Haynes International, Inc.
Q1 2017 Earnings Call Transcript

Published: 3 Feb 2017

[Operator:]

Greetings, and welcome to the Haynes International Inc First Quarter of Fiscal Year 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Mr. David Van Bibber, Controller and Chief Accounting Officer for Haynes International. Thank you Mr. Van Bibber, you may begin.

[David Van Bibber:]

Thank you very much for joining us today. With me today are Mark Comerford, 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 can 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, 2016. 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 Mark.

[Mark Comerford:]

Thank you Dave, good morning everyone and thanks for joining us today. Hopefully you've all seen the press release and had a chance to review it. We’ll follow our standard agenda in today's call. I’ll open with comments about the business and our end markets and then Dan will give you greater detail on the financial results. As you saw from the press release, business conditions in the first quarter were challenging, customers manage their purchases and inventory tightly as we approach year end and growth [00

[Dan Maudlin:]

Thank you, Mark. It is typical for our first quarter to be seasonally challenging with lower production days due to holidays, vacations and planned maintenance shutdowns. However, this quarter was more challenging than expected, especially the last month of the quarter in December. Customers managed their year-end balance sheets with destocking especially impacting our aerospace shipments. We continue to see sluggish business activity in the base business commodity side of certain markets as evidenced by our weaker transactional business in the first quarter. Volumes were lower sequentially in each of our market categories pushing our overall shipments below 4 million pounds. At these low volume levels, unfavorable fixed cost absorption compressed margins. In addition, sequentially we had moderately lower levels of specialty application projects that contributed to the gross margin compression. Offsetting only a portion of these unfavorable items was better nickel alignment with the cost of nickel in our cost of goods sold being more aligned with the market price of nickel contained in our selling price which resulted in nickel being nickel neutral in the quarter. In addition, we are very focused on spending reductions in light of these low volumes, with reduced hours in the manufacturing facilities and careful review of spending in all areas of the company. Our net sales in the first quarter of fiscal 2017 were 93.4 million representing a reduction from last year's Q1 of 1.8% and a sequential dip of 13.2% from Q4 of fiscal 2016. Our gross margin as a percentage of net sales of 11.2% was compressed 1.5 points from last year's Q1 and 1.2 points from Q4 of fiscal 2016. Another item weighing on profitability in the first quarter of 2017 is our pension and retiree health care expense, which increased 1.1 million this quarter due to the reduction in discount rates at our valuation on 9/30/2016. Looking ahead to the full-year 2017, we expect pension and retiree health care expense to increase 4.4 million from 19 million in fiscal 2016 to 23.4 million in fiscal 2017. This 4.4 million increase is on top of a 6.4 million increase from fiscal year 2015 to 2016. SG&A cost combined with research and technical costs were 11.3 million in the first quarter of 2017 which is comparable to the 11.2 million in the first quarter of last year. All-in the net loss for the first quarter of 2017 was a loss of 672,000 compared to last year's first quarter net income of 228,000. Outlook for next quarter, we expect this challenging environment to continue in the second quarter of fiscal 2017. While we will not have the impact of lower production and shipping days due to holidays and planned maintenance shutdowns that impacted the first quarter, we are expecting lower levels of specialty application project shipments in the second quarter as compared to the first quarter as well as continued low base volumes in challenging price competition. Some customers have expressed optimism for increased demand in the industry and we share that optimism. However that is not expected to materialize until the second half of 2017. Management currently expects revenue and earnings in the second quarter to be similar to the first quarter of fiscal 2017. Backlog was 167.3 million at December 31, 2016, a decrease from last quarter of 1.1 million with a 10.8 [ph] decrease in average selling price per pound partially offset by 11.4% increase in pounds. The decrease in average selling price per pound reflects shipments of the high value specialty application projects from the backlog, while the increase in pounds was due to a low shipment volume in the first quarter of 2017. And to give you an updated number, the backlog at January 31, 2017 slightly decreased to 166.4 million. Cash flow and liquidity. Net cash provided by operating activities was 13.5 million for the first quarter of 2017, higher than last year by 3.3 million. And with the 5.9 million of capital expenditures, we made 7.6 million in free cash flow. We will continue our focus on free cash flow going forward, while simultaneously managing inventory levels, which we expect will position us well when our markets recover. Our cash balance remains strong at 64.9 million, including restricted cash and our revolver balance remains at zero borrowings. Our strong balance sheet positions us well for capital allocation opportunities and future value creation. In conclusion, given the current market environment, we are staying focused on managing spending levels, adjusting production hours worked to match the backlog and order entry rate and focusing on free cash flow. The narrative in the marketplace is showing optimism for growth in late calendar 2017 and we believe we are well positioned to benefit when markets improve, especially as we near the completion of our investments in additional sheet capacity to capitalize on the strengthening aerospace market. And with that, I will now turn the call back over to Mark.

