Haynes International, Inc.

Good morning, and welcome to the Hanes 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. If you would like to enter the queue at any time to ask a question, you may press star 1 on your phone. You may press star 2 if you wish to remove yourself from queue. 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.

Thank you very much for joining us today. With me today are Mike Shore, President and CEO of Hanes International, and Dan Modlin, 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.

Thank you, Dave.

Good morning, everyone. The work of our Haines team has resulted in significantly improved performance. I'd like to talk about this improvement over three time periods, fiscal 18 to fiscal 22, our current quarter Q1 of fiscal 23, 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 18 to fiscal 22 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 break-even point. We've been able to accomplish this by maintaining and even enhancing our competitive advantages, by pricing for the value provided, by reducing our variable costs, and by accomplishing market share gains resulting in above average key market segment growth rates. The 25% break-even reduction has resulted in a gross margin that has 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 1,225 employees around the world. Next, as I transition to talk about a recently completed first quarter of fiscal 23, I'd like to start with safety. Our entire team continues to relentlessly communicate the need for ongoing improvement in 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 23, 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 pricing and achieved a gross margin of 17.4%, leading to a net income of $7.7 million. When we removed the negative estimated impact of the raw material headwind from our first quarter, our adjusted gross margin calculates to be 21.6%. The results for our first quarter, when compared to Q1 of fiscal 22, 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 Haines HR-235 alloy. This alloy was developed by our team at Haines 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 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 Haines 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 23 contracts and based on that, we are anticipating a positive margin impact across fiscal 23, 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 23, as far as backlog and book-to-bill, our backlog is now at a company record $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 in inventory. In response to our record backlog levels, we have deployed cash to work and 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 Haines alloy and 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 tube facility in Arcadia, Louisiana. Now transitioning and what's next for Haines. 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, our calculated Q1 adjusted gross margin percent in 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 23, 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 23, 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 level 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 23 as our higher levels of order entry turn 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 31st, 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 in 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.

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 61 cents, 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 dollars 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 percent and exclude this estimated 5.6 million impact, the gross margin excluding this headwind would calculate to 21 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%. See our 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 break-even point by 25%. This has now provided us with a profitability leverage to enable a solid net income result, even at Q1 volumes below 5 million pounds, 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 FOSS continued to improve with SG&A including research and technical expense at $11.9 million in the first quarter or 9% of net sales as compared to last year's 2-1 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 930.22. 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 1231.22 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 FY23 are moderately higher, in line with federal and state statutory rates. Quarter 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 22. 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 23, we estimate that with our improved profitability combined with our melt rates continuing to come in more 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 23, similar to last year's first quarter. We are forecasting to spend 20 to 24 million in fiscal year 23, which puts the remaining quarters 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 23 to be 15% to 20% higher than fiscal 22 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.

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 are 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 to questions.

The floor is now open for questions. If you would like to enter the queue to ask a question at this time, you may press star one on your telephone keypad. Once again, ladies and gentlemen, that'll be star one on your telephone keypad at this time if you'd like to enter the queue to ask a question. And we do ask, if listening on speakerphone this morning, to please pick up your handset while asking your question to provide optimal sound quality. Please hold a moment while we poll for questions. And the first question this morning is coming from Steve Perzani from Sidoti and Company. Steve, your line is live. Please go ahead.

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 impact. in the remaining three quarters, given what we've seen in nickel recently? Any shift in your view on that?

We believe that 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, 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 as we get through this quarter and then turn positive in the back half of the year.

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, or actually we forecasted 4.5 million for nickel, and it came in at 4.3, 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.

And, Steve, the key for us is what happens with nickel price. We'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 on.

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?

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 are 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 flue gas desulfurization. And when you look three months, these three months versus prior year, our FTD participation was down almost 81%. So, yeah, we are 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.

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?

We are confident as long as raw materials remain neutral. We look at the back half of this year, given our bookings, which are consistently over $50 million a month, we look at the back half of the year as extremely strong for us. So we are melting for that now. So we are still melting at an elevated level. as compared to what we are shipping as this product begins to get through the employees that are now in and are being trained or getting ready to process this. So we expect the second half of the year, based on the bookings we have and based on the manpower we have in place and the training that is ongoing right now, to be very strong. And so, yes, the answer is we're already melting for that. We just want to get to the point where we're leveling out our shipments with what we're currently melting.

Fair, fair. Thanks, Mike. Thanks, Dan. Thank you.

Thank you. And your next question this morning is coming from Michael Leshock from KeyBank Capital Markets. Michael, your line is live. Please go ahead.

Hey, guys. Good morning. Good morning, Mike. Morning. I wanted to start off on CapEx. As you had mentioned, it was lower this quarter, and your guidance implies an increase throughout the remainder of the year. Are you still seeing some constraints there to get the work done, or is that easing now? And then maybe secondly, could you talk about some of the projects that you have underway or that are planned for the balance of the year?

