Haynes International, Inc.
Q1 2019 Earnings Call Transcript

Published: 1 Feb 2019

[Operator:]

Good day, ladies and gentlemen, and welcome to the Haynes International First Quarter Fiscal 2019 Earnings Call. All lines have been placed on a listen-only mode. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host, David Van Bibber, Controller and Chief Accounting Officer. The floor is yours.

[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 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, 2018. 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.

[Mike Shor:]

Thank you, Dave. Good morning, everyone, and thanks for joining us on the call. We’ve now completed the planned rebuild and upgrade of our bright annealing furnace within our Kokomo facility. As previously discussed, the furnace was initially installed in 1980 and was in need of a complete rebuild. It was the last piece of the puzzle that was required to expand our cold finish flats capacity from 13.5 million to 18 million processed pounds per year. The work required was expensive and was planned for 12 weeks. We expected to have the furnace ready to process production material in early January. We did run into complications, but we had it up and running on January 23. We’re excited to now have the capability to pursue incremental cold finish flat business and finally have the capability to begin to reduce our lead times in this high-value, differentiated product. As discussed on the last call, this outage, combined with the normal lower shipment levels over the holiday period, had a significant impact on the Company’s financial results in the first quarter of fiscal 2019. As guided, the reduced volume, revenue and profitability caused us to be below breakeven for the quarter. Our overall volume was 4.3 million pounds, which was expected but well below our general goal to exceed 5 million pounds per quarter. Now that the furnace rebuild is complete, incremental increases in cold finish flat sales are expected to be one of the key drivers to revenue growth and the strengthening profitability over the balance of fiscal 2019. With the first quarter and the planned equipment outage behind us, we are continuing our focus on the recent steady improvement in gross margin. As a quick side note, Dan will explain in a moment the implementation of a new accounting regulation related to pension expense. This accounting method moves non-service pension costs out of cost of sales and gross margin to below operating income. When I’m mentioning the sequential history of gross margin percentages, I have made this restatement to all periods to make sure we are comparing apples to apples. So back to the recent steady improvement in gross margin. We bottomed out on gross margins seven quarters ago at 8% and then achieved the following in each sequential quarter

[Dan Maudlin:]

Thank you, Mike. This quarter represents a transition quarter with the planned outage impacting Q1 revenue and earnings. Even with this outage, we achieved net revenue of $107.1 million, which is 19.4% higher than the same period last year, and we generated gross margin of $11.3 million or 10.6% of revenue as compared to $9.1 million or 10.1% in Q1 of last year. We estimate the outage impacted net sales by $8 million to $10 million, lower gross margins by roughly 120 basis points, both of which contributed to the net loss in the quarter. Short-term earnings pain, but it was the last major piece of CapEx as we can now begin to push our cold finishing production levels consistently higher than the 13.5 million pounds with a new cold finish flats production capacity level of 18 million pounds. While we’re still discussing gross margins, let me elaborate on the pension changes that Mike mentioned. Fist, as you recall from last quarter’s earnings update, we mentioned a favorable valuation at 9/30/2018, resulting in a favorable reduction in our balance sheet liability of $38.3 million compared to the previous year. This translates into lower pension and retiree health care expense hitting this quarter compared to last year by approximately $1.3 million. Second, we implemented a new accounting standard related to retirement benefits which requires all non-service costs to be reclassified out of operating income, mostly out of gross margin, to a new line in the P&L called non-operating retirement benefit expense. In the current quarter, this reclassification was $900,000. Also, all prior periods presented have been reclassified to be consistent and comparable, this includes both in the P&L and in the gross margin MD&A tables. This reclassification last year’s Q1 was $2.1 million. No net income impact, just moving it on the face of the P&L. Back to the quarterly results. We shipped 4.3 million pounds during the quarter, impacted by both the planned outage and the typical holidays normal maintenance outages and customers managing their calendar year and balance sheets. Looking forward, we now resume our goal of 5 million pounds shipped each quarter, which would alleviate the margin headwind from fixed-cost absorption. Our specialty application project sales in Q1 were $5.9 million. This compares to each quarter last year as follows

[Mike Shor:]

Thanks, Dan. The new focus and spirit of optimism exists at Haynes in light of the many opportunities we are taking to improve our processes, our performance and our cost. One final point worth noting, Dan and I just returned from our three locations in Asia, which are in China, Japan and Singapore. We met with all of our employees and reviewed our focus improvement initiatives and heard about our staff’s concerns and improvement ideas for the company. I continue to be very impressed with the talented people that work for our company. Together, I believe we can successfully grow this business profitably to the benefit of our shareholders, our employees and our customers. With that, let’s open the call to your questions.

[Operator:]

Thank you. The floor is now open for questions. [Operator Instructions] Our first question comes from Edward Marshall with Sidoti Company. Edward, go ahead.