[Mark Comerford:]

Thanks, Dan. The economic picture right now is cloudy. I think everyone in our industry is hearing the same thing from customers that they see improvements coming as we move deeper into calendar 2017. Our aerospace business has held up well and there are indications that it will strengthen over the next year. Our project business is slowing from an invoicing activity point of view, but remains very robust as far as coating and design activity. Our core chemical process industry business is still soft, as soft as I can ever remember of being. And the industrial gas turbine business is also soft. It's been soft now for about three years since we had those peak periods in 2012-2013. Our other products are slow, but like aerospace, there appears to be some applications and orders that may come through as the year progresses. And our tolling business is still good. As I mentioned earlier, we're seeing indications of confidence returning to the industrial manufacturing, it looks like higher volume materials are starting to see better demand. The PMI strengthening and customer sentiment is clearly improving. I think we still have a couple of tough quarters to get through, but I believe we're putting in that bottom right now and I also believe that Haynes is in a strong position to take advantage of the next upcycle. With that Michelle, let's go ahead and open the call to questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Edward Marshall with Sidoti & Company. Please proceed with your question.

[Edward Marshall:]

Good morning, guys. So wanted to talk about the US dollar. I mean I think that's affecting quite a bit of the business here and what are some of the things that maybe you're doing to and maybe some of the things you're thinking about with the dollar. Have you considered hedges? And then more importantly, I guess when I look at the business, does it affect special projects as much as this affects the transactional orders?

[Mark Comerford:]

Very little, Ed. If you think of really the dollars impacting our business, probably the best way to think about that gets back to the corrosion business, where we have the highest number of competitors and it's also the highest number of global competitors. So, there is activity in Europe and Asia with local producers. We are starting to see them import some material into the US and get a little more aggressive on some applications, but typically it's been where we've seen, for instance, I mentioned that we finally started to see some large applications getting quoted. And so I think and we mentioned that the pricing activity on those has just been, it's been terrible on the corrosion side. So we're seeing more of that type of activity getting very aggressive on those, but again I get back to and we talked about this a lot last quarter. It's not the kind of thing where we're getting a phone call three times a week or once a week. It's -- it happened once or twice all of last quarter. And again, that's more of an indication of just how slow the large projects side of the business is as opposed to how competitive things are right now. When I talk about the strong dollar impacting us, I can't say it's really been hurting us a lot so far, but I'm constantly paranoid. I see this as a problem when the world does pick up again that you'll probably see some pretty good activity in other parts of the world. Here's where it helps us, Ed. We've got products that bear the cost of freight extremely well. We are located all over the world and strong dollar or weak dollar when you're looking at some of these applications, the selling price of the material is still not a gigantic part of the overall cost of producing some of these large reactors and vessels. The technical expertise still comes into play and more often than not, a lot of our more advanced materials come into play where there is some shelter from currency fluctuations. Where we win is we win with the proprietary materials or we won with things like fabrication and welding capabilities overseas. And again, that's where we have our most shelter from. The transactional business for, I'll say, HASTELLOY C-276, which is quite often just going to be a price type of buy. By the way, the fact that we own our own distribution system, when some of these projects come through and there's an urgency for the material or they're filling out a large bill of materials, maybe with somebody else's material, but they have the smaller buys within that, they end up coming to us because we have our own distribution system. I gave you a long answer to a pretty simple question, but I wanted to give you a lot more color on that topic.

[Edward Marshall:]

Are you foregoing, I mean just to clear, are you foregoing orders because of price or are you just getting priced out?

[Mark Comerford:]

We have definitely walked away from some orders where the pricing was below what we feel we're making money on, but like I said, I'm not kidding you. Last quarter, it was once or twice that we -- that phone call came across my desk.

