Haynes International, Inc.
Q2 2019 Earnings Call Transcript

Published: 5 May 2019

[Operator:]

Good day, ladies and gentlemen, and welcome to the Haynes International Second Quarter Fiscal 2019 Earnings Call. All lines have been placed on a listen-only mode, and the floor will be opened for your questions and comments following the presentation. [Operator Instructions] At this time, it is my pleasure to turn the floor over to your host for today, Mr. David Van Bibber, Controller and Chief Accounting Officer. Sir, 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.

[Michael Shor:]

Thanks, Dave. Good morning, everyone. Our 30 areas of focused improvement opportunities continue to fuel my enthusiasm for the potential of our business. However, our improvement initiatives and our solid revenue this quarter did not translate into the gross margins that we believe this business is capable of. We believe that we have identified the issues and we'll discuss them today. Before doing that, I'd like to talk about the progress we have made. Our current focus and emphasis on improvements is taking hold throughout our company and is very exciting to be part of. The details are as follows. Order entry has been strong with our last three months averaging $45 million in order entry, putting our backlog at $253 million, our highest level since 2012. Our volumes shipped increased to 5.2 million pounds in Q2. We believe that our efforts to increase volume have transitioned from the talking-about-it phase to successful execution. Our Kokomo operations produced approximately 2 million pounds in March; well above our furnace outage impacted three month average of 1.4 million pounds, with our cold-finish flat produced pounds improving every month. We're seeing very positive signs that our cost reduction and efficiency initiatives in Kokomo and at our tubing operations are taking hold and should impact our bottom line when the orders involved begin to ship to our customers. We are now realizing price increases for new orders for the high-value differentiated portion of our mix, mainly on the products we sell into the aerospace market. We began to see a bottom-line impact of this in our second quarter. We are seeing excellent and meaningful efforts in our Wire business and our worldwide distribution facilities related to sustained profitable growth. Finally, we are proceeding with the introduction and sales development of two of our newest patented alloys

[Daniel Maudlin:]

