Haynes International Inc (HAYN) 2022 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the Haynes International, Inc. Third Quarter Fiscal 2022 Financial Results. (Operator Instructions)

I would now like to turn the call over to your host, Controller and Chief Accounting Officer, David Van Bibber. Please go ahead.

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 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 a number -- 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, 2021. 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.

Thank you, Dave. Good morning, everyone. We continue to make excellent progress in our third quarter. The highlights are as follows. Overall, order entry averaged approximately $61 million a month, both over the third quarter and for the past 6 months. Third quarter aerospace order entry was one of our best ever for both pounds and dollars with GBP 3.2 million and $100 million entered. Our backlog has now increased for 15 consecutive months, and we ended the quarter at a record level of both pounds and dollars at GBP 12.1 million and $330.2 million.

Revenue increased for the sixth consecutive quarter with Q3 revenues of $130.2 million, up 11.2% sequentially. Gross margin was an impressive 25.5%. Our adjusted EBITDA was $26.1 million, meaning that we are at or above a $100 million EBITDA run rate. And finally, our net income was $15.6 million, which was 12% of revenues in our third quarter.

As I've noted in the past, we believe that our significant improvement is based on our team's focus on each of the key components of our business. Specifically, we are striving to even further enhance our core competencies of innovative alloy and application development. We continue to build competitive advantage through our excellent technical and sales service. Our momentum is building with a relentless focus on yield and operations improvement, and our customers are experiencing and acknowledging the value we provide with our differentiated, high-quality, high-value niche products and services.

We believe that the result of all of these efforts is fundamental and sustainable improvement in our business. My sincere thanks to everyone in our company for generating business performance in our third quarter that has not previously been seen in the Haynes base business. I would like to also note that while our results have improved significantly, we all feel that more is possible for our company over the next few years.

Now as far as additional details for the third quarter. As noted, revenue was $130.2 million, up 11.2% sequentially and almost 48% year-on-year. The Q3 highlights by market are as follows.

Aerospace continues to strengthen. As noted previously, we entered $100 million in aerospace orders just this quarter. Our Q3 shipments increased as we continue to emerge from the impact of the pandemic, reaching 46.8% of sales in the third quarter. Our aerospace sales increased 15.2% sequentially and 79.6% year-on-year. We have now achieved 95% of the revenues for aerospace from our prior average high point in 2019. In pound shipped, we are at 83% for the fiscal year '19 average. The strength we are seeing is predominantly from single-aisle growth. We expect further growth as the larger plane builds improve in the future. We continue to believe based on current order entry levels that our Aerospace sales will be a record monthly shipping levels over the next 3 to 6 months.

This quarter, the airline industry generally reported strong demand for travel and all involved believe this will extend beyond the summer. I was just at the Farnborough Airshow and you could clearly feel the enthusiasm for growth that the industry is experiencing. As far as worries of a recession, I heard many say that the aerospace industry already had the recession during COVID and that we are emerging strong. Looking at our order book, I believe that to be the case.

In CPI, we are seeing strength in both special projects and our base CPI business. Our sales increased 5.8% sequentially and 42.2% year-on-year. We continue to see growth in this business segment due to both pent-up demand and access to plentiful and relatively affordable natural gas supplies within the United States. Higher oil prices seem to also be encouraging CapEx spending in CPI, which will help continue to drive our demand.

In IGT, after a very strong Q2, we saw a sequential drop in shipments in Q3, down 3.2% sequentially. This is nothing more than order timing as revenues were up 34.5% year-on-year. As noted on our last call, while renewables continue to grow, natural gas powered industrial gas turbines are projected to remain over 30% of U.S. power production out to 2050. We continue to have a very strong presence in hot gas path parts from major OEMs, including the ongoing and ever-increasing use of our proprietary alloy HAYNES 282. As far as our other markets, we saw a significant sequential increase in revenue due to increases in shipment into the flue gas desulfurization and oil and gas markets.

Now moving to gross margin. It's a great story. We continue to see improvement with gross margin increasing by 550 basis points sequentially and 1,000 basis points year-on-year. Even and without the estimated raw material tailwind, which Dan will discuss shortly, the year-on-year increase in gross margin was significant at 930 basis points. This shows that the main drivers of our improving margin performance with the supply of high-value differentiated products and services, our variable cost improvements and the volume leverage we are achieving with better absorption of fixed costs. The raw material tailwind helped, but was not the main driver for our margin improvement.

