Haynes International, Inc. (NASDAQ:HAYN) Q1 2023 Earnings Call Transcript

Haynes International, Inc. (NASDAQ:HAYN) Q1 2023 Earnings Call Transcript February 3, 2023

Operator: Good morning and welcome to the Haynes International First Quarter Fiscal 2023 Financial Results Conference Call. At this time, all participants have been placed on a listen-only mode and we will open the floor for your questions and comments after the presentation. . It is now my pleasure to turn the floor over to your host, David Van Bibber, Controller and Chief Accounting Officer. David, 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 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, 2022. 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 L. Shor: Thank you Dave. Good morning everyone. The work of our Haynes team has resulted in significantly improved performance. I would like to talk about this improvement over three time periods, fiscal 2018 to fiscal 2022, our current quarter of Q1 of fiscal 2023, and what we continue to expect from this point forward. My point of emphasis here is that yes, our team has accomplished a great deal but also that we believe based on the markets we serve and the actions our team continues to take that the best is yet to come for us. We continue to forecast sustained growth in revenues and earnings over the next three years. First, looking at the fiscal 2018 to fiscal 2022 time period, our improvement journey has resulted in fundamental and sustainable changes to our business.

I reviewed the impact of our significant year-on-year and quarter-on-quarter improvements in my comments last quarter. Our team’s focus, dedication, and accountability for results has resulted in a proven 25% reduction in our breakeven point. We have been able to accomplish this by maintaining and even enhancing our competitive advantages by pricing for the value provided, by reducing our variable cost, and by accomplishing market share gains resulting in above average key market segment growth rates. The 25% breakeven reduction has resulted in a gross margin that is now consistently been over 20% when removing both the positive and negative impacts of raw material fluctuations. Achieving steady state gross margins over 20% has quickly moved from a stretch goal to an expected result every quarter based on the efforts of each of our approximately 1225 employees around the world.

Next, as I transition to talk about our recently completed first quarter of fiscal 2023, I’d like to start with safety. Our entire team continues to relentlessly communicate the need for ongoing improvement and safety in all of our facilities through leadership, daily interaction and communication, and where needed process change. Safety continues to be our core and our overarching principle. As far as our financial results for the first quarter of fiscal 2023 we were able to overcome an estimated $5.6 million unfavorable impact in raw material headwinds related to the drop in both nickel and cobalt prices and achieved a gross margin of 17.4% leading to a net income of $7.7 million. When we remove the negative estimated impact of the raw material headwind from our first quarter, our adjusted gross margin calculates to be 21.6%.

The results of our first quarter when compared to Q1 of fiscal 2022 were 33% higher in revenue, 47% higher in adjusted EBITDA, and 66% higher in net income. Our seven major takeaways from the quarter are as follows; first, related to continued alloy and application development, our research and technology teams are continually developing data to help promote our proprietary alloys into new applications for us. One important hurdle to clear for new alloys is the need to be included in industrial codes and standards. Such inclusion often requires a considerable amount of testing. Recently, an ASME or American Society of Mechanical Engineers code case has been approved for Haynes HR-235 alloy. This alloy was developed by our team at Haynes for use in the petrochemical industry, especially syngas production and in the processing of ammonia, methanol, hydrogen, and liquefied natural gas.

The new code case will open doors for our HR-235 alloy to a number of high temperature, high pressure applications. Another approach to developing new applications for our proprietary alloys is by developing alternative — alternate processing routes to optimize properties which are key to a particular application. A recent example is the invention of a new heat treatment for HAYNES 282 alloy, which results in a significant improvement in intermediate temperature ductility. This new patented heat treatment enables our 282 alloy to be considered for several new applications, including turbine cases and other components requiring a combination of high strength and ductility. Second in our list of takeaways for the quarter, our efforts on our variable cost reduction initiatives continue.

We continue to see significant bottom line results related to yield improvement projects and process changes to improve variable costs on our key products. Next, we continue to find opportunities to price for the value that we are providing to our customers. Our competitive advantages related to alloy and application development, providing high quality products typically in relatively small quantities, our mill and company owned service center combination, and our outstanding technical and customer service allow us to continue to differentiate ourselves in the market segments we serve. We have now had favorable updates to our calendar year 2023 contracts and based on that, we are anticipating a positive margin impact across fiscal 2023 despite many inflationary issues we all face.