Thank you, Mike. We shipped 5.2 million pounds this quarter, even with our cold-finishing outage continuing for nearly one-third of the quarter. As Mike mentioned, this was the highest quarterly volume in four years and a company record in aerospace volumes. This drove top line revenue to $127 million, up 19.3% sequentially from Q1 this year and up 15.7% above last year's second quarter. Our frustration, as Mike outlined, was translating this solid top-line into a gross margin as a percentage of net sales that was below our expectations. Gross margin as a percentage of net sales was 11.5%, which included many headwinds that Mike mentioned. But allow me to address each one and comment on our forward view. First, additional costs related to the cold-finishing upgrade impacted margins this quarter. These are start-up type of costs including inefficiencies in scrap and yield impacts caused by the outage. Some of these products are still in inventory, but are expected to flush through the financials by the end of our third quarter. Therefore, this is expected to also impact our third quarter gross margins. Second, our specialty application project revenue this quarter was only $3.2 million as compared to $5.9 million in Q1 and $6.7 million in last year's Q2. This lower level impacted our overall margins. Looking forward, we expect a moderately improving forecast of sales for special projects in the second half of the year. However, it is lower than our original forecast set at the beginning of the fiscal year. This lower forecast is primarily due to project approvals being delayed rather than projects lost. We still see many favorable opportunities in our potential project pool looking forward into fiscal 2020. Third, we saw generally less favorable product mix in Q2, primarily related to the type of alloy shipped. This is partially as a result of the lower special projects I just mentioned. But even beyond that, it is included in our base business. Looking forward, we expect this product mix headwind to normalize and alleviate going forward. Fourth, the dramatic decline in the price of cobalt. Cobalt is typically not a raw material that moves the overall needle as it represents only roughly 5% of the content of our shipped pounds. Our customer pricing agreements are structured to attempt to minimize our commodity price risk. However, there can be a timing misalignment with our mill costs, when a rapid decline is experienced in the raw material, especially for products with longer production cycles or with transactional shipments out of our service center inventory. The magnitude and velocity of this recent cobalt decline caused a moderate compression on our margins this quarter and may continue to impact margins in Q3, and possibly Q4, assuming no rebound in cobalt prices. If cobalt prices stabilize or increase, this compression should be alleviated. Overall, as we look forward, we are projecting an increase in both gross margin dollars and gross margin percentage. As volumes continue to improve, these headwinds alleviate and as additional strategic initiatives favorably impact our P&L. Moving down the P&L. SG&A, including research and technical costs were $11.5 million in the second quarter of fiscal 2019. This is $1.7 million lower than the same period last year. Last year's SG&A included an increase in our allowance for bad debts on a foreign account. In addition, this quarter had a foreign currency gain as compared to a foreign currency loss for the same period last year. We expect the second half of fiscal 2019 SG&A, including research and technical costs to average approximately $12 million per quarter. Non-operating retirement benefit expense on the P&L was created when we implemented the new accounting standard related to reclassifying all non-service pension and retiree healthcare costs out of operating income to this new line in the P&L. As a side note, remember that all prior periods presented have been reclassified to be consistent and comparable both in the P&L and in the gross margin MD&A tables. No net income impact, just moving it on the P&L, but it does change the prior period gross margins and operating income subtotals. In Q2, non-operating retirement expense was $900,000 compared to last year's Q2 of $2.1 million. This reduction is primarily related to our favorable valuation at September 30, 2018. Our tax rate for this quarter was 26%, which is more normalized than recent quarters as we have realized positive pre-tax income this quarter. The tax rate last quarter, in Q1 of this year, was impacted by a discrete item related to vested stock options that were forfeited. In addition, last year's tax expense was impacted by the new U.S. tax reform laws. And to finish off the P&L, net income this quarter was $1.5 million or $0.12 per diluted share. Turning to backlog, after increasing 10.1% in Q1, the backlog increased an additional 6.4% in Q2 to $253 million at March 31, 2019. This increase in backlog is notable, given our increase in shipments this quarter. As Mike mentioned, customer order levels have been solid, putting our backlog at its highest level since 2012. Outlook for this next quarter. With a full quarter of our new cold-finishing capability and a solid backlog to support higher business levels, we expect revenue and earnings in the third quarter of fiscal 2019 to be higher than the second quarter of fiscal 2019. Liquidity, cash was $10.8 million at March 31, 2019, representing a $1 million increase during the first half of the year. Net cash provided by operating activities was $12.1 million in the first six months of fiscal 2019, which includes a tax refund of $4.6 million. Controllable working capital increased during the first half of the year by $2.4 million with accounts receivable increasing $7.7 million due to increased sales. Partially offsetting this was accounts payable and accrued expenses increasing by $4.2 million and inventory decreasing by $1 million during the first six months of fiscal 2019. We have been striving to manage inventory levels down even in a period of rising revenue and production levels. Capital spending was $5.4 million in the first half of fiscal 2019. The forecast for capital spending in fiscal 2019 is approximately $12 million, which we lowered from previously reported $16 million to better align up with the pace of our actual spending. In conclusion, we are committed to managing a thoughtful capital allocation strategy as we continue to focus on execution related to our strategic improvement initiatives. These initiatives are expected to drive meaningful growth in profitably and shareholder value. Mike, I will now turn the discussion back over to you.

[Michael Shor:]

Thanks, Dan. Our team at Haynes is working hard and we're beginning to see the impact of our successful execution of our strategic focus initiatives. The lack of translation in the stronger gross margins has been frustrating, but we're optimistic as we move forward. We remain committed to successfully growing the profitability of this business to the benefit of our shareholders, employees and customers. With that, Jess, let's open the call to questions. Thank you.

[Operator:]

Thank you. [Operator Instructions] We'll go first to Edward Marshall at Sidoti & Company.

[Edward Marshall:]

Hi, Mike. Hi, Dan. How are you? Good morning.

[Michael Shor:]

Hi, Ed. How are you?

[Edward Marshall:]

Good. So I wanted to ask about the impact of the equipment downtime. You talked about processing costs and yield - and lower yields. Can you measure, did you quantify what you thought that impact might be?