Net income was $15.6 million, up from the previous quarter's $8.5 million, showing the power of our team's focus and actions. Our book-to-bill for the third quarter based on revenue was 1.5. That's the third consecutive quarter of at least a 1.5 book-to-bill level. For the third quarter, Aerospace was 1.6, CPI was 1.2 and IGT was 1.4.

Now moving to inventory. Inventory increased by $52 million over the quarter, of which $47 million is currently applied to customer orders in our work-in-process inventory. The growth in inventory is obviously being driven by the combination of increased prices of both nickel and cobalt as well as the significant increase in our backlog. Our company must continue to support our customers in the unprecedented level of order entry we've been experiencing. Our backlog grew 20% from $281 million to over $338 million during this past quarter.

It's also important to point out that the growth in inventory is simply due to the fact that we have averaged $61 million a month in order entry over the past 6 months compared to $41 million per month in shipments over the same time period. It's important to note as we produce and ship, the backlog shipments will begin to catch up with order entry, which is projected to be a very good thing for our cash and our bottom line.

Some additional highlights of our business from the quarter. Related to alloy and application development, Haynes has been and continues to be a leader in inventing and developing high-performance alloys for a number of different markets, such as aerospace, power generation, chemical processing and emerging markets. Haynes is always working with end users and OEMs to develop an in-depth understanding of the future material needs of the industries that we serve. Based on our knowledge of the anticipated future material needs of these markets, Haynes has numerous alloy development programs currently underway. Some examples include the development of alloys for the next generation of both aerospace and IGT gas turbines. The testing of current and new alloys for the next generation of hydrogen-powered turbines for aerospace and IGT and the evaluation of possible next-generation alloys for CPI emerging technologies and nuclear power generation.

In addition, beyond this development phase, Haynes has several alloys that are at various stages of being commercialized. These include HASTELLOY HYBRID-BC1 alloy, a corrosion-resistant alloy for the CPI market; HAYNES HR-224 alloy, a highly oxidation-resistant alloy for emerging technologies and industrial applications; HAYNES 244 alloy, a low coefficient of thermal expansion alloy for gas turbine applications. I should point out that this alloy, HAYNES 244, has already been specified into a new aerospace engine application; next, HAYNES HR-235 alloy, a metal dusting-resistant alloy for petrochemical applications; and finally, HAYNES 233 alloy, and alloy with a unique combination of strength and oxidation resistance, which is already being considered and continues in the advanced stages of testing for an aerospace engine application.

As I've said many times before, alloy and application development are core competencies for our company. Our current development and commercialization work continue to build on what has been a true strength and differentiator for our company.

Moving on. Related to our efforts on safety, I continue to be impressed with our team's focus, leadership, daily communication and implementation of process change, all with the goal of continued safety performance improvement at Haynes. In addition, we are currently monitoring the recent uptick in COVID-related illnesses and absences. Our entire team continues to do a very good job with COVID-related communication and education with all of our employees.

Next, as far as our work related to ESG, we now have an ESG and sustainability manager in place with a very strong background in safety and environmental science. We also continue to focus on the start-up of our new 1-megawatt solar facility, on evaluating possible future ESG-related capital projects, on additional corporate disclosures and on collecting the data required to set specific and responsible corporate sustainability goals.

Wrapping up my comments as noted on our last earnings call, based on our team's ongoing and relentless work to add value and reduce variable costs, along with the continued growth that is anticipated in our 3 core markets, we project over the next 3 fiscal years, additional improvements in our business performance and business metrics. We continue to project the following.

Our compound annual growth rate is estimated to be 15% from fiscal '21 to fiscal '25 driven by a compound annual growth rate for Aerospace exceeding 25% over this time period.

We see aerospace growing to approximately 55% of revenues by fiscal year '25. Gross margins are projected to remain comfortably over 20%. Positive operating cash flow is projected to begin in mid-fiscal year '23. And finally, we're projecting a fully funded pension plan within 2 years.