[Edward Marshall:]

Got it. I don’t want to get ahead of ourselves here, I mean I feel like you're describing what sounds like the bottom of the cycle, looking up from prior cycles, I mean fiscal 07, it was 115 million in EBITDA, 85 million in fiscal ’12, the most recent peak. I'm just kind of curious as to when you look up and the business has changed quite a bit, can you talk about in the context of maybe the last two cycles, where you think your business has and I don't want you to pinpoint in guidance and anything like that, but could you pinpoint what the efficiencies have done to the business in context of those prior two peaks?

[Mark Comerford:]

I think one of the best indicators Ed is, we lost money, but we're in that marginally breakeven. And if you look, when Haynes does under 4 million pounds historically, especially under 4 million pounds with nickel where it is these days, that's -- if you look back a few years ago and even deeper into the history, Haynes will be hemorrhaging. Below 4 million pounds is a tough place to make money. And it's tough to get any kind of absorption and it's a different. That gets exponential when it's below 4 million pounds with nickel where it is these days. I think that's a tribute to some of the things we've done from managing as far as look on the off answer side, making sure we have the right product mix that we want to run through our mills, the great aerospace market right now is certainly a big help. But even you saw things where we had some pretty good pricing in this quarter, even with the fact that there's not a lot of business out there right now. So I think that's kind of testament to some of the changes that we've made and some of the things that have gone on. But I think that's probably the best thing we talk about right now.

[Dan Maudlin:]

And certainly the investments that we've made, we're currently completing one with the sheet manufacturing and that's going to, as I've mentioned before, increase our ability to do the center gauge sheet, which is skewed towards the aerospace market, but other markets as well. But that's going to increase our capacity from 13.2 million pounds up to 18 million pounds. That's a 36% increase. So certainly, more longer term, when the market starts picking back up in that area, that's going to be some good leverage for Haynes. And then historically, some of the investments we made in our tubular facility, on the titanium side, Mark mentioned in his comments that that's helping us now, but on the nickel base side, when the corrosion market picks back up, that's going to be some nice leverage for us as well as the investments we’ve made in the heavier gauge sheet or I'm sorry heavier gauge plate type product forms in Kokomo. So when markets are more normal, I think we will certainly get some leverage from those previous CapEx investments.

[Mark Comerford:]

And just to give you an idea too Ed, we talked a little bit about transactional activity and that's where -- I watch transactional activity and I look for industry lead times as, I mean, you know how I think. That's how I look for an opportunity to start getting aggressive on pricing to manage pricing more aggressively. And that opportunity just hasn't been here. If you look at transactional activity and you look at last quarter, last quarter October was pretty good. Last time when we talked to you, we were coming off October. It was a pretty good. November went down, December was probably the worst month I can remember in the last two or three years. Activity picked up in January. Transactional activity, just to give you an idea, transactional activity in December was 40% off of what we might call normal. And then in transactional activity, in January was 12% off what we would call normal. I like to see that the transactional activity picked up a little bit. It's one data point. Will it be sustainable? I don't know, but that's where I started saying, okay, I also like what some of our peers reported. Universal reported better activity in the tooling side, which is a leading cycle indicator at least when I look at specialty metals. Carpenter and Alleghany reported some better activity out there. So I think as we start moving through the leading cycle and into the later cycle items, I think that's where we'll start to see things pick up.

[Edward Marshall:]

Sounds like you're easily describing a potential 100 million to 125 million in EBITDA is it possible to peak? Not sure, what I’m expecting, but I’m going to ask this question anyway and this is the last one. Commentary has been slightly better, I'd say, better than it's been the last couple of quarters despite what I think is probably one of the weaker quarters of late. And that's been seasonal really based. But I guess I could characterize it as investors I guess should be somewhat frustrated with the push out another quarter or quarter and I get, it's out of your control. But we've been through a lot of cycles. You and I together and maybe quicker cycles than you had historically, but what kind of confidence do you have sitting here today and what kind of reassurances could you give as we kind of look forward into the back half of the year with the commentary as you've been saying that maybe kind of takes that frustration out of that quarter to quarter push that we’ve been seeing?