[Daniel Maudlin:]

Well, we certainly looked at all four of these items that we mentioned as headwinds and it's difficult to get an accurate quantification of them. But I will say this, if I kind of ranked these four, I would put the cold-finish outage at the top of the list. Maybe impacting our margin maybe was a third of the issue. Second is special projects, it's maybe another third. And then, the last two, the lower value mix and the cobalt issue combined I would say would be maybe a third of the issue. So the cold-finish outage certainly had an impact. And as we mentioned, it impacted the cost through the outage and kind of through the start-up phase. And we shipped some of that product this quarter and that's what impacted margins. And we still have some in inventory, so still kind of expect to flush the rest of that through in the next quarter. So it will be a bit of a squeeze on margins next quarter as well, but then flush through as we go forward.

[Michael Shor:]

And it is a great source of frustration. Obviously, we don't take furnaces like this down very often. And we truly saw, as we were limping into the outage and as we came out, the actual cost per pound and yield issues which were significant for us and something obviously that we're looking forward to putting behind us. But we got to ship the rest of the orders out there.

[Daniel Maudlin:]

And as Mike mentioned, from a production point of view, we are seeing back to normalized levels of yields and cost in the batches, so.

[Edward Marshall:]

Got it. So, you said it's not representative of what your gross margin, what you believe the gross margin for this business is. So maybe you can kind of talk about what you think the gross margin should have been, particularly in this quarter, what you've seen if you didn't have the underlying issues. And then secondly, when I look longer-term, where do you think this business should be, trading on a gross margin type basis?

[Daniel Maudlin:]

Yes, I mean, we typically don't disclose what our targets are and what our forward guidance is on gross margins. But you can look backwards a bit couple of quarters. We finished the end of last year, Q4 at 14.6%. So, obviously, this quarter being post-cold-finish outage, at 11.5%, we certainly - we're disappointed in that. So we're looking to get back on track at incremental improvements in margins as we move forward. But we haven't really disclosed what our targets are or what the gross margin guidance would be.

[Michael Shor:]

Yeah, let me hit a couple of highlights here. Some of it's a review of what was on the call and some of my thoughts going forward; not numbers, but concepts. We talked about four issues. We talked about Drever's special projects mix in cobalt. Special projects will come back to what has been our average level in that $6 million range. The mix, we believe, will average out. So we'll have issues moving forward with cobalt and obviously cleaning up the Drever. But I also have to talk about what we think the impact of these [thirdian] [ph] issues are going to have going forward. The existing positives are

[Edward Marshall:]

Got it. And the final one for me, you said it quick, and I just want to make sure I understand it. You said, you shipped - was it 2 million pounds in March in Kokomo and previously that was 1.4 million? Can you kind of talk about what that means, what you're kind of trying to tell us there? Thanks.

[Michael Shor:]

Yeah. What it is, is we've obviously been struggling with our cold-finish flats and volume with our cold-finish flats, and it's led to large backlogs. And our - what I would call our furnace impacted low volumes are averaging produce pounds of about 1.4 million pounds per month and that number has come up significantly. These aren't shipped pounds, these are produced pounds, and that's where we started to approach now 2 million pounds, which is quite frankly where we should be as we move forward. The beauty of this for me is instead of our sales force, our terrific sales force saying you need to find a way to get more in, we are now beginning to push our sales force on, okay, we are truly beginning to open up capacity, let's go out and get some additional orders. It's a mindset change. I've got great confidence, but it's a real shift for us. And remember, this product is mainly an aerospace product.

[Daniel Maudlin:]

And just as a quick side note I might add that we've quoted what our goals are on cold-finish produced pounds. So don't confuse that with our total produce pounds we were quoting here. Cold-finish, if you recall, before the capital investment, we were at 13.5 million produced pounds for a year - and our goal or the additional capacity that we added is 18 million pounds. So that's about 1.5 million pounds per month. We're not to that levels yet, but that's our goals on cold-finish, which is a subset of the 2 million pounds that Mike's referring to.

[Edward Marshall:]

Got it. Thanks guys very much. I appreciate your comments today. It's been helpful.

[Michael Shor:]

Yeah.

[Daniel Maudlin:]

Thank you, Ed.

[Operator:]

[Operator Instructions] And gentlemen, there appear to be no further questions at this time. If you'd like, I'll turn the conference back to Mike Shor for closing remarks.

[Michael Shor:]

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

[Operator:]

Thank you. Ladies and gentlemen, this will conclude today's conference. We thank you for your participation. You may disconnect your line at this time and have a great day.