Sure. As far as constraints, the constraints that we have are really getting what we need in for each of the components of our CapEx projects. So it's not at this point any longer any type of internal constraint. Our plan would be when we take equipment down to upgrade it, We would build an inventory after that, and from there, you know, be able to do these outages that we need. So our issues right now in CapEx are clearly related to getting the equipment in. We obviously had a very light first quarter in CapEx. To be frank, that wasn't intentional. It's just that we're not getting in what we need to get into our company as far as equipment and components to put things together for us.

And then on, go ahead.

I was going to mention some of the projects. I think we've mentioned some of the reliability of equipment and alleviating some of the bottlenecks as it goes through the process. There's an ANK line, for example, where we're spending a sizable amount of money CapEx around $5 million, so we're going to be upgrading that line as well.

Just to give you a list of what we've got going on right now, we've got what was in process or recently completed is our solar field at the wire facility. We're now beginning work on the solar field in our tube facility. We have water jet cutting, incremental water jet cutting in our Laporte Service Center. We've completed our Hanes wire cleaning. We've done some control upgrade work for manufacturing for security purposes of our systems. Some grinders. We are in the process of putting the final touches on what's called the automatic gauge control system at the four high. Most critical piece of equipment. That's truly the brain of the operation. And some other grinders. And then, of course, our big upgrade coming is our A and K line. And that's in between the four mil and finishing and, and that we got about five and a half million dollars in the budget. We're just waiting for the equipment to come in. So beyond that cranes, tow motors, um, some equipment for our cold finish flat area, a little of everything really just to keep us moving forward.

Got it. That's, that's really helpful. Um, and, and then I wanted to ask on other markets, I know that's the smaller market for, for you, but, um, given the ASP at nearly double the rest of your markets, it can have a meaningful swing to earnings. So I wanted to ask what the driver's been there over the last couple quarters, and are there any trends that are sustainable that could maybe maintain pricing around these current levels?

So one of the things I talked about in the script was some of our new alloys and code cases and getting material in with some of our new alloys. But the In other markets, number one, what helped us is flue gas desulfurization going down so much. But the other thing that helped us is we continue to drive our metal, our new alloys into the oil and gas market and oil and gas year on year. was up almost 62%. So, yeah, we're going to continue to look. We review on a monthly basis with our application engineering team what we're driving in and where we're driving it to. But as you know, you know our business. Our key is getting to the end users and creating a pull from the end users through these products. And that's what we saw this past quarter in oil and gas.

And we certainly, you know, you look at the average selling price in other markets, you know, $50.77 this quarter, which was fantastic. You know, last quarter was 47, so still quite high. Compare that to a year ago, it was more like 30, you know, between 35 to 40. So you see a lot of volatility in here because there's a lot of different applications, a lot of different alloys. So as Mike mentioned, you know, a little mixed management to get out of the flue gas desulfurization side of it really makes a big difference. As far as being a big earnings mover, I mean, yes, we certainly love higher-end alloys into these applications, but keep in mind it was 290,000 pounds for the quarter. you know, out of the four and a half. So it's still, you know, a smaller part of the pie than, say, aerospace, industrial gas turbines, and CPI.

And then lastly, on the labor environment, is it the hiring side of things or is it training that's the biggest constraint right now? And maybe if you could give an update on where you're at on the hiring front and how much more headcount is there left to go? Thanks.

Sure. It depends on the location. In Kokomo, we're nearly fully staffed. We've brought in over 100 people. In fact, next Monday, we have another 12 that are being hired and being brought in. So we feel great in our largest operation in Kokomo where we are. It's just from a safety perspective and from a quality perspective, making sure that people are fully trained on their operation before we let them loose. And that's what we're going through right now and, quite frankly, making very good progress with that. feel good about on the production side being fully staffed. I think also in Kokomo, everyone in the world is having some issues related to the trades, and we are aggressively pursuing making sure that we have long-term stability in our key trades in Kokomo. Now, in our other facilities, the major ones being our wire facility, our tube facility, and our LaPorte, Indiana distribution facility, a little tougher to have access to talent. They've done a great job of making sure they hit their forecast on a monthly basis, but it's a little more difficult there than it's been in Kokomo.

Thanks, guys. Thank you. Thank you.

Thank you. And once again, ladies and gentlemen, if you would like to ask a question at this time, you may press star 1 on your telephone keypad to join the queue. Once again, please press star one at this time if you would like to join the queue to ask a question. And there are no further questions in queue at this time. I'd now like to turn the floor back over to management. Thank you.

To our shareholders and our audience on the call today, we really appreciate your ongoing interest in Haynes and for being part of our ongoing improvement journey. We look forward to talking 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.