At this point, I'll hand this over to Dan for additional details on our financial results.

Thank you, Mike. Financially, this was another impressive quarter. With the 25.5% gross margin, representing a 550 basis point sequential improvement and a 1,000 basis point improvement over the same period last year, net income of $15.5 million, an 84% sequential increase.

Looking at year-over-year, last year's third quarter net income was just above breakeven, which is when we proved our new GBP 3.7 million breakeven point, which was 25% lower than previously. Now this year's Q3 was GBP 4.5 million shipped. The profitability leverage is evident with strong incremental margins. Our successful efforts to increase production rates, with workforce additions and continued investment in inventory, has driven increasing shipments this quarter, resulting in strong profitability and a bullish forward outlook.

A few important points I wanted to address earlier in my prepared remarks. First, the raw material tailwind while favorable, was not the main driver of our profitability improvement. The raw material impact this quarter from nickel and cobalt was estimated to be $4.1 million or 310 basis points. Even without the tailwind, our gross margin would have been still very solid at 22.4%. If we then remove the raw material impact from last year's results as well, the 1,000 basis point improvement only slightly narrows to 930 basis points. The main driver of our improvement was our price and cost improvements, combined with our higher production and sales volumes.

Second, our order entry and backlog are at extremely high levels. We had $184.5 million in order entry this quarter, with Aerospace order entry hitting $100 million with a 1.6 book-to-bill ratio. Backlog was $338.2 million at June 30, '22, an increase of $57.5 million or 20.5% sequentially over the March quarter end.

Third, the $46.5 million utilization of our revolver. The primary item which drove this cash deployment was increased inventory. Over the quarter, inventory increased $52 million with nearly all this increase in work-in-process inventory. The increase in inventory was both price related and volume related. In fact, the majority of the increase in inventory value was from raw material market price increases. About 2/3 of the inventory increase or $34 million was from higher raw material prices. This will get recouped as the inventory shifts with a higher raw material component of our sales price, but initially consumes cash with the higher raw material purchase cost. The remaining 1/3 of the inventory increase or $18 million is volume from our higher melt rates to keep up with our surging backlog.

This decision to invest in increasing our melt rates, which increases our work-in-process inventory pounds is the fuel for our top line growth. We expect to further utilize the credit facility going forward to support our growth. We estimate that our cash needs will balance out with our utilization at around 60% to 70% of the credit facility size. While this is safely below the maximum, we are in talks with our bank group about potentially increasing the size of our credit facility as our borrowing base exceeds the current facility size by over 40% or a borrowing base of $140 million.

Finally, EBITDA hit $26.1 million for the quarter, exceeding a milestone $100 million annual run rate. We provided our definition of EBITDA in our press release, Schedule VI, starting with our P&L operating profit plus add backs from the cash flow statement of depreciation, amortization and stock compensation, which is noncash amortization.

One additional comment on nickel prices. We are benefiting from a tailwind now. With the recent decline of nickel and the volatility of nickel, this tailwind could neutralize and potentially become a headwind. We will continue to be very transparent about the estimated raw material impact on our results.

Additionally, Haynes like every business, has encountered inflationary pressures, a tight labor market and supply chain delays, but our team continues to successfully navigate our way around these issues. Our goal continues to be offsetting inflationary pressures with price increases and/or cost reductions such as improving yields, productivity and process improvement.

Continuing with the P&L, SG&A with research and technical expense was $12.8 million in the third quarter or 9.8% of net sales. Great to see that to be single digits again. We expect this to continue to decrease as our revenue increases, but with SG&A costs rising at a much slower rate.

Operating income was $20.4 million this quarter, which represents sequential growth of 9.7% compared to the second quarter of fiscal '22 and $19.1 million growth from last year's third quarter. The operating income improvement on a year-to-date basis compared to last year is $48.5 million.

Nonoperating retirement benefit income of $1.1 million was favorable to last year's quarterly expense of $1.5 million. This is a $6 million improvement, which is expected for the full year. The U.S. pension funding percentage is impressively holding at 92% even during the recent market volatility. As Mike mentioned, we're very proud of how well our customized LDI strategy is securing our funding percentage.

