extended lead times. Maxed out there. Customers want more at about 14.5 million pounds. Mix plates are rolling up but about that. When the Drever comes back and we have all equipment running, we have 18 million pounds of capability. We do not have that today.

[Daniel Maudlin:]

And as we mentioned, we're at around the 14.5 million, pushing 15 million pound level now. But it's a little sporadic, a little volatile. So with this Drever outage, we will, I think, get more consistent and be able to push up to those 18 million pounds. It was all -- as I mentioned, we've had this plan for a while. So it's always part of the plan, we just didn't know when would be the right time to take the outage. And we certainly see it, the cap line doing much better and up and running. So the time is in the first quarter.

[Philip Gibbs:]

Can you give just some more color around the outage? I think, Dan, you talked about CapEx being what it will be in Q4. But Dan, as you look into Q1, is it a Q1 absorption issue that you'll take in the P&L and the CapEx spend that you have to make? I'm just trying to think about that. And then a question for Mike, subpart of that. Where does all this cold-finished plate -- not plate, but sheeting part business going in terms of end market momentum?

[Michael Shor:]

Okay, I'll take the last one first. It's -- our cold finish flat nickel-based super alloys are going into the aerospace market. The market is very strong. We can tell, by the way, that there's not much inventory in the supply chain because as our lead times go out, we really get our customers' attention on that. So we know there's not a lot of buffer in the supply chain. But it's an aerospace play, and that expansion is also an aerospace play. As far as the outage, the good news is we've invested in this so-called cap line, which is up and running. And so that will offset some of this. What we're seeing is that our Q1 production will be lower by about 450,000 pounds, equating to sheet coil available sales lower by about 360,000 pounds or about $8 million in sales. We do not believe, and we hope, the revenue will not be impacted in the quarter by that much as we draw down inventory, and so as best we can, other product forms. The good news is offsetting that impact is over the balance of the year, especially Q4, we will see higher amounts, and the net impact we're hoping for the year to be 0. And then, of course, the good news for us is moving from that 14.5 million we've talked about up to about 18 million once we have all of our new equipment and modified equipment in place.

[Daniel Maudlin:]

And keep in mind, this is planned around our normal kind of holiday outage time frame in which we typically do planned outages. So we kind of put it all in concert with that to have the impact as minimal as possible. And as Mike said, for the year, we hope to not have the impact to be there at all. In fact, those higher operating levels we can achieve. After the Drever is upgraded, I think will be very beneficial for us.

[Philip Gibbs:]

Now is there a CapEx impact in Q1? Or did you just frame it kind of -- I mean, Mike, you framed it up, obviously, in terms of the volume and the revenue and the momentum there. But is there a CapEx spend? I didn't quite understand if there will be for Q1.

[Daniel Maudlin:]

Yes, to a degree, there will be probably -- this outage will probably be in the neighborhood of $3 million, but it was all part of the plan that we had originally set out. So around $3 million.

[Operator:]

At this time, I'd like to turn the floor back over to Mr. Shor for closing comments.

[Michael Shor:]

Thanks, everyone, for your time today. Thank you for your interest and support of Haynes. We look forward to updating you again next quarter. Take care, everybody.

[Operator:]

Ladies and gentlemen, thank you for your participation. This concludes today's conference. You may disconnect your lines at this time, and have a wonderful day.