As far as market performance, our aerospace volume increased 17.3% along with a 13.5% increase in aerospace average selling price, resulting in a 33.2% aerospace revenue increase compared to the prior year. This increase is primarily driven by the single aisle recovery. We continue to see solid demand in the aerospace market driven by both consumer demand and the need for more fuel efficient engines using more advanced alloys. Volumes into the chemical processing industry slightly decreased 1%. However, CPI average selling price increased 31.5% resulting in a 30.2% CPI revenue increase compared to the prior year. Continuing, industrial gas turbine volumes were up 61.3% along with a 10.5% increase in the IGT average selling price, resulting in a 78.3% IGT revenue increase compared to the prior year.

Other markets revenue increased by 1.6% and other revenue increased by 5.7%. We continue to remain bullish on the demand we are seeing in all of our markets going forward. Continuing with our takeaways from the first quarter of 2023, as far as backlog and book-to-bill, our backlog is now at a company record of $408 million. Our book-to-bill ratio calculated from revenue dollars was 1.3 for the quarter, with aerospace at 1.3 and industrial gas turbines at 1.7. Both our CPI and other markets backlogs declined slightly with book-to-bill ratios at 0.9, driven in part by our mixed management initiatives. Next, I’ll cover our investment and inventory. In response to our record backlog levels, we have deployed cash to work in process inventory to drive higher top line revenue.

Given this occurred at the same time as increases in raw material prices, this required a draw on our revolver, which at the end of the quarter was $88 million. We believe this temporary investment will yield a solid return with the growth of our business in particular in the second-half of the year. And finally on ESG, we continue to make significant progress. The recent highlights include Haynes alloy application development to support customer and end market carbon reduction programs, social programs to support our employees and our communities, our ongoing ESG related disclosures by our ESG and sustainability program manager, supplier audits of supply chain partners, and the initiation now of our second solar project, this one being planned as a rooftop solar array at our two facility in Arcadia, Louisiana.

Photo by Paul-Alain Hunt on Unsplash

Now transitioning and what’s next for Haynes. Based on our current performance and our ongoing improvement actions, we continue to anticipate excellent growth opportunities with improved year-on-year financial performance. Specifically, as far as improving margins are calculated, Q1 adjusted gross margin percent when removing the nickel and cobalt related raw material headwinds was 21.6%. We expect to incrementally improve on that assuming neutral raw materials for the balance of fiscal 2023 despite the inflationary pressures we face. This is because of the benefit of increased volumes along with our ongoing work on costs and providing high value differentiated products and services to our customers. Next, we expect to set a revenue record within our aerospace market in fiscal year 2023, despite the industry supply chain issues and the slow ramp up of twin aisle builds.

As far as full year performance, our current bookings and book-to-bill levels supports our current anticipated growth rate of 15% to 20% year-on-year for both revenue and earnings. We’re also projecting operating cash flow to turn positive beginning mid fiscal year 2023 as our higher levels for order entry turned into higher shipments and raw material purchases are more in line with our order entry. Finally, on the pension, we are currently near 94% funded for the U.S. pension plan with a net liability as of December 31, 2022 of $19.6 million compared to $106.8 million just 27 months ago. We continue to be pleased with the stability of our funding percentage even in volatile market conditions. In addition, we will continue to keep the pension funding and our capital allocation considerations as we pursue 100% funding of the plan.

Okay, I’ll now hand this over to Dan for additional comments and perspectives on our first quarter.

Daniel W. Maudlin: Thank you, Mike. We had a solid start to the new fiscal year with year-on-year revenue up 33.4% and strong revenue growth in our three major end markets compared to last year’s Q1. We had a moderate sequential drop in revenue of just under 8%. However, Q1 is typically sequentially lower due to holiday schedules, planned maintenance outages, and customers managing their calendar year end balance sheets. Historically, this Q1 sequential drop has generally been larger than 8% in many cases. Net income was 7.7 million and an EPS of $0.61, which is consistent with the company guidance we provided. This was achieved even though the raw material headwind related to nickel and cobalt was higher than expected. The estimated gross margin impact from nickel and cobalt price fluctuations is derived from a model developed by the company to measure how the commodity price changes flow through net revenues and cost of sales.