Our effective tax rate for the first 9 months of fiscal '22 was 25%. Current estimates for the full year effective tax rate would be 25% to 26%. And all in, our net income this quarter was $15.6 million with a diluted earnings per share of $1.24, representing an 85% sequential increase.

Liquidity, we had cash on the balance sheet of $9.4 million at June 30 and $46.5 million borrowed on the company's credit facility. This represents a net cash change over the quarter of $27.8 million. Controllable working capital changed by $39.8 million with inventory increasing $52 million and AR increasing $4.2 million with a sizable offset from accounts payable and accruals changing by $16.4 million. Our liquidity at the end of the quarter was $62.9 million, with $53.5 million available on the credit facility.

Capital spending was $11.5 million in the first 9 months of fiscal '22, and we're planning to spend $15 million in fiscal '22, slightly lower than the $17.7 million previously estimated, primarily due to equipment supply constraints. These constraints are not expected to impact our operations.

Outlook for next quarter. We intend to continue the ramp-up of both production and sales levels in response to our record backlog. We expect revenue and earnings in our fourth quarter of fiscal '22 to be slightly above the results from the third quarter of fiscal '22.

In conclusion, it is very exciting to see our strategy driving our financial recovery. Our growing revenue, gross margins at 25.5% and strong profitability are expected to lead to increasing shareholder value. While current investments in working capital are required for this growth, it is estimated to set us up nicely to generate positive operating cash flow starting around the midpoint of fiscal '23 and strengthening over '24 and '25. Achieving an EBITDA milestone of exceeding $100 million annual run rate is exciting and provides enthusiasm for our forward outlook.

Mike, with that, I will now turn the discussion back over to you.

Thank you, Dan. Teamwork shown by our employees and the excellent results achieved make me very proud of everyone at our company. The best part of our story is that anyone you ask within Haynes will tell you that we believe the best is yet to come. To my coworkers, well done, and thank you.

At this point, Kelly, please open up the call to questions. Thank you.

(Operator Instructions) Your first question is coming from Steve Ferazani with Sidoti & Company.

Obviously, the one I want to hone in on a bit here is the gross margin. I thought you did a great job explaining the impact from the raw material tailwind. But I'm trying to think about even if we back that out, if you're in that 22% to 23% range, given that you should be increasing some volume moving forward and maybe get a little bit more productivity and efficiency at the plants. Are you thinking there's upside from that number? Are we near a peak gross margin type level?

Steve, it's Mike, obviously. We expect revenue to grow -- to continue to grow as you know. Therefore, we certainly expect gross margin dollars to grow. As far as gross margin percent, we typically don't provide that type of guidance. Obviously, we saw excellent results, and we gave you the actual number as to how much was the tailwinds. I would say right now, we're at a neutral nickel level right now when you take that 3.1% out, so we're in the 22% range. And we have the potential if nickel drops on some of that coming down. But we also have potential offsets, so we continue to gain momentum with more volume in this plant with continued work on price and continued work on costs.

Yes. And I would just add to that. I mentioned incremental margins. And with volumes continuing to increase, we were at GBP 4.5 million this quarter. And back to that $5 million quarterly run rate is where we're hoping to get and that's going to continue to provide incremental strength, continue to provide some contribution margin. The lower breakeven point that we've accomplished here really is a game changer and really makes that profitability leverage that we're going to be able to get as we continue to increase volumes very exciting. So it's good stuff.

Great. Just -- and I know this is a great problem to have, but I'm thinking about the turn on to a cash flow positive level. And just given huge orders you're continuing to get and, obviously, the positive momentum in Aerospace, the widening natural gas price differential, which certainly I would expect driving in the near-term U.S. chemical demand. I would think that could stretch out as your book-to-bill continues to be well above 1. So how are you thinking about the revolver given that maybe that stretches out a bit before the turn to a more positive cash flow?

Yes. We're certainly monitoring that closely. And that's why I mentioned, we are talking to our banks about the possibility of increasing that if order entry continues. We're forecasting to have utilization on the revolver up to maybe 70%. So talking to increase that in our borrowing base, $140 million. And that's even with, to be honest, a cap on work-in-process inventory of 40%. So we got a $40 million cap on work in process.