[Edward Marshall:]

Good morning, Mike and David. How are you guys?

[Mike Shor:]

Good Ed, how are you?

[Dan Maudlin:]

Good.

[Edward Marshall:]

I’m great. Thank you. Good. I guess I’ll start where you finish and talk about maybe Asia, China specifically. I know that’s – there are some sales that go in that direction. I’ve heard mixed results this quarter thus far from the impact maybe from a raw material price and also from a demand perspective. Can you just kind of elaborate on what – China and slowdown in China might mean for Haynes?

[Mike Shor:]

Ed, obviously, first thing we’re dealing with China is the 5% tariff on all of the nickel goods that we ship into China. So far, obviously, that’s had a minimal effect on us. In the past, as we have across our Company, we’ve been hurt by some power generation business or lack thereof, but we see continued strength. Our team is very enthusiastic about the demand they see and what’s coming forward for us. As we continue to focus on the plate initiative we’ve talked about, that also helps.

[Dan Maudlin:]

And if you look back at last year, our sales into China, if you look at our 10-K was about 4% of our revenue. We’re actually a bit ahead of that percentage this quarter in sales into China. It is slightly off our plan, but we were expecting some very nice growth in China. Slightly off our plan, but ahead of last year.

[Edward Marshall:]

Got it. And then, switching to the equipment upgrade and the fact that it ended in the end of January, I assume in a seasonally stronger quarter in 2Q there’ll be somewhat of an impact. Are you going to be able to make up that difference that would have been in 2Q with that, I guess almost month of last revenue from that time?

[Mike Shor:]

Ed, we expected to start really right after the first of the year. We had a variety issues on the back end of that furnace that caused us to start January 23. Let me just throw a little plug in here. I’m proud of the people that we had working on that. They worked day and night to try to figure out their issues and they did that. Taking that much time out of one of three furnaces, obviously, could have a potential impact on our volume. We’re not giving up one on the quarter, obviously, but we’re pushing as hard as we can on that. And the other thing is it doesn’t help our absorption when you’re down for 23 days extra.

[Dan Maudlin:]

And just one reminder, Ed, as well, yes, typically, our fourth quarter is seasonally our strongest quarter of the year. So keep that in mind when we’re looking at Q2.

[Edward Marshall:]

I’m sorry, you said seasonally strongest. You meant 4Q is seasonally weakest?

[Dan Maudlin:]

No, our fourth quarter ending September is typically our strongest.

[Edward Marshall:]

Got you. I was thinking December. Okay. How much volume was the impact in 1Q from, say, the loss of the equipment for that time period?

[Dan Maudlin:]

Yes, we estimate, from a production point of view, about 400,000 pounds. Now that yields down a bit. When we’re talking sales pounds, it’s going to be lower than that because it could go to a service center and be cut into a cut piece or something like that. So from a sales pound point of view, just a bit off of 400,000 pounds. But we estimate revenue, if we were to sell everything that we would have produced had we not been down, our revenue impact in the quarter of about $8 million to $10 million.

[Edward Marshall:]

Got it. And then finally, Mike, your assessment of backlog, how much of the backlog increase might have been as a result of having less capacity available for customers? How much of it was potentially from the excitement from customers to, hey, you know what? We can get in line. You’ll have added capacity 2 Q. And then, ultimately, how much of that might have been from just true pickup in demand?

[Mike Shor:]

We – Ed, I think the best way to answer that, obviously, only shipping 4.3 million pound has an impact on the backlog. However, I will tell you that we had very, very strong order entry in November and December. Obviously, we’re just closing out January now so we don’t have final numbers on that, but we also were very pleased with what we saw in January.

[Edward Marshall:]

Got it. Thanks very much guys. Appreciate your comments.

[David Van Bibber:]

Thank you.

[Operator:]

Our next call comes from Phil Gibbs with KeyBanc Capital. Phil?

[Phil Gibbs:]

Good morning.

[Dan Maudlin:]

Good morning, Phil.

[Phil Gibbs:]

Dan, look like D&A for whatever reason, I think we had $4.6 million. Last year, it was $5.8 million. Any reason why that was inordinately low? And what are you expecting for the year?

[Dan Maudlin:]

Yes, it declined from last year. And I’m going to push you way back to 2014 during the restructuring and fresh start, that was 14 years ago, and at that point, a lot of those items were amortized over 14 years and even the expected service life on some of our assets were reset to 14 years. So that ended at the end of August last fiscal year. So this quarter is a bit lower in depreciation. I would expect the full year to be around $20 million, maybe slightly less than $20 million.