This incorporates revenue flow across each different type of pricing mechanism and the timing of how the cost of nickel and cobalt flow to cost of goods sold, including the impact of the commodity price exposure on our scrap cycle. Our model calculated a headwind of $5.6 million compared to our assumption at the beginning of the quarter of $4.5 million. The difference was primarily driven by the headwind created by the price drop in cobalt. If we look at our gross margin of 17.4% and exclude this estimated $5.6 million impact, the gross margin excluding this headwind would calculate to 21.6%. This 21.6% compares to 21.5% sequentially last quarter in Q4 of FY22 for the same methodology and compares to last year’s Q1 of 16.2%. PR analysis of the impact of raw material tailwinds and headwinds and the effect on gross margins in our press release contained in Schedule 6 which describes this non-GAAP measure.

We are expecting this headwind to neutralize over the next quarter, but of course this will depend on where raw material prices actually move over that time period. This gross margin was accomplished at a lower volume level of 4,552,000 pounds shipped. We have described in prior calls our successful efforts to lower our breakeven point by 25%. This has now provided us with the profitability leverage to enable a solid net income result even at Q1 volumes below £5 million, plus a heavy raw material quarterly headwind. This lower breakeven is expected to be an ongoing financial benefit as volumes grow. Like every industrial business, we continue to encounter inflationary pressures such as electricity rates, a tough labor market, and supply chain delays.

Our team continues to successfully navigate our way around these issues and find successful solutions or offsets. Our goal continues to be offsetting inflationary pressure with price increases and/or cost reductions such as improving yields, productivity enhancements, and process improvements. Our efforts to increase melt rates and product flow, driven by our continued investment in inventory, combined with our increase in production employees and a strong backlog provide an optimistic forward outlook, especially in the second-half of fiscal 2023. As this process takes some time, we expect product flow to gain traction and meaningfully increase shipping volumes in Q3 and Q4, driving increased second-half top line sales and earnings. Our leverage on SG&A costs continued to improve with SG&A including research and technical expenses at $11.9 million in the first quarter or 9% of net sales as compared to last year’s Q1 of 12.3%.

Operating income was $11.1 million this quarter, which is double last year’s first quarter. Non-operating retirement benefit income was 0.4 million, which was less favorable to last year’s quarterly benefit of $1.1 million due to the actuarial valuation at 9/30/22. A portion of this change was offset by a favorable service cost change within our cost of sales. The U.S. pension funding percentage strengthened to nearly 94% even during recent market volatility due to our customized liability driven investment strategy. Our U.S. net liability at 12/31/22 is at 19.6 million, a significant improvement from the 106 million at 9/30/2020 not that long ago. Our effective tax rate for the first quarter was 22.5%. Current estimates for the remaining quarters of FY 2023 are moderately higher, in line with federal and state statutory rates.

Order entry and backlog continued to be at high levels. Backlog again set a company record at 408.2 million, up 34.4 million or 9.2% over the quarter, and up 190.7 million, or 87.7% from the first quarter of fiscal 2022. This represents 22 months of growing backlog and strong demand signals. This growing backlog level continued to drive our cash deployment into inventory. Inventory increased 33 million over the quarter with about 80% of that from inventory pounds increasing. This increased our utilization of the credit facility with the balance on the revolver at 88 million at 12/31/22. Looking across fiscal year 2023, we estimate that with our improved profitability combined with our melt rates continuing to come in more in line with shipping levels, the growing utilization of the revolver should ease and free cash flow is expected to turn positive mid-year fiscal 2023.