[Mark Comerford:]

Ed, I think really a lot of it is sentiment. I mean, you're seeing strengthening sentiment and you're seeing a lot of our peers and a lot of these guys are in the larger, I'll say commodity materials that have been hemorrhaging for years. We were fortunate. Our project activity really carried us well through the last two years when a lot of other people were really, really struggling. So it's a lot of sentiment that I think is a positive indicator as we move forward. In my opinion, Haynes is extremely well positioned. We continue to expand our cut parts capability. We’re manufacturing parts for people. So as far as aerospace, gas turbine, you see pricing holding up in those areas and we've done well as far as penetrating into accounts with new alloys and those cut parts capabilities. I think that's a great story to tell. And it just -- I think it underscores how well positioned we are. On the corrosion side, I think it's going to be a long haul. I think it's going to be tough. We have to continue to develop new applications and get our new alloys out there, because I think some of the more commodity oriented alloys, that pricing is going to be difficult for a while yet. I'm very positive, my sentiment is very positive and Ed, here's where I'm -- this is where my paranoia kicks in. I don't have an order book that supports the things, the positive sentiment yet. That's what and I'm an engineer. That's what -- I go back to the numbers and that's when I keep going out to the people out here in the middle and even talking to customers even this week saying I know things sound great guys. But I’ve got to keep trying to take inventory out, I got to keep generating cash. So we have better flexibility moving forward. If you look at our inventory numbers from quarter-to-quarter, it was up and I think that, I'll tell you that gets back to the lousy December we had. So it's again activity picked up in January, but we've got to manage the business to the order book we have right now. We've got our eye on that future and we're watching for signs of an uptick, but I still haven't seen a strengthening backlog and that's the way we've got to run the business.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Phil Gibbs with KeyBanc Capital Markets. Please proceed with your question.

[Phil Gibbs:]

Good morning. Hey, Mark and Dan. Question was on some commentary you just made about some of your peers seeing some positive momentum in the last quarter and noticeably, there was a pickup in some of the jet engine business and I know you’re heavily tied into that market. Just curious what the disconnect may have been for you in the quarter? I think we would have expected it, given some of those results to be a little bit better.

[Mark Comerford:]

I think it's a couple of things, Phil. Like one, I don't know their product mix as far as titanium products or as far as how much was forgings going into that industry. I know that we at Haynes, I can really talk about us. We really beefed up on the engine supply chain, especially with some of the new alloys that we’re manufacturing and there have been some delays in the new platforms. And so there was some inventory correction occurring. And so we saw some of that. There's obviously too some spare parts correction that goes on as you're transitioning from legacy platforms into the newer platforms. So I can tell you from the Haynes point of view, those are probably two of the impacts that, I don’t want to say, hold us back, as quite frankly, we're still at a very good level in aerospace. But I think the growth in general for the new platforms has clearly been pushed out a little bit and I think we're ready to support that as it comes through. I think we're in great shape. Again, to get back to CapEx we've done in the last few years, that capital cycle is largely come -- we’re looking to move to more of -- we still have some projects to do, looking to move to a more maintenance type level of CapEx and I think we’re really well positioned there. And I think we're in great shape as these platforms kick in moving forward through ‘17.

[Phil Gibbs:]

Mark, I mean, speaking about the platforms, how do we think about Haynes’ participation on things like the leap in the year turbofan as they get redesigned maybe relative to your positioning on some of the legacy narrow body platforms?

[Mark Comerford:]

Yeah. If you look at the Haynes 282 and we’ve said this to you before that specked in to the Pratt 1000. Look, that will cannibalize some of our own 718 that was going in to some of those applications, but it clearly gives us a leg up on our peers as far as what they used to have as far as 718 and those applications. So that'll help us a lot as far as 282. And there will be continued skirmishes among all the competitors, all of our peers in going after a number of the applications on all of these new engine platforms that move out there. Whereas some of the other people in the industry that are more long product oriented have integrated themselves in the supply chain through the forging operations. We're not a long product manufacturer. So we're not going to integrate ourselves into the forging area. What we've done is we've integrated ourselves into the parts business and I think you guys realize and you see that our cut parts business has really done well over the last, I’ll say, over the last five years especially, penetrating and winning applications and winning customers in aerospace as well as gas turbine.

[Operator:]

There no further questions at this time. I would like to turn the call back over to Mr. Mark Comerford for closing remarks.

[Mark Comerford:]

Thanks very much, Michelle. Thank you everybody for your time today and thank you for support and interest in Haynes. We’ll look forward to updating you again next quarter.

[Operator:]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful guy.