So we increased the size of the revolver to, say, $150 million then our borrowing base would actually go up a bit to right there to $150 million. So I think we have plenty of liquidity related to that and our bank group is a great relationship with great -- with the bank group and our strategy and they're very happy with that. So we're in talks to do that if backlog continues to increase.

And Steve, just one more point on this. I think what's really important is that we're booking as I said in the script that about $61 million a month for the past half of the year. And over that time, we're only shipping at $41 million because of lead times. So as we now begin to get this product through the plant, obviously, our revenues go up, which also will assist the cash flow. Yes, absolutely.

So you'll catch up no borrow, even if you maintain this type of booking level, you're going to catch up on the other side anyway, is what you're saying?

With the lead time, we are going to see a steady increase in our revenues, absolutely, once we get the lead time.

And the increasing profitability, of course, drives cash flow as well.

Right. Fantastic. Again, it's a great problem to have. And certainly, I think the banking group would have no issue here. Great. Appreciate the color.

Your next question is coming from Michael Leshock at KeyBanc Capital Markets.

First, I wanted to ask on 4Q guidance. Obviously, there's a lot going your way, but I wanted to ask about anything that might be a negative impact sequentially. We've seen raw material prices fade. So maybe there could be a headwind there, all else equal. But anything else to consider as a potential headwind that maybe was stronger in fiscal third quarter than what you're expecting in fourth quarter?

We -- as we take a step back and look at this business, what everyone talks about is manpower and is inflation. And what we have been able to do in each of our facilities has been able to do related to manpower has been outstanding. We -- I think I said in the last call or call before, we were fully staffed and I'll pick on Kokomo and Kokomo. We're now adding another 100 people in Kokomo to be able to handle this increase -- continued increase that we're seeing in bookings. So we feel really good that we are manned for, they're trained to work safely. They're getting trained on their jobs. And that's going really well.

And then the other issue out there is inflation. This is, again, beyond raw materials. And on the inflation side, we continue to focus on not using inflation as an excuse. We continue to focus on what are we going to do to lower our variable cost to manufacture and significant -- where possible, increase our price based on the value we provide in order to offset that. So we feel good about what's going forward and the increased volume on top of that.

Got it. That's helpful. And I wanted to ask also on what the biggest supply chain constraints are for you. Is it that manpower that you mentioned? We heard Boeing this week cite some of the casting constraints, particularly on the engine side. But what are you seeing within your supply chain? Is it labor or logistical or anything in particular that you're seeing?

It's definitely not labor. We have -- I won't say that we're fully staffed, but we're a handful away to be staffed for the levels that we have right now. And we're actively successfully hiring for the levels that we see 3 months and 6 months out, so not an issue. I would say the biggest issue we deal with on a regular basis, but our team works around it is transportation. Trucking for everybody is an issue, not only outgoing, but incoming for our raw materials. So that's an ongoing issue. Our people are very proactive, and I think they've done a heck of a job with it.

And the comment that I made about CapEx, that's kind of an incoming issue as well where the delivery of the equipment is just a longer lead time than we expected. So that may be partly freight coming into us or it may be partly the manufacturing of that equipment.

Got it. And then just lastly for me. What's your outlook for special projects within CPI for fiscal '23? You did call out some pent-up demand there. Do you see that lasting over the next 12 to 18 months? Or any color you can provide on the duration of that pent-up demand for CPI?

We saw -- just talking about current quarter, we saw increases not only in revenue, not only in margin, but margin percent in our special projects, and we do expect to see continued growth in special projects because of the real strong application development. I've talked about our technical staff a lot. When you have alloys like 282, HYBRID-BC1, G-35, B3 that are out there to solve problems. In my mind, as long as we're spending, it's going to continue to grow. So we see a lot coming from CPI. We also see coming from emerging technologies and so-called, clean energy production, like supercritical CO2 and even small modular power plants. So we feel good about what's happening and that's going to continue to grow.

(Operator Instructions) There appear to be no further questions in queue at this time. I would now like to turn the floor back over to the President and CEO, Mike Shor, for any closing remarks.

Thanks, Kelly. To our shareholders and our audience on the call today, we thank you very much for your ongoing interest in our company and for being part of our improvement journey. We'll talk to you again next quarter. Thank you.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.