[Phil Gibbs:]

Okay. That’s helpful. And Mike, I thought I heard you talk about the GE9X some things that you may have on that. I think that’s not the expert here on this, but I think it’s on the 777X or it’s linked to be – do you think those have largely been settled already, or in terms of the share shifts and expectations on that? And am I thinking about the right thing?

[Mike Shor:]

We – obviously our goal with the higher temperatures and – in these engines is to continue to push and educate on our proprietary alloys. And we do have PW 1100 series, PW 1500 series proprietary alloys there, mainly because of high temperature strength, and also two alloys specified on the GE9X.

[Phil Gibbs:]

And as the GE, you know this more than I, as the GE9X something that’s going to be produced or is in current production right now.

[Dan Maudlin:]

It’s in current production now. So it is something – it’s the new generation of the GE90. So we’re making some very good headway on the applications development side of that, as well as other new generation engines Mike mentioned Pratt & Whitney, but also we have some specialty alloys on the CFM LEAP as well.

[Phil Gibbs:]

Okay. And then I call at the commentary on the sales impacts from the outage and the gross margin impact. How should we be thinking generally about gross margins and revenue in the second quarter? Do we effectively think you pick up all that – pick up all those lost sales and then you get 120 basis points of margin expansion? Or is that just the baseline? I just don’t want to get expectations to out of balance on the margin side, because you obviously have more visibility than we do.

[Mike Shor:]

Yes. I mean, obviously, the seasonality is a bit different from Q1 to Q2. And then as I mentioned earlier to Ed, Q4 is seasonally much stronger in all the other quarters as well. So keep that in mind as you’re kind of pushing forward. We don’t give guidance on margin, but I certainly would expect the 120 basis points that we estimated, it impacted us in the quarter that to be made up with this – the caveat that Mike mentioned with, starting up a bit later than we expected. So that could have an impact on absorption, and that could have an impact on how much we get out over the quarter. We’re certainly very focused on executing this quarter and getting that caught up, if we possibly can and we hope to do that.

[Phil Gibbs:]

Thank you.

[Dan Maudlin:]

Thank you.

[Operator:]

[Operator Instructions] And we do have another question from Edward Marshall with Sidoti & Company. Go ahead, Edward.

[Edward Marshall:]

I just wanted to follow-up with one more on CapEx. You’re estimating $16 million for the year, that assumes that you’ll double what you did in this most – in this quarter here of $2.3 million for each quarter going forward, so about $4.6 million a quarter. I’m curious with the main upgrade behind you, where does that capital go? What’s your intention there with the remainder of the year?

[Dan Maudlin:]

At this point, I’d call $16 million the max that we will spend. And error capital right now is going to be all maintenance capital. We’ve got a wonderful mix of new equipment as we’ve documented over the last couple of years and what’s in there, but it’s very important to make sure we maintain all the other equipment we have. So it’s really maintenance capital.

[Mike Shor:]

Yes. And some of the capital spend on the Drever outage may be very well spill into January from a CapEx point of view. So keep that in mind as well. But yes, I think $16 million is a max. We’ve historically struggled to spend as much as we forecast in this area. So I would suggest $16 million is the max.

[Edward Marshall:]

Got it. And anything discussed with Arcadia? I know, Mike, you mentioned some stuff in your prepared remarks. I know that’s been a focus of yours. Any additional comments that you can talk about at Arcadia, may be is that something we’ll discuss further? Do you think the – any issues that you might have been having there are now behind you just any comments?

[Mike Shor:]

We spent approximately $37 million on capital. Our goal is to significantly increase our titanium tubing capability. That plant has both titanium tubing and nickel tubing capability. We are working to make sure that they achieve the commitments that was out there for the CapEx as far as volumes in titanium, but we’re also working across the board to understand what it’s going to take to significantly lower our costs and, where appropriate, increase our prices there. On top of all that, blocking and tackling like on-time delivery, inventory management, we’re working through all of it. Dan and I spent an extensive period of time down there few months ago and we’ll be back in the not too distant future. So I’m pleased that we are gaining momentum, but we are not where we need to be yet.

[Edward Marshall:]

When you say reduce costs is that something that’s – and I know it’s probably premature and you don’t want to get into it. But does that include things like sourcing or further efficiency upgrades? I’m just trying to think about maybe what capital might be allocated towards, what further capital might be up?

[Mike Shor:]

There’s – we’re not talking about any significant capital. What we’re talking about is the blocking and tackling of trying to make sure that we’re as cost competitive as anybody out there.

[Edward Marshall:]

Got it. Okay, thanks guys.

[Mike Shor:]

Thanks, Ed.

[Operator:]

Thank you. I’d like to turn the floor back over to Mr. Shor.

[Mike Shor:]

Okay. Thank you, everyone. Thanks for your time today. Thank you for your interest and support of Haynes. We look forward to updating you again next quarter. Have a good day.