Q3 2023 Haynes International Inc Earnings Call
Greetings and welcome to the Haynes International Inc. Third quarter fiscal 2023 financial results conference call at.
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A question and answer session will follow the formal presentation.
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I'll now turn the conference over to your host controller, and Chief Accounting Officer, David Van Bibber, you may begin.
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 1095 and section 21 E of the Securities Exchange Act of $19 30 for the words believe anticipate plan and similar expressions.
<unk> 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 its fiscal year ended September 32022.
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.
As previously disclosed on June 10, 2023, Haynes began experiencing a network outage indicative of a cyber security incident.
At that point, our incident response team in conjunction with third party specialist began to investigate the incident determine the impact and restore functionality to our systems.
On June 20, <unk>, just 11 days after the incident, we announced that we were back up and running and had substantially restored our operations, including our administrative sales financial and customer service functions.
I am very proud of our entire team for reacting communicating and recovering very well as we fought through the incident.
Despite our rapid actions and responses, we did incur significant outages in many of our operations approximately.
Approximately 11 days of manufacturing or over one third of the month of June was impacted.
The outages led to an estimated $18 million to $20 million reduction in shipments in June and therefore in our third quarter.
That reduction in shipments along with the impact of the outage had on efficiency and the cost incurred related to our investigation and restoration efforts.
Sold it in an estimated reduction in earnings per share of approximately 40 to 45.
Although it will be difficult to offset the miss third quarter shipments in our fourth quarter due to our high operating levels. We have regained good momentum with the flow of orders at each of our operating locations and expect our fourth quarter revenues to be the highest of our fiscal year.
Our team is now once again focused on the actions that have resulted in excellent financial performance over the past year.
These actions include the following three items first a focus on gross margins that when removing the third quarter impact of the cyber incident and raw material fluctuations continues to be top of class in our slice of the industry.
Next a reduction in our breakeven point that is approximately 25% below where it was when we began this improvement journey five years ago.
And finally, our continuing efforts to focus on and improve our core competencies and differentiators.
Including alloy and application development to supply of high value products and services and outstanding sales and technical service.
Illustrate the positive effect of reducing our breakeven point in Q3, we shipped just $4 4 million pounds because of the impact of the network outage.
We made $8 $8 million and net income this is despite being below our previous breakeven point of 5 million pounds of quarter.
I will now move on to revenue and market performance in our third quarter.
Despite the one time impact of the cyber incident, the numbers tell a very compelling story.
Revenues were $143 $9 million down five 8% sequentially, but up 10, 6% year on year.
As far as our markets, our sequential and year on year CPI revenues were down significantly because of both the cyber incident, and our ongoing mix management and pricing for value initiatives.
Our IGT revenue, while being down sequentially due to the cyber incident was still up 17% year on year.
This was primarily due to our share gain.
Excellent sales.
Technical service and increasing use of our proprietary alloy Haynes 282, and land based gas turbines.
Our other markets declined both sequentially and year over year.
Due to both the cyber incident and our withdrawal from the majority of the low margin flue gas the sulfur as Asian or F. G D market.
As far as aerospace market, our third quarter numbers truly emphasizes the strength of the aerospace market for Haynes. Despite the GAAP in June shipments, our aerospace revenues increased 27% year on year and 16, 3% sequentially.
These increases show the unprecedented demand and growth that we're experiencing in this market.
Further emphasizing the strength of the aerospace market I'll touch on the Paris Air show, which occurred in June where we met with many customers along with engine and airframe builders.
Each meeting was very similar with three main themes first the industry's inability to build inventory and the engine supply chain second the anticipated need for increasing volumes of nickel based superalloy and titanium tube for years to come and third the outstanding sales.
And technical service provided by Hanes due to a combination of excellent people unquestioned quality and outstanding service out of our company owned customer facing service centers.
To put some additional color on this the news out of the aerospace industry continues to be very positive.
Per recent communication from Safran to suppliers. There is a backlog of more than 10000 leap engines and their objective is to deliver 50% more leap engines in 2023 versus 2022.