We expect to be using this positive cash flow in the back half of the year to begin to pay down the revolver. Our expanded 160 million credit facility provides strong liquidity moving forward. Capital spending was 3.3 million in the first quarter of fiscal 2023, similar to last year’s first quarter. We are forecasting to spend 20 million to 24 million in fiscal year 2023, which puts the remaining orders of this year’s capital spending at a higher pace than Q1. Outlook for next quarter and full fiscal 2023. Given the strength of our record backlog along with the manpower and work in process inventory being put into place, we expect revenue and earnings in the second quarter of fiscal 2023 to be higher than both the first quarter of fiscal 2023, as well as the second quarter of last year.

Further, the company expects full year fiscal 2023 to be 15% to 20% higher than fiscal 2022 for both revenue and earnings. In conclusion, Q1 was a solid start to the year, even with the higher than expected raw material headwinds. We believe that our cash investment into inventory and our increase in production headcount will provide a solid return on investment with increased revenues and earnings in the second half of the fiscal year. Demands in our primary markets remain strong as reflected in our backlog growth. These factors, along with strong management team execution provide an optimistic forward view of growing shareholder value. Mike, with that, I will now turn the discussion back over to you.

Michael L. Shor: Thank you, Dan. Wrapping up, I want to thank our workforce for a job well done. I would match this entire team against any out there. They’re hardworking, focused on being best in class, and have the expertise to continue to expand the gap versus others related to our core competencies, competitive advantages, level of innovation, and business performance. At this point, I’ll ask our operator, Tom, to please open the call up for questions.

See also Buffett Stock Portfolio: Recent Buys and 13 Best Value Dividend Stocks to Buy .

Q&A Session

Operator: . And the first question this morning is coming from Steve Ferazani from Sidoti & Company. Steve, your line is live. Please go ahead.

Steve Ferazani: Morning, Mike. Morning Dan. Thanks for taking my questions. I just wanted to start with the commodity headwinds. You clearly had guided for this impact this quarter. You were very slightly off, but you expected this quarter specifically to be where you would see the impact and you expected more neutral in the remaining three quarters given what we’ve seen in nickel recently, any shift in your view on that?

Michael L. Shor: We believe that at, by the time we get to the end of the second quarter, that we will neutralize these headwinds. Obviously it continues to depend on what happens to the price of these elements, but what we were caught by the way, Steve before in this current quarter is the huge drop in cobalt, which was more than we had estimated, which is why we were off in our original estimate versus where we are now. But yeah, we expect these to subside towards the — as we get through this quarter and then turn positive in the back half of the year.

Daniel W. Maudlin: Yeah, and I concur with that. The model that I mentioned in my prepared remarks kind of calculates what we believe the estimated actual impact is over a quarter. And it also, we use that for some forecasting as well, and that works pretty well with nickel. We forecasted 4.3 million or actually we forecasted 4.5 million for nickel and it came in at 4.3 million, so quite close. It was the cobalt side of the forecast that we had a problem with. That was a headwind calculated to be 1.3 million and that’s where it was unexpected.

Michael L. Shor: And Steve, the key for us is, what happens with nickel price? You’re making these assumptions based on assuming nickel will level out, and the only thing I can guarantee is it’s never level, it’s going to move one way.

Steve Ferazani: Understood, understood. In terms of you talked last quarter about resource allocation, particularly pricing out of potentially lower margin business given how strong backlog was and demand, it looks like we saw some of that in chemical processing when we look at volume and pricing, is that what we’re seeing and would you expect given that your backlog continues to grow to continue those efforts?

Michael L. Shor: Yeah, we will continue to manage mix and we will continue to look at higher volume opportunities that are lower margin opportunities to determine if we want to do that. You said it correctly, our volume was down 1% by shipments, but our revenues were up in CPI 30%. And the main reason for that is because we have something we’ve talked about on and off, which is very high volume, very low margin business called flu gas to sulfurization. And when you look three months, these three months versus prior year our FTD participation was down almost 81%. So yeah, we’re certainly going to pick and choose and we’re certainly going to make sure that our customers that are long-term critical customers get ahead of the queue there.

Steve Ferazani: Great, just last one for me. In terms of you talking about turning cash flow positive the second half of the year, obviously raw material prices have leveled off. But as your orders continue to build that would indicate continuing needs to grow inventory, given the strength of your backlog, are you still confident you can go cash flow positive second half?