In addition, numerous numerous published projections show significant commercial aerospace growth, both short term and through the balance of this decade with passenger traffic returning to peak 2019 levels. This year.
And the commercial aircraft fleet anticipated to double over the next 20 years.
Finally, as far as backlog and book to Bill our backlog in June increased for the 27th consecutive month, reaching a new record with our end of Q3 backlog now at $468 $1 million.
For comparison before this ramp up our prior backlog record was $288 $6 million.
Our Q3 total book to Bill based on revenue was one point too with the Arrow at 1.1, CPI and other markets at 1.0, and IGT continuing very strong at 1.5.
Our past current and anticipated future work on both cost reduction and our supply of high value differentiated products and services along with a record backlog gives us great hope and excitement for the future of our company.
Before wrapping up my comments I have a few additional points to cover.
First I am pleased with the ongoing proactive approach on safety within all of our facilities. Our most recent accomplishments include. The addition of a safety training specialists to our staff our focus on maintaining and updating key safety procedures within all of our plants and our safety suggestion system throughout each one of our <unk>.
Facilities. In addition in 2023, our wire facility in North Carolina received 10 year sharp recognition sharp, which stands for safety and health achievement and recognition program is designed for small and medium sized plants that have established implemented and maintained exceptional.
Workplace safety standards.
Next we are very pleased to announce that we have reached a five year agreement with our Kokomo, United Steelworkers Union.
The agreement has been overwhelmingly ratified by our workforce.
We have a dedicated and talented group of employees throughout Haynes and we look forward to continuing down our path of further safety quality delivery yield and cost improvement.
The next time I want to touch on is hains is innovative alloy and application development, which are true core competencies that are the heart of our company.
Our strength is developing and bringing to market niche highly differentiated products that are the result of long term research and application development efforts.
More of our newest alloys Haynes 233 alloy Haynes 244 alloy past alloy hybrid DC, one alloy and Haynes HR 235 alloy or a different stages of commercialization and have shown clear initial signs of market acceptance.
Our newest high temperature alloy pains to 33 was developed with an outstanding combination of high temperature strength and oxidation resistance. Unlike many other alloys $2 33 alloys extremely versatile.
And it is currently being tested or has already been selected by some major Oems in the aerospace IGT industrial heating and chemical process market segments.
Finally, my sincere thanks to our hanes team for their performance and teamwork as we worked our way through the issues and the opportunities of this past quarter because of the people of Haynes our future is bright.
Now I'll hand, the call over to Dan for comments on our financial results.
Thank you Mike This has certainly been a challenging quarter. However, the good news is the underlying fundamentals of the business and our improvement strategy are still intact and in focus.
Our Q3 volume shipped was $4 4 million pounds. This volume would've previously resulted in a net loss however, with our lower breakeven point, we were profitable with $8 8 million net income and with $13 7 million operating cash flow for the quarter.
Another telling metric as our average selling price per pound.
Which in total included including conversion revenue was $32 51 per pound shipped this quarter is clearly reflects the high value products, we provide and the differentiation of our product mix from others in our peer group.
Combine this with our company our record backlog our investment in inventory puts us in a favorable position as we look to the future.
The cyber security incident that occurred this quarter caused an impact on sales of roughly $18 million to $20 million, which we expect to make up over the next few quarters.
As Mike mentioned this impacted earnings per share with an estimated 40% to 45.
Or roughly $5 $5 million.
Most of this was attributable to the revenue shortfall, which we expect to recover with the associated incremental margin, but some costs or inefficiencies and costs related to the investigation and restoration efforts that were within our insurance deductibles.
Some of these costs impacted cost of goods sold and so in SG&A.
This quarter also included a raw material headwind of $1 $5 million. This was driven by cobalt market prices continuing to fall, causing the headwind.
This estimate is derived from our model developed by the company to measure how the commodity price changes flow through net revenues and flow through cost of sales.
Fourth quarter earnings are expected to be unfavorably impacted by additional headwinds from the continued reduction in the price of both nickel and cobalt.
Raw material price fluctuations can impact our results more sharply than others in our peer group given our product portfolio being solely high end nickel and cobalt based alloys remember that average selling price of $32 51.
Production of these types of alloys generates a significant scrap screen, which of course is recycled back into the milk, but puts the commodity price risk on the company for that scrap screen and it has an impact when market prices change sometimes favorable sometimes unfavorable.
Raw material price risk for the product that shipped to the customer is reasonably well managed with our escalators and de escalators for raw materials, but this scrap exposure is difficult to effectively hedge.
Our gross margin for the quarter was 18, 1%, including the cyber security incident, and the raw material impact.
Our production momentum is back and we are now producing at very high levels at each of our facilities, we anticipate that our fourth quarter volume ships will be the best of our fiscal year.
Our SG&A, including research and technical expense was eight 9% of net sales for the quarter as compared sequentially to Q2 of 9% even with lower revenues.
SG&A dollars were $12 8 million for Q3.
Operating income was $13 2 million this quarter, which is a sequential decrease driven by the cyber security incident.
Our effective tax rate for the third quarter was 23, 5%.
And all of this resulted in net income of $8 8 million in a diluted earnings per share of <unk> 68.
Impacted by the cyber security incident of $40 to 45.
And raw materials of <unk> <unk> per share.
A few additional points regarding our financial position.
Our revolver balance was $98 7 million a decrease of $9 3 million during the third quarter of fiscal 'twenty three.
We renewed our credit facility and increased it to $200 million, providing strong liquidity going forward.
This amended agreement has a slightly better interest rate grid and has a five year term, which matures in June of 2028.
Looking to Q4, we expect the revolver balance to increase due to the revenue impact of the cyber security incident, this quarter and its Q4 impact pushing out cash collections on those receivables into later quarters.
Our U S pension plan funding percentage continues to improve with a quarter end funding percentage at 94, 4% and a long term liability on the balance sheet at $16 $6 million. This was $108 million less than three years ago.
Our backlog is at a record level of $468 1 million as of June 32023, an increase of 21 4 million from the second quarter of FY 'twenty, three and an increase of $130 million from the same period last year.
Our controllable working capital was $426 2 million as of June 30th an increase of $47 9 million since the beginning of the fiscal year. This increase was driven by inventory with a June 30 balance of $411 7 million, representing a $54 one.
<unk> increase this fiscal year as we grow our production levels and our topline revenue.
Our capital investment in the first nine months of fiscal 2023 was $11 8 million.
Our total forecasted capital expenditures for FY 'twenty, three has been slightly reduced to $16 million to $18 million adjusting for delays of equipment receipts from supply chain issues.
Outlook for next quarter with.
The cyber related revenue impact is expected to be made up over the next few quarters into fiscal 2024.
The company has regained good momentum with the flow of orders at each of its operating locations and expect fourth quarter fiscal 2023, net revenues and earnings to be the highest of the fiscal year.
Fourth quarter earnings are expected to be unfavorably impacted by additional headwinds from the continued reduction in both nickel and cobalt.
In conclusion.
<unk>.
While it was a challenging quarter, we navigated it well as we progress through the fourth quarter of this fiscal year and into fiscal 2024, we remain optimistic with our improvement initiatives still in focus a strong backlog a strong work in process inventory position and returning production momentum.
These are positive factors to drive shareholder value creation.
Mike with that I will now turn the discussion back over to you. Thank you Dan.
Our team continues to be encouraged by our performance and the future potential of our business.
Thanks to all of you for your continued interest in our company with that Holly, let's open the call to questions.
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Your first question for today is coming from Mark Reichman at noble capital market.
Good morning, and thank you for taking my questions.
Hey, Mark Hey, Mark.
The first question I have as Dan mentioned insurance deductibles and I was going to ask you know what.
Which of your policies might apply to business interruption and.
Will you be able to make any recoveries either through your insurance policies.
Yes, we did have specific cyber security insurance.
So there are coverage there is coverage related to that so the cost that you see kind of flowing through June is really within those deductibles of that policy.
There is business interruption insurance, but the deductibles on that are quite high as far as the number of days you were down we were down 11 days. So that's.
Not a big.
Amount versus the deductibles within those particular policies, but we do have cyber security insurance that will cover the balance.
The second question is.
The second question is are you when you look at the backlog and the sequential increase is one way to look at that that maybe $18 million to $20 million of that build is due to you know the.
The buildup from the cyber security incident or is that is that not the right way to think about it.
Mark Yes, it's the $18 million to $20 million is clearly related to the left the 11 days that we did not operate.
The plant going down and then coming back up in the 11 days in between is the reason for that.
Okay, but did that impact us is that what drives kind of does that how much of the backlog increase was driven by that.
In other words, the $4 46 points I went to the $4 68.
Yeah I'll answer it this way our order entry.
Without that material and there is greater than what we are shipping which is causing the backlog increase.
Okay.
Okay, Great no. That's very helpful. And then just lastly, just looking at kind of the trends in the shipments by markets.
Head count a pivot away from chemical processing.
In the third quarter looking out of the fourth quarter would you would you say that the third quarter are kind of good markers for you for chemical processing and the other markets in other words would you say that those are kind of normalized volume for those two segments or or just some commentary there.
In general obviously, we're expecting across the board increase volume.
In Q4 versus Q3, but the chemical processing market is really two markets. It's the high end special projects and other high end businesses, which we continue to pursue and are very good for our company, but there is also the lower end alloys.
Alloys that are more commoditized and we look to continue to apply our capacity to those markets as to the aerospace and power generation market as opposed to the chemical processing market. We don't say no to our customers. We just tend to price it in a way that we are.
Our pursuing what makes the most sense for the company some of that results in order some of that does not.
Well, that's very helpful and thank you very much thank.
Thank you Mark.
Your next question is coming from Steve Sarah Zani at Sidoti <unk> Company.
Good morning, Mike morning, Dan.
Obviously, a very successful Paris Air show all the way around aerospace demand still seems like we got a multiyear runway when you think about your backlog, which as you know almost.
Almost a year's worth of note in a more normal year.
And way above what you've seen before you've noted in.
Particularly in response to the previous question. The fact that you've moved away from that lower margin.
Flu does.
Florida to self registration.
Is there more customer rationalization, you can take them sure love to have a huge backlog but.
I'm sure you'd like to see more higher margin going through your plants is there more rationalization to come given the runway we are expecting in aerospace.
I would say instead of customer rationalization, it's all about individual products and what we do within those products. There I want to be clear there are some outstanding portions of business for us in the chemical processing market. What we are doing is our customers are looking at what's happening with the gear turbo.
And builds the leap builds the <unk> hundred 20 builds and the 737 builds and their labor and their orders based on that and we have done because of the combination of our mill and our distribution centers a very good job of supporting them and we'll continue to do that so it's to me, it's just making sure our customers in there.
Four we understand what's coming and making sure we layer that in to be able to supply the supply chain with what they need.
Any thought to capacity expansion and our use of third parties to meet puts but certainly a very very strong demand.
Strong March.
Sure when we all go back to the last cycle and the 2015 to 2018 timeframe, we saw significant growth coming in the aerospace and therefore, we expanded fairly significantly our key product or cold finished products or cold finish flat in our titanium capacity so that has.
<unk> is in pretty good shape with where we are the issue that we've talked about before is vacuum induction melting.
<unk> is very very tight right now and we have begun to use outside conversion where needed to supplement.
R V I M melting so we're looking at that we also look at the future on what's needed related to again, a core aerospace plot product titanium tube and we're looking for ways to also through internal actions expand our capacity there.
Great. Thanks, if I could just get one more in obviously, we saw some reduction the revolver you know second half cash flow tends to be much stronger with the first half working capital build am I thinking this right probably a pay down in four Q and then first half youre going to see the build again, because it's hard to bring that down win.
Your book to Bill continues to be over one times right.
Yes, one issue with the revolver with the cyber security incident happening in late June .
As as that gets that revenue gets pushed out those receivable collection on those receivables get pushed out as well so.
I actually mentioned in my prepared remarks, we expect the revolver to increase over the fourth quarter.
Okay as those as.
As we catch up on the cyber incident over the next few quarters, we'll regain that cash back of course, but.
The timing of that will just be pushed out a bit more so we expect an increase in the revolver from where we're at at the end of June .
By the end of September .
And then as we got as part of the reason to have expanded the size of it.
Sure I mean, we wanted to have strong liquidity going forward, we look at our backlog at record levels and it's continuing to grow so certainly wanted to be prepared to.
Engage in that and grow the business.
And the risk of if nickel goes crazy again, if nickel skyrockets up we want to not have to slow anything down and be able to absorb that within our revolver as well if needed just a risk prevention.
Perfect Alright, thanks, Mike.
Thank you Steve.
Your next question for today is coming from Michael Lee shock.
Keybanc.
Good morning, Mike.
Dan.
I wanted to ask you as we look forward the next few quarters.
You mentioned you plan to make up to 18 to 20 million in revenue from the diabetes security incident, but I didn't hear anything on that 40 to 45 in EPS. So I'm just wondering what the margins are behind that lost revenue is it lower margin business that you may have shifted away from and just how did how did those.
Margins relate to the overall company margin.
I think it would be very similar to the overall company margins I mean, we pushed out potentially 18% to $20 million and I mentioned that as we as we recover that revenue will recover that incremental margin as well. So that is not lost it's just going to be pushed into later quarters.
But I did mention that you know there are some costs related to this you know.
It related to the inefficiencies related to the restoration efforts and the cost when you have a cyber security incident like this those of course would not be recovered, but the incremental revenue certainly will as we catch up.
On those lost shipments.
And then what are the current bottlenecks in your operation today.
And how are some of the <unk> melt constraints that you've had in the past how have they improved over the past few months.
Where do you see the biggest opportunities to further improve bottlenecks.
I think theres two two are actually three areas that we're working to improve.
As our manpower has been applied to our cold finish flat manufacturing, we see an opportunity to relieve the backlog and in fact, we're seeing evidence of that and be able to manufacture more cold finish flats. In addition.
On the aerospace hydraulic tubing side with titanium tubing. We are currently looking and we have people in place now looking at what we can do to <unk>.
Not really the current bottleneck, but anticipate what could be coming as far as a bottleneck with increasing demand there and so we're looking on how to further expand that and then the obvious one is what we've talked about with vacuum induction melting and using.
Outside conversion to supplement we're doing that we continue to we expect to continue to do that for a while as we move forward. So those are the three or all aerospace focused and we feel good about getting after each one of those.
And then where do you see inventory.
And as we move forward.
Kind of mentioned it but just wondering if that could be a source of cash in the fourth quarter or into fiscal 'twenty four or do you kind of need to maintain the levels you're at to support the strong demand in the short run I would expect we would maintain the levels. We're at if not a small increase potentially as we continue to invest in the milk.
Certainly over FY 'twenty four as that revenue.
Next up.
Then that would stabilize and more than likely a decrease in inventory levels at that point in our cash generation that comes with it. So FY 'twenty four yes, I would agree that would probably decline, but in the short run in Q4, no not necessarily.
And just lastly for me.
Do you have any raw material price expectation.
For the fourth quarter.
Because you you had mentioned it made maybe a headwind.
But just give him a nickel and cobalt is done.
All else equal what are your expectations for the coming quarter.
We expect.
Well, let's take a step back nickel was about $13 a pound in December <unk>.
960 pound in June cobalt was at $39, we have a fair amount of that material going through its now at $16 a pound.
So we expect unfavorable headwinds in Q4, no doubt about it both from nickel and from cobalt and this particular quarter Q3, I mentioned in the really that was just driven by cobalt. So now in Q4, it's cobalt plus nickel that we're expecting in Q4.
Yes.
Got it. Thank you guys. Thanks, Michael.
Your next question for today is coming from Chris <unk> at Northcoast research.
Yes.
Hey, good morning, guys.
Good morning, Chris Hey, Chris Okay. I wanted to ask you about the GE <unk> engine, because I believe there has been some pull forward of triple seven X production.
Is there any opportunity or I guess I should say are you changing the way you think about supplying that engine now where any kind of pull forward your contribution to figure out.
Yeah.
Have two proprietary alloys that are going into that engine. We have all shown great patients for this to come to fruition.
Have seen activity from our customers as far as components. So we are well prepared for when the demand comes in for the the Nymex that we will be ready for it.
So it's predominantly next year, you'll see I should think about.
<unk>.
This process is not going to be a quick process I think we've learned that based on what we've seen over the last year or two but the key for us Chris as these proprietary alloys and so we want to make sure that whatever is required out there from us where we are well ahead of that which we are.
Can you talk a little bit about the special project pipeline I'm wondering if you've seen any change in the environment given the rise in interest rates or kind of the macro concerns out there.
We continue to see progress with special projects, we've actually seen an increase in special projects over the past year.
However, as everyone knows in this industry. There are long lead times. So some of our most recent wins will be shipped fiscal 'twenty four and beyond.
We do expect to see continued growth here, it's what we do with our application development efforts.
And what's great about these projects all of the things I Love alloys, I love talking about it.
82 hybrid <unk> 35.
They are all involved in strong contributors to special projects.
One of your competitors recently talked about a slowing industrial and energy shipments in the current quarter related channel inventory destocking or macro issues. I was just wondering if you see anything like that when you think about like transactional volumes or maybe the tolling business is there anything near term.
That's a that's been negative out there.
On the energy side, when we talk energy, we talk power generation.
And what we see in power generation as demand for our alloy to 82 continues decline.
<unk> business is still strong out there to say the least we've got share gain in IGT, we have new alloy initiatives and from our view and power generation long term trends are very positive because of coal being retired and natural gas being one of the choices out there. So no we've not seen any decline at all.
Thanks, so much.
Thank you. Thank you.
Your next question for today is coming from Sam Douglas at narrow River capital.
Hey, guys good morning.
Yeah.
A couple of questions during the cyber outage, where you guys are still manufacturing, but not shipping or not manufacturing at all just trying to know.
The majority of our operations, where we're not.
Able to operate because of the lack of access to our shop floor system. So we had a and some of our hot end operations, we operated for a little while but the majority of our operations were down.
Okay, Alright, Thank you and then I guess.
Adjusting for the cyber outage impacts you outlined I mean is there any anything.
That gives you pause in the previously 15% to 20% revenue and EPS Guide that you gave.
Last quarter.
I think I'll start and I'll, let Dan that wrap it up we've had two issues that we've dealt with here one is the cyber incident and the impact of the cyber incident. The second is the ongoing decline of raw material prices beyond that we feel great about where our businesses. We continue to focus on what's gotten us to this point high value differentiated products and <unk>.
Sure that they are valued by our customers the way they should.
And significant and a relentless focus on variable cost reductions so feel very good about that.
I would echo that I think our strategy is very much intact.
<unk> incident, obviously had an impact on that guidance and in raw materials keep in mind, the raw material impact last year.
We had year to date through the third quarter about $8 4 million of a tailwind in raw materials, and we highlighted that in pointed that out.
This year that is about an $8 8 million headwind. So a difference of over $17 million swinging from a tailwind to a headwind this year and that has surprised us a bit in the later quarters here. So the 15% to 20% guidance that we had provided this isn't a surprise additional headwind than we were.
Unexpected.
Got it.
Thank you very much.
Thank you Sir.
We have reached the end of the question and answer session and I will now turn the call over to Mike for closing remarks.
Thank you Holly and thank you all for your time today.
We as always appreciate your interest and support of our company and we'll talk to you again next quarter. Thank you.
This concludes today's conference and you may disconnect. Your lines at this time. Thank